Ghana - Rural Financial Services Project

Document of The World Bank Report No: 20367 GH PROJECT APPRAISAL DOCUMENT ONA PROPOSED CREDIT IN THE AMOUNT OF SDR 3.9 MILLION US$5.13 MILLION EQUIVALENT TO THE REPUBLIC OF GHANA FORA RURAL FINANCIAL SERVICES PROJECT MAY 12, 2000 Rural Development III Country Department 10 Africa Regional Office  CURRENCY EQUIVALENTS (Exchange Rate Effective March 3, 2000) Currency Unit = Cedis Cedis 4,000 = US$1.00 US$1.00 = Cedis 4,000 FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS ADB Agricultural Development Bank AfDB African Development Bank ARB Association of Rural Banks ASIP Agricultural Sector Investnent Project AGSSIP Agricultural Services Subsector Investment Program BOG Bank of Ghana BSD Banking Supervision Department (BOG) CAR Capital Adequacy Ratio CAS Country Assistance Strategy CBO Community Based Organization DANIDA Danish International Development Agency ERP Economic Recovery Program FECECAM Federation des Caisses d'Epargne et de Credit Agricole Mutuel FINSAC Financial Sector Adjustment Credit FSA Financial Services Agencies GCE General Certificate of Education GHAMFIN Ghana Microfinance Network GOG Government of Ghana IAPSO International Agency Procurement Service Office ICB International Competitive Bidding IDA International Development Agency IFAD International Fund for Agricultural Development LACOSREP Land Conservation & Smallholder Rehabilitation Project (IFAD) LC Letter of Credit Vice President: Callisto Madavo Country Manager/Director: Peter Harrold Sector manager/Director: Jean Paul Chausse Task Team Leader: Rudolph A. Polson  ABBREVIATIONS AND ACRONYMS (cont'd) MIS Management Information Systems MDPI Management Development & Productivity Institute MOF Ministry of Finance MOFA Ministry of Food and Agriculture MRFI Micro and Rural Finance Institution MTR Mid Term Review NBFI Non-Bank Financial Institution NCB National Competitive Bidding NGO Non-Governmental Organization NPID New Products and Innovations Department NPIF New Products and Innovations Department PSC Project Steering Committee QCBS Quality Cost-Based Selection RB Rural Bank RCB Rural and Community Bank RFID Rural Finance Inspection Department (BOG) RFSP Rural Financial Services Project RMDS Regional Microfinance Development Specialist SCIMP Smallholder Credit, Input Supply and Marketing Project (IFAD) SHG Self-help Group SOE Statements of Expenditures TASC Transition Apex Steering Committee UNDP United Nations Development Program VIP Village Infrastructure Project  I  GHANA RURAL FINANCIAL SERVICES PROJECT CONTENTS A. Project Development Objective Page 1. Project development objective 3 2. Key performance indicators 4 B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 5 2. Main sector issues and Government strategy 5 3. Sector issues to be addressed by the project and strategic choices 9 C. Project Description Summary 1. Project components 11 2. Key policy and institutional reforrns supported by the project 13 3. Benefits and target population 14 4. Institutional and implementation arrangements 16 D. Project Rationale 1. Project alternatives considered and reasons for rejection 17 2. Major related projects financed by the Bank and other development agencies 19 3. Lessons learned and reflected in proposed project design 21 4. Indications of borrower commitment and ownership 22 5. Value added of Bank support in this project 23 E. Summary Project Analysis 1. Economic 23 2. Financial 25 3. Technical 30 4. Institutional 30 5. Environment 31 6. Social 31 7. Safeguard Policies 32 F. Sustainability and Risks 1. Sustainability 33 2. Critical risks 33 3. Possible controversial aspects 34  G. Main Conditions 1. Effectiveness Condition 35 2. Other 35 H. Readiness for Implementation 35 I. Compliance with Bank Policies 36 Annexes Annex 1: Project Design Summary 37 Annex 2: Project Description 39 Annex 3: Estimated Project Costs 50 Annex 4: Cost-Effectiveness Analysis Summary 51 Annex 5: Financial Summary 52 Annex 6: Procurement and Disbursement Arrangements 60 Annex 7: Project Processing Schedule 70 Annex 8: Documents in the Project File 71 Annex 9: Statement of Loans and Credits 72 Annex 10: Country at a Glance 73 Annex 11: Innovative Pilots Linking Informal and Formal Financial Institutions 76 Annex 12: Classification of Rural Banks, December 1998 78 Annex 13: Overview of IT Constraints Facing Rural and Community Banks 81 Annex 14: Flowchart of Project Management Organization 86 Annex 15: Organizational Chart: Apex Bank for the rural and Community Banks 87 MAP(S) IBRD 30892  GHANA RURAL FINANCIAL SERVICES PROJECT Project Appraisal Document Africa Regional Office AFTR3 Date: May 12, 2000 Team Leader: Rudolph A. Polson Country Manager/Director: Peter C. Harrold Sector Manager/Director: Jean-Paul Chausse Project ID: P069465 Sector(s): AY - Other Agriculture, FS - Financial Sector Development Lending Instrument: Financial Intermediary Loan (FIL) Theme(s): Rural Development Poverty Targeted Intervention: N Project Financing Data [ Loan Z Credit El Grant OI Guarantee El Other (Specify) For Loans/CreditslOthers: Amount (US$m): 5.13 Proposed Terms: Currency Pool Loan (CPL) Grace period (years): 10 Years to maturity: 40 Commitment fee: % Service charge: % Flnencing 33an: So~urc~ L GOVERNMENT 0.75 0.00 0.75 IDA 2.95 2.18 5.13 AFRICAN DEVELOPMENT BANK 2.92 2.09 5.01 INTERNATIONAL FUND FOR AGRICULTURAL 5.39 4.73 10.12 DEVELOPMENT BENEFICIARIES 1.95 0.00 1.95 Total: 13.96 9.00 22.96 Borrower: GOVERNMENT OF GHANA Responsible agency: BANK OF GHANA Address: Accra, GHANA Contact Person: The Director Rural Finance Inspection Dept. (RFID) Bank of Ghana, Accra Tel: 233-21-665338 Fax: Email: Other Agency(ies): Bank Supervision Department (BSD) Bank of Ghana Address: Accra, GHANA Contact Person: The Director Bank Supervision Department Accra, Ghana Tel: 233-21-665034 Fax: 233-21-662038 Email: easiedu@bog.gov.gh  Annual 2.5 4.7 4.9 4.2 2.8 3.8 Cumulative 2.5 7.2 12.1 16.3 19.1 22.9 Project implementation period: 6 Years Expectedeffectivenessdate: 01/01/2001 Expectedclosingdate: 12/31/2006 OMs PAD PoF, R.:- 2 - -2-  A. Project Development Objective 1. Project development objective: (see Annex 1) 1. The Rural Financial Services Project (RFSP) seeks to promote growth and reduce poverty in Ghana by broadening and deepening financial intermediation in rural areas through the following measures: (i) strengthening operational linkages between informal and semiformal microfinance institutions and the formal network of rural and community banks in order to expand services to a larger number of rural clients; (ii) building capacity of the rural and community banks, the principal formal financial intermediaries operating in rural areas, in order to enhance their effectiveness and the quality of services they provide; (iii) supporting the establishment of an apex structure for the rural banking system to provide the economies of scale needed for these unit rural banks to address generic constraints related to check clearing, specie supply, liquidity management and training, etc. which have impeded growth of the rural finance sector; and (iv) strengthening the institutional and policy framework for improved oversight of the rural finance sector. 2. Strengthening effective linkages between informal and formal financial sector institutions will involve the following measures: (i) developing, testing and disseminating innovative products and instruments suitable to the needs of rural clients, often comprising small community self-help groups, associations with limited organizational skills, assets and information; (ii) supporting the organization, training and empowerment of informal financial institutions, community self-help groups and associations to enhance their ability to mobilize savings and access credit from formal sources; (iii) investing in various mechanisms for more effective linkages between informal and formal financial sectors for better integration; (iv) improving the regulatory and policy environment under which informal financial sector entities operate to enable them to exploit new market opportunities; and (v) training and capacity building of microfinance institutions that serve rural clients and often help link them to more formal sources of finance. 3. The capacity building program of the rural and community banks will comprise the following measures: (i) undertaking a thorough and in-depth assessment of the financial and management performance of each rural bank in order to determine the extent of the constraints affecting their profitability and operational effectiveness and to design appropriate policy response (liquidation/restructuring, capacity building needs, etc.); (ii) supporting a human resource development program for key staff and personnel (e.g., managers, accountants, rural credit analysts) in order to augment the overall quality of rural bank personnel; (iii) upgrading internal controls and procedures for greater transparency of operations needed to enhance depositors' confidence; (iv) investing in various technologies needed to promote rural bank-to-rural bank communication, operations and synergy; (v) rationalizing agency banking and linking the number of agencies to each individual rural bank's capacity; and (vi) addressing residual policy constraints (geographical restrictions, secondary reserves, classification standards, etc.) which affect the smooth operations and functions of the rural banking sector. 4. Establishment of an apex structure for the rural and community banks will entail the following measures: (i) sensitizing of member rural banks, their shareholders, and clients on the - 3 -  proposed institutional changes which will be introduced under the apex initiative; (ii) developing and clarifying the institutional and legal framework under which the apex will operate; (iii) supporting technological innovations that will permit more efficient exchange of information between the member rural banks, the apex, and the oversight departments of the Bank of Ghana, the central bank; (iv) strengthening the responsible departments of the BOG for more effective oversight of the activities of the apex bank and the member rural banks; (v) supporting training and other capacity building activities needed for the effective operations of the apex; (vi) establishing a decentralized clearing and support system of the apex consistent with the regional clearing systems of the Bank of Ghana; and (vii) financing technical assistance to put into place appropriate operational procedures and policies needed for transparency and accountability of apex operations. 5. The program will also strengthen the Banking Supervision Department (BSD) for effective monitoring and supervision, as well as strengthen the capacity of the Rural Finance Inspection Department (RFID) for rural finance policy and strategy formulation. These two departments are the focal points for monitoring of the rural and community banks. The investment in new technologies will facilitate improved reporting, standardization, and timely analysis of rural banks' returns to more effectively guide decision makers and provide an early warning system of changes in rural banks' performance. It will also reinforce the capacity of the Ministry of Finance (MOF) to coordinate various programs supporting rural, informal and microfinance institutions and to collaborate in the development of capacity building programs. 6. The approach and strategy described in paras. 2 to 5 above represent a holistic response to the deep-rooted malaise of the rural financial sector which has significantly impeded the unleashing of rural economic growth and undermined realization of the benefits of earlier financial sector reforms (FINSAC). The need for a holistic approach is guided by past government policies and the salient lessons of donor assistance to the sector, which has been piecemeal, uncoordinated and short-term (as opposed to long-term), and thereby resulting in less-than-optimal development impact. The objectives of this program are therefore consistent with the GOG's overall economic development and poverty reduction strategy as contained in the CAS and their attainment will lead to the emergence of a strong and vibrant rural financial sector to support private, rural economic initiatives, and complement ongoing operations (rural infrastructure, services, etc.) and expand benefits of the earlier macro-level reforms to the rural inhabitants. 2. Key performance indicators: (see Annex 1) Output Indicators Informal and Microfinance Sector * No. of rural microfinance groups organized and trained (by gender); * No. of clients reached by rural microfinance institutions; * Total deposits mobilized by rural/microfinance institutions; * No. of rural/microfinance groups accessing credit from rural banks. Rural Banks * No. of clients and % of women as total borrowers; -4 -  * No. of rural banks operating profitably; * Percent increase in loan recovery rates among rural banks; and * Percent increase in annual profitability of rural banks. The Apex Structure * Perecnt increase in rural savings deposit of member banks; * No. of rural banks meeting capital adequacy ratios; * Level of profitability of apex bank; * No. of rural banks with full share subscription in the apex. Impact Indicators * Total annual loans and advances of rural banks; * Total annual savings mobilized by rural banks; * Total number of clients of rural banks (Apart from quantitative indicators, information on qualitative indicators will also be collected and analyzed, paying special attention to disaggregation of gender aspects. Also, participatory evaluation processes will be implemented). B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1) Document number: 20185-GH Date of latest CAS discussion: 03/08/2000 1. The Country Assistance Strategy (CAS) dated March 8, 2000 supports overall economic growth and sustainable poverty reduction through macroeconomic stability, fostering an enabling enviromment for broader private sector participation in economic development, and ensuring broad-based socioeconomic development through decentralization of core services. The proposed investment program is consistent with, and directly supports, these development goals of the government. The rural financial institutions are the primary vehicles for providing critically-needed financial services to Ghana's rural areas where an estimated 70 percent of the total population of 18.5 million live. By helping to better integrate the informal and formal financial sectors, strengthen capacity of participant institutions, empower rural groups and associations, and provide the institutional framework for addressing generic constraints, the proposed operation will help to unleash rural economic growth leading to reduced poverty (an important GOG objective). It will also help to broaden and deepen coverage of rural financial services to a larger number of rural dwellers (who otherwise would not have access), help to better integrate rural and urban markets, and improve overall efficiency of financial service delivery. In addition, the proposed operation strongly complements and adds value to other ongoing and/or planned operations also supported by the CAS. 2. Main sector issues and Government strategy: Sector Issues 1. With Ghana's rural sector accounting for 60% of total employment and 39% of GDP, efforts to improve the sector's competitivity and productivity remain at the heart of the country's -5-  accelerated growth and poverty reduction strategy. However, this sector, which is largely dominated by agriculture, remains severely constrained by poor infrastructure, resulting in high input costs and low output prices, and limited used of improved inputs and modem production processes and methods as a result of poor agricultural services and inadequate access to credit. 2. The lack of access to credit for input purchase (fertilizer, seed, labor), processing, and trade remains a key constraint to improved economic performance in the rural sector, both agricultural and non-agricultural. The rural sector's share of total formal credit was a mere 8 percent in 1999. In addition, there has been a steady withdrawal from lending to the rural sector by domestic commercial banks, particularly after the 1990 elimination of the 20 percent mandatory lending to agriculture, and this share (of 8 percent) is likely to fall. There is potential for filling part of this void with resources from the 111 small, community owned rural banks, and a multitude of small informal micro finance organizations and specialized microfinance institutions (including NGOs), but these entities are weak, fragmented, and operate with outdated technologies and under residual policy constraints which need to be urgently addressed. However, based on international best practices and lessons of past operations in Ghana's rural financial sector, this would only be effectively filled if rural microfinance institutions are appropriately strengthened to more effectively perform such tasks. Secondly, the lack of access to institutional credit further tends to undermine government efforts in other areas as well, preventing attainment of strong development impact. With substantial investments in infrastructure and services, the lack of a strong rural financial sector is the "critical missing link" of an integrated rural development strategy, the lack of which continues to stifle private sector initiatives in the rural economy. Strengthening of the rural financial system will therefore put into place the third pillar needed for rural economic growth and poverty reduction. A number of these constraints are discussed below. 3. Weak rural banks. Many rural and community banks are weak, with limited skilled staff, and outmoded technologies to adequately deliver services to rural clientele, a diversified group with different and often changing needs for financial services. Of the 134 rural banks in existence as at December 31, 1998, 23 were classified as distressed, with negative capital adequacy ratios (CARs), or a CAR of less than 1 percent. [The CAR measures the ratio of owned funds (such as paid up capital, free reserves, plus accumulated profits or less accumulated loss) to risk assets]. These 23 distressed rural banks were closed in 1999, after ascertainment of their inability to regain financial viability. Of the 111 rural banks remaining, 2 more became distressed during the last quarter of 1999 alone, and these will likely be closed by BOG in accordance with the banking laws. About 56 of the 111 banks are rated as mediocre, defined as rural banks with capital adequacy between 1 percent and 6 percent. The remaining 52 banks rated satisfactory are based on the narrow classification of capital adequacy ratio alone, i.e., those with capital adequacy equal to or greater than 6 percent. The performance rating does not take into account other key performance measures such as provision for bad and doubtful debt, portfolio quality, shallow capital and deposit base, etc. If more stringent criteria were applied, many of the banks currently ranked satisfactory would be further downgraded. The average paid-up capital for the satisfactory rural banks is only Cedis 48.1 million (UJS$13,000) and average networth of Cedis 282.1 million (US$78,000). Many banks are not often supervised within a given financial year: 29 of the 52 satisfactory rural banks were last supervised in 1998, the longest supervision lag being March -6-  1998. There is also a large divergence in rural bank status, depending on the data source: there is an average divergence of Cedis 56 million in networth based on returns submitted by the rural banks and the examination conducted by the Central Bank. This is due mainly to the poor provisioning for bad and doubtful debts by the rural banks, and the lax supervision provided by the BSD. Consequently, policy prescriptions are likely to differ, depending on the data source used. Another area of weakness is human resources. A training needs assessment undertaken in 1999 from a sample of 42 of the rural banks showed that 60 percent of managers had only a diploma or certificate, and 12 percent had GCEs or equivalent; only 28 percent of rural bank managers had degrees. Also, 50 percent of all accountants had diplomas, 50 percent had GCE levels, and none had formal degrees in accountancy. All projects officers only had a diploma or certificate, with many having very little practical knowledge of rural investment appraisal. 4. Poor integration of formal and informal sectors. There is little real formalized relationship between formal and informal financial sector entities. Existing relationships are often ad hoc. This relative isolation of the two sectors impedes effective integration of the rural and urban economies needed to attain sustainable impact on rural poverty reduction. In reality, the formal and informal financial sectors are important parts of the same continuum, and efforts need to be made to remove constraints affecting the smooth flow of information, technology, and resources between them. Some rural banks have increased outreach through association with NGOs that have established methodology, and through linkages with susu collectors and clubs. 5. Uncoordinated nature of past donor efforts. Past donor assistance to the rural financial sector has often been piecemeal, driven by each donor's comparative advantage and rural development strategy. IFAD has in the past focused largely on grassroots, micro finance institutions; IDA, on the larger financial sector and the rural banks; and AfDB, on lines of credit channeled largely through the ADB. Until now, there has not been a concerted and coordinated response so much so that in some instances, measures instituted by one donor have often worked at crossed purposes with the efforts of other donors: for example, a line of credit is given to a rural bank by one donor while another donor is financing capacity building activities in the same rural bank; or both donors support the same capacity building activities but use different triggers and requirements. Coverage has also been limited: for example, focusing on a few rural banks or informal associations within a project sphere of influence. Also, experience has often not been shared, often leading to costly duplication of efforts. Finally, donor assistance has often been short-lived, not allowing for sufficient time for reforms to take hold -- for example the IDA-financed project closed in 1995 when some reforms were still in progress, with no follow-up operation planned. 6. Thin and overextended oversight capacity. The Bank of Ghana (BOG) has the statutory mandate to monitor rural bank operations (as is the case for other, mostly urban based, commercial banks). However, this task is made very difficult by the large number, isolation and wide geographic distribution of the 111 rural banks. As a result, poorly performing banks (that actually need) do not often receive the intense supervision required and some banks may not be supervised in a given financial year. Current BOG supervision strategy normally consists of a team visiting each rural bank for 3 - 4 days to review reports and ascertain data reported. This approach was adequate when there were only a few rural banks in existence. Now, with over 111 - 7-  rural banks scattered all over the 10 administrative regions, and many more applications from communities wishing to establish rural banks under consideration, this approach is now costly and unsustainable. The situation is exacerbated by poorly trained staff of the rural banks and poorly maintained files for quick supervision. Often, the BOG team may need to clean up the recording system first before beginning its supervision, leading to lost time. Hence, new technological reporting standards which take into account not only current but future growth needs of the rural financial system are urgently required. Government Strategy 1. Regarding overall rural development, the government has undertaken a series of reforms and initiatives aimed at improved natural resource management, better rural infrastructure, and improved quality of agricultural services to the rural population. [Government strategy for the sector is contained in these strategy documents: Vision 2020 (1996); National Environmental Action Plan (1991); Forestry Master Plan 1996-2020 (1996); Land Sector Medium Term Plan 1996-2000 (1996); Accelerated Agricultural Growth and Development Strategy (draft 1997, being finalized in 1999); Wildlife Development Plan 1998-2003 (1998); National Soil Fertility Management Action Plan (1998); and Cocoa Sector Development Strategy (1999)]. In addition, government is undertaking, with multidonor support, major investment programs in rural infrastructure (ASIP and VIP) and services (AGSSIP) which will be complemented by the proposed project. 2. Government strategy for promoting rural financial intermediation calls for deepening outreach and expanding services to a large number of rural clients by: (i) promoting the formal/informal micro-finance sector through increased networking and capacity building, (ii) strengthening the overall capacity of rural banks for effective intermediation; (iii) creating a conducive environment for commercial bank intervention in the rural sector; and (iv) reviewing the role of the country's Agricultural Development Bank (ADB) in supporting accelerated agricultural growth, particularly with regard to medium and long tern lending. 3. In this context, GOG began the first systematic efforts to restructure the rural banking sector between 1989 and 1995, with the IDA-financed Rural Finance Project. The project, which was also implemented by BOG, had a combination of institutional reforms and a line of credit to eligible rural banks. The undertaking of these reforms was a condition for individual bank participation in the line of credit scheme. However, experience of its implementation shows that many rural banks rushed through with these reforms in order to access the line of credit (which was quickly being depleted), and the capacity building process was halted as soon as the onlending resources which acted as a catalyst were exhausted. Additionally, GOG has initiated other reforms for non-bank institutions, such as the PNDCL 328 (Non-Bank Financial Institutions Act) of 1993. Furthermore, the Ministry of Finance, in association with the Ghana Microfinance Network (GHAMFIN), has prepared a strategic framework for the development of microfinance which will be presented to Cabinet after revision following a stakeholders' workshop. - 8-  3. Sector issues to be addressed by the project and strategic choices: 1. There is a clear recognition by policymakers that reform of the rural financial sector is critical to the offtake and sustainability of economic growth on the one hand, and distribution of the growth generated to a larger share of the population, on the other. The latter distribution is key to attainment of poverty reduction targets which is a cornerstone of government strategy of poverty reduction. GOG has made substantial efforts in the past which have had some payoffs: (a) encouraging and promoting the establishment of rural banks among rural communities, characterized by local ownership and management; (b) undertaking financial sector reforms (FINSAC) which were essential in removing government control of some banks and broadly improving the policy and regulatory environment for the overall financial sector; (c) extending financial sector reforms to the rural banks, and ending a regime of targeted credit and interest rate ceilings for the agricultural sector, thereby creating a more competitive environment; (d) encouraging the establishment of the Association of Rural Banks (ARB) and supporting its efforts to transform the rural banks into an effective apex structure for a more efficient and responsive rural financial system; and (e) facilitating development of a training program for capacity building of micro and rural finance institutions through many private groups, including GHAMFIN. 2. In this context, and in order to build upon the successes of the earlier efforts mentioned above, this operation will address the following issues: 3. Institutional reforms. Transformation of the rural financial sector will require strong and sustained emphasis on sector capacity building of its constituent institutions. Unlike other sectors, previous capacity building efforts in the rural financial sector have been largely uncoordinated and narrowly focused at specific nodes along the rural finance continuum, thereby resulting in little multiplier effect on the rest of the financial sector, or the rural economy. Based on this lesson, the approach to capacity building adopted under this program will have the following key attributes: holistic: following the continuum of institutions in the rural financial sector, from the informal financial sector, to the rural banks, the apex body and the Bank of Ghana; multifaceted: with many broad attributes, covering human resource development, institution strengthening of rural groups and associations, and various technological options; externalinternal linkages: utilizing a judicious blend of both international and national experiences, best practices and knowledge; and long-term: sustaining reforms for the entire project duration and beyond to allow institutions to grow and become less dependent on continued donor or government subsidies. 4. Strengthening linkages and Microfinance Capacity The broader issue concerns the extent to which real development impact can be realized without effective integration of the rural and urban economies. In Ghana, despite years of successful reforms, an estimated 30 percent of the rural poor live below the poverty line, with no major change in rural livelihoods. That benefits of macroeconomic reforms have not yielded the desired impact on rural welfare (to the extent anticipated) underpin the existing rural-urban dichotomy in the economic development process. While a large part of this is due to the difficulties inherent in the rural milieu (transaction costs, -9-  high risks, uncertainties, inaccessibility, etc.), there is increasing evidence that the weak nature of rural institutions (both financial and non-financial) is an important constraint in harnessing the rural economic potential. On one hand, the informal sector entities are too fragmented and lack the education, information and assets (collateral) needed to effectively obtain financial services. On the other hand, many of the formal financial institutions in urban (and quasi-urban) settings further lack the experience and organizational arrangements to link "backward" into the rural sector. For example, although a high proportion of clients of rural banks are informal groups, many of these banks often fail to effectively harness this source by developing appropriate instruments -- "specialized windows and services" tailored to the needs of these client groups. In many instances, rural banks tend to adopt the behavior and mannerisms of the larger commercial banks in the capital Accra, with very strict and limited hours of operation unsuitable to their clientele. Many rural banks also tend to use financial products and loans made specifically for the urban clients who have access to capital and collateral. This inflexibility results in a mismatch between rural informal clients and formal financial entities. On the positive side, some of the leading rural banks have teamed up with NGOs to introduce microfmance methodologies such as village banking. The proposed operation will help develop and test new instruments and products that will take into account the important roles and comparative advantages of each actor in the rural/micro finance continuum (rural banks, NGOs, community-based organizations, and rural associations, susu groups, etc.). The emphasis will be on: (i) identifying, mobilizing and training informal groups in mobilizing and managing their funds; (ii) organizing, sensitizing, and empowering informal groups as effective partners with formal financial sector entities; (iii) inculcating savings behavior among group members through practical programs and other innovations for more effective group cohesion; and (iv) training and capacity building for microfmance institutions, including NGOs, to assist in group development and training through their active participation in the provision of rural and microfmancial services. 5. Capacity building. The weak capacity of both formal and informal financial sector entities is an important issue in developing strategies for a functional rural finance system. The capacity dimensions of the rural banks are to a large extent systemic, reflecting both structural and technological constraints which they face. The rural setting provides an effective barrier to technological infusion and adoption, and/or attraction and retention of skilled and experience staff. Such staff often opt to stay in the large urban centers with basic social and economic facilities. This situation is further exacerbated by the lack of adequate resources of the rural banks to provide the incentive to attract skilled staff, even in any setting. An important structural aspect of the capacity dimension relates to the unit nature of the rural and community banks. For example, operating in a restrictive catchment area, a small unit bank cannot, in a cost effective manner, capture and utilize new information, have strong bargaining position with suppliers of services such as training, or upgrade facilities. Hence, support for an apex is consistent with the need to build strong and functional rural banks, with generic services being provided in a cost effective manner by pooling of resources, experience and expertise. A technological dimension of the capacity problem (also linked to the shallow resource base of the rural banks) relates to the inability to invest in, and/or harness basic information technology for operational purposes. Even in an era when many ready off-the-shelf software exists, such as microbanker, many rural banks depend on cumbersome ledgers, which makes reporting difficult. Acquisition and training of rural bank staff to effectively adapt these innovations to rural banking would lead to huge cost savings - 10 -  in the long run and higher reporting standards. The program will therefore finance technical assistance for specific institutional strengthening activities (strengthening internal controls, improving procedures for greater transparency and accountability, strengthening the operations of savings mobilization agencies, strengthening capacity for rural investment appraisal, etc). Strategic Choices 6. Why rural banks and micro-finance institutions? The rural sector comprises nearly 80% of Ghana's population of 18.5 million, with rural economic activities providing employment and incomes for an estimated 60% of rural dwellers. At the same time, nearly 30 percent of rural inhabitants live below the poverty line. However, financial services remain significantly limited at present, mainly provided by informal groups and rural banks. After relatively successful macroeconomic and financial sector reforms, the absence of strong rural and micro finance institutions have continued to impede the attainment of rapid rural economic development. Existing rural financial institutions are often community-based, with strong sociocultural linkages. The rural banks in particular are characterized by broad-based shareholdings by community members and, compared to the larger commercial banks, have a higher propensity to serve clients with low asset base, education and/or collateral -- clients who otherwise would have little or no access to formal financial services. At the same time, there is an emerging network of specialized microfinancial institutions that are testing out international best practice methodologies and adapting them to Ghanaian microfinance context and situations. Given the dispersion of rural banks, the nature of community ownership, and rural client base, development of strong rural and micro finance institutions would provide a coherent framework for rural economic growth that would lead to lowered poverty rates and improved standards of living for a majority of the country's population. 7. Why an Apex Structure for the rural and community banks? The network of 111 rural and community banks are widely (but non-uniformly) dispersed throughout the 10 administrative regions of Ghana. Each rural bank is a separate and free standing, limited liability corporation operating under the Banking Laws of Ghana (PNDCL 225). Given its limited size and deposit base, each of the rural banks is weak, both administratively and technically, and cannot on its own tackle industry-wide constraints described above. Bilateral protocols established with the larger commercial banks to provide these services are often costly, as these commercial banks are also competitors of the rural banks. There is an existing but albeit limited framework of cooperation amongst the rural banks under the Association of Rural Banks (ARB) for the provision of common services. The apex arrangement is therefore a logical expansion of, and further formalizes, the cooperative mechanism established under the ARB for the provision of common/generic services in a more cost effective manner. C. Project Description Summary 1. Project components (see Annex 2 for a detailed description and Annex 3 for a detailed cost breakdown): 1. The project components (summarized in the table below) are as follows: - 11 -  Capacity Building - Informal Financial Sector 6.39 27.8 1.86 36.3 Financial Sector Development Capacity Building of Rural Banks Financial Sector 5.05 22.0 0.00 0.0 Development Institution Building - Apex Institutional 9.89 43.1 2.90 56.6 Development Institutional Support 1.63 7.1 0.36 7.0 Total Project Costs 22.96 100.0 5.12 100.0 Total Financing Required 22.96 100.0 5.12 100.0 1. Capacity Building - Informal Financial Sector. This component will focus on strengthening informal and microfinancial entities by developing, organizing, and training community groups and associations; training and capacity building for microfmance institutions; developing and testing various instruments and products that would foster stronger linkages between the formal rural and community banks and informal financial sector entities; sharing of best practices, including those from within the subregion; facilitating the input of NGOs as partners in rural financial sector institutions; and removing any administrative and/or regulatory impediments to achieving effective integration. Activities under this component will build upon existing initiatives such as the Ghana Microfinance Network (GHAMFIN), susu groups, women's' banking initiatives, cooperatives and credit unions, etc. 2. Capacity Building - Rural and Community Banks. This component will focus on: (i) restructuring weak rural banks and strengthening their operational effectiveness; (ii) strengthening internal controls of all rural banks including provision of new information technologies, logistics and training of key staff; (iii) rationalizing the approach to agency banking (mobilization centers) by improving communication and logistics and better defining criteria for setting up such centers that are linked to individual rural bank capacity; (iv) updating rural banks operational procedures and policies; (v) providing support for information technologies (and related training) for more efficient electronic reporting to the apex and BOG; (vi) developing an overall staff development plan for all categories of rural bank staff, including Board of Directors and implementing these plans; (vii) strengthening rural bank-to-rural bank communication to facilitate greater operational linkages; and (viii) reviewing and removing residual policies that may impede rural bank efficiency such as those restricting geographical area of coverage, secondary reserve requirements, etc. 3. Institution Building - Apex. This component will: (i) finance technical assistance needed to set up, train and operationalize an apex bank for the rural and community banks for the network of 111 rural and community banks, including the key units/departments of the apex; (ii) provide support for initial capacity building activities, logistics (facilities, communications, etc.) and other start-up activities; (iv) support development of operational procedures and policies for the apex consistent with the requirements of the Banking Law (PNDCL 225); and (v) finance short-term technical assistance of trained and experienced international experts to assist the rural and community banks in establishing and operating the apex initiative. - 12 -  4. Institutional Support. This component will provide support to the BOG, notably the Banking Supervision and Rural Finance Inspection Departments, to upgrade staff skills and improve technologies. For the BSD, in particular, this support will be critical in enabling it to modify its current approach to supervision of the rural banks, and thereby shifting to greater standardization and electronic reporting, retrieval and analyses of returns, and more targeted supervision of banks based on assessment of the returns submitted prior to going to the field. Additionally, establishing a credible database will facilitate better pre-supervision preparation which will shorten the time spent by BSD staff at each rural bank. Support will be provided to RFID to strengthen its capacity for rural finance policy and strategy formulation, as well as for program implementation and monitoring. Support to the MOF will ensure continuity in ongoing rural microfmance initiatives such' as coordination of various programs and donor initiatives and development of training programs and funds being supported under the NBFI project. This component will enable effective implementation, monitoring and evaluation of project activities, including financial management, reporting and audits (by independent frmns). 2. Key policy and institutional reforms supported by the project: 1. Policy and institutional reforms supported by the project are as follows: (a) Proliferation of Rural Bank Agencies. Many rural banks have opened branches and agencies without proper clearances by the BOG. In many instances, these branches are located in far away towns much removed from the main office of the rural banks. With weak capacity at the center, lack of proper logistics, and poor rural communications, supervision of these rural branches are often sporadic. The lack of proper monitoring leads to fraud in some of these agencies, affecting rural depositors. Also, far flung branches further burden the already overstretched supervision capacity of BSD. It is therefore important to rationalize the approach to agency banking of the rural and community banks, linked to the capacity of the member banks. The key action steps for these reforms will be as follows: (i) BOG will issue a Memorandum to the management of all rural banks reiterating that henceforth it will close all agencies and branches opened after January 1, 2001; (ii) BOG will urgently undertake a study to determine the magnitude of the problem (amount of depositors funds involved, the relative importance of these agencies in the overall portfolio of the rural bank; the impact of these agencies on lending practices, etc.). The findings of these studies will be discussed with the donors and an agreement will be reached on clear and monitorable Action Steps leading to the rationalization of these agencies. These steps would include the closing of non-profitable rural bank branches operating illegally in the rural areas. (b) Secondary Reserve Requirement. BOG has established a 10 percent primary and 52 percent secondary reserve requirement for the rural banks. Given the weak capacity of these rural banks, the key objective of the high secondary reserve ratio is to limit the exposure of depositors funds in the event of rural bank failure. This high secondary reserve limits the amount of loanable funds available to the rural banks. Also, it unduly penalizes rural banks following prudential guidelines from lending for viable rural enterprises. The proposed policy change explicitly links the level of secondary reserve to -13-  the banks' performance and commitment to prudential requirements such as loan recovery, appropriate provisioning for bad and doubtful debts, adequate internal controls, etc. The following action steps are therefore envisaged: (i) Primary Reserve. Depositing with the apex the primary reserve of 10 percent of all member rural banks of the apex; (ii) Secondary Reserve. The secondary reserve of 52 percent will be modified to ensure that rural banks meeting all prudential requirements have greater access to loanable funds while penalizing those banks which do not apply prudential measures. The secondary reserve ratio for all rural banks will therefore be based on the capacity of each rural bank and on a graduated basis (20%, 35% and 52% of secondary reserve, for example) depending on performance and capacity of each bank. A graduated, risk-based secondary reserve requirement acceptable to IFAD and IDA will be established by BOG before effectiveness of the credit, with implementation monitored by BSD and the Apex Bank. (c) Inappropriateness of Rural Bank Sanctions. All commercial banks (including rural banks) operate under PNDCL 225. Despite their large differences in size and operations, both the large commercial banks (GCB, Barclays) and the small rural banks are subject to the same sanctions for violations of operating procedures and policies. The stiff penalties and fines applicable to larger commercial banks cannot be applied to the rural banks which have small capital base and low profitability. The relatively high fines mean in effect that these sanctions are not enforced at all on rural banks, further contributing to lax adherence to rules and policies. The policy change envisaged would be as follows: (i) the apex bank would become the equivalent of the other commercial banks for purpose of the sanctions applicable under PNDCL 225; (ii) a separate (and appropriate) set of sanctions would be developed for the rural banks which are more consistent with their size, profitability and asset base; (iii) violations of PNDCL 225 by the apex would be enforced by BOG, while violations by the rural banks would be enforced by the apex bank. BOG will ensure that it does not transfer to the apex bank those sanctions over which the central bank has fudiciary responsibility, such as withdrawal of the license of a rural bank. In all cases, the apex bank will ensure that sanctions applicable to member rural banks are communicated to these banks via their Board of Directors, which shall have such rights to impose these sanctions. The apex bank may, upon recommendations of the Board, deny access to apex services to rural banks in repeated violations of the operating procedures and policies and general code of conduct of participants in the apex arrangment. The BOG will be duly notified by the apex of changes in the status of a member bank,and BOG reserves the right to take additional steps as necessary to ensure compliance under the Banking Laws (PNDCL 225). The revised Guidelines of sanctions applicable to the rural banks acceptable to the donors will be prepared by BOG prior to credit effectiveness. In addition, the Code of Conduct of rural banks which are members of the apex acceptable to the donors will be prepared and adopted by member banks prior to effectiveness of the credit. 3. Benefits and target population: Benefits I . The interventions proposed under this operation will have both direct and indirect benefits. -14 -  In general, direct benefits will include increased investment in Ghana's rural sector due to the existence of a functional rural financial sector, which would lead to-expanded income investment opportunities in both the rural farm and non-farm sectors. These, in turn, would lead to expanded employment and improved incomes of rural households, including female-headed households as they play a more important role in rural credit compared to their male counterparts. The net effect of sustained rural employment and incomes would be measured in terms of greater food security, household incomes, and lowered rural poverty rates. By broadening coverage and diversifying the range of instruments, products and services, these benefits would be captured by a wider segment of the rural population, including those from among the poorest segments. Improved savings mobilization would enhance the pool of financial resources available for investment in rural enterprises, with substantial income effects in the rural economy. Indirect benefits would include stronger and more vibrant rural financial institutions capable of adopting new technologies and better managing risks, expanded pool of skilled personnel, more efficient transmission of information, and improved confidence in the rural financial sector by rural depositors, investors and borrowers. 2. Specific component benefits and targets are described below: (a) Informalfinancial sector. An additional 330,000 rural clients are expected to benefit through access to financial services and products, whether as direct rural bank clients; through an anticipated 8,000 self-help groups (SHGs) to be organized and trained under the project over the next six years in collaboration with NGOs; through specialized microfinancial institutions; through cooperating arrangements with susu collectors and clubs; or through new innovations such as financial services agencies (FSAs). Based on past experience under the IFAD-financed SCIMP project, about 60 percent of the SHGs would be women's groups, while 70 percent of susu collectors' clients would be women. The total number of women participants is therefore estimated to be in excess of 200,000. At an average deposit rate of about Cedi 30,000 per day per client, incremental rural savings mobilized is conservatively estimated as Cedi 10 billion (IJSD 2.5 million) per annum. (b) Rural and community banks. Investment in communications facilities, both to facilitate electronic reporting and effective oversight of rural banking activities, would lead to reduced reporting costs (travel from rural towns to the Central Bank in Accra) and more efficient service provision. Capacity building in agency management and improved linkage with informal sectors would lead to increased deposits in the rural banking sector. Investment in human resource development would lead to improved quality of the portfolio of rural banks, improved services, and better capacity to deal with risks. The latter is very important as many rural bank staff do not have adequate training on investment appraisal and loan administration. (c) Apex bank. The key benefits would be: (i) more efficient service provision to the rural banks through access to the national and regional clearing system; (ii) improved liquidity and reduced costs of transactions through timely provision of specie to member banks; (iii) greater profitability through improved investment decisions and better management of - 15 -  risk; and (iv) greater confidence in the rural banking sector. Target population 3. For informal financial sector institutions, the program will target rural groups and associations, including women, as well as the poorest segments of the rural population served by informal and microfinancial entities. For rural and community banks, the program targets the 1 1 1 rural and community banks and their managers, Directors and shareholders. More than 1 11 managers, at least 220 accountants and over 500 to 800 Directors will be trained under the project. The program will be national in scope but focused on specific strata of the rural financial sector. However, participation of member banks will be phased, based on clear criteria and determined by the needs assessment of these rural banks. 4. Institutional and implementation arrangements: 1. The project will be implemented by the Rural Finance Inspection Department (RFID) of the Bank of Ghana. RFID has increased its capacity in recent years to manage similar operations, beginning with the Rural Finance Project which closed in 1995. The scope of responsibilities of the RFID has been recently reduced with the transfer of its management audit functions to BSD and a clearer focus on policy and strategy development. This sharpened mandate now better prepares RFID to implement this program aimed at institutional and policy reforms and capacity building of the rural financial sector. Project implementation will therefore be mainstreamed in the RFID, with key project staff being seconded to the RFID to augment its capacity through a competitive search process within the BOG departments. Those staff seconded will not have competing responsibilities and will spend their time fully in project implementation. Where such staff do not have adequate training, training in procurement and financial management will be provided through the project to augment their technical skills. The key project staff within the BOG will comprise a Project Coordinator, Procurement Specialist, and Accountant. These staff will report to the Director, RFID. 2. Implementation of the microfinance component will be the responsibility of the RFID, with activities contracted out to private sector entities, such as GHAMFIN, which will oversee the technical support being provided by participating NGOs. Each potential beneficiary group meeting eligibility criteria will prepare a funding proposal requesting support under the Rural and Microfinance Capacity Building Fund. All such proposals will be reviewed by a committee comprising the ARB, head of the microfinance clusters, representative of an NGO specializing in rural/microfinance, the Head of the Microfinance Unit of MOF, and the RFSP Project Coordinator. The Project Coordinator within RFID shall chair this committee. All proposals approved by the Committee will be recorded and sent to the implementing agency which will oversee contracting of services. In its implementing responsibility, the implemenring agency will ensure quality of services, as well as timeliness of quarterly and annual reports to the RFSP management. Disbursement under all such contracts will be made by the RFID, based on applicable disbursement and procurement procedures and thresholds. 3. Similarly, a New Products and Innovations Fund (NPIF) will be established under the New Products and Innovations Department (NPID) of the apex to promote research and development - 16 -  of new and innovative instruments and products for rural financial intermediation. The NPIF Committee will comprise of all members of the MFCDF, the Director of the NPID of the apex and the Deputy Managing Director of the apex, who will chair this committtee. For an interim period of two years until the NPID of the apex has been established, the Committee will be chaired by the Head, Microfinance Unit of the MOF and the responsibilities transferred to the apex after this transition period. The latter arrangement will ensure continuity in similar ongoing programs under the NBFI Project while allowing the apex to develop its own capacity. 4. Overall policy guidance on RFSP implementation will be the responsibility of a multisectoral Project Steering Committee comprising the following: (i) The Governor, BOG or his designee; (ii) the Director, RFID; (iii) one representative of the Ministry of Finance; (iv) one representative of the Ministry of Food and Agriculture (MOFA); (v) one representative of the ARB; (vi) one representative of a rural/microfmance network; and (vii) the Project Coordinator who shall act as Secretary to the PSC. The PSC will be chaired by the Governor, Bank of Ghana. The terms of reference of the PSC is in the Implementation Manual. 5. Project Monitoring. Project monitoring will include: (i) monitoring of overall implementation, including procurement, disbursement, and financial management; (ii) monitoring of the rural bank reform processes, including adherence to stipulated legal requirements of performance, etc.; (iii) monitoring of supervision input of the agencies of the BOG such as BSD and RFID; and (iv) monitoring of general indicators of project development impact. A participatory baseline survey will be undertaken. The project development impact will take gender and poverty-related aspects into consideration. Apart from quantitative indicators, information on qualitative indicators will also be collected and analyzed. D. Project Rationale 1. Project alternatives considered and reasons for rejection: 1. Several alternative formulations of this operation were considered and rejected by key stakeholders and donor partners as inappropriate for the Ghana rural/micro finance context: (a) Multiple donor projects targeted at different tiers of the rural finance continuum. Lessons of AfDB, Bank and IFAD-financed operations have shown the need for providing support to the rural and microfinancial sector in a holistic manner that adds value to and complements each individual donor initiative. Poorly coordinated approaches of the past have often resulted in dissipation of scarce resources and efforts, bottlenecks in sharing lessons of experience, institutional rigidities which undermine sustainability, and overall low development impact. The approach adopted by this project is based on a coordinated program co-financed by the principal donors active in Ghana's rural finance sector, with each donor participation based on its area of comparative advantage. (b) Capacity building versus lines of credit. The focus of the proposed operation is to strengthen capacity of formal and informal financial sector institutions for effective intermediation given the chronic weakness of the rural banking system: 24 distressed, 56 mediocre, and 52 deemed satisfactory based on a narrowly defined CAR criterion. The issue - 17 -  is not a line of credit as such but appropriate sequencing of interventions that would ensure enhanced impact of the reforms. The first step toward increasing the liquidity available is to improve the capabilities of the rural and community banks so that the 52 percent secondary reserve requirement can be lowered, thereby releasing liquidity to those rural and community banks capable of managing it. If inclusion of a line of credit is not properly sequenced, it would conflict with the core institutional building objectives of this operation, leading to less-than-optimal impact of these reforms on the rural economy. The initial emphasis on capacity building does not preclude all options for a resource infusion to the rural financial sector during implementation. For example, some donors would consider support for a line of credit after the initial period of reforms, and such facility could be targeted at the satisfactory rural banks, with key triggers for participation. Also, after the reforms, many commercial banks, notably the ADB, would consider wholesaling credit to the rural banks rather than maintaining non-profitable rural branches. Therefore, a short and intense period of reforms would lead to the inflow of new resources to the rural financial sector, both from external and mobilized sources. Hence, the option of including a line of credit as a part of this program was rejected as too distractive to its core capacity building objectives. (c) Use of an Existing financial institution as the apex for the rural banks. Historically, Ghana's rural banks developed under a unit (as opposed to branch) banking culture, whereby each bank is independently owned and managed by members of rural communities. Requiring an existing financial entity, such as the ADB, to become the apex structure for the rural banks would undermine the community ownership structure and lead to centralization of decision making and service delivery at the time when the focus is on decentralization of financial services and decisionmaking, and greater community participation in the rural development process. The apex concept builds upon both the culture and history of the rural banking sector in Ghana, nurtured on a foundation of voluntary association promoted under the Association of Rural Banks (ARB). The proposal to have another competitor commercial bank providing services to the network of rural banks as the apex was discussed and rejected during project preparation by member rural banks during the Sensitization Campaigns held in Accra, Takoradi, Cape Coast, Kumasi, Tamale, Sunyani and Koforidua in 1999. Hence, such imposition would be a top down model, with a high non-participation rate by the member rural banks. Furthermore, the experience of the rural and community banks in dealing with commercial and development banks has not proven satisfactory in terms of timely provision of services. It also does not appear likely that existing commercial banks will treat rural and community banks as priority clients. - 18 -  2. Major related projects financed by the Bank and/or other development agencies (completed, ongoing and planned). T 1 g . .g.............. . .Latest Supervision Sector Issue j Project (PSR) Ratings .____ ____ ____ ____ ____ ____ ____________ (Bank-financed projects only) Implementation Development Bank-financed Progress (IP) Objective (DO) National agricultural research strategic National Agricultural Research S S plan formulation and its short-term (Closed 12/31/99) implementation Rehabilitation and development of research infrastructure Human resources development Strengthening research/extension linkages Development of a unified national National Agricultural Extension S S agricultural extension system with (Closed 10/31/99) strong research linkages for diffusing improved agricultural technology Capacity building Policy reforms in cost recovery and National Livestock Services U S privatization of animal health services (Closed 12/31/99) Getting government out of commercial production of livestock Institutional reform Production and distribution of improved livestock breeds, forage and pasture resources Increasing exports of non-traditional Agricultural Diversification S S agricultural exports, horticulture (Closed 12/31/99) capacity building Legislative reform Fisheries Capacity Building S S Formulation of policy and action plans for sustainable management of fisheries resources Development of aquaculture Capacity building in public and private sectors (community-based organizations) - 19 -  Support to reforms of the formal S S financial sector, and liberalization of FINSAC the financial institutions Closed Support for capacity building of the Rural Finance Project S S rural and community banks Closed 6/30/95 S S Support to reforms and capacity Non-Bank Financial Institutions building of non-bank financial Project institutions Support to reforms in the public sector Public Sector Financial Mngt S S and capacity building of key sector Technical Assistance Project agencies Closingl2/31/01 Access of rural population to Agricultural Sector Investment S S infrastructure, i.e. feeder roads, tracks, (Closed 11/30/99) markets, water supply (for humans, Village Infrastructure livestock and irrigation), storage and (Closing 12/31/04) small scale food processing equipment Other development agencies Provision of input supply, marketing IFAD - Small holder Credit and credit services Inputs Marketing Provision of extension, livestock and IFAD - Upper East Rural water supply services Development Provision of extension, livestock and IFAD - Upper West Rural water supply services Development Research and production of planting IFAD - Root and Tuber materials Improvement Development of an integrated pest management system Community support and mobilization Research, production, inputs and AfDB - Food Crops marketing support services Improvement Rehabilitation of small scale surface Japanese - Irrigation i. water irrigation schemes Rehabilitation Eradication of Cocoa Swollen Shoot EU - Cocoa Swollen Shoot Virus Disease Eradication Control of Rinderpest disease in cattle EU - Pan African Rinderpest Privatization of animal health services Control -20 -  Production of rice in valley bottoms French - Rice Improvement Capacity building DANIDA - Technical Institutional strengthening Assistance to Ghana Rural Banking Sector Promotion of agricultural exports and US - Trade and Investment investment Promotion IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory) 3. Lessons learned and reflected in the project design: 1. The IDA-assisted Rural Finance Project (closed in 1995) provided the first comprehensive support to Ghana's rural banking sector. The project included both a line of credit to eligible rural banks and technical assistance for a financial restructuring program for rural banks to enable them to become more efficient in rural savings mobilization and credit delivery. IFAD has supported more than five projects in Ghana over the last six years, three with a credit/rural financial services strengthening component focusing on micro lending for small scale on-farm/off-farm income generating activities, with particular emphasis on rural women. The AfDB has had four successive lines of credit (1980, 1985, early 1990s, and 1999) to the Agricultural Development Bank (ADB). All of these donor activities have been largely uncoordinated (until now) and the salient lessons learned have been incorporated into the RFSP: (a) Training. Training of RB directors and staff has emerged as an essential element in the development of a viable rural banking sector with strong internal controls, transparency, better business practices and management of risks. Consequently, this project will have a heavy emphasis on training throughout all levels of rural, micro and informal financial institutions. (b) Need for an Apex Institution. Lack of an apex institution has made it difficult for individual rural banks to sustainably deal with common constraints, e.g. check clearing, specie supply, and liquidity management. Hence, the project will support the setting up of an apex bank that would permit attainment of a desirable level of economies of scale in dealing with these constraints. (c) Need for stronger oversight. Improved oversight of rural bank activities enhanced depositors' confidence in the overall rural banking sector, and this will be further supported under the project. (d) Timely Reporting of returns. Long distances from the central bank and weak capacity affect the ability of the rural banks to provide timely returns to the supervising entity, the Bank of Ghana. Such delays in reporting undermiine the ability of the BSD to provide timely oversight of banking activities. Investments in communications and related technologies will help to address this problem. (f) Partnerships with NGOs crucial. Groups organized and trained by NGOs have shown promising results, especially when group membership remained small and manageable. Thus, NGOs will be contracted to carry out group formation and training activities for the informal -21 -  financial sector. (g) Emphasis on Savings Mobilization. The IFAD experience confirmed that building and sustaining a strong rural financial system requires emphasis on savings mobilization as opposed to lines of credit, a key feature of this operation. 4. Indications of borrower commitment and ownership: I1. The activities supported under this operation are the outcomes of consultations among many internal stakeholders (Bank of Ghana, ARB, member rural banks, private sector entities) and with the donor partners. They therefore represent a collectively felt need. In addition, these activities are the logical continuation of past donor (AfDB, DANIDA, IDA and IFAD) efforts in the rural financial sector for which the Borrower has requested assistance in the past. The proposed operation therefore has strong borrower ownership as demonstrated by the following: * Borrower has undertaken a broad technical review and feasibility study of the apex and has put together a cogent proposal for support by all participating donors; 5 Borrower's central bank (BOG) allocated and disbursed an amount of Cedis 500 million as seed capital to finance pre-start up activities even before donor funds were available; * Borrower has initiated broad consultations, including visits both within Asia (Philippines Rural Banks) and Europe (Rabobank) to assess and gain international experiences and lessons in rural banking. The Borrower has sought the technical partnership of the Rabobank (Netherlands) which has a similar apex structure to assist it in implementing this program; * Borrower has established a high-level Transition Apex Steering Committee (TASC) chaired by the Governor of the Bank of Ghana (the central bank) and, correspondingly, a Technical Committee to guide the conceptualization and design of this program; * Borrower has undertaken a nationwide Sensitization Campaign to make all rural banks and their management aware of these important changes and the likely impact on their institutions and communities; * Borrower has supported development of a comprehensive training program for microfinance institutions through collaboration with GHAMFIN; * Borrower convened a Multidonor Roundtable on the Apex initiative during which consensus was developed on the key activities to be supported and agreement reached on the next steps; and * The Apex has been registered and a provisional license for its operations has been issued by the BOG pursuant to Banking Laws 225. 2. Borrower has therefore strong ownership of the product and has taken clear leadership of - 22 -  the process of reforms in the rural financial sector. 5. Value added of Bank support in this project: 1. The Bank has worked closely with the Borrower and with many other donors, notably AfDB and IFAD, in providing support for strengthening rural financial institutions in Ghana. The Bank has therefore worked at all three levels of the rural financial continuum -- microfinance and the informal rural and cooperative sector, the rural and community banks, and the central bank. Consistent with its global experience and knowledge base, the Bank brings significant international experience from Asia and other regions, in assisting the government's efforts to strengthen its rural financial sector and implement the reforms needed to unleash sector growth. In addition, the proposed operation complements past and on-going operations in the sector financed by the Bank in rural infrastructure (ASIP and VIP), in agriculture services (AGSSIP), and microfmance (NBFI). The Bank's participation complements well IFAD's comparative advantage on rural poverty reduction and informal financial institutions, and AfIB's.comparative advantage with Agriculture Development Bank. These two donors would not together constitute the critical mass of experience and strategic focus needed to provide the holistic support along the continuum of rural financial system. The combined participation of these three donors, unprecedented in the rural microfinance sector in Ghana, is therefore needed to support this program. E. Summary Project Analysis (Detailed assessments are in the project file, see Annex 8) 1. Economic (see Annex 4): O Cost benefit NPV=US$ million; ERR = % (see Annex 4) 3 Cost effectiveness O Other (specify) 1. Cost Effectiveness Analysis 1. The project is an important vehicle for the GOG and the other internal stakeholders (BOG, rural and community banks, informal financial sector actors, etc.) to implement a series of well coordinated and targeted reforms of the rural financial sector aimed at inducing an acceptable level of efficiency in rural financial intermediation in support of growth and poverty reduction. The cost effectiveness analysis therefore focuses on: (i) the expected reduction in transaction costs of service delivery; (ii) the reduction in response time to the needs for rural depositors and borrowers; and (iii) the overall quality of the rural financial sector portfolio attainable through training and investments in improved internal control and technology. 2. The key assumptions are as follows: (a) while a myriad of informal and microfmancial sector institutions are active in the rural milieu in Ghana, the assessment will focus on the susu groups, selfhelp associations and GHAMFIN members for which baseline information exists; (b) for rural and community banks, the cost-effectiveness analysis will focus only on primary -23 -  changes and their impact, for example, the extent to which investment in organizing and training groups lead to direct reduction in transaction costs, or how adoption of technologies would result into time saved. Secondary (but nevertheless important) impact such as subprojects investments, while substantial, will only be described; (c) where technical data are not available, the cost effectiveness assessment will utilize an assessment based on relative degree of intensity of the induced impact of the change, for example, negligible, low, medium or high impact; and (d) for purposes of comparison, the assessment will look at both before and after project scenarios, and then a relative measure of the magnitude of the expected change. Background and Context of the Analysis 3. The wide range of infonnal and micro financial institutions in Ghana offer substantial potential to reach poor people in rural areas and link them up to the financial system (particularly through Rural and Community Banks). While a number of institutions-ranging from susu collectors to NGOs to savings and loan companies-have adopted international best practices and made important advances in recent years, the scale and capabilities of these institutions remain limited. Building the capacity of these institutions and linking them better to each other and to the financial system through RCBs is a critical component of the Project in order to achieve the objective of making financial services more widely available to the rural poor. Training of the staff and Directors of specialized MRFIs is expected to improve their application of best practices and financial accounting systems, resulting in increased operational and financial sustainability and hence greater capacity to reach growing numbers of rural clients. Training to community-based organizations, self-help groups, susu collectors and clubs, and other informal institutions is expected to increase the number of savings and credit groups as well as the ability of the target population to better manage and mobilize their own funds, establishing a better basis for fornal and semi-formal MRFIs to work with them to provide access to savings, credit, and other financial instruments. Grants will also be provided specifically to facilitate development of such linkages, as well as the development of new, innovative financial products suited to rural client groups. The expected result will be substantial increases in savings mobilized from rural households, as well as an expansion in their share of credit allocations by RCBs. 4. The project would lead to the training of rural bank staff and directors, upgrading internal control procedures to ensure greater transparency in reporting, improving technology for more efficient reporting, building of capacity for rural credit appraisal, and strengthening mobilization agencies. It is expected that investment in training will lead to a higher caliber of staff, better managed rural banks with an effective and efficient Board. This in turn will lead to better investment and money management decisions, greater ability to manage risks, and overall healthy portfolio. Improved internal controls would lead to reduced fraud, and enhanced confidence of rural communities in their local banks. Investment in information technology would lead to more cost-effective submission of rural banks' returns, better economic integration of the rural banking sector, and reduced operating costs of the rural banks. Support for the mobilization centers would lead to increased deposit mobilization, increased deposit base, and more effective oversight of -24 -  agency activities by the rural bank. Summary Effectiveness Analysis 5. Details of the cost effectiveness analysis is in Annex IV but are summarized below. 6. Impact. The project is expected to substantially increase the number of rural poor with access to financial services, whether at the level of community-based organizations, MlRFIs, or rural banks. The direct impact is expected to be an addition of some 100,000 rural poor clients (at least 60,000 of them women), about half linked to rural banks (and an average increase of about 500 per bank) and the other half as clients of other MRFIs (an average of about 500 for 30 GHAMFIN members), susu collectors and clubs (about 100 benefiting directly from the project and adding an average of 200 clients), and new community savings and credit groups (about 500 formed with an average membership of 30). The data base for monitoring these figures is weak, and it will be important in the early phases of the project to improve baseline data and monitoring systems. The resulting increase in resource mobilization is expected to show up in a doubling of deposits in rural banks (from the Dec. 1998 base of cedis 117 billion). Because of present reserve requirements, no more than 38% of those additional deposits would be able to flow into increased credit for RCB clients; nevertheless, it is expected that a lowering of the secondary reserve requirement for satisfactory rural banks would also enable total loans and advances to double (from the Dec. 1998 base of cedis 58 billion). While the share of the poor in rural bank credit is not available, this share is expected to rise as a result of the linkage efforts, so that loans and advances to them would rise more than in proportion to the aggregate figure. 7. The ultimate impact of this increase in the financial assets and access to credit and other financial services would be to improve the ability of the rural poor to manage the risks of economic cycles and shocks that lead to fluctuating incomes and to invest and obtain the working capital necessary to raise their level of income. Since these effects of increased access to financial services are well documented, the project's monitoring and evaluation activities will not take on the expense of systematic measurement of impact at the household level, although an effort will be made on a sample basis to verify that the impact of increased access to microfmance in Ghana conforms to experience elsewhere. 8. The training activities of the Informal and Micro Financial Sector Component are innovative in that they attempt to develop a sustainable market of training services for MRFIs, consistent with the emerging international consensus on best practices for development of business development service markets. It is expected that MRFIs will increasingly recognize the value of training their productivity and performance and hence will be willing to bear an increasing share of the cost. The subsidy rate on professional development courses for RMFIs is expected to fall from 75% to 25% during the project period, with at least some of the highly-demanded courses being offered independently by private training providers on a full cost-recovery basis. 2. Financial (see Annex 5): NPV=US$ million; FRR = % (see Annex 4) Corporate Status and Establishment Costs of the Apex Bank 1. The Apex Bank is a public limited liability company registered under the banking law with -25-  rural banks as its principal shareholders. A head-office and five branches (Accra, Kumasi, Takoradi, Bolgatanga and Sunyani) will be established for an estimated $8.1million covering the rehabilitation of premises, training for apex staff, vehicles, office equipment, furniture, data and voice communication equipment within the Apex-Rural Bank-Central Bank network, technical assistance, and initial operating capital. In order to avoid possible dominance of the Apex Bank by the larger rural banks, the Apex Bank's shares will be distributed evenly across all rural banks, regardless of each rural bank's size. In order not to compromise the rural bank's financial health, it will be required that no rural bank's capital adequacy ratio falls below the prudential level of 6.5% after its share subscription to the Apex Bank. Based on December 1999 financial performance data for rural banks, a capital contribution of