Malawi - Rural Financial Services Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No.: 20622 IMPLEMENTATION COMPLETION REPORT (Credit 2513-MAI) ON AN IDA CREDIT IN THE AMOUNT OF SDR18.0 MILLION TO THE REPUBLIC OF MALAWI FOR A RURAL FINANCIAL SERVICES PROJECT June 20, 2000 Rural Development Operations Eastern & Southern Africa This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS Currency Unit = Malawi Kwacha (Mk) At Appraisal US$1 = MK 4.00 At Completion US$1 = MK 45.70 WEIGHTS AND MESAURES Metric System FISCAL YEAR OF BORROWER July 1st - June 30th ABBREVIATIONS AND ACRONYMS ADD Agricultural Development Division ADMARC Agricultural Development and Marketing Corporation APIP Agricultural Productivity Investment Programme BDU Business Development Unit DCA Development Credit Agreement DEMATT Development of Malawi Traders Trust FAO Food and Agriculture Organization GOM Government of Malawi ICR Implementation Completion Report IDA International Development Association IFAD International Fund for Agricultural Development IDA International Development Agency LCB Local Competitive Bidding MFSP Mudzi Financial Services Project MOAI Ministry of Agriculture and Irrigation MOF Ministry of Finance MRFC Malawi Rural Finance Company NGO Non Governmental Organizations QAG Quality Assurance Group RBM Reserve Bank of Malawi RFSP Rural Financial Services Project SACA Smallholder Agricultural Credit Administration SAR Staff Appraisal Report USAID United States agency for International Development WB World Bank Vice President: Callisto Madavo Country Manager/Director: Barbara Kafka Sector Manager/Director: Sushma Ganguly Task Team Leader/Task Manager: Jorge A. Mufioz FOR OFFICIAL USE ONLY IMPLEMENTATION COMPLETION REPORT MALAWI RURAL FINANCIAL SERVICES PROJECT TABLE OF CONTENTS Page No. 1. Project Data 1 2. Principal Performance Ratings 1 3. Assessment of Development Objective and Design, and of Quality at Entry 2 4. Achievement of Objective and Outputs 4 5. Major Factors Affecting Implementation and Outcome 9 6. Sustainability 10 7. Bank and Borrower Performance 12 8. Lessons Learned 12 9. Annexes Annex 1. Key Performance Indicators: 15 Table 1: Outreach Indicators Table 2: Sustainability Indicators Annex 2a Project Costs and Financing, 16 Annex 2b Project Costs by Procurement Arrangements 16 Annex 2c Project Financing by Component 16 Annex 3. Cost Benefit Analysis 17 Annex 4a Bank Inputs: Site Visits 18 Annex 4b Bank Inputs: Staff 18 Annex 5. Ratings for Achievement of Objectives/Outputs of Components 19 Annex 6. Ratings of Bank and Borrower Performance 20 Annex 7. Supplementary Tables 21 Annex 8. ICR Mission Aide Memoire Annex 9. Government of Malawi's Project Completion Report This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization.  1. Project Data Name: RURAL FINANCIAL SERVICES Credit 2513-MAI Number: Country/Department: MALAWI Region: Eastern & Southern Africa Sector/subsector: AC - Agricultural Credit; FS - Financial Sector Development Key Dates Original Revised/Actual PCD: 07/24/91 Effective: 07/16/93 09/30/96 Appraisal: 03/01/93 MTR: 11/22/95 11/30/96 Approval: 06/15/93 Closing: 12/31/96 12/31/99 Borrower/Implementing Agency: Govemment of Malawi/Malawi Rural Finance Company Other Partners: STAFF Current At Appraisal Vice President: Callisto Madavo Kim Jay Cox Country Manager: Barbara Kafka Steve Danning Sector Manager: Sushma Ganguly Chaim Helman Team Leader at ICR: Jorge A. Mufioz Team Leader ofAppraisal N. Okidegbe ICR Primary Author: Tim Lamrock (FAO)' 2. Principal Performance Ratings (HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HL=Highly Likely, L=Likely, UN=Unlikely, HUN=Highly Unlikely, HU=Highly Unsatisfactory, H=High, SU=Substantial, M=Modest, N=Negligible) Outcome: S (with qualification) Sustainability: L (with qualification Institutional Development Impact: SU Bank Performance: S (marginally) Borrower Performance: S (marginally) QAG (if available) ICR Quality at Entry: U U Project at Risk at Any Time: No No FAO/CP. This ICR is based on a draft prepared by the FAO/World Bank Cooperative Program, led by Mr. Lamlock, which carried out an ICR mission to Malawi from March 20 to 3 1", 2000. The Mission's Aide Memoire is included as Annex 8 to this report. The ICR was finalized by Jorge A. Mufioz (AFTRI) and Stanley Hiwa (AFMMW), with contributions from Steven Jaffee (AFTPS). 3. Assessment of Development Objective and Design, and of Quality Entry 3.1 Original Objective: The main development objective of the project was to improve access to financial services for the rural sector on a sustainable basis. The overall strategy was to corporatize and convert the Smallholder Agricultural Credit Administration (SACA) into a limited liability finance company (Malawi Rural Finance Company - MRFC) for eventual privatization and conversion to a privately-owned rural bank. The othey stated objective was to improve the policy and institutional framework for financial intermediation by supporting the development of linkages between the formal and informal financial sectors, and strengthening related non-financial institutions serving the rural sector. The main objective was clear, concentrated on improving the impact and securing sustainability of rural financial services, and built on the experience of previous rural credit projects2. The initiative formed part of continuing efforts in Malawi to assist smallholder farmers to increase their incomes through the use of purchased inputs and to enable a diversification of income in rural areas by financing the start-up and expansion of micro and small non-farm business activities. The design of the project was based on the perceived satisfactory experience of SACA, through which large numbers of farmers were organized into groups and provided with loans and achieved, for a period of time, loan recoveries that exceeded 90%. However, the SACA program was based on interest rate and crop input price subsidies and harsh, politically-backed methods of loan recovery. SACA had been a part of the Ministry of Agriculture and rural credit was thoroughly integrated into farm extension activities. The underlying total costs of the rural credit program were unknown. Achieving sustainability in rural financial services required that the new financial intermediary operate autonomously, that rural credit and extension be formally de-linked, that the company obtain high recovery rates, and that it apply commercial principles to its operations. It was believed that SACA would need to be converted into a private rural bank to ensure its sustainability. The project design provided for this transformation to take three years. The objective of a commercially-run, rural financial intermediary was ambitious, given the relatively weak state of the Malawi economy in the early 1990s, as well as the weak human resource base of the implementing agency. This challenge was even greater since MRFC was formed at a time of major political change and came to operate within a very volatile macroeconomic and sectoral environment. The original three year time horizon for transforming SACA into a private rural bank was unrealistic. However, the broader objective of establishing a commercially-viable rural financial institution, catering to smallholder farmers and small rural businesses, was appropriate. The second objective was not as clear and was too broad. The improvement of the policy and institutional framework for rural financial intermediation was a valid objective, yet this falls largely in the domain of public policy and should have therefore been the responsibility of the Government. No specific provisions were made for within the project to directly assist consensus-building and policy-making on rural finance. Instead, a responsibility for creating inter-organizational linkages was given to a new Business Development Unit within MRFC and it was assumed that, through such linkages, there would be improved interaction between formal and informal financial institutions. Even if this were to occur, it was not appropriate for a unit of MRFC to be leading a wider process of policy development for rural finance. Any public role was inconsistent with the activities of a Company that was working its way toward a private sector status. 3.2 Revised Objective: The assumption in the SAR that MRFC would start from a solid foundation was undermined by the virtual collapse of SACA in 1992/93 following a drought in 1991/92 and the politicization of credit in the run-up to the 1994 elections. More than 80% of SACA's loan portfolio from the 1991/92 and 1992/93 seasons was in default. The impact of this collapse on the project became clear between the time of appraisal and effectiveness. Whilst the project documentation underwent no formal revisions, it was clear 2 In particular, the Bank-supported Smallholder Agricultural Credit Project (Cr 1851N-MAI) 2 that the first and most critical step in project implementation was to rebuild a system of small farmer credit and to re-establish a culture and system for credit repayment. The perceived vacuum in small farmer credit was a major factor behind the decision on the part of the Bank's management to go ahead and declare the project effective in 1994 despite all the prevailing uncertainties. Such a major change in operating circumstances should have ordinarily led to a re-appraisal of the project. This was not done. Even without a re-appraisal, there should have been a formal reassessment and restatement of the project's objectives, time-frame, and performance targets. This would have provided a realistic framework for implementation and facilitated subsequent supervision and ratings. The major changes in the country's political and economic circumstances had a substantial impact on the operations of MRFC and on its own scope for growth and institutional development. Although a formal restructuring of the project never took place, from the time of the mid-term review it was recognized that the 'private rural bank' solution might be both unrealistic and inappropriate, especially given MRFC's clientele and its important 'public' or 'developmental' role in the rural economy. During the last two years of project implementation efforts were made to promote a dual commercial/developmental mission for MRFC and to lay the basis for an alternative governance and ownership structure for the company which might involve one or more strategic partners. 3.3 Original Components: The project originally had three components: (i) institution building (US$ 16.7 million with US$ 8 million IDA financing) to corporatize and convert SACA into MRFC, and to use various institutions, including the Development of Malawi Traders Trust (DEMATT), to assist in preparing investment proposals for agricultural, small and micro-enterprises and to provide related training and advisory services; (ii) a line of credit component (US$ 20 million with US$ 17 million with IDA financing) to finance the short-term loan requirements of farm and non-farm rural activities provided under a subsidiary loan agreement between the Reserve Bank of Malawi and MRFC3; and (iii) a pilot program component4 to support innovative approaches to providing financial services to rural women entrepreneurs. During the project's implementation period, MRFC was also the implementing agency for the IFAD-financed Mudzi Financial Services Project (MFSP). This project was designed to provide credit to both farm and non-farm activities in a manner similar to RFSP, but to poorer groups for whom the requirement of collateral was waived. MRFC managed this portfolio on an agency basis for a fee. The Mudzi project has provided support to building the institutional capacity of MRFC in terms of technical assistance, equipment and systems development. 3.4 Revised Components: The components were not revised, although some resource re-allocations were made within the institution-building component and between this and the line of credit. The pilot program to support rural women entrepreneurs was essentially developed under the Mudzi Financial Services Project. 3.5 Quality at Entry: An assessment carried out in 1999 by the Bank's internal Quality Assurance Group (QAG) concluded that the quality at entry for this project was poor. QAG determined that the design of the project was not sound, especially with regard to the unrealistic expectation of converting SACA/MRFC into a private rural bank within a relatively short time period. The QAG also noted that the overall macroeconomic and policy environment had changed significantly after appraisal and that the project was not ready for implementation, which led to a gap of 15 months between project approval and effectiveness. The ICR reaches the same conclusions, additionally supported by the finding that the assumption in the SAR that the repayment experience of SACA would continue following major political Term of 15 years, with a 10 years grace period. The interest rate would be the RBM-determined reference rate, an average of the prevailing rates payable by the two commercial banks on savings. 4This was to support the development of new products and services and required no a-priori specification or budget allocation in the SAR. 3 and structural change was proved to be invalid before effectiveness, that the delay in effectiveness was caused mainly by the changes and uncertainty in the project's operating environment due to the collapse of SACA, and that the component to achieve improved policy and institutional linkages in the rural financial sector was wrongly designed. However, under the supervision of the Bank, there were changes to the strategy and targets of the project in line with the changed implementation circumstances so that, whilst the strict design and description of the project was deficient, its implementation satisfactorily followed a more pragmatic approach with more realistic actions and targets. 4. Achievement of Objectives and Outputs 4.1 Outcome/Achievement of Objectives: The project supported the restoration of the smallholder farmer credit system during the mid- 1990s, rebuilding upon elements of the SACA staff and institutional structure, yet applying a new set of operating principles to better ensure sustainability and transparency. While it was not anticipated at appraisal, the operations of MRFC proved instrumental in the take-off of smallholder burley tobacco production in the wake of structural adjustment reforms. This is one area where the Bank's contribution to the country's liberalization process was not limited to balance of payments support, but actually included significant assistance aimed at strengthening the emerging private sector. MRFC provided essential working capital for a large proportion of the newer smallholder and small estate tobacco growers, which in turn stimulated the emergence of the private Intermediate Buyer system in tobacco marketing. MRFC credit provided the impetus and structure for an intensive effort-supported by the Ministry of Agriculture and Irrigation-to form and train farmer clubs. Many such clubs have received other types of support and are now aiding their members in input procurement, crop transport, and the marketing of different commodities. Survey and other evidence point to the beneficial effects of MRFC loans on smallholder client incomes and savings. The net profit of burley tobacco for an average MRFC smallholder client (cultivating 0.2 ha) was estimated' at US$ 132 during the 1998/1999 seasol. MRFC finances more than half of country's organized smallholder burley producers. During the 1998/99 season, MRFC financed roughly 25% of Malawi's total burley production, thus directly contributing to the generation of some US$ 39 million in foreign exchange earnings. These activities have injected some US$ 20 to $30 million annually into the smallholder rural economy. MRFC's impact in small business development has been more modest, although the company's financial services have provided improved liquidity to crop trading networks in recent years. The project was successful in creating, implementing, and strengthening a rural financial institution that has operated on commercial principled, while retaining a focus on smallholder farmers and small business in a rural development setting. It was successful in formally de-linking credit from extension, although MOAI extension officers remain important in the process of group training. The emphasis on autonomy (especially in matters of lending policy and decision-making), despite the evident pressures of Malawian politicians during a period of substantial adjustment and structural change in the agricultural sector, and the decision to adopt and implement selected commercial principles proved valuable in progressing towards the project's objectives and helped in ensuring its sustainability during a period of volatile and generally unfavorable circumstances. There was a constant effort to enforce a discipline of prudent financial management and to improve MRFC's products, loan recovery and client relations. On the negative side, MRFC has not developed effective local savings services, and was only marginally successful in creating a diversified risk profile in its lending operations as the project maintained a heavy bias towards rural lending to smallholders with one cash crop (tobacco), a risky endeavor for a commercially-oriented institution. During the implementation of the project, it became clear that MRFC could not operate as a profit-maximizing company if it were to continue to serve the This is likely to drop by more than 30% this year, as tobacco prices are averaging only US$0.90 per kg,, down from an average of US$ 1.38 / kg. in 1999. 6 As a reference, Malawi's per capita income was estimated at US$190 in 1998/99. Including the application of commercial interest rates, the need for financial or physical collateral for loans, economic and financial evaluation of proposed crop and business activities, and no loans to past defaulters unless they participate in a loan restructuring and repayment program. 4 rural farming population, and the strategy that was followed was to apply, as far as possible, commercial principles to a development role. The project was successful in re-establishing a smallholder farmer credit system. This has had a major impact in facilitating the rapid growth of export-oriented smallholder farmers and increasing rural incomes in Malawi. MRFC's operations are likely to continue in the short-term, but the long-term future of these operations, and the achievement of the main development goal of the project, sustainability in rural financial services, is doubtful and contingent on the decisions to be taken on the strategic options and other matters (see section F. Sustainability). At the time of writing the ICR, processes to examine these issues are underway and the operating experience of MRFC in the next twelve months without Bank supervision will be crucial in determining its future. It is considered too early to accurately assess the final outcome, and the likely longer-term fiture of MRFC. For these reasons, the outcome of the project is provisionally rated as satisfactory, with the qualification that this assessment needs to be reviewed in twelve months time to take these decisions into account. The following would need to be present at this time to maintain this rating: (i) continued expansion in outreach to the rural sector and improvement in loan recovery resulting purely from actions of MRFC in the absence of Bank supervision; (ii) continued profits from operations; (iii) responsible cost control; (iv) satisfactory resolution of issues concerning the future financial and technical partnerships currently under discussion; (v) determination of a plan for supervision of MRFC under Malawi legislation'; and (vi) continued commitment of the Government to support, or at least not to disadvantage, MRFC in the context of future policy movements and donor-supported activities in rural finance. Non-performance in any of these areas would make the sustainability of MRFC in the longer-term unlikely. 4.2 Output by Components: Institutional Development : ARFC: The project was instrumental in creating the Malawi Rural Finance Company as a private limited liability company registered under the Companies Act. The net value of SACA's assets and liabilities that were transferred as a Government contribution to the project was MK 45 million (US$3 million equivalent at the time of the conversion). MRFC commenced business in October, 1994 with expatriate technical assistance in two key positions - General Manager and Financial Controller. The project supported MRFC with vehicles, equipment and supplies. A Board of Directors was appointed which enabled MRFC to operate and take decisions independently of Government. Significant investment was made in creating the management and systems capacity of MRFC, and the project was successful in creating the Company as a commercially run institution. While MRFC independently adopted its lending policies, there remained inevitable ties with Government. The Government retained a 100% shareholding. Operational cooperation with the Ministry of Agriculture (and several other Ministries) was important, most significantly in the formation and training of farmer clubs. The vast majority of MRFC field and branch offices were located at Ministry of Agriculture ADD offices.9 The majority of staff of MRFC initially came from the SACA program of the Ministry of Agriculture, and a corporate culture change was needed to refocus staff towards commercial practices and attitudes. This was a high risk factor for the company's development, and the caliber and vision of the management of the company would be crucial in this challenging role. In addition, there was no provision in the project to establish new branch and field offices separate from those of the Ministry of Agriculture. In spite of the extra costs that would have been incurred, it could be argued that this would have been desirable for three reasons: (i) to create the perception in the minds of the borrowers that MRFC was not a continuation of SACA, and that strict repayment discipline and full commercial principles would be employed; (ii) to clearly identify the cost of operating a branch network which would otherwise remain as The current institutional and legal status of MRFC does not compel any Government authority to supervise it. During the project's implementation, MRFC was also the implementing agency for the IFAD-supported Mudzi Financial Services Project. This project was designed to provide credit to both farm and non-farm activities in a manner similar to RFSP, but to relatively poorer beneficiaries for whom the requirement of collateral was waived. MIRFC managed this portfolio on an agency basis for a fee, and therefore the assets and liabilities of the Mudzi project do not form part of those of MRFC. The Mudzi project has contributed to some innovations, yet it has consumed a large amount of MRFC management attention and almost completely monopolized the efforts of MRFC's Business Development Unit. 5 a "subsidy" from the Government to MRFC; and (iii) to create identifiable "assets" that could be valued in the context of a shift to private ownership. This issue should have been considered more thoroughly by the senior management of MRFC as a necessary step in improving its knowledge of its customers and its ability to manage loan recovery, but the costs of so doing would have been high. The project provided funds for the Development of Malawi Traders Trust (DEMATT) to undertake the preparation of investment proposals for potential clients of MRFC. DEMATT did undertake some training for MRFC staff, but no investment proposals were prepared. More generally, MRFC failed to take advantage of the project resources available for consultancy support. The resistance of management and the Board to drawing upon external (paid) advisors, was one factor which contributed to an over-dependence on the part of MRFC on technical and other advice from the World Bank. The original objective of turning MRFC into a private bank was never formally changed, although by the time of the mid-term review (and indeed earlier) there were discussions about whether it would be more advantageous that MRFC be registered and supervised as a 'non-bank financial institution' rather than as a 'bank' under Malawi law. Subsequent discussions focused on the feasibility and desirability of privatizing the company. To most of the concerned stakeholders, a pure privatization was not considered an appropriate direction for MRFC. It was agreed that an Options Study be prepared, under the auspices of the Privatisation Commission, to explore various institutional options and make recommendations to Government. A considerable delay occurred in the negotiations between the Privitisation Commission and the selected consulting firm, such that the Options Study had not yet begun by the closure of the RFSP. In the meantime, it is 'business as usual' for MRFC with the exception that it no longer is formally supervised by IDA. Policy and Institutional Linkages: The operations of MRFC were greatly affected by a range of agricultural and financial sector policies, and a considerable amount of Bank supervision time was spent attempting to improve the policy and institutional environment. The emphasis of the project was on commercially-based operations and it was not appropriate that MRFC would undertake activities that were clearly the responsibility of Government. However, the project did provide an opportunity for the Bank and MRFC to participate in the national debates on wider institutional and policy issues, such as interest rate policies, credit guarantee schemes, the choice of credit vs. grants for very low income farmers, tobacco marketing arrangements and costs, foreign currency or foreign exchange-linked lending by financial institutions, and drought risk management in relation to agricultural credit. The commercial principles upon which MRFC was operating were a subject of much policy debate within Malawi. Efforts were made in promoting the continuation of reforms to improve market access and marketing efficiency for tobacco, raising awareness of the need for drought and exchange rate risk management measures, and promoting an approach which makes clear policy and program distinctions between farm credit and rural safety nets (including grants). The impact of the project on policy and institutional reform was greater in terms of preventing the back-sliding on sectoral policies or minimizing the potentially damaging effects of certain government initiatives than on the design or implementation of new policy reforms in the financial sector. In spite of this effort, the whole policy and planning area for rural financial services within the Government remains weak. Several other credit/finance schemes were implemented during the project with different terms and conditions which had a negative impact on MRFC, and which placed at risk MRFC's (and others') efforts to create a strict repayment discipline in rural areado The project design did not make adequate provision for actions to affect the wider institutional and policy framework for rural finance. There was an expectation that MRFC's Business Development Unit would strengthen inter-organizational linkages and perhaps foster dialogue on broader policy issues in rural finance. In practice, the BDU focused its activities on staff training and MRFC loan product development, with most of its efforts devoted to the Mudzi Project. Once the Mudzi procedures and MIS " For example, both the Agricultural Productivity Investment Programme (APIP) and the Agro Inputs Fund operated with non- commercial interest rates and with a large measure of loan default guarantee from Government. ITese provided the private sector operators (i.e. fertilizer companies) of these schemes advantages over MRFC. Repayment rates under these schemes were comparatively poor despite the favorable terms offered to farmers. 6 arrangements were put in place, the BDU was essentially closed and its functions absorbed elsewhere in the company. Line of Credit: As a result of the collapse of SACA, when MRFC started its operations in 1994, its initial outreach covered only about 50,000 farm household beneficiaries. Economic reforms at the time altered the economics of maize production such as to make it financially marginal for farmers to borrow money to implement the recommended maize technology package. The resulting shortfall in demand was made up through the requirements for working capital of emerging small-holder tobacco growers. Over the next two years, this outreach increased two and half times to approximately 120,000 households, including a small number of borrowers under the Mudzi program. Over the subsequent three years, MRFC's agricultural outreach has remained within the range of 100,000 to 140,000 (including Mudzi borrowers). This outreach is partly a result of demand and partly as a result of MRFC lending policies. Demand has been influenced by prevailing interest rates and input and crop prices and by competition from other sources, both the commercial banks and various government-backed schemes. With liberalization came a relaxation of the former exclusion of smallholders from growing burley tobacco. This provided a major opportunity for some small farmers to engage in the production and direct sale of a profitable export commodity. One key constraint they faced was access to operating capital. Thus, MRFC was instrumental in facilitating this process which in the course of just a few years would significantly change the structure of burley tobacco production and marketing in Malawi. Seasonal lending operations started in the 1994/95 cropping season. Seasonal loans were provided to farmers' clubs (consisting of some 15-17 members) and to small estates (i.e. farms with some 10-25 hectares of land). The core of the agricultural lending was for inputs for tobacco and maize production, yet a small proportion (i.e. 15-25%) of MRFC's agricultural portfolio was for other crops (i.e. cotton, rice, tea, spices) and livestock enterprises (especially poultry). Annex 7, Table S I shows the progress in implementing seasonal loans. Overall loan recoveries have fluctuated between 72% and 96% during the project, with an unweighted average loan recovery rate of 85%1 Although this result was below the SAR target of 95%, it is better than the performance of other Malawi financial institutions during this volatile period. Seasonal loans reached a peak in 1998/99 at MK 480 million, up from MK 191 million in 1997/98, but with much of the increase due to the dramatically higher cost of inputs, and only a relatively small increase in outreach, 110,000 beneficiaries as compared with 92,000. In 1999/00, some MK 373 million has been lent to an estimated 83,500 beneficiaries.MRFC's average loan size is small in per capita terms, largely explained by the country's extremely low per capita income. The ratio of its loan size to per capita income is 40%, comparable to 41% for other rural or microfinance institutions. The commercial loan portfolio consists of individual business loans, group-based business loans, personal loans to employees of organizations, Mudzi group-based business loans administered under the IFAD Loan. Annex 7, Table S2 summarizes the commercial loan portfolios in MK million (and numbers of loans) consolidated for all MRFC branches. MRFC has revamped its lending operations for business loans to improve the quality and sustainability of such lending. As a result of these changes, the nominal value of loans made and the number of beneficiaries fell in 1998/99 from the previous year. This restructuring has improved the quality of the commercial loan portfolio. The percentage of loans past maturity for personal and business loans has dropped from 12% in 1996/97 and 25% 1997/98, respectively, to 2% aid 10% in 1998/99 (Annex 7, Table S3). Commercial/business loans (primarily for crop trading, making and repair of farm implements, and retail shops) constituted around 15% of the MRFC total loan portfolio in 1998/99. The proportion for 1999/2000 will likely be just over 20%. MRFC has experienced three very good years and two years during which its loan recoveries were below 80%. One of these two poor seasons was 1995/96 when RFC undertook a huge expansion in lending at a time when it was simultaneously cutting large numbers of (SACA-inherited) staff. The outreach expansion overwhelmed the company's oversight capacity and compromised its performance. Loan recoveries also fell short during the 1998/99 season for a number of reasons largely outside of the company's control (including a drought in one part of the country, very adverse commodity price movements at one point in the season, and the failure on the part of the public Smallholder Tea Authority to repay MRFC for loans already repaid (to STA) by farmers. 7 Pilot Program for Women Entrepreneurs: The activities for this component were subsumed under the Mudzi project. The vast majority of Mudzi clients are women, while the proportion of beneficiaries under the RFSP lending has generally been in the range of 35-45% (lower than the 57% international average for other microfinance institutions). There was an RFSP loan covenant that a women entrepreneur action plan be prepared and it was assumed that any actions would form part of MRFC's overall micro/small business strategy. This was subsequently overtaken by several events. One was the crisis management/ rebuilding focus of MRFC's early operations and the second was the emergence of a plethora of new donor-supported schemes to assist income-generating activities among women. Later on, MRFC saw little reason to develop a specific action plan, especially because already a majority of its business loan clients (including Mudzi) were women. In 1999 a consultant did carry out a study for MRFC but there has yet been little impact from this work. 4.3 Net Present Value/Economic Rate of Return/Cost Effectiveness: Neither a net present value nor an economic rate of return for the project were calculated at appraisal. Recent studies on the financial viability of agricultural enterprises in Malawi indicate that tobacco is the most financially attractive smallholder crop, and that its export market price can support the use of purchased inputs. With the rise on price of inputs, particularly fertilizer following liberalization, most smallholder crops now have reduced financial viability to the extent that the use of fertilizers is not feasible, particularly for food crops. The following observations on cost effectiveness are relevant. In the Malawi context, at the time the project was appraised in the early 1990s, there were probably three options available to the Bank for providing agricultural input credit to smallholders: (i) creating of a separate financial institution that interacts between farmers and inputs supply companies; (ii) modifying the operating procedures of a Ministry of Agriculture-based institution; and (iii) supporting a variety of small, localized savings and credit organizations piloting various schemes. Option (ii) would not have been financially sustainable and it went against the principles of the policy reforms being pursued. Option (iii) has been pursued by other donors, notably USAID, with limited success. Therefore, the creation of MRFC and the building of its capacity through the project was considered to be the appropriate path and, whilst there was no analysis of these options at appraisal, it was probably justified. However, the cost effectiveness of creating a separate institution for the provision of agricultural input credit needs to be considered in the light of the economies that can be achieved by linking credit services with input provision. This option may not have been available in the early 1990s, as input supply for smallholders was still dominated by state-owned institutions, especially ADMARC. So, like option (ii), providing credit linked to ADMARC input supply would have gone against the process of reducing the role of the State and allowing the entry of private sector finns. One way that the project increased the cost-effectiveness of credit delivery was by using the existing ADD facilities. 4.4 Financial Rate of Return: No financial rate of return for the project was calculated at appraisal, but an indicator for financial performance of MRFC was set as the after-tax return on investment of 5%. MRFC's current rate of return on investment is 6%. This assessment is nominal. When adjusted for inflation and exchange rate movements, the overall performance of the Company is less encouraging, as the asset base is declining in real terms and reducing its capacity to loan finance largely imported inputs. However, the most significant financial returns of the project were those captured by beneficiary farmers. For example, during the 1998/1999 season, net profits from burley tobacco alone by MRFC clients totaled some US$19 million. 4.5 Institutional Development Impact The project was successful in creating MRFC as a commercially-oriented institution serving smallholder farmers. The rating is satisfactory. 8 5. Major Factors Affecting Implementation and Outcome 5.1 Factors outside the control of Government or the Implementing Agency * With smallholders entering burley production, the stop order system operated by Auction Holdings Limited provided an effective mechanism for loan recovery which had a major positive impact on the feasibility of advancing credit to smallholders. * The oligopsonistic tobacco marketing system (with a marketing single channel through the auction stage) resulted in lower than equivalent world prices being offered, and high charges for sales commissions and stop order fees. There remain inefficiencies in the collection, grading, baling and transport systems that often downgrade tobacco, resulting in lower prices to farmers. There were incentives for farmers to sell to intermediate buyers thereby by-passing the stop-order mechanism, and resulting in increasing loan default. * Farm margins and profitability dropped over time, particularly for food crops. With the deteriorating exchange rate, fertilizers rose in price, up more than double in 1998. Food and cash crop prices did not show the same relative increases and therefore financial margins on agricultural production were reduced, which in turn reduced the feasibility of using purchased inputs on credit, especially at high interest rates. 5.2 Factors generally subject to Government control * Delays in project effectiveness. * Macro-economic instability with high inflation, devaluation of the Kwacha and lending rates reaching a high of 50%. This negatively affected the interest rates charged to customers with a flow-on increased default rate, and undermined the lending base of MRFC. * Weak political commitment of Govemment to support MRFC to become a viable rural financial institution, and lack of a clear policy for rural financial sector intermediation. There was a proliferation of different input supply/inputs credit schemes implemented by Government and donors during the project, adding to confusion in the minds of borrowers as to terms and condition of such schemes, and diminution of the strict repayment discipline being promoted by MRFC. * Failure to adhere to time-bound action plans for examining and working towards future strategic options for MRFC in the context of the privatization process. * Political interference in the lead up to elections concerning the expectation of farmers in participating, and the repayment obligations of borrowers. 5.3 Factors generally subject to Implementing Agency control * There was a commitment of the Board and management of MRFC to pursue the corporate strategy of MRFC but there was not sufficient effort put into building external relationships with key policy-makers, fanner organizations, local officials, and the media. MRFC also fell short in nurturing a corporate team effort in staff at all levels. 5.4 Costs and Financing: The investment costs incurred in building the capacity of MRFC was less than that expected at appraisal ($11.4 million compared with $16.7 million), but the cost of the line of credit component was as expected at appraisal (US$ 20 million) (Annex 2a). A reallocation of resources was made in late 1998, from some of the categories under institutional development to the line of credit. 9 6. Sustainability 6.1 Rationale for Sustainability Rating: Sustainability of rural financial services is the core of this project, and it is therefore the major aspect that need to be assessed in determining the rating of the outcome of the project. The underlying original target for sustainability of the project was that MRFC would become a private bank. This was an unrealistic target in the time frame and business environment in which the project was implemented. Other indicative indicators for sustainability are presented in Annex 1, Table 2. The record is mixed. Loan repayment rates have met or exceeded the original target in two out of five years of operation. The proportion of business loans past maturity was very high in the early years but has dropped significantly, and by 1998/99 was at the target. The record on financial indicators is also mixed, for even when the return on equity (in Kwacha terms) was within expectations, in real terns, the return has been smaller or negative. In the year 1998/99, the recovery rate was 78% and 84% on seasonal and business loans, respectively. Total income was MK 357 milliod2 and, after a provision for doubtful debts of MK 143 million, MRFC made a profit after tax of MK 14 million on shareholders funds of MK 170 million. A similar result is forecast for 1999/2000 where the recovery rate is budgeted at 80%. At the close of the project, lending rates to MRFC clients were in the range 48% to 51%, and returns on Treasury Bills around 40%. This season's income from investment operations will exceed that from lending operations. With a reduction in lending activities, the net income from investment activities (net of cost of funds) is forecast at MK 190 million, compared with net income from lending activities of MK 51 million. In the future, MRFC can be expected to achieve small annual increments in its loan portfolio size and outreach over the average levels achieved during the last three years. It will be able to break-even or earn a very small profit, provided that it maintains or exceeds its average loan recovery rate of 85%, maintains very tight cost management, and that nominal margins on lending and investment operations remain at around 20% and 10%, respectively. Adverse changes to these parameters would force the Company into a loss position. Further large devaluation's of the Kwacha could undermine MRFC's lending capacity, unless the Company is permitted to implement a currency risk management strategy (such as extending US Dollar-linked loans to finance export-oriented crops). The Company's operations will continue to face climatic and agricultural price-related risks. What were the main factors that explain the past sustainability of MRFC and how likely are these to continue in the future? The main factors that have contributed to the commercial viability of MRFC over the past six years are: (i) a results-oriented corporate culture, free from political interference, and a competent and politically astute Board of Directors; (ii) a favorable GOM monetary policy which allowed high financial returns on Treasury Bills, combined with a strong management and information system and effective financial management; (iii) profitable cash cropping opportunities for borrowers with strong demand for loans, combined with a reasonably well functioning tobacco marketing and stop- order system; and (iv) close IDA oversight and advice of MRFC operations, and broader IDA policy- related pressure and support for MRFC's interests. Factors (i) and (ii) are likely to continue; (iii) is somewhat uncertain and risky, as the prospects for significant crop diversification by smallholders are poor; and (iv) it will be indirect and considerably less intensive. What is the likely future for MRFC? In the absence of a major devaluation, MRFC should have adequate resources (from the retained resources from this project and from the on-going IFAD-supported Mudzi Project) to continue and expand its operations over the next year or two. The project's short-term sustainability is rated as likely. However, the longer-term sustainability of MFRC is more uncertain due to the factors set out below and contingent on the operating experience of the company in the next twelve months and decisions to be taken during this time on its future. 12 US$ I = MK 46 as at February, 2000. 10 6.2 Transition Arrangements for Regular Operation: The future sustainability of MRFC will depend on the impact on the company of: (i) the continued macro-economic instability; (ii) the vulnerability of the company's loan portfolio and financial assets to climatic, price, or exchange rate shocks; (iii) the increased competition which the company is facing, primarily from publicly-backed subsidy and grant programs in agriculture; (iv) its ability to meet operation costs in the event of falling general interest rates, and hence reduced lending margins; (v) its reduced lending capacity through the repayment of the subsidiary loan starting in 2003; and (vi) an examination of the options for its future. MRFC needs to implement an effective strategy to increase loan recovery from the present 78%- 80% level towards 90%, to further diversify its loan portfolio, and to ensure that any increase in business is of the highest quality possible. However, to improve administration of its loans in the field, MRFC would need to increase its costs, both investment costs in field and branch office capacity (staff training, loan product development work, improved market understanding, etc.) and operational costs. At present, MRFC has a considerably lower (7.6) staff expense/total loan portfolio ratio than comparable peer rural/micro-finance institutions (14) so some expansion may be feasible. Under the terms of the subsidiary loan agreement between MRFC and the Reserve Bank of Malawi, repayments of capital would commence in 2003 for a period of five years. The amount of principal and interest outstanding under the subsidiary loan agreement at February, 2000 is MK 710 million (US$ 15.4 million). These repayments would represent a heavy drain on the cash flow of MRFC, and would result in a significantly reduced lending capacity by the end of the repayment period and in reduced investment income. It is likely that Government will agree to renegotiate the terms of this subsidiary loan agreement, for keeping these as they are would result in a significant reduction in the amount of loanable funds to smallholders. A comparison with other rural or microfinance institutions shows that MRFC's asset base is comparatively low as a direct result of operating on borrowed equity. Most microfinance institutions in developing countries, especially NGOs, receive a significant proportion, or all, of their equity as a grant. Also, this feature of the financial structure of MRFC will have a more immediate bearing on the assessments made of MRFC by any potential strategic partner, and would need to be renegotiated with the Ministry of Finance or refinanced to ensure the maintenance of a capital lending base. It is recognized that the business of seasonal agricultural finance to small farmers is high cost and high risk, and not inherently profitable, and therefore some degree of external "public" financial support will be required to maintain MRFC in the medium to longer term. Therefore, the future of MRFC will depend on an analysis of future options, and actions on the part of the Board and management to actively seek strategic partnerships. It was envisioned that, by the closure of the project, options for MRFC's future governance and financing would have been explored and that the new governance/ownership structure would be in place or at least be decided upon. There has been a delay in carrying out the Options Study and thus the project closes with question marks about future institutional development arrangements. While some form of strategic partnership-involving an injection of new lending resources, some re-negotiation of the subsidiary loan agreement, and some further technical support-is envisioned, the details have yet to be worked out. The development of rural financial intermediation is a high Government priority, and will be included in the future general dialogue between the Bank and the Government in both a sectoral and macroeconomic context. 11 7. Bank and Borrower Performance Bank 7.1 Lending: As identified by the Quality Assurance Group, the Bank was deficient in the design and appraisal of the project since the objectives were unrealistic and the project was not ready for implementation. 7.2 Supervision: The Bank supervised this project very closely, and provided valuable guidance to MRFC in the absence of supervision from the Reserve Bank of Malawi. Intensive supervision was required to overcome design limitations, to maintain efforts towards reaching unrealistic objectives and, when these were recognized as unattainable, to assist MRFC and Government to adjust to new targets and strategies. The future supervision of MRFC as a financial institution is unclear. The withdrawal of direct Bank supervision has left a vacuum (see footnote 7 above). 7.3 Overall Bank Performance: Overall, the Bank's performance is rated as marginally satisfactory. Borrower 7.4 Preparation: Rated satisfactory. Government made significant contributions in the original design of the project, leading a consultative process with key stakeholders. 7.5 Government Implementation Performance: The Government made available the remaining SACA funds ($3 million) as its contribution to the project cost. The Borrower completed its contribution to the ICR. There has been general compliance with legal covenants, although with some delays. However, it was slow in meeting the conditions of effectiveness, and has shown only moderate commitment to the project. 7.6 ImplementingAgency: MRFC's performance in implementing the project has been satisfactory with the Board and management demonstrating commitment to the project, and to implementing the principles of commercial operations and autonomy in the Company. 7.7 Overall Borrower Performance: Overall, the borrower's performance was marginally satisfactory. 8. Lessons Learned The lessons to be learned from this project are: * Commercial banking and microfinance, though different, can be complementary. The vision offered by the original design of the project required the creation of a microfinance institution and its development into a full service commercial bank within the spate of three or four years which proved to be impossible. In addition, MRFC was to adopt a business strategy that focused on small farmer and small business clients-with the application of a core set of commercial principles. The implementation of this strategy created significant contradictions and trade-offs as credit demand outgrew MRFC's potential outreach. 12 * Support to rural and agricultural finance institutions requires a relatively long-term commitment on the part of donor organizations. At least a five- to ten-year time horizon may be necessary to adequately build institutional capacity and enable the piloting of products and outreach before scaling up. Under volatile economic conditions, the institutions need to develop strategies and coping mechanisms for which external support may be necessary. Regardless of the quality of its services and staff, rural/agricultural finance institutions will periodically experience bad years in line with the fluctuating fortunes of their clientele. This should be assumed in project design and its occurrence should not (necessarily) imply that either the project or the institution is 'at risk'. * Flexibility is critical in the design of rural finance components and it is ill-advised to ex-ante restrict the types of clientele and types of activities which the financial institution can lend to. Market circumstances will certainly change over the course of the project and new opportunities and new competition will arise. * Large scale institutional seasonal lending to smallholder rain-fed agriculture is a costly and risky undertaking. Some degree of subsidy, underwriting part of the initial and possibly some of the operation's administrative and technical assistance costs, may be required if the expected developmental impact of such an enterprise justifies the costs. This is a good example that is fully consistent with the provisions contained in Operational Policy 8.30, "Financial Intermediary Lending", which allow for institution-building grants, provided these are given as part of an agreed institutional development plan. In addition, the risk element needs to be mitigated by (i) some sort of drought- (or other weather or market-induced shock) relief insurance mechanism, and (ii) significant portfolio diversification with strong urban links to offset the high co-variance of risk-exposure among rural borrowers. The project was successful in providing for the development of an institution which operates according to sound business principles ("its commercial objective"). It also played a major role in the emergence of a large export-oriented and commercially-viable smallholder class of farmers ("its developmental objective"). However, the project did not succeed in establishing appropriate risk-mitigation mechanisms to ensure the long-term sustainability of the institution. * Agricultural/rural finance should not, generally, form the basis for stand-alone projects. Agricultural finance is intimately tied up with broader developments in agricultural market development and the regulations of agricultural markets. The institutional solutions for agricultural credit may well derive from structural changes in agricultural marketing (either for inputs or commodities) and the dominant suppliers of agricultural finance may not be financial institutions themselves. This should be carefully assessed at the early stages of project preparation. In the particular case of MRFC, there were few, if any, acceptable delivery channels for crop finance in the early 1990s. However, the agricultural market context of its operations did not feature, explicitly, in project design. * High loan recoveries for smallholder farmers can be obtained provided that there is (i) a profitable lead crop/livestock enterprise, (ii) there is a reliable quasi- or non-market institutional mechanism for loan collection (i.e., an auction stop order; a contracting organization), and (iii) loan repayment discipline is not undermined by parallel quasi-credit programs which apply subsidized interest rates and other preferential terms. * In an agriculturally-based economy, rural and agricultural credit will always certainly be highly politicized. Managing political relationships is therefore critical to credit and institutional sustainability. It is vital for rural financial institutions to build effective alliances and open channels of communication with key policy-makers, farmer organizations, local officials, and the media. MRFC fell somewhat short in nurturing its external relationships. As a result, the World Bank became far greater involved in problem-solving and inter-institutional relations than would be considered optimal. * Savings mobilization lies at the center of much of the 'best practice' literature on rural finance. There are, however, circumstances where significant attention to savings mobilization may not be 13 appropriate. In MRFC's case, the bulk of its clientele is resource-poor small farmers. Their farming system and virtually all of their incomes is based upon rainfed agriculture, involving a single short season of rain and wide inter-seasonal climatic variability. Incomes are very low and little cash savings are carried from one season to another. Carrying cash in rural Malawi is risky. Also, there is very limited urban-rural flow of remittances. Were MRFC to promote savings and increasingly rely upon those savings for its lending resources, it would be amplifying the effects of periodic drought on its operations. Drought results in reduced loan repayments and would also result in the simultaneous withdrawal of deposit savings from its clientele. Mobilizing savings from other types of clients-i.e. urban residents-would have side-stepped this risk problem, yet would have diverted MRFC's attention and resources toward urban areas, infrastructure development, etc. * In circumstances of high inflation and risk of currency devaluation, it may be necessary to move to foreign currency (-linked) lending in order to preserve the capital of the financial institution and in order to provide reasonable interest rates to borrowers. This can most easily be applied when financing the production of exported commodities, especially those already priced in (or whose price is linked to) foreign exchange. * The capacity of rural financial institutions or agencies needs to be built with a heavy emphasis at field level, in the areas of physical infrastructure, field staff training, development of information and control systems, development of branches as profit centers and payment of staff incentives based on loan recovery, loan portfolio diversification and savings promotion. Cost efficiency is crucial to success, and this may increase the importance of information and communication technology in the future. * The group joint liability principle has a positive impact on loan recovery, but its contribution to this is unclear. Perhaps the overriding influence on an individual's or group's motivation for repayment is to ensure qualification for credit for the following season. Automatic loan recovery mechanisms through a contracting, marketing or processing organization, such as the stop-order mechanism for tobacco, make credit schemes for cash and industrial crops far more justifiable in terms of sustainability than for food and other subsistence crops, but provides reduced incentives to broaden the lending base; * Short-term loan financing (by way of the subsidiary loan agreement) does not create a long-term capital base for lending operations of a financial institution; * Financial Institutions should be licensed under the banking legislation of the country from the beginning to enable continuing and consistent supervision in accordance with the prevailing regulations. 9. Partner Comments (a) Borrower/Implementing Agency: none (b) Cofinanciers: none (c) Other Partners (NGOs/Private sector): none 10. Additional information none 14 Annex 1 Key Performance Indicators Table 1: Outreach Indicators Indicator Original 1994/95 1995/96 1996/97 1997/98 1998/99 Target I H of Smailholder Clubs for 14,000 2.904 6,0o0, 4.606 4.079 5.452 seasonal loans (Mudzi in Clubs (614) (945) (639) (1,722) parentheses) # of Smallholder Club member 400,000 43,560 90,135 69,090 61,185 81,780 beneficiaries (Mudzi in (9,210) (14,175) (9,585) (25,830) parentheses) % of Club Member No 36 37 37 39 41 beneficiaries who are women specific target # of Small Estate seasonal loan 7,100 3,310 7,930 6,414 7,449 6,918 borrowers # of Business Loan clients 800 N.A. 817 1,190 1,834 1,567 (Mudzi in parentheses) (678) (1,991) (4,796) (6,234) Total # of beneficiary 56,800 132,560 112,102 107,196 143,173 households * # of Deposit Accounts No 10,056 19,709 28,899 51,843 61,783 specific target * Based on the number of club members and business borrowers plus an estimated four beneficiaries per estate client given the onward financing of tenant households. The total beneficiary figure does not include recipients of personal loans. These latter have numbered 5,000 to 10,000 in recent years. Table 2: Sustainability Indicators Indicator Original Target 1994/ 1995/96 19961 1997/ 1998/99 95 97 98 Loan repa)ment rate on >9003 95 75 89 90 70 seasonal loans Proportion of business loans <10% n.a. 37 30 25 10 past maturity Gross Margin (Lending rate No specific target 10 17 24 31 25 - cost of funds) Staff costs/total loan No target. Peer 16 5 11 9 7.6 portfolio group of 'fully sustainable institutions' is 14% Pre-tax Profit (K million) 5.0 0.1 9.6 25.0 24.6 Return on Equity >5% 5 0 5 10 12 Autonomy No political OK Mudzi OK OK OK interference in lending lending operations Affected Shareholding Restructuring GOM to be reduced to Not yet minority shareholder achieved 15 Annex 2a Project Costs and Financing Project Costs by Component (in US$ million Equivalent) (see also Table S4) Project Component Appraisal Estimate Actual/ Latest Estimate Percentage of Appraisal Insmution-Building $1h 7 $11 4 6x",, Line of Credit $20.0 $20.6 102% Total $36.7 $32.0 87% Annex 2b Project Costs and Financing Project Costs by Procurement Arrangements (in US$ Million Equivalent) (see also Table S4) !Expenditure Procurement lethod Appraisal Procurement Method Actual/Latest Caregories Estimate Estimate ICB NCB Other NBF Total ICB NCB Other NBF Total 2. Goods 0 247 0 ,37 o 405 I 29) 3. Services 4. Misc. I__ 9 36 4 792 5 72S Total 0 2 47 I 573 5 147 7 u17 Note NBF= Not Bank Financed (includes elements prouded under parallel co-financing procedures Consultants under trust funds, any reserved procurement and any other miscellaneous items). The procurement arrangements for items listed under "Other" and details of the items listed as NBF. Annex 2c Project Costs and Financing Project Financing by Component (in US$ million equivalent) (see also Table S4) Componen t raisal Estimate Actual/Latest Estimate Percenta A raisal Bank Gover Co- Bank Gover Co- Bank Gover Co-financing nment financin nment financin nment _ 8 IIsItuion X u 8 7 7 2 - 2 ,, 43",. Building Line of Credit 17.0 3.0 17.6 3.0 104% 100%J TOTAL 25.0 11.7 24.8 7.2 | 99% 62% 16 Annex 3 Cost - Benefit Analysis Not calculated at See text Appraisal Ecne cAtga ah igcal4palysis _______ __ _Appraisal' Latt htmtes A fa.-Latest Estimates Benefits Costs Net Benefits !IRRINPV 17 Annex 4a Bank Inputs: Site Visits Stage of Project Cycle MonthlYear No. of Persons Performance Ratings, and Specialty* Implementation Development Progress Objectives Appraisal/Negotiations June,Jul% 1902 FA (2) Supervision I March 1094 FA Ec. Cr Not effectixe 2 JulN. 1994 Fa Ec.C No efrfecIe 3 October. 1004 Ec 12) U _ 4 Februar%, l95 Ec 1)' 5 5 June. IMiS Ec I2) U S 6 No%ember. 19t5 Ec (21 S C 7 Julh. IC)J( Ec (2 F.A S S Mid Term 8 No%ember. IQOh Ec (2. FA 12) S S Review Cr 9 MaN I9Q7 Ec (2) FA S S 10 Januan. 1J4'8 Ec FA S 5 II June. I4uS Ec 13 FA S 12 March. 1 q0w Ec (2) FA S 13 September. 1904 Ec. FA S S ICR March. 2006 Ec. Ri,ral S S Finance Sp Ie) to Specialized staff skills FA - Financial Analyst Ec - Economist Cr - Credit Specialist ** Key to status as shown on PSR/Supervision Form 590 Annex 4b Bank Inputs: Staff * Stage of Project Cycle Actual/ Latest Estimates Staff Weeks US$ (000) Identification/Preparation na Appraisal/Negotiation n.a 3 I Superirision n,a 5li ICR .4i Total U1 * Also includes Bank-financed and trust fund consultants 13 Subject to qualification and review. 18 Annex 5 Ratings for Achievement of Objectives * / Outputs by Components** Macro Policies X Sector Policies _ Physical x Financial x Institutional Development x lEnvironmental x Social: x Poverty Reduction _ Gender x Other (Specify) Private Sector Deveiopment _ Public Sector Management x Other (Specify) * Relates to the objectives specified in the SAR ** Relates to the outputs specified in the PAD 19 Annex 6 Ratings of Bank and Borrower Performance Highly Satisfactory Unsatisfactory Highly Satisfactory Unsatisfactory Bank Performance: Leading I____ _____ Supervisi" x Overall ) ) Borrower Performance: Prearaio x iGovernmen Implewentation iPerformante Impleme6in Agency Overal a (1) (1) Marginally satisfactory. 20 Annex 7 Supplementary Tables Table Si: Seasonal loan portfolio status of outreach and recovery as at the end of November each year 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 ** Loans, MK 35 241 166 191 480 373 million No. of Loan 6,197 13,934 11,003 11,698 12,503 10,065 accounts No. of clients* 51,058 121,692 94,414 92,247 110,435 83,567 Loan recovery, 92 74 88 89 77 80 * Based on estates (4), tobacco and other clubs (15) ** Estimated (Source: MRFC) Table S2: Commercial loan portfolios in MK million (and numbers of loans) consolidated for all MRFC branches as at 29 February, 2000. Type of loans 1995/96 1996/97 1997/98 1998/99 1999/2000 Personal - 1 (183) 73 (12,078) 34 (4,258) 15 (1,786) loans Business 13 (817) 20 (1,190) 37 (1,834) 32 (1,567) 14 (557) loans MUDZI 1 (678) 4 (1,991) 12 (4,796) 21 (6,234) 13 (2,671) loans Total 14 (1,495) 25 (3,364) 122 (18,708) 87 (12,059) 42 (5,014) Table S3: Quality of the commercial loan portfolio in the period 1995/96-1998/99 in terms of loans past maturity expressed in MK million (as well as percentage of the disbursed loans) as at 30 September of each year. Type of loans 1995/96 1996/97 1997/98 1998/99 Personal - 0.5 (4) 9.0 (12) 0.6 (2) Business 4.60 (37) 5.7 (30) 9.1 (25) 2.7 (10) MUDZI 0.16 (10) 0.5 (14) 2.6 (28) 1.5 (7) Total 4.76 (33) 6.7 (27) 20.7 (16) 4.8 (5) 21 Table S4: Calculation of Project Costs Actual Costs in MK 000 94/95 95196 96/97 97/98 98/99 Total Goods 5,455 0 5,713 3,617 14,198 28,983 Training 1,632 756 908 347 2,477 6,120 Technical Assistance 1,083 4,342 4,146 8,736 10,573 28,880 Credit 30,000 180,000 15,501 0 244,722 470,223 Salaries 3,501 8,742 14,502 18,970 27,689 73,404 Operating Costs 8,871 13,509 21,070 32,335 62,163 137,948 Total 50,542 207,349 61,840 64,005 361,822 745,558 Approx. Exchange 15.04 15.135 15.156 25.989 43.346 Rate Costs in US$ 000 equivalent 94/95 95/96 96/97 97198 98/99 Total Goods 363 - 377 139 328 1,206 Training 109 50 60 13 57 289 Technical Assistance 72 287 274 336 244 1,213 Credit 1,995 11,893 1,023 - 5,646 20,556 Salaries 233 578 957 730 639 3,136 Operating Costs 590 893 1,390 1,244 1,434 5,551 Total 3,361 13,700 4,080 2,463 8,347 31,951 Source: MRFC 22 Annex 8 FOOD AND AGRICULTURE ORGANIZATION OF THE UNITED NATIONS ' ' Investment Centre Division MALAWI Rural Financial Services Project (RFSP) (IDA Cr. 2513-MAI) Implementation Completion Report Mission Aide-memoire Introduction 1. A mission't from the Investment Centre Division of FAO visited Malawi during the period 20th to 31st March, 2000 to prepare the Implementation Completion Report (ICR) for the above project. The mission worked closely with the Malawi Rural Finance Company (MRFC) and held discussions with officials of the Ministry of Agriculture and Irrigation (MOAI), the Ministry of Finance (MOF) and the Reserve Bank of Malawi (RBM). The mission met with staff of donors and NGOs who have been involved with agricultural credit or inputs supply programs in Malawi, and with staff from private input suppliers. The Mission visited Kasungu ADD and had discussions with staff from the MRFC branch and two field offices, and visited fanner clubs that are clients of MRFC. 2. The mission would like to express its appreciation for the support and assistance given by all officials and staff of the Government and all interested agencies with whom the mission has been working. 3. This aide-memoire was the subject of a discussion at a wrap-up meeting of the Mission held on Friday, 31st MArch, 2000, chaired by a representative of the Permanent Secretary, MOAI. Comments made by participants and agreed with the mission at that meeting have been incorporated into this final version. Assessment of Development Objective and Design, and of Quality at Entry Project Objectives 4. The development objective of the project was to improve the access to financial services for the rural sector, including women, on a sustainable basis. The overall strategy was to corporatize and convert the existing Smallholder Agricultural Credit Administration (SACA) into a limited liability finance company as a first step to its subsequent conversion into a private rural bank. The other stated objective was to improve the policy and institutional framework for financial intermediation by supporting the development of linkages between the formal and informal financial sectors, and strengthening related non-financial institutions serving the rural sector. 5. The main objective was clear, concentrated on securing sustainability of rural financial services, and built on the experience of previous rural credit projectg. The objective was relevant to continuing Tim Lamrock, Economist, Investment Centre Division, FAO/World Bank Co-Operative Programme, Rome and Anthon Slangen, Rural Finance Officer, Agricultural Marketing and Rural Finance Service, FAO, Rome. In particular the Bank-supported Smallholder Agricultural Credit Project (Cr 1851-MAI) 1 efforts in Malawi to find a way to assist farners in achieving increased farm incomes through the use of purchased inputs, and to enable a diversification of income in rural areas by financing the start-up and expansion of micro and small non-fann business activities. The design of the project was based on the satisfactory experience of SACA, under which the design and management of loan operations through clubs enabled a large outreach and average recovery rates of about 90%. However, SACA was not commercially run and was heavily dependent on the Government, especially through its support from the extension service. There was a need to transform SACA into a private rural bank to ensure its sustainability. The project anticipated that this transformation would take three years.. 6. The second objective was not as clear and was too broad. The improvement of the policy and institutional framework for rural financial intermediation was a valid objective, but falls in the public domain and therefore should have been the responsibility of the Government. However, this responsibility was given to a Business Development Unit within MRFC on the assumption that it could recover its costs through charging for its services. There was no identified demand for these services and this unit could only be expected to concentrate on MRFC's clients and business operations. Any public role was inconsistent with the activities of the Company working its way to privatization. Components 7. The project had three components: (i) an institution building component (US$ 16.7 million with US$ 8 millionIDA financing) to corporatise and convert SACA into MRFC, and to use the Development of Malawi Traders Trust (DEMATT) to assist in preparing investment proposals for agricultural, small and micro-enterprises and to provide related training and advisory services; (ii) a line of credit component (US$ 20 million with US$ 17 million withlDA financing) to finance the short-term loan requirements of farm and non-farm rural activities; and (iii) a pilot program componen3 to support innovative approaches to providing financial services to rural women entrepreneurs. 8. During the project's implementation period, MRFC was also the implementing agency for the IFAD- financed Mudzi Financial Services Project (MFSP). This project was designed to provide credit to both fann and non-farm activities in a manner similar to RFSP, but to poorer groups for whom the requirement of collateral was waived. MRFC managed this portfolio on an agency basis for a fee, and therefore the assets and liabilities of the Mudzi project do not form part of those of MRFC. In addition, the Mudzi project has provided support to building the institutional capacity of MRFC in terms of technical assistance, equipment and systems development. The cost was not identified in SAR. 2 Assessment of Project Design 9. The components, activities and scale of the project were logical on face value. However, the underlying assumptions concerning the environment in which the project would be implemented were not realistic, and the basis for confidence that the good repayment experience under SACA would continue did not take into account other factors that could reasonably be expected to change. 10. The challenge of converting MRFC into a viable private rural bank was a highly ambitious one for a newly formed company to achieve in a short time given that MRFC was formed in a time of major political change, and macro-economic reform. A smooth passage and high political commitment of the Government to enable and assist MRFC in establishing itself was required. 11. The SAR pointed to the group approach to lending, through the formation of farmer or business clubs, as the main factor underpinning the loan recovery success of SACA. However, the harsh, politically- motivated loan recovery methods that were,in place during the period up to 1991/92 were also a strong influence on loan recovery. The assumption in the SAR that MRFC would take over a valuable and well-performing sniallholder loan portfolio as a start to its business activities was undermined in 1993/94 with the collapse of SACA due to widespread non-repayment with the advent of market liberalization and a major political change in the country. 12. The majority of staff of MRFC came initially from the SACA program of the Ministry of Agriculture, and a corporate culture change was needed to refocus staff towards commercial practices and attitudes. This was a high risk factor for the company's development, and the calibre and vision of the management of the company would be crucial in this challenging role. In addition, there was no provision in the project to establish new branch and field offices separate from those of the Ministry of Agriculture. This would have been a desirable feature for two reasons (i) to create the perception in the minds of the borrowers that MRFC was not a continuation of SACA, and that strict repayment discipline and full commercial principles would be employed; and (ii) to create identifiable "assets" that could be valued in the context of a shift to private ownership. Quality at Entry 13. An assessment carried out in 1999 by the Bank's internal Quality Assurance Group concluded that the quality at entry for this project was poor. The reasons for this assessment were that the design of the project was not sound due to unrealistic expectations regarding the future privatization of MRFC, and that the project was not ready for implementation which led to a gap of 15 months between project approval and effectiveness. Overview of Project Implementation Implementation Experience General 14. The project was appraised in June/July, 1992, approved in June, 1993 and signed on Ft October, 1993. Project implementation was initially delayed due to the non-fulfillment of the conditions of effectiveness for the appointment of senior staff of MRFC and the finalization of a subsidiary loan agreement between RBM and MRFC for the line of credit. A March 1994 review mission 3 identified the collapse of SACA as a major obstacle regarding the effectiveness of the project but following a public awareness campaign that encouraged repayment of SACA loans, and assurances from the then Minister of Agriculture that all efforts would be made to recover the amounts outstanding, effectiveness was declared in September, 1994 when the other conditions of effectiveness were met. 15. The original closing date was 3 1st December, 1996, but there were three extensions to the project's closing date and the project finally closed on 3 It December, 1999. The first extension was to allow for the delayed effectiveness date, and the two further extensions were granted to allow more time for the project to pursue the privatization process ofMRFC. There were a total of 13 supervision missions, including the mid-term review which took place in November, 1996. Institutional Development MRFC 16. The project was instrumental in creating the Malawi Rural Finance Company as a private limited liability company registered under the Companies Act. The net value of SACA's assets and liabilities that were transferred as a Government contribution to the project was MK 45 million. MRFC commenced business in October, 1994 with expatriate technical assistance in two key positions - General Manager and Financial Controller. The project supported MRFC with vehicles, equipment and supplies, and start-up costs for MRFC branch and satellite offices. A Board of Directors was appointed which enabled MRFC to operate and take decisions independently of Government. However, there remained inevitable ties with Government, particularly as the Govermnent remained the 100% shareholder, and as there was a reliance on the Ministry of Agriculture for operational co-operation at field level. MRFC relied on the activities of Field Assistants to create awareness of MRFC's services, to fonn clubs and to provide basic training for MRFC's clients. In addition, MRFC set up business in ADD offices with many of the branch and field office staff being fomer employees of the Goverment under SACA. 17. Overall, with Bank support, and later with support from the Institutional Development component of the IFAD Mudzi Financial Services Project, significant investment was made in creating the management and systems capacity of MRFC, and the project was successful in creating the Company as a commercially run institution. 18. The project provided funds for the Development of Malawi Traders Trust (DEMATT) to undertake the preparation of investment proposals for potential clients of MRFC. DEMATT did undertake some training for MRFC staff, but no investment proposals were prepared. Policy and Institutional Linkages 19. The project was designed to improve policy and institutional linkages in rural financial intennediation. This was to be done through a Business Development Unit set up within MRFC which was expected to serve all financial institutions in Malawi and charge for its services. However, this was a public role, and inconsistent with MRFC's vision of operating as a private company. In the end, the BDU existed with the expatriate TA for two years and concentrated on developing internal systems and procedures for MRFC. It was then closed. There has been little impact on overall policy and institutional linkages through this component. The representatives ofMRFC at the wrap-up meeting indicated that there has been a difference of interpretation at effectiveness placed on this component (i.e. that its purpose was 4 more limited), and that theBDU was wrongly placed in MRFC to achieve the broader objective of improved policy and institutional framework for the rural financial services sector. Line of Credit 20. Seasonal lending operations started in the crop season October 1994/September 1995. Seasonal loans are provided to farmers clubs (tobacco clubs and other clubs mainly for maize and cash crops) and small estates. Moreover, the MRFC administers loans provided to MUDZI clubs under the IFAD MUDZI Financial Services Project. The following table summarises the seasonal loan portfolio status of outreach and recovery as at the end of November each year when most outstanding loans for the previous season should have been recovered. 1994/95 1995/96 1996/97 1997/98 1998/99 Loans, MK 35 241 166 191 480 million No. of Loan 6,197 13,934 11,003 11,698 12,503 accounts No. of clients 1/ 51,058 121,692 94,414 92,247 110,435 Loan recovery, 92 74 88 89 77 1/ Based on estates (4), tobacco and other clubs (15); excluding MUDZI 21. A comparison between 1997/98 and 1998/99 shows that: * Seasonal loans to tobacco clubs increased from MK 81 million to MK 241 million at the cost of a deterioration of the loan recovery from 95% to 79% * Seasonal loans to other clubs increased from MK 16 million to MK 50 million with a reduction in the recovery rate from 92% to 63% * Seasonal loans to estates increased from MK 93 million to MK 189 million with a reduction in the recovery rate from 84% to 78% * MUDZI seasonal loans increased from MK 14 million to Mk 67 million with a fall in the recovery rate from 77% to 49%. 22. In times where MRFC attempted to expand its lending operations, recovery fell. These periods coincided with increases in interest rates, which would have had a negative effect on loan recovery. Also, capacity shortcomings in loan administration at field level negatively affected loan recovery, particularly in 1998/99 when Field Assistance were also involved in the administration of the Agricultural Productivity Improvement Programme and the Starter Pack scheme. For the 1999/2000 crop season it had been planned to disburse MK 545 million seasonal loans, but as at 17 March, 2000 MK 418 million loans had been approved and disbursed. 23. The commercial loan portfolio consists of personal loans to employees whereby loan recoveries are deducted at the source from the salaries paid for by the employers; individual business loans (approved at MRFC branch and headquarters levels; at branch level they are now only continued for repeat borrowers), group-based business loans (started in July 1999); and MUDZI group-based business loans administered under the IFAD Loan. 24. The following table summarises the expansion of the commercial loans in MK million (and numbers of loans) consolidated for all MRFC branches as at 29 February, 2000. 5 Type of loans 1995/96 1996/97 1997/98 1998/99 1999/2000 Personal loans - 1( 183) 73(12,078) 34(4,258) 15( 1,786) Business loans 13 (817) 20(1,190) 37(1,834) 32( 1,567) 14( 557) MUDZI loans I (678) 4(1,991) 12(4,796) 21(6,234) 13(2,671) Total 14 (1,495) 25 (3,364) 122(18,708) 87(12,059) 42( 5,014) 25. In 1998/99 emphasis has been put on strengthening the lending capacities and procedures of MRFC instead of expanding its commercial loans. Although this has improved the quality of the commercial loan portfolio, at the same time it has not contributed to a highly needed diversification of the overall loan portfolio. Seasonal loans constituted in 1998/99 85% of the MRFC total loan portfolio. For the year 1999/2000 MK 180 million commercial loans had been planned, out of which at the end of February, 2000, however, only MK 42 million had been disbursed. While the business season is mainly concentrated in the period February-July it is clear that the target figure for commercial loans and further diversification of the loan portfolio will not be reached. 26. The next table summarises the quality of the commercial loan portfolio in the period 1995/96-1998/99 in terms of loans past maturity expressed in MK million (as well as percentage of the disbursed loans) as at 30 September of each year. Type of loans 1995/96 1996/97 1997/98 1998/99 Personal - 0.5(4) 9.0(12) 0.6(2) Business 4.6 (37) 5.7 (30) 9.1(25) 2.7 (10) MUDZI 0.16(10) 0.5(14) 2.6(28) 1.5(7) Total 4.76(33) 6.7(27) 20.7(16) 4.8(5) Pilot Program for Women Entrepreneurs 27. The activities for this component were subsumed under the Muzdi project to develop lending approaches to the majority of Mudzi clients who are women. A study was financed by the project late in 1999, but there has been little impact of this study to date. Achievement of Objectives and Outputs General 28. The project went a long way to restoring the access to rural credit following the collapse of SACA just before effectiveness. The existence of MRFC was crucial in enabling the development of smallholder burley tobacco production by providing the essential start-up working capital required, and was therefore a significant contributor to improving the incomes of these beneficiaries. At the time of closure of the project, MRFC is providing a service to a share of the rural population which could not be filled by other existing institutions, agencies or companies in Malawi. 6 Policy and Institutional Linkages 29. There was little impact on overall policy and institutional linkages for the rural finance sector as a whole through the project. The emphasis of the project was on commercially-based operations and it was not appropriate that MRFC would undertake activities in the public interest. The whole policy and planning area for rural financial services within the Government is weak, and currently many different credit/finance schemes are in place which have different terns and conditions, which place at risk the effort to create a strict repayment discipline in rural areas. The Agricultural Productivity Investment Programme (APIP) and the Agro Inputs Fund both operate under a large measure of Government guarantee for loan default. This puts the private sector input supply companies who manage the credit at an advantage over MRFC, in addition to the advantage that is afforded by the lower than commercial interest rate structures of these schemes. The credit activities of the companies involved in the schemes are also to some extent supported by their core business -- inputs supply and distribution. APIP is neither institutionally or financially sustainable and a major revision of the program is under way. MRFC as a private rural bank 30. The original objective of turning MRFC into a private bank by December 1996 was formally maintained throughout the project. However, in the last two years of the project, it was clear that the target for MRFC to operate as a private bank with registration and supervision under the Banking Act of 1989 was not achievable, that the best that could be achieved was that MRFC would continue as a non- bank financial institution, that privatization was not feasible and that some strategic partnership would need to be fonred with one or more international development/ microfinance institutions and the Governnent. In this way, further injections of capital and technical assistance could be found. Options for the future of MRFC will be examined after the closure of the project. MlfRFC Financial Position 31. In the year 1998/99, the recovery rate was 78% and 84% on seasonal and business loans respectively. Total income was MK 357 million and after a provision for doubtful debts of MK 143 million, MRFC made a profit after tax of MK 14 million on shareholders funds of MK 170 million. For 1999/2000, the recovery rate is budgeted at 80%. Income will reach MK 380 million with a budgeted net profit again of around MK 14 million after provision for doubtful debts. With a reduction in lending activities, the net income from investment activities (net of cost of funds) will be MK 190 million, compared with net income from lending activities of MK 51 million. As at the end of February, 2000, the amount held in Treasury Bills is MK 428 million with loans outstanding of MK 667 million with a provision for loss at MK 241 million. Outreach 32. Whilst the stated objectives of the project remained constant, the appraisal targets were scaled down due to the fact that the portfolio and outreach that was assumed to be taken over from SACA was far less than that assumed at appraisal. The targets and actual achievements against these targets for the key indicators of outreach are set out in the following table. 7 Indicator Original Target Revised Target for Achievement for Target for 1999/00 1998/99 1998/99 Outreach Indicator Year-to year expansion of MK 158 million, 14,000 MK 195m 7,800 clubs MK 290m, 5,500 clubs, MK 200m, 3,800 clubs, season loan portfolio for clubs, 400,000 and 156,000 beneficiaries 82,000 beneficiaries 57,000 beneficiaries smallholder clubs beneficiaries Year-to-year expansion in MK 8 million with 7,700 MK 94m, 10,000 estates MK 189m; 7,000 estates MK 173m; 6,100 estates seasonal and medium beneficiaries term loan portfolio for small estates Year-to-year expansion in MK 3.2 million with MK 60m with 1,500 MK 60m Currently MK 40m with business loan portfolio 7,700 beneficiaries beneficiaries MK 120m expected Savings services Increasing percentage of 20% of the loan portfolio 14% of the loan portfolio loan portfolio, reaching 25% of the loan portfolio 33. The outreach targets were revised substantially downwards following the collapse of SACA, but the indicators show that the revised targets for outreach have not been achieved - more worrying is the fact that outreach is in decline for the year 1999/2000. The appraisal targets for outreach were 400,000 club beneficiaries and 7,700 estates, but were revised to 156,000 club beneficiaries and 10,000 estates. In 1999/2000, MRFC will have some 3,800 clubs with 57,000 beneficiaries, and 6,100 estates totaling an amount of MK 370 m. The appraisal target for business loans was MK 100 n. Business loans of MK 40 n are currently effective, but there are plans to increase to this over MK 150m, but will more realistically reach MK 100 m in nominal terms. The conclusion is that revised outreach targets were not met, and that business loans will not reach targets in real terms. Sustainability 34. The indicators and achievements were as follows: Sustainability Indicator Original Target Revised Target for Achievement for Target for 1999/00 1998/98 1998/99 Loan repayments on Exceed 90% with a target Unaltered 78% 80% seasonal loans of 95% After-tax profit; retum on Profit each year (real) Unaltered 6% 6% investment return on equity greater than 5% Dependence on subsidies Year-to-year reduction, Unaltered Partially achieved; the both technical and future would rely on financial further injections of capital and technical expertise from a development partner but on commercial terms. However, future profitability is uncertain if operating conditions change. 8 Shareholding GOM reduced to a Unaltered Not achieved; minority shareholding by privatization not feasible. 1998 35. These indicators show that objective of sustainability of rural financial services, as measured by loan recovery rates, profitability of operations and future dependence on subsidies, was also not achieved. Major Factors Affecting Implementation and Outcome Factors outside the control ofGovernment or the Implementing Agency * With smallholders entering burley production, the stop order system operated by Auction Holdings Limited provided a mechanism for loan recovery which had a major positive impact on the feasibility of advancing credit to smallholders. The group joint liability principle also had an impact on recovery, but its contribution to this is unclear; * The monopolistic tobacco marketing system results in lower than equivalent world prices being offered, and high charges for sales commissions and stop order fees. There are inefficiencies in the collection, grading, baling and transport systems that often downgrade tobacco, resulting in lower prices to farmers. There are incentives for farmers to sell to intermediate buyers which results in increasing loan default where a stop order would otherwise have been effective in recovering outstanding loans. * Farm margins and profitability have reduced, particularly for food crops. With the deteriorating exchange rate, fertilisers have risen in price, up more than double in 1998. Food and cash crop prices have not shown the same relative increases and therefore financial margins on agricultural production have been reduced, which in turn reduced the feasibility of using purchased inputs on credit, especially at high interest rates. Factors generally subject to Government control * Collapse of SACA; * Delays in project effectiveness; * Macro-economic instability with high inflation, devaluation of the Kwacha and lending rates reaching a high of 50%. This negatively affected the interest rates charged to customers with a flow-on increased default rate, and undemined the lending base of MRFC; * Weak political commitment of Government to support MRFC to become a viable rural financial institution, and lack of a clear policy for rural financial sector intennediation. There was a proliferation of different input supply/inputs credit schemes implemented by Goverunent and donors during the - project, adding to confusion in the minds of borrowers as to tenis and condition of such schemes, and diminution of the strict repayment discipline being promoted by MRFC; * Failure to adhere to time-bound action plans for examining and working towards strategic future options for MRFC in the context of the privatization process; * Political interference in the lead up to elections concerning the expectation of famers in participating, and the repayment obligations of borrowers. Factors generally subject to Implementing Agency control 9 * There was a commitment of the Board and management of MRFC to pursue the corporate strategy of MRFC but there was not sufficient effort put into building external relationships with key policy- makers, fanner organizations, local officials, and the media. MRFC also fell short in nurturing a corporate team effort in staff at all levels. Sustainability 36. Sustainability of rural financial services is the core of this project, and it is therefore the major aspect that need to be assessed in determining the rating of the outcome of the project. The underlying original target for sustainability of the project was that MRFC would become a private bank. This was an unrealistic target in the time frame and business environment in which the project was implemented. The indicated targets for sustainability were not achieved. 37. MRFC can be expected to maintain a portfolio of the size and outreach budgeted for 1999/2000, and make a marginal profit after allowing for 80% loan recovery rates provided operating conditions remain. This implies firstly that the cost structure of the company is maintained and that nominal margins on lending and investment operations remain at around 20% and 10% respectively. Any adverse change to these parameters would force the Company into a loss position. Also, since the portfolio is largely lent for tobacco inputs, the climatic, agricultural and price risks are such that the company could not survive any major set backs in these areas. If and when overall macro-economic conditions improve, with reduced inflation and lowering of interest rates, this would result in reduced nominal lending margins which would force a review of the cost structure of the company. 38. There needs to be an effective strategy for making attempts to increase loan recovery from the present 78%-80% levels towards 90%, to further diversify the loan portfolio, and to ensure that any increase in business is of the highest quality possible. However to improve administration of its loans in the field would require additional cost, both investment costs in field and branch office capacity (infrastructure, systems, training etc) and operational costs. 39. It is recognised that the business of seasonal agricultural finance to small farmers is high cost, and high risk, and not inherently profitable, and therefore some degree of external "public" financial support will be required to maintain MRFC in the medium to longer term. Therefore the future of MRFC will depend on an analysis of future options, and actions on the part of the Board and management to actively seek strategic partnerships. As mentioned above, options for the future will be considered following the closure of the project. Bank and Borrower Performance Bank 40. The Bank was deficient in the design and appraisal of the project since the objectives were unrealistic and the project was not ready for implementation. The Bank supervised this project very closely, and provided valuable guidance to MRFC in the absence of supervision from the Reserve Bank of Malawi. Intensive supervision was required to overcome the design limitations, to maintain efforts towards reaching unrealistic objectives and, when these were recognized as unattainable, to then assist the MRFC and Government to adjust to new targets and strategies. 10 41. This supervision was perhaps too close, in that Bank supervision missions were involved in resolving issues that should have been handled by the Board and management. This close supervision increased a perception that MRFC was a "World Bank" agency.The future supervision of MRFC as a financial institution is unclear. The withdrawal of the Bank has left a vacuum, and this responsibility for this role needs to be assumed by the Reserve Bank of Malawi under the Banking Act. Borrower 42. The Government was slow in meeting the condition of effectiveness, and has shown only moderate commitment to the project. The Government made available the remaining SACA funds ($4.5 million) as its contribution to the project cost. There has been general compliance with legal covenants, although with some delays. MRFC's demonstrated commitment to the project and its performiance in implementing the project has been satisfactory. Observations on Credit Methodologies Group lending methodology versus stop-orders 43. The effects of joint and several liability and peer pressure of group members are not clear, in particular under the current conditions of high inflation with lending rates that have increased to about 50% and declining crop profitability for fanners. While close loan follow-up by MRFC field staff and strong group leadership are considered essential, it is felt the stop-order system used on the tobacco auction for the MRFC loan recovery is a greater contributing factor to loan recovery. The recovery rates for last year for clubs and estates are similar. On the other hand, small farmers can avoid the long delays and high costs of the auction system by side-selling to intermediaries and a secure system of identity cards should be introduced together with the development of individual client information (Credit bureau). 44. In the long term, viable rural lending can be only secured by investing in a decentralised banking infrastructure of the MRFC at field level and by adequately training and supervising field staff. Payment of loan officers should be made dependent on their loan recovery performance and MRFC branches should be treated as full profit centres (with loan loss provision taken as a cost) with an incentives-based staff salary system. Loan collateral versus equity contribution 45. There is often some confusion between the sound financing practice that a loan should cover only part of the total investment costs with the borrower contributing the remaining capital, and the insistence by lending institutions on loan collateral as a mandatory saving deposit. Banks often accept as collateral only real property that should have a sales value equal to or higher than the loan amount. In group lending, the joint and several responsibility of the members constitutes a so-called social collateral, while in addition the MRFC demands an up-front cash collateral deposit of 15% of the loan. This will never protect MRFC filly in the event of default. Borrowers are paid lower rates on their mandatory collateral savings than on the amount borrowed and it appears fair to substitute the collateral deposit with an equity contribution to the investment costs, and instead to accept voluntary deposits that can be withdrawn in time of liquidity need and receive a market interest rate. 11 Credit in kind versus in cash 46. Currently the MRFC seasonal borrowers receive inputs in kind against input supplier vouchers, while commercial loans are provided in cash. Rural financial institutions that operate under free market conditions and provide full inter-mediation services of both savings and credit facilities normally do not restrict their borrowers to only certain lending purposes. Flexibility in lending termis, short- and tern- lending, and conditions is in particular critical when competition and new profitable investment opportunities arise. Savings 47. There was considerable debate during the project concerning savingstnobilisation, and this was a point of disagreement between the Board ofMRFC and Bank supervision missions. Access to safe deposit facilities and easy withdrawal of rural household savings for liquidity and emergency purposes is as important, and often more in demand, than-the availability of complementary lending resources for viable investment purposes. At the same time, a financial institution that mobilises savings uses a relative stable and economic source of lending resources. Deposit taking financial institutions are more demand-oriented and conscious of costs and have a better infornation on their clients, but at the same time require higher capabilities of staff and management in maintaining client relationships and financial and risk management. The diversification of savings and loan portfolios to reduce risk is crucial, but this could divert attention and resources toward urban areas, infrastructure development, etc, away from a rural focus. Lessons Learned 48. The lessons to be learned from this project are: * When the project was first extended in December, 1997 and it was evident that the vision of MRFC as a private bank was not attainable, the project should have been forally restructured at that time with revised objectives in line with current environment. This would have perhaps given the opportunity for the project to turn its attention towards assisting the Government in pursuing the project's other objective of an improved policy and institutional framework, rather than only pursuing the elusive objective of MRFC as a privatised bank; * Rural finance in an agriculturally-based economy such as Malawi is highly politically sensitive. Considerable effort needs to be made to nurture strong relations with the government and its agencies, as well as with the donor community and the private sector.MRFC felt limited in this since it was seen as a World Bank project; * A stable and enabling macroeconomic environment is essential for efforts to develop in Malawi a commercially-run and cost-effective financiat institution that provides viable financial services, that include both savings and credit facilities, to the rural population. Under the current conditions of high inflation and lending rates, the potential for profitable investment opportunities both in farm and non- farm production activities will be extremely limited. This equally applies to the assessment of potential equity partners/investors in the financial institution itself; * The capacity of rural financial institutions or agencies needs to be built with a heavy emphasis at field level. In general, much more emphasis should be given to field staff training, development of information and control systems, development of branches as profit centres and payment of staff incentives based on loan recovery, loan portfolio diversification and savings promotion. 12 * Whilst the group liability principle contributed to loan recovery, the existence of the stop-order mechanism for tobacco was crucial in ensuring high loan recoveries for smallholder farmers under liberalized market conditions. Automatic loan recovery mechanisms through a contracting, marketing or processing organization make credit schemes for cash and industrial crops far more justifiable in terms of sustainability that for food and other subsistence crops; * Efficient marketing systems are essential to the financial viability of agricultural production, with a flow-on effect on the ability to service agricultural finance; * Seasonal agricultural finance centered on small farmer clients is not inherently profitable no matter how effective the financial institution is managed. A subsidy element, underwriting part of the operation's administrative and technical costs will almost certainly be necessary, regardless of the institution's effectiveness in loan recoveries; * Risk strategies need to be considered by financial institutions in circumstances of macro-economic instability to preserve the lending base of the institution; * A diversified portfolio is also a prerequisite for sustainability, and this implies both farm and non-farn lending for rural clients, and a measure of rural and urban lending as well. There is always a major risk with climate failure with agriculture, and this is compounded with many other marketing risks when there is a large exposure to a single crop. Financial institutions leading for agricultural purposes need to create reserves for default resulting from climatic risks; * Where the Government supports the development of a commercially-based company or activity, there needs to be a consistent approach to all such activities and companies through clear policy and guidelines; * Financial Institutions should be licensed under the banking legislation of the country from the beginning to enable continuing and consistent supervision in accordance with the prevailing regulations. Next Steps 49. The mission will submit a draft ICR to the Bank within three weeks. At this time, the document will be intemally reviewed by the Bank, and will also be submitted to the Government in draft form for comment. Lilongwe, 3 1st March, 2000. 13  Annex 9 DRAFT REPORT MINISTRY OF AGRICULTURE GOVERNMENT OF MALAWI AND IRRIGATION PROJECT COMPLETION REPORT [PCR] FOR THE MALAWI RURAL FINANCIAL SERVICES PROJECT Cr. 2513 - MAI MINISTRY OF AGRICULTURE AND IRRIGATION PLANNING DIVISION P.O. BOX 30134, LILONGWE 3. MARCH, 2000 TABLE OF CONTENTS Currency 3 Weights 3 Fiscal Year 3 Abbreviations and Acronyms 4 List of Tables in Text 5 List of Tables in Annex 5 Preface 6 1.0 Introduction and Background of Project 9 2.0 Project Objectives 10 3.0 Project Targets 10 4.0 Loan Conditions 10 5.0 Project Cost and Financing 10 5.1 Project Cost 10 5.2 Project Financing 12 5.3 Project Financial Progress 14 6.0 Project Implementation 16 6.1 MRFC Activities and Organizational Structure 16 6.2 Procurement Component 17 6.3 Line Credit 19 6.3.1 Planned Activities and Achievements 19 6.4 Beneficiary Impact Assessment Survey (BIAS) 20 6.5 General Problems Faced 22 6.6 Study Findings under RFSP 23 6.7 Banks and Borrowers Performance 23 7.0 Critique 24 7.1 Collateral 24 7.2 Interest Rates (%) 24 7.3 Farm gate prices 24 7.4 Quality of Inputs (fertilizer) 24 7.5 Staff Training Opportunity and Upgrading 24 8.0 Project Sustainability and Future Operations 25 9.0 Key Lessons Leamed 10.0 Comments and Conclusion 25 11.0 Recommendations 28 12.0 Annexes 29 2 CURRENCY EQUIVALENTS Currency Unit: MKl.00 = 100 Tambalas Exchange Equivalents of MK to US$ during the Project Appraisal and Implementation period: 1992 US$1.00 = MK 3.60 1993 US$1.00 = MK 4.00 1994 US$1.00 = MK 7.90 1995 US$1.00= MK15.00 1996 US$1.00 = MK15.30 1997 US$1.00 = MK15.50 1998 US$1.00 = MK30.00 1999 US$1.00 = MK44.00 WEIGHTS AND MEASURES Metric System FISCAL YEAR OF BORROWER 1st Oct. - 30th Sept 3 ABBREVIATIONS AND ACRONYMS ADD Agricultural Development Division ADMARC Agricultural Development and Marketing Corporation APIP Agricultural Productivity Investment Programme BDU Business Development Unit BIAS Beneficiary Impact Assessment Survey CBM Commercial Bank of Malawi CMEU Central Monitoring and Evaluation Unit CSR Center for Social Research DCA Development Credit Agreement DEMATT Development of Malawi Traders Trust EU European Union FAs Field Assistants GB Grameen Bank GOM Government of Malawi IDA International Development Association IFAD International Fund for Agricultural Development IDA International Development Agency IMF International Monetary Fund LCB Local Competitive Bidding MMF Malawi Mudzi Fund MOAI Ministry of Agriculture and Irrigation MOF Ministry of Finance MRFC Malawi Rural Finance Company NBM National Bank of Malawi NGO Non Governmental Organizations NRDP National Rural Development Programme ODA Overseas Development Administration OPC Office of the President and Cabinet PSAR Project Staff Appraisal Report PCR Project Completion Report PO Portfolio Officer PPF Project Preparation Facility RBM Reserve Bank of Malawi RDP Rural Development Project RFSP Rural Financial Services Project SACA Smallholder Agricultural Credit Administration SACP Smallholder Agricultural Credit Project SDR Special Drawing Rights USAID United States agency for International Development WB World Bank 4 LIST OF TABLES IN TEXT Table 1.0 Loan Conditions under RFSP 11 Table 2.0 Project Financing Plan 12 Table 3.0 Estimated Project Costs 13 Table 4.0 Flow of RFSP funds in Mk 14 Table 5.0 Profit and Loss Amount Analysis for RFSP 15 Table 6.0 Funds Allocation Schedule For RFSP - IDA (SDR million) 17 Table 7.0 Loan Repayments against loan Disbursement in Mk and % 20 Table 8.0 National Production for some Food and Cash Crops 28 LIST OF TABLES IN ANNEX Annex 1.0 Related Bank loans/credit 31 Annex 2.0 Interest Rates charged by MRFC compared to CBM 32 Annex 3.0 List of RFSP supervision Missions 33 Annex 4.Oa Actual Allocated Funds Vs Expenditure to Project Closing Date 34 Annex 4.Ob Reallocated Funds Vs Expenditure to Project Closing Date 34 5 PREFACE This Project Completion Report (PCR) is for the Rural Financial Services Project (RFSP) Credit 2513 -MAI which was approved in 1993 with assistance from World Bank. The total amount of the project was US$ 36.7 million at a base exchange rate of MK 4.0 to US$ 1.0 for cost estimates purposes. This project was planned after implementation of the Smallholder Agricultural Credit Project (SACP) activities through Ministry of Agriculture of Irrigation (MOAI) failed to attain its objectives and collapsed as the project closed in 1992 due to poor repayment rates by beneficiaries (smallholder farmers). The Agricultural Credit System in Malawi dates back to 1973 before the Grameen Bank was created. This system was owned by the government and acted as a source of institutional credit for the rural population of Malawi since its introduction. This credit system was implemented through the Agricultural Development Divisions (ADDs) and later by the Smallholder Agricultural Credit Administration (SACA) from 1973 to 1992. The overall objective was to improve the rural standard of living as it was recognized that agricultural production can be improved, through proper use of farm inputs. These inputs contributed to an improved standard of living, through increased crop yields, increased household food security, and increased income. The credit system became an example in Africa of a successful government - supported credit program because of its loan repayment rates which was at an average of 97 %. As repayment rates reduced to 25 % due to several factors which included severe droughts and political liberalization SACA collapsed in 1992. It was reported during the findings of the Smallholder Agricultural Credit Repayment Crisis study carried out by Center for Social Research in 1994 that the exceptionally high repayment rates achieved during the early years of the project were to a large extent the results of the draconian and coercive loan recovery methods employed by Youth Leaguers of the then ruling party - Malawi Congress Party (Msukwa et. al, 1994; Mawaya, 1994). It is due to these problems and failures that the GOM with funding from International Development Agency (IDA)- World Bank established the Malawi Rural Finance Company (MRFC) to take over operations of SACA. MRFC opened its doors for the first time to customers offering different type of loans on 1st October, 1994 through funding under the RFSP. The total project cost of US$ 36.7 million includes:- US$ 25.1 million from IDA, US$ 4.0 million from the Government of Malawi (GOM), US$ 4.7 million financed by MRFC earnings through SACA remaining funds, and US$ 3.0 million from sub borrowers. This credit facility closed on 31st December, 1999 after two extensions. The company maintained the joint liability lending approach followed by SACA but to operate under commercial principles with a board of directors independent from the GOM and later to be transformed into a licensed Rural Bank in the near future (GOM, 1994, and World Bank, 1993). 6 This report covers RFSP activities and their fundamental objectives were: a) easy access to financial services for the rural sector, including women, on sustainable basis; b) assist the government towards improving the policy and institutional framework for rural financial intermediation by supporting the development of linkages between the formal and informal financial sectors, and strengthening related non-financial institutions serving the rural sector. The project aim was to reach all farmers who benefited from SACA focusing on improving their accessibility to financial services in groups or individuals with an aim of improving their income levels and food security through the provision of credit by MRFC and extension services by MOAls field staff. The loan was made effective after GOM and MRFC fulfilled the tied conditions. Risks feared to affect the implementation of the project included:- increase in default, removal of subsidy leading to increase in price of fertilizer, and inflation. The project implementation was affected by the devaluation of the Malawi Kwacha in 1998 which led to revision of interest rates time and again. Flow of IDA funds was quite substantial throughout the project period. Utilization of funds as the project closed on 31st December, 1999 was 94.80 % of the total project cost. The breakdown per component is as follows: Equipment and Vehicles = 48.62 % Technical Assistance = 101.99 % Studies and Training = 110.91 % Operating Costs = 91.70 % Project Preparation Facility = 100.00 % Medium loans = 316.93 % Seasonal loans = 84.35 % After the lending capacity of MRFC was affected due to the devaluation of Mk in 1998 led to the reallocation of funds within the RFSP in order to allow the company to continue with its lending programs as it lending capacity was reduced (details of the reallocation of funds is attached in the Annex). The utilization % of the Credit Line was so high {316.93 % and 84.35 % respectively) due to the reallocation of funds. This did not affect the activities of the other components. Though MRFC experienced some losses it still made some profits as indicated in the Profit and Loss Account Analysis from 1994/95 to 1998/99 season varying from Mk 0.1 to Mk 25.0 million. MRFC being a profit making company has 8 branches, 27 satellite offices, 163 field offices with a total of 316 staff throughout the country as it follows the institutional framework of MOAI. Common loans lent to smallholder farmers were Agricultural Seasonal Loans. In 1994/95 MRFC disbursed MK 34.9 million worthy of loans to smallholder farmers and this increased to MK 547.3 million during the 1998/99 season. 7 Most equipment and vehicles under the project were procured during the first years of the project though the procedure took long as IDA had to approve first. Several training programs were made to both MRFC headquarters and field staff in various areas such as credit management, group dynamics and micro finance. Farmers were also trained for them to qualify for loan service. As from 1994/95 season about 2,893 clubs benefited from MRFC seasonal loans and this increased to 5,490 clubs in 1998/99 season. Loan repayments varied during the project period from 75 % to 95 %. This was due to the high interest rates caused by fluctuations in value of Mk and low farm gate prices which reduced farmers gross margins. Defaulters were charged with a penalty of 15 % of the loan, denied loans in future seasons, and the last resort was to bring them to the court of law. Though other lending institutions were available in most areas where MRFC is operating competition was so minimal due to the fixed amount of loans offered and lack of proper procedures followed during loan repayment. Results of the Beneficiary Impact Assessment Survey (BIAS) carried out on impact of RFSP on beneficiaries indicated that farmers were happy with loans from MRFC though they complained of collateral and high interest rate. Though the project implementation was successful it had some problems which included:- late distribution of inputs and poor quality of fertilizer during early years of the project, devaluation of Mk and delays in processing of farmers payment between Auction Floors and MRFC Headquarters. Overall, the Donor and Borrowers (GOM and MRFC) performance was satisfactory. Data collection and report writing for this PCR was done from 29th February to 13th March, 2000 in three selected Agricultural Development Divisions (ADDs) namely Salima, Machinga and Mzuzu ADDs. The findings from this report will be used by the donor consultants (FAO / World Bank Cooperative Programme) to come up with the donors report. The team involved in this work comprised of Ms. M.J. Nyekanyeka, Mr. R Mchenga and Mr. G. Chande from the Central Monitoring and Evaluation Unit (CMEU), Planning Division - MOAI. Funds for this exercise was provided by MRFC. Many thanks go to MRFC members of staff namely: the Acting General Manager of MRFC, Mr. Murotho; the Operations Managers, Field Supervisors, and Portfolio Officers of Salima, Machinga and Mzuzu MRFC Branches; ADD staff namely the Divisional Crops Officers from Salima, Machinga, and Mzuzu ADDs, Project Officers from Salima, Bwanje, Zomba, Balaka, and Rumphi RDPs; Section Agricultural staff, and club members from the areas visited who benefited from MRFC agricultural loans. Their support and assistance rendered has greatly contributed to the compilation of this PCR. 8 1.0 INTRODUCTION AND BACKGROUND OF PROJECT Before Malawi Rural Finance Company (MRFC) was setup World Bank had assisted the Government of Malawi (GOM) in several development programs in agriculture which included credits and loans to develop the agricultural sector. Most of these funds were targeted to smallholder sub sectors. The GOM throughout the 1970s and 1980s benefited from several multi donor assistance where remarkable investments in physical agricultural infrastructure was made and was characterized by establishment of research, extension, credit systems and increase in staffing levels'. Though all these development assistance were made in the agricultural sector, not much had been done as proliferation of these establishments did not trickle downto the smallholder farmers as they have been constrained by a number of factors which included lack of capital or access to credit to purchase agricultural inputs. The setting up of Blocks and formation of farmer groups or clubs was encouraged to expand the coverage of extension services and promoting low cost technologies and access to credit. However this fell short of addressing some of the underlying institutional and policy issues. These projects including SACA were implemented to set effective growth and income increases among smallholder farmers. The Rural Financial Services Project (RFSP) was identified when the Smallholder Agricultural Credit Administration (SACA) closed in 1992. This led the GOM through the assistance from IDA -World Bank to setup MRFC to take over SACA responsibilities in order to achieve and improve the accessibility of credit to smallholder farmers while operating on a commercial basis. Malawi Rural Finance Company (MRFC) began its operations on Ist October, 1994, and was meant to become a major financial institution with the widest network providing a full range of financial services in the form of loans and savings facilities to rural households and micro, small and medium entrepreneurs on a competitive and sustainable basis. The RFSP was established to assist in improving access of smallholder farmers in financial services on sustainable basis and assist the government towards improving the policy and institutional framework for rural financial intermediation by supporting the development of linkages between the formal and informal financial sectors, and strengthening related non-financial institutions serving the rural sector. Several studies under this project were commissioned with an objective of improving MRFC services. These were done by several consultants which included International Food Policy Research Institute (IFPRI). These studies were to help policy makers and rural banking practitioners in Malawi and elsewhere to better design and support sustainable rural financial institutions that meet the needs of poor rural households. ' List of related credit/loans that World Bank has assisted Malawi in developing Agriculture in the country is in Annex 1.0 in the Annexes. 9 2.0 PROJECT OBJECTIVES The project's principal objectives were to:- a) Provide financial services and credit facility in the rural areas of Malawi. b) Provide credits to micro, small and medium enterprises in the country. c) Offering Banking Services The type of loans offered included:- - Seasonal Agricultural loans - Collateralised (RFSP) - Business loans - Collateralised (RFSP) Interest Rates charged on these loans were market determined. 3.0 PROJECT TARGETS 1. Provide credit to more than half a million (500,000) smallholder farmers opposed to 330,000 during SACA. ii. Improve accessibility of financial services to smallholders and improve repayment loan % through proper company repayment channels. iii. Increase fanner level of food production through increase in cultivated area and adoption of hybrid maize and use of fertilizer. iv. Increase fanner incomes through growing of cash crops i.e. tobacco, cotton etc. v. Increase in employment vi Reduce rural poverty while enhancing and accelerating economic development of rural areas of Malawi. 4.0 LOAN CONDITIONS. In order for RFSP to become effective, several critical conditions were laid down according to IDA requirements to be fulfilled by both GOM and MRFC. These are indicated in Table 1.0. 5.0 PROJECT COST AND FINANCING 5.1 Project Costs The Total Project Cost was estimated to be US$ 36.7 million (MIK 146.90 million) at the mid-1993 exchange rate of MK 4.00: US$ 1.00 including physical and price contingencies and base cost. The I0 foreign exchange component was about US$ 13.1 million (36.0 %) of the project cost. Table 2.0 shows the Project Financing Plan for the RFSP. TABLE 1.0 LOAN CONDITIONS UNDER THE RURAL FINANCIAL SERVICES PROJECT (RFSP) CONDITIONS FULFELM[ENTDS Conditions for Loan Effectiveness Establishment of a company to operate the credit Malawi Rural Finance Company (MRFC) activities at a profitable margin. established in 1993 Company to be registered as stipulated by the GOM Registration of MRFC done as a limited regulations liability company according to GOM regulations and satisfactory to IDA The transfer of the activities, assets and liabilities of MRFC took over all the assets and SACA from GOM to MRFC (par. 4.7); liabilities of SACA which were worthy US$ 4.7 million. Appointment of MRFC's General Manager, BDU Positions fulfilled by the time the company Manager and Financial Controller with qualifications began operating on 1st Oct. 1994 satisfactory to the Bank (as stipulated in Project Staff Appraisal par. 4.8); A receipt by IDA of satisfactory subsidiary Signing of subsidiary agreement and agreement between the RBM and MRFC (par. 4.15). forwarded to IDA. The finalization of MRFC's organizational structure MRFC organizational structure developed satisfactory to IDA (par. 5.2); to IDA satisfaction The preparation and adoption by MRFC of manual Development and adoption of policies and of operating policy, guidelines and implementation operations done to IDA satisfaction procedures acceptance to IDA (par. 5.5); The establishment by MRFC of guidelines for credit Done according to IDA satisfaction processing and administration acceptance to IDA (par. 5.11). Establishment of a business development unit to the Done according to IDA satisfaction acceptance to IDA (par. 5.4) 11 TABLE 2.0 PROJECT FINANCING PLAN Local Foreign Total US$ Million IDA 11.9 13.1 25.0 Government 4.0 - 4.0 MRFC 4.7 4.7 Sub-borrowers 3.0 - 3.0 Total 23.6 13.1 36.7 Table 3.0 indicates an estimated Investment and Recurrent cost of the project which included price contingencies for both local and foreign cost added, based on March, 1993 price. 5.2 PROJECT FINANCING The RFSP was financed by World Bank (IDA), GOM and other earnings from SACA balances and sub-borrowers. The IDA credit of US$ 25.00 million covered 100 % of foreign costs and 51.0 % of local costs, which when combined, constituted 68.0 % of total project costs. The GOM contribution of US$ 4.00 million was expected to cover 17 % of local cost, representing II % of total project cost. The remaining Sub borrowers and SACA balances of US$ 3.0 million and US$ 4.7 million covered 13 % and 20% of local costs representing 8 % and 13 % respectively of total project cost. There were two credit lines available to MRFC. One under IDA funding as indicated in Table 2 and 3 above; and the other one of US US$ 12.0 million from IFAD under Mudzi Financial Services Project (MFSP). The financing of the RFSP was done in tranches to MRFC through RBM at a reference rate. The activities that were carried out under this project were in general affected by devaluation which reached up to 70 % in 1998 which reduced MRFC lending capacity. Hence this led to the GOM and World Bank to reallocate RFSP resources from other components to the lending component to enable the company to proceed with the program. These macroeconomic shocks are still being felt by the company up to the time the project phased out. 12 Table 3.0 ESTIMATED PROJECT COSTS Local Foreign Total Local Foreign Total NI 000 US$ 000 A. INVESTMENT COSTS 1. Goods 0.00 25143.30 25143.30 0.00 6285.80 6285.80 (Matri/Vehic/Equip) 2. Training 2039.80 226.60 2266.50 510.00 56.70 566.60 3. Technical Assistance 0.00 - 7820.00 7820.00 0.00 1955.00 1955.00 4. Line of Credit 72000.00 8000.00 8000.00 18000.00 2000.00 20000.00 TOTAL 74039.80 41189.90 115229.80 18510.00 10297.50 28807.40 INVESTIEENT COSTS B. RECURRENT COSTS 1. Salaries 13754.80 0.00 13754.80 3438.70 0.00 3438.70 2. Other operating Costs 3994.40 9320.20 13314.50 998.60 2330.00 3328.60 TOTAL RECURRENT 17749.20 9320.20 27069.30 4437.30 2330.00 6767.30 COSTS TOTAL BASELINE 91789.00 50510.10 142299.10 22947.30 12627.50 35574.80 COSTS Physical Contingencies 0.00 1257.20 1257.20 0.00 314.30 314.30 Price Contingencies 2451.70 821.50 3273.20 612.90 205.40 818.30 TOTAL PROJECT 94240.70 52588.80 146829.50 23560.20 13147.20 36707.40 COSTS 5.3 PROJECT FINANCIAL PROGRESS 13 The flow of IDA funds was quite substantial throughout the project period though it was affected by some macroeconomic shock (devaluation) which led to the company to seek for reallocation of funding in order to continue with the program to expand its customer outreach. Table 4.0 shows the flow of RFSP - IDA funds under Investment and Recurrent costs over the project life period of five (5) years. TABLE 4.0 FLOW OF RFSP - IDA FUNDS IN (Mk) Allocated and Actual Expenditure to Project Closing Date Category Amount Allocated Amount 'Y Fund (SDR) Disbursed (SDR) Balance (SDR) Utilization Credit Line Medium Term 888,478.00 2,815,813.35 (1,927,335.35) 316.93 % Loans Seasonal Loans 13,586,522.00 11,459,589.98 2,126,932.02 84.35% 14,475,000.00 14,275,403.33 199,596.67 98.62 % Institutional Development Component Equipment and 1,3632,558.00 662,988.43 700,569.57 48.62% Vehicles Technical 1,072,848.00 1,094,181.37 (21,333.37) 101.99% Assistance Studies and 50,853.00 56,402.17 (5,549.17) 110.91% Training Operating Costs 764,956.00 701,423.21 63,532.79 91.70% PPF 272,785.00 272,785.97 (0.97) 100.00% Sub Total 3,525,000.00 2,787,781.15 737,218.85 79.09 % Total 18,000,000.00 17,063,184.48 936,815.52 94.80 % k PPF = Project Preparation Facility As indicated above the % for the Credit Line is so high (316.93 % and 84.35 % respectively). This is because funds from some components under Institutional Development were reallocated to the Credit Line after holding discussions with GOM and World Bank when the lending capacity was affected by the devaluation of Mk which occurred in 1998. This reallocation of funds under RFSP had no effect on the activities of the components under Institutional Development. Though MRFC experienced some losses it still made some profits after considering the loan loss 14 provisions and provisions against irrecoverable deposits and after meeting staff and operating costs. This was because loan loss provisioning policy requires that 100 % provision be made against all seasonal loans which go past their maturity dates. Under this policy full (100 %) provision is made the day after a loan goes past its maturity date. This policy for business loans is similarly very conservative and stringent. Such profit outcome would assist the company to be able to sustain its activities. Table 5.0 below show the Profit and Loss Account Analysis of MRFC from 1994/95 to 1998/99 seasons. Table 5.0 PROFIT AND LOSS ACCOUNT ANALYSIS MK 000 million 1994/95 1995/96 1996/97 1997/98 1998/99 Overall loan 42.1m 277.1m 218.4m 362.4m 567.0m Portfolio (Seasonal and Business) Interest Income 27.7m 161.2m 115.1m 158.4m 357.6m Interest Expense 4.6m 51.7m 25.5m 27.4m 101.1m Staff Cost 6.9m 14.9m 23.1m 34.3m 48.4m Operating Costs 8.6m 12.3m 17.4m 26.0m 54.5m Loan Loss 2.5m 81.9m 23.2m 45.3m 128.9m Provisions Net profit before 5.Om 0.1m 9.6m 25.Om 24.7m Tax but after Loan Losses 15 6.0 PROJECT IMPLEMENTATION 6.1 Malawi Rural Finance Company (MRFC) Activities and Organizational Structure: Malawi Rural Finance Company Limited (MRFC) was established in 1993 under the Companies Act 1984 as a private limited liability company. It was established as a new Finance company by the Government of Malawi (GOM) under financial and technical assistance from the World Bank. The company started its operations on 1" October, 1994 and presently operates as a Finance Company. The shareholders, the Board and the management are fully committed to transform the company into full Bank status. The GOM owns 100% of the Issued and Paid Up share capital of the Company through the Ministry of Finance. Currently the fully paid up share capital of the Company stands at MK 101 million. MRFC has been given a special exemption by the Reserve Bank of Malawi (RBM) to accept deposits from the public. This exemption is however conditional to the effect that 'the company can not use the funds raised from its depositors to fund its lending activities. The company has currently eight (8) branches, 27 Satellite Offices, 163 Field Offices spread throughout the rural areas of Malawi with a total number of staff of 316 compared to 255 in 1994/95. MRFC customers fall in diverse categories and these are:- Resource Poor Subsistence Farmers and Entrepreneurs, Smallholder Farmers' Clubs, Owners of Small & Medium Estates, and Micro & Small Entrepreneurs. The loan services MRFC offers include:- i) Seasonal Agricultural loans - Collateralised (RFSP) ii) Business loans - Collateralised (RFSP) iii) Small Business Loans without upfront Collateral (Mudzi Small Business Loans Scheme) iv) Seasonal Agricultural loans without upfront collateral ( Mudzi Tikolore Scheme) and v) Banking Services The first two loans (i & ii) under RFSP involve payment of 10 to 20 % up front cash collateral to both rural and urban customers. The other two loans (iii & iv) under Mudzi are offered to resource poor farmers and entrepreneurs who can not afford MRFC's regular upfront 10 % cash collateral. Service (v) is offered to villagers where transactions are done right at the village level. Interest Rate charged to MRFC customers is done at market rate calculated by considering cost of funds MRFC operating expenses, loan loss provision and a small margin. Interest Rate % charged from 1995 to 1999 varied from 34 % to 54 % (RBM Reference Rate and, MRFC %) compared to 29 % to 51 % of Commercial Bank of Malawi (CBM Base + 3 %. Details for each years Interest Rate (%) are indicated in Annex 2.0. A three tier Interest Rates structure is offered by MRFC where Prime Customers attract the lowest rates, Repeat Customers pay 2 % higher rates than prime and First Time customers pay 3 % above the Prime Customer Rates. 16 Malawi Rural Finance Company (MRFC) is known to beneficiaries through Agricultural and MRFC field Staff and production of brochures which are usually distributed to the people. The 1998/99 overall loan portfolio (Seasonal + Business) is MK 547.30 million compared to MK 34.9 million in 1994/95. 6.2 PROCUREMENT COM[PONENT As MRFC was a new company there was need to procure alot of equipment hence there was an increase in operating cost in 1994/95 season. This included procurement of computers, office equipment, vehicles, motorcycles etc. Table 6.0 shows the IDA funds allocation schedule for each component under RFSP. TABLE 6.0 FUNDS ALLOCATION SCHEDULE FOR RFSP - IDA (SDR MILLION) Category Amount Allocated {SDR} % of Expenditures to be Financed 1.0 Goods & Services A Sub-projects under Part A 1,450,000.00 100 % of foreign Expenditure and 90 % (i}of the Project of local expenditures. B Eligible Expenditures for 10,100,000.00 100 % of foreign Expenditures and 90 % Incremental seasonal of local expenditures credit under Part A {ii}of the Project 2.0 Equipment and vehicles 3,250,000.00 100 % of foreign expenditures and 80 % Under Part B.1 of the of local expenditures project 3.0 Technical Assistance 850,000.00 100% Under Part B of the project 4.0 Studies and Training 375,000.00 100 % under Parts B and C of the Project 5.0 Operating Costs under 375,000.00 90 % Part B of the Project 6.0 Refunding of Project 375,000.00 Amount due pursuant to Section 2.02 {d} Preparation Advance of this agreement 7.0 Unallocated 1,225,000.00 Total 18,000,000.00 17 Procurement of project equipment was done by MRFC management as the General Manager and Financial Controller were trained in IDA procurement procedures. Major procurement activities were first to be approved by the donor, and in most of the times this led to delays in procurement of some items. The reports for procurement for each category is as follows: a) Vehicle and Equipment Vehicles and equipment were procured during the first and second years with some replacements or additions in the remaining years while other goods and services, supplies and spare parts were to be procured through out the project life. b) Technical Assistance Several Technical Assistance were recruited and these were the General Manager, Financial Controller and Manager Business Development Unit was part of the conditions to be met before the company began operating. Several short Consultants were hired to carry out several studies under the project. c) Training Several Training opportunities were offered to both MRFC staff (Headquarters and Field) and beneficiaries (farmers and others). Most field staff were trained in credit management, group dynamics and micro finance. Some staff from MRFC Head office and some supervisors were trained on Micro banker Computer systems. These training's enabled MRFC staff to implement the projects activities effectively and efficiently. d) Operating Cost of MRFC Operating cost was met locally as it mostly covered staff salaries, maintenance costs of both vehicles and other equipment, accommodation and other office expenses, stationery, and Project Preparation Facility (PPF) {costs incurred during the preparatory phase of establishing the company). These expenses have been highlighted in Table 5.0 above. e) Line of Credit These were the funds to be lent to different categories of MRFC beneficiaries as indicated in Table 6.0 above. The Line of Credit was affected in 1998 due to devaluation and reallocation of funds was done within the project after holding discussions with GOM and World Bank. Details of the performance of this Line of Credit component will be discussed in detail in the following sub heading. 18 6.3 LINE CREDIT 6.3.1 Planned Activities and Achievements In general, the objective of providing credit to smallholder farmers was substantially achieved as number of farmers benefiting from MRFC Seasonal Loans increased during the project period. Farmers got the loans through clubs which were selected by MRFC staff after being trained by the Agricultural staff. More Women clubs benefited from MRFC loans to grow cash crops i.e. cotton and tobacco under the project.. Clubs were trained in group dynamic and credit management by Agricultural staff in 8 sessions taking 2 hours per session using the materials produced by MRFC and the clubs were later screened by MRFC staff to test if they qualify for MRFC Seasonal Loans. These Seasonal Loans included: fertilizer, hybrid maize seed and chemicals for cotton growers. Since MRFC started operating on Ist October, 1994 to date number of clubs benefiting from MRFC loans has increased despite the company facing other problems which included defaulters, loss of cash and devaluation. Details of numbers of clubs benefiting from the project were as follows: Season 1994-1995 1995-1996 1996-1997 1997-1998 1998-1999 Clubs 2,893 6,010 4,777 4,086 5,490 The amounts of money lent to smallholder farmers during 1998/99 was MK 547.3 million compared to MK 34.9 in 1994/95 season. During the project period loan repayments for these Seasonal Loans varied from 75 % to 95 %. Table 7.0 shows Loan Repayment Percentages (%). The variations in loan repayments was due to some factors which included:- drought, floods, low farm-gate price for some crops i.e. cotton, maize, and at times the lower prices being offered at the Auction Floor affected the farmers gross margins. The devaluation of Mk also affected the gross margins for the crops. Clubs that fail to repay their loans have been charged with a default penalty of 15 % of the loan and declared defaulters and never to be given loans unless they repay their previous loans. The last resort was to take them to the court of law. 19 Table 7.0 LOAN REPAYMENT AGAINST LOAN DISBURSEMENT IN Mk AND % SEASON SEASONAL AMOUNT AMOUNT NOT RECOVERY LOANS REPAID in (Mk REPAID (Mk in RATES DISBURSED in million) million) (Mk in million) 1994/95 34.9 33.2 (1.7) 95% 1995/96 249.6 187.2 (62.4) 75 % 1996/97 174.1 154.9 (19.2) 89% 1997/98 204.2 183.8 (20.4) 90 % 1998/99 547.3 421.4 (125.9) 77% 1999/2000 - Total 1,210.1 980.5 (229.6) 81 % In general the projects activities were not seriously affected by competition from other lending institutions though they offered their loans at a lower interest rate than that of MRFC. There was slight competition with ADMARC, Farmers Finance Company (FFC), Tobacco Association of Malawi (TAMA) and the Commercial Banks in general. This was due to the fact that the organizations offered fixed amount of loans unlike MRFC loans which were flexible. Coordination between MRFC and MOAI was said to be satisfactory though agricultural staff rated it unsatisfactory due to some differences in coordination of other issues under the project or that they expected too much. Supervision Missions from the donors side were very useful as they gave guidance to MRFC management. 6.4 Beneficiary Impact Assessment Survey (BIAS) The objective of this survey was to assess the impact of the RFSP on its beneficiaries (Smallholder farmers). The survey was carried out in March, 2000 following the closing of the project on 31st December, 1999 and was done by MOAl- Planning Division's - CMIEU as part of the preparatory work for the Project Completion Report (PCR). A total number of 25 farmers' clubs, 10 MRFC staff and 12 Agricultural staff who were interviewed from Salima, Machinga, Mzuzu ADDs and MRFC Branches. 20 - Most of the clubs interviewed were engaged in tobacco, cotton and maize growing. The most common farm inputs issued to farmers was fertilizer for tobacco and maize production while for cotton they were given pesticides. - Most of the clubs were formed during 1994/95 and 1995/96 season. This gives an impression that most of the clubs became organized soon after the inception of MRFC. - Almost all the clubs were basically formed with an aim of acquiring agricultural loan in order to increase production of food and cash crops inorder to improve their food security levels and income status hence improve their living standards. - Membership level was between 15 to 20 members as stipulated by MIRFC selection procedures. All clubs indicated having a functional committee which coordinates the club activities. - Most of the farmers reported that they were informed by the Field Assistant (FA) about the existence of the MRFC although most of these clubs could not give or spell out clearly the objectives of MRFC apart from issuing credit to smallholder farmers. - There is a very strong indication that farmers have been getting technical advice both from MRFC staff and Agricultural Staff on agronomic activities in their gardens and how to service the loan. They indicated that this has improved their club performance in club management and increase in food and cash crop production. - The timeliness in input delivery was indicated to be done on time despite delays during the early years of the project implementation (1994/95 and 1995/96. The quality of the inputs especially fertilizer has been good except one or two seasons where some clubs complained of fertilizer which had lots of sand and stones. - Though there were other lending institutions within the ADD visited most clubs did not benefit from their loans as they were so fixed though their interest rates were lower than those of MRFC. - Most clubs knew about SACA though only a few benefited from it. This was because most of the clubs were formed after SACA had closed. Those who knew about SACA indicated that MRFC loans are better off than SACA ones as these were basically for food crops and fixed while for MRFC it included cash crops and very flexible. - Most MRFC staff knew about RFSP and its objectives. Same with Agriculture staff though they had no access of the Project Appraisal Document. 21 - Implementation of project activities by MIRFC were done in collaboration with Agriculture staff especially in training farmer clubs in group dynamics and credit management while MRFC staff did the screening test. - Common loans offered were Agriculture Seasonal Loans. Their interest rates varied from 34% - 54% during the project period. - Other lending institutions operating in ADDS were TAMA, ADMARC, Farmers Financing Company (FFC), Norsk Hydro, and Commercial Banks etc. - Monitoring project activities was done through field visits, reports and meetings at Branch, Satellite and Field offices. - Problems faced included:- reduction in size of portfolios due to default and political pressure, floods, erratic rains, and low farm gate prices. - Quality and timeliness of the implementation of project activities improved over the project period. - Overall the project objectives were substantially met though they were some macroeconomic shocks which affected the implementation of the project activities. 6.5 General Problems faced A few problems were faced during the project period from both MRFC and the beneficiaries (smallholder farmers). The company had problems such as:- late distribution of inputs and in some cases poor quality of inputs (fertilizer which had sand and stones), loan recovery was poor and in 1998 the company was greatly affected by devaluation which went up to 70 %. Seeking for a no objection from donor to procure certain items led to delays in the project activities. Frequent changes of Task Managers has affected the implementation of some of the project activities. For the beneficiaries (smallholder farmers) their main problem under RFSP activities were as follows: Collateral affected the number of farmers to benefit from MRFC loans as farmers did not have the cash for the up front payment, high interest rates which kept on changing during the season, lack of Agricultural Staff in some areas which led to farmers lacking some Technical Advice, delays in processing payment between Auction Floor and MRFC headquarters etc. 22 6.6 Study Findings under RFSP Several studies have been commissioned by several organizations under the RFSP. These studies included those done by IFPRI2. IPFRI were given a short consultancy after they completed a two year study on Rural Financial Markets in Malawi in collaboration with Bunda College of Agriculture. The principal aim of this study/research was to provide information which could help policy makers and rural banking practitioners in Malawi and elsewhere to better design and support sustainable rural financial institutions that meet the needs of poor rural households. Findings of this study indicated that:- - Microfinance institutions targeted to poor people can operate successfully and achieve high loan recovery rates. - Peer selection, monitoring, and pressure are taking place in credit groups in Malawi. There are some institutional and socio-cultural constraints that put limitations to the extent to which the benefits to the lender from these incentives can be realized. These at times rise due to culture being defined as what is acceptable. These might affect the performance of a lending program. - The ability of MRFC to reach and monitor a large number of borrowers scattered throughout the country is due to the institutional framework of MOAI network throughout the country though it has also some problems. 6.7 Banks and Borrowers Performance Since the project was approved in 1993 by the donor IDA - World Bank and implementation of project activities began there were sixteen (16) supervision missions3 came to supervise the project activities and one of these was a Mid Term Review for RFSP. Several task plans were drawn to speed up the implementation of the project activities. Action plans were drawn by donor on how project components should be implemented and how recovery should be done and improved. In general supervision missions inputs were useful and guiding both technically, and administratively leading to the success performance of the company. The GOM and the project implementers [MRFC] performance was also satisfactory. The government made available the SACA remaining funds (US$ 4.7 million) and its contribution of US$ 4.0 million. Almost all conditions were met by the government and the implementer MRFC. Goods and services procured under the project were done according to IDA procuring procedures. Fourth Semi-Annual Report prepared by Aliou Diagne, dec. 1999 - Design and Sustainability Issues of rural Credit and Savings Programs for the poor in Malawi: An action-oriented Research Project. List of these supervision mission is attached in the Annex 3.0. 23 7.0 Critique As the previous chapters have evaluated the implementation of the RFSP activities being implemented by MRFC in collaboration with Agricultural Staff, discussions on achievements as well as failures and reasons have been highlighted. This chapter is to critique and evaluate the manner of execution of RFSP activities. 7.1 Collateral The charging of the 10 to 20 % collateral needs to be reconsidered as many farmers fail to get seasonal loans from MRFC due to lack of cash for the upfront payment. 7.2 Interest Rates The devaluation of Mk in 1998 affected the lending capacity of MIRFC leading to interest rates increasing and varying within a season. The cause of these variations in interest rates were not proper transmitted by Portfolio Officers to farmers so that they understand why the rates vary at times. This variations in interest rates affected the gross margins for the farmers. 7.3 Farm gate prices The low farm gate prices for some of the crops i.e. maize and cotton has affected the gross margin of the farmers leading to some farmers defaulting. There is need to peg most of these crops prices to US dollar just as the case with tobacco. Tobacco is affected too by the lower prices being offered at the floor. 7.4 Quality of inputs (fertilizer) The quality of inputs especially fertilizer was reported to be very poor during the early years of the project. The fertilizer had sand and stones which affected the yield output. Though trading of agricultural inputs has been liberalized there is need for the GOM and MRFC to be testing the quality of the inputs to ensure farmers get good quality fertilizer. 7.5 Staff Training Opportunity and Upgrading Though it was reported that some training was done for MRFC staff most of it was On the Job Training. Though this is appreciated there is still need for future professional training for some of the staff which will act as an incentive and lead to upgrading them staff from one level to the other. 24 8.0 PROJECT SUSTAINABILITY AND FUTURE OPEERATIONS The objectives of at least by reaching most of the smallholder farmers throughout the country. MRFC has been able to make profits though some losses were incurred. Though the projects' activities were carried out at a macro level, its objectives were substantially achieved leading to project sustainability being likely as long as some factors would be adjusted i.e. additional funding would be available to continue implementing these project activities. MRFC financial projections of the coming financial year shows that operating costs, including staff costs, are likely to out grow the growth in income. These increases will affect the gross margin of the company thereby reducing the projected profitability for the coming season unless the company will be able to improve their lending margins or expand their lending volume. Since lending margins are market driven it is felt that increase in lending volume should be encouraged and proposed. MRFC then through GOM will seek for additional credit lines from World Bank in order for RFSP activities to be sustainable. The company too ought to look for ways of reducing loan losses. As Malawi's economy is agro-based and mainly lies on tobacco as its major export source the future prospects of MRFC remains tied to the future of the tobacco industry, and the exchange and interest rate movements in the economy. It is due to this that the company proposes to be offering its tobacco customers US dollar denominated loans. This will assist in reducing losses of the company capital as was the case in 1998. This proposal has been tabled to GOM and a decision has not yet been made. Once this would be approved it is to be taken on board and launched from 2000/2001 season. 9.0 KEY LESSONS LEARNED * Rural and agricultural credit are always politicized. Managing political relationships is therefore critical to credit and institutional sustainability. MRFC fell short in nurturing its extemal relationships which resulted in World Bank to be more involved in problem- solving and inter-institutional relations than would be considered optimal. Its over dependence on this 'intermediation' was disadvantageous to the company as it strives to sustain its operations following the closure of the RFSP. * Credit institutions should be able to operate free from political interventions. * Since MRFC was registered as a company and not a financial institution it fell outside the supervisory arm of the Reserve Bank of Malawi. It was mostly supervised by World Bank missions and its extemal auditors. A special arrangement might have been sought to extend RBM supervisory activity to MRFC. . Microfinance and agricultural finance involve quite different challenges. They 25 require different skills, and different types of loan appraisals, monitoring arrangements, record-keeping, etc. MRFC has struggled to manage and marry the two, especially on its microfinance dimension. . MRFC is also offering Savings Banking facilities. The services should be encouraged and sustained as most smallholder farmers who are MRFC clientele are benefiting from this facility as it dose not only provide resources to the farmers/ groups but also builds up risk funds for them in case of defaulting. . Competition is not necessarily beneficial when it comes to administration of subsidized development-oriented finance. There is a relative small market for rural and agriculture finance in Malawi and hence the need for competition to follow acceptable micro-finance best practice in order to reduce confusion being potrayed to potential clients , Though microfinance literature indicates whether or not (high) interest rates matters or whether the key issue is simply providing access to effective services MRFC, did not experience any of this though some beneficiaries still complained about this. Currently MRFC is negotiating with GOM through MOAI on how interest rates could be reduced assuming GOM will agree to consider reducing the cost of funds to the company or remove the reference rate altogether. . Seasonal agricultural finance centered on small farmer clients is not inherently profitable no matter how effective the financial institution is managed. A subsidy element, underwriting part of the operation's administrative and technical costs will almost certainly be necessary, regardless of the institution's effectiveness in loan recovenes. . High loan recoveries for smallholder farmers can be obtained provided that there is a (a) a profitable lead crop/livestock enterprise, (b) mechanism for loan collection (i.e. an auction stop order, a contracting organization), and (c) loan repayment discipline is not undermined by parallel quasi-credit programs which apply subsidized interest rates and other preferential terms. * In circumstances of high inflation and currency devaluation, it may be necessary to move to foreign currency (-linked) lending in order to preserve the capital of the financial institution and in order to provide reasonable interest rates to borrowers. This can easily be applied when financing the production of exported commodities, especially those already priced in (or whose price is linked to) foreign exchange. * Flexibility is critical in the design of rural finance components and it is ill-advised to restrict the clientele and types of activities which the financial institution can lend to. Market circumstances will certainly change over the course of the project and new 26 opportunities and new competition will arise. Agricultural/rural finance should not, generally, form the basis for stand-alone projects. Agricultural finance is untimely tied up with broader developments in agricultural market development and the regulations of agricultural markets. The institutional solutions for agricultural credit may well derived from structural changes in agricultural marketing (either for inputs or commodities). The dominant suppliers of agricultural finance may not be financial institutions themselves. This should be carefully assessed at the early stages of project preparation. Though application of the joint and several liability principle is said to have improved loan repayment rates over the years in Malawi, there is still some evidence that at times it induces non-payment by individual members who observed other 'free riders'. Legal enforcement of financial contracts (with borrowers) proved largely to be ineffective and expensive. Taking borrowers to court may have had a limited demonstration effect, although actual direct recoveries from legal procedures probably did not exceed the legal costs. The economic and political environment facing MRFC has been one of unusual turbulence as Malawi has been undergoing a major transition toward democracy and market liberalization, involving substantial social and even psychological change. This has affected all facets of MRFC's operations. Considering the prevailing turbulent environment, together with the underlying high risk of its focal operation, MRFC's performance (and even survival) is rather remarkable. Repayment through stop order at the Auction floors for the tobacco growers has shown to be effective as it reduces chances for defaulting. There is need to identify a market point for the other crops so that loan deductions be done directly. This would reduce the percentage of defaulters. 27 10.0 COMMENTS AND CONCLUSION All loan conditions set under RFSP were fulfilled by both GOM and MRFC for the project to be effective. These conditions included the recruitment of a General Manager, Manager BDU and Financial Controller. In general most of the projects objectives have been achieved though they were affected by several factors. Recommendations made by Supervision Missions were so helpful and guiding as it contributed to the success of the implementation of the project activities. Most of the projects' target have been met substantially. The project was able to offer credit to more smallholder farmers through clubs and accessibility of the financial services to smallholder farmers was met due to the fact that MRFC network falls in line with MOAI institutional framework which covers all areas throughout the country. Loan repayment has in general improved under MRFC operation as it varied from 75 % to 95%. This was because most of the seasonal loans issued to smallholder farmers who grow tobacco were deducted directly at the Auction Floors hence reducing defaulting attempts. In general food security levels has improved at household levels as indicated in production and hectarage in the National Crop Estimate Figures produced by MOAI. Same with cash crops i.e. tobacco, cotton etc the number of growers had increased same with production (mt) and hectarage (ha) though this can not only be attributed to MRFC loans alone but also to other factors which included good seasons, other line credits offered by other lending institutions and usage of new technologies i.e. adoption of usage of hybrid maize [MH 18 etc] and use of fertilizer. Table 8.0 indicates the increase in production and hectarage for a few selected crops. TABLE 8.0 NATIONAL PRODUCTION FOR SOME FOOD AND CASH CROP CROP 1994/95 1995/96 1996/97 1997/98 1998/99 it Ha mnt ha Mt ha Mt. ha it. ha Maize 1,327.865 1,225,580 1,793,461 1.242,588 1,226,478 1.233.538 1.772.392 1,391,365 2.479.406 1,446,773 S/heans 15,011 23,266 42,374 53.611 28,425 39,9604 30,170 42.976 40.811 65,704 Tobacco 20,659 244,412 49,786 46,277 65,781 66.547 81,181 89,961 71,690 90,205 Cotton 25,197 52,237 82,591 79,073 45,122 70,734 36,381 45,077 51.321 53,766 * Source: National Crop Estimate Figures by MoAI. As more farmers were engaged in growing of cash crops due to Crop liberalization in 1994, smallholder farmers income levels has improved leading to improved living standards through building of houses, acquisition of several household goods including bicycles etc. Partially there has been an increase in employment rate as some people were employed under MRFC to implement RFSP activities, and even farmers were able to employ people to assist them in their fields activities as casual laborers. 28 The project activities have also assisted in reducing the rural poverty while enhancing and accelerating economic development of rural areas of Malawi. This can be seen through the improved living standard of the rural people and the increase in per capita for some of the households though they still lack some services like public infrastructure etc. Though it can be said that the project has been a success there is still more to be done to improve the living standard of the rural people in Malawi. These are indicated in the following chapter to be considered by both the donor, GOM and the implementing company MRFC inorder to make future credit projects in the country a success. 11.0 RECOMMENDATIONS The following are Recommendations put forward for consideration in future credit projects in the country:- " There is need to streamline the scope of future projects inorder to facilitate easy implementation and monitoring. " Need for the government to increase number of lending institutions and diversify loan schemes in the country. i.e. farmers should be empowered to form their own village banks and include other agriculture implements in their loan packages. . There is need to shorten the procedures when implementing projects i.e. instead of having a Special Account abroad open one locally. Procurement procedures need to be reconsidered as current situation leads to delays in procuring some of the required items as no objection has to be seeked from IDA. . Need for donors to use local personnel or government staff when supervising projects and when carry out some studies i.e. impact studies etc. . Need for the GOM to assess performance of Technical Assistance recruited under projects in the country. This will help to check if the specialist is performing according to standards spelt out in their Terms of Reference [TORs]. * Collateral should be either reduced or removed as many smallholder farmers fail to get a loan from MRFC due to lack of cash for the up front payment. . Timeliness in the disbursement of loans should be improved. Same with quality of inputs especially fertilizer. . Information sharing among all concerned stakeholders should be improved . Infrastructure at all levels should be improved for smooth implementation of project activities. " Flexibility in procedure and policy changes should be encouraged in order to cope up with-the surfacing of competition * Farm produce should be considered as a form of loan repayment apart from cash. * MRFC should consider extending the loan to cater for other very important garden operations. This should be in form of cash so that farmers don't work as casual laborers in other peoples gardens seeking for cash. 29 . Payment process from Auction Floors to MRFC should be improved. . Need for staff motivation and incentives to be set in order to encourage staff to work efficiently and effectively. Staff development is required through upgrading by offering upgrading courses. * Need to reduce interest rates charged on loans. The current ones are too high. . Need for MOAI to fill in the vacant sections as in most of the ADDs some of the sections have not been manned for some seasons leading to farmers not benefiting from agronomic technical advices. . There is need for Public Relation drive between participating agencies and the local community. . Coordination between MRFC headquarters, branches and MOAI, and the ADDs should be strengthened. . Politicians should maintain their non interference in the project activities but should provide an enabling environment. 30 12.0 ANNEXES ANNEX 1.0 RELATED BANK LOANS/CREDIT. LOAN/CREDIT TITLE PURPOSE YEAR STATUS OF APPRO VAL 1. National Rural Development To assist GOM to implement Nov. Closed 30 June 1985 Programme - NRDP Phase I the first 5-year phase of the 1978 PCR dated June 1987 program. Completion of Lilongwe Land Development Programme (LLDP) 2. National Rural Development Similar components to NRDP Oct. Closed September 1988 Programme - NRDP Phase III IV. Main objectives to 1981 PCR dated May 1990 (Cr. 1183-MAI) increase agricultural production, income and welfare of the smallholder sector. 3. National Rural Development The project included April Closed April 1991 PCR - NRDP Phase IV (Cr.1343- components to strengthen and 1983 dated April 1991 MAI) support extension services, training and adoptive research and made provision for improved credit and marketing facilities. 4. Smallholder Fertilizer (Cr. Assist the smallholder sector April Closed 31 March 1988 1352-MAI) in the procurement of inputs, 1983 mainly fertilizer. 5. Agricultural Services Project Designed to help formulate June Closed on 30th (Cr.2514-MAI) and implement institution and 1993 September, 1999 management reforms in research, extension and input supply system. 6. Rural Financial Services To improve the assess to June Closed on 31st Project (Cr.2513-MAI) financial services for rural 1993 December, 1999 sector 31 ANNEX 2.0 INTEREST RATES CHARGED BY MRFC COMPARED TO CBM Year RMB MRFC CBM Reference Rate Prome Rate Base + 3% February, 1995 24 .38% 40% 35+3 May, 1996 34.89 % 54 % 48 + 3 July, 1996 26.65 % 54 % 48 + 3 September, 1996 20.90 % 54 % 37 + 3 November, 1996 10.59% 34 % 29 + 3 March, 1997 9.18% 34% 26+3 April, 1998 11.53% 43% 35+3 September, 1998 16.30 % 43 % 35 + 3 December, 1998 19.97 % 47 % 31 + 3 March, 1999 26.28 % 49 % 48 + 3 September, 1999 26.28 % 45 % 48 + 3 November, 1999 29.24 45 % 45 + 3 32 Annex 3.0 LIST OF RFSP SUPERVISION MISSIONS DONOR MISSIONS DATE / MONTH YEAR Review Mission 31st March 1994 " " 13th July 1994 " " 14th October 1994 Supervision Mission 15th November 1994 " "27th February 1995 " " 10th April 1995 " 24th July 1995 " " 25th January 1996 June 1996 12th July 1996 " " 19th August 1996 Mid Term Review 2nd December 1996 Supervision Mission 5th June 1997 13th January " " 26th March 1999 " " 24th September 1999 33 Annex 4.Oa Actual Allocated Funds Vs Expenditure to Project Closing Date Category Amount Allocated Amount Disbursed Balance % Fund Utilization (SDR) (SDR (SDR) Credit Line Medium Term Loans 1,450,000.00 2,815,813.35 (1,365,813.35) 194.19% Seasonal Loans 10,100,000.00 11,459,589.98 (1,359,589.98) 113.46% 15,550,000.00 14,275,403.33 (2,725,403.33) 123.60 % Institutional Development Component Equipment and Vehicles 3,250,000.00 662,988.43 2,587,011.57 20.40 % Technical Assistance 850,000.00 1,094,181.37 (244,181.37) 128.73% Studies and Training 375,000.00 56,402.17 (318,597.83) 15.04 % Operating Costs 375,000.00 701,423.21 (326.423.21) 187.05 % PPF* 375,000.00 272,785.97 102,214.03) 72.74 % Sub Total 6,450,000.00 2,787,781.15 2,437,218.85 43.22 % Unallocated Revolving Fund Total 18,000,000.00 17,063,184.48 (288,184.48) 94.80 % PPF = Project Preparation Facility Annex 4.Ob Reallocated Funds Vs Expenditure to Project Closing Date Category Amount Amount Disbursed Balance % Fund Allocated (SDR (SDR) Utilization (SDR) Credit Line Medium Term Loans 888,478.00 2,815,813.35 (1,927,335.35) 316.93% Seasonal Loans 13.586,522.00 11,459,589.98 2,126,932.02 84.35% 14,475,000.00 14,275,403.33 199,596.67 98.62 % Institutional Development Component Equipment and Vehicles 1,3632,558.00 662,988.43 700,569.57 48.62 % Technical Assistance 1,072,848.00 1,094,181.37 (21,333.37) 101.99% Studies and Training 50,853.00 56,402.17 (5,549.17) 110.91% Operating Costs 764,956.00 701,423.21 63,532.79 91.70 % PPF* 272,785.00 272,785.97 (0.97) 100.00 % Sub Total 3,525,000.00 2,787,781.15 737,218.85 79.09 % Unallocated Revolving Fund Total 18,000,000.00 17,063,184.48 936,815.52 94.80 % 34 PPF = Project Preparation Facility 35  MAP SECTION  ISRD 29374 To Der Es Sølao hitip MALAWI - 0 Chisen . Thi rnipwøproduced N , ADMINISTRATIVE t"e DIVISIONS e°,"id o'", *°o REGIONS AND DISTRICTS on this mo do not n n,.we,dg.en&0re,p.RUr,i 1 1 oyjudgmn om the 10g T stowes øf ony tenriterN J- Ka or ony f r n --- PRINCIPAL ROADS bodri.RIVERS -..TOWNS DISTRICT CAPITALS 19 -N s, NATIONAL CAPITAL r I- 0 14 Mzirnba DISTRICT BOUNDARIES L 4 -C, '71 - - REGION BOJNDARIES 1° ZAMBA ....-- INTERNATIONAL BOUNDARIES KO'ErERS 0 20 40 60 80 100 C MILES 0 20 40 6C I.I.AMBlQUE M HINJI ý TO U,wek. -JAMhinjii LLNGWE 14 l Ded,.ro Nccola " gcch Ntcu øl.a } JHERN Boao MACHINGA MOZAMBIQUE é ZOM CMwa • ~Zomb GIO IEP S- Å- ZAIiE -J ROT5..N.- mADAG¶C February 1998