Extended Annual Review Report

Project Number: 40932 Investment Number: 7264 August 2013

Senior Unsecured Loan Inecobank Closed Joint Stock Company Micro and Small Enterprise Financing Facility (Armenia)

This is an abbreviated version of the XARR which excludes commercially sensitive and confidential business information that is subject to exceptions to disclosure set forth in ADB's Public Communications Policy 2011.

CURRENCY EQUIVALENTS

Currency Unit – dram (AMD)

At Appraisal

At Project Completion

22 October 2007 31 August 2012 AMD1.00 – $0.0030 $0.0024

$1.00 – AMD329.50 AMD409.25

ABBREVIATIONS

ADB – Asian Development Bank CAGR – compounded annual growth rate CAR – capital adequacy ratio EMP – environmental management policy ESRMP – environmental and social risk management program IFI – international financial institution LIBOR – London interbank offered rate MFI – microfinance institution MSMEs – micro, small, and medium-sized enterprises ROIC – return on invested capital SBB – small-business bank SMEs – small and medium-sized enterprises

NOTE

In this report, “$” refers to US dollars.

Vice-President L. Venkatachalam, Private Sector and Cofinancing Operations Officer-in-Charge J. Yamagata, Private Sector Operations Department (PSOD) Director C. Engstrom, Private Sector Financial Institutions Division, PSOD Team leader S. Seet, Investment Specialist, PSOD Team members C. Abuel, Project Analyst, PSOD

A. Taneja, Principal Investment Specialist, PSOD In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgment as to the legal or other status of any territory or area.

CONTENTS

Page BASIC DATA i EXECUTIVE SUMMARY ii

I. THE PROJECT 1

A. Project Background 1

B. Key Project Features 1

C. Progress Highlights 2

II. EVALUATION 3

A. Project Rationale and Objectives 3

B. Development Impact 3

C. ADB Investment Profitability 7

D. ADB Work Quality 7

E. ADB’s Additionality 8

F. Overall Evaluation 8

III. ISSUES, LESSONS, AND RECOMMENDED FOLLOW-UP ACTIONS 8

A. Issues and Lessons 8

B. Recommended Follow-Up Actions 9

APPENDIXES 1. Project-Related Data 10 2. Private Sector Development Indicators and Ratings – Financial Intermediaries 11 3. Economic and Banking Sector Overview 13 4. Comparative Financial Statements 17 5. Environmental and Social Management System 21

BASIC DATA Micro and Small Enterprise Financing Facility

(7264−REG)

Key Project Data

As per ADB Loan Documents ($ million)

Actual ($ million)

Total Project Cost ADB Investment:

Loan: Committed Disbursed Outstanding

3.0

3.0

3.0

3.0

Key Dates Expected Actual Concept Clearance Approval Board Approval Loan Agreement Loan Effectiveness First Disbursement Loan Closing

2006 2007 2008 2008 2008 2012

10 Jul 2006 22 Oct 2007 1 Aug 2008

21 Aug 2008 21 Aug 2008 21 Sept 2012

Project Administration and Monitoring Number of Missions

No. of Person-Days

Concept Clearance 1 K Due Diligence Mission 1 5 Private Sector Credit Committee Meeting 1 -- Board Approval 1 --

EXECUTIVE SUMMARY

In October 2007, the Board of Directors of the Asian Development Bank (ADB) approved a regional loan and guarantee facility of up to $20 million to microfinance institutions (MFIs) and small-business banks in ADB’s developing member countries in Central and West Asia. The program aimed to provide wider access to debt financing for MFIs and small-business banks, which included Bank Eskhata in Tajikistan, Inecobank Closed Joint Stock Company (Inecobank) in Armenia, and Ineximbank in the Kyrgyz Republic. ADB’s MFI loan and guarantee facility was its first nonsovereign lending facility for private sector financial institutions in the region. The facility was structured as a program using a portfolio management approach, with predefined eligibility criteria, assessment parameters, approval procedures, and subborrower reporting requirements. This approach allowed smaller but healthy financial institutions that would not qualify to participate in the program on their own. The facility’s objectives were also aligned with ADB’s microfinance development strategy of 2000, which aimed to develop financial infrastructure and build viable financial institutions. In August 2008, ADB disbursed a $3 million loan to Inecobank to support its lending expansion to micro, small, and medium-sized enterprises (MSMEs). The proposed loans to the other approved MFIs (Bank Eskhata and Ineximbank) did not materialize as planned because of supervening events that prevented successful conclusion of loan agreements. The purview of this report covers only a review of ADB’s loan to Inecobank. Inecobank is a medium-sized, privately owned bank with a strong focus on microfinance. Despite its small size, Inecobank is well regarded by its peers in Armenia and enjoys the confidence of several international financial institutions (IFIs) and foreign lenders. The presence of some of these IFIs as members of the board of directors has played an important role in providing operational guidance and improving Inecobank’s corporate governance; risk management; and environmental, social, health, and safety standards. Second only to ACBA Credit Agricole Bank in terms of microfinance lending volume in Armenia, Inecobank remained profitable throughout 2007–2011, even while the Armenian economy was adversely affected by the 2008–2009 global economic crisis. After a lending lull in 2009, Inecobank accelerated its lending rapidly during 2010–2011. Inecobank’s high net interest margins from its microfinance focus allowed it to generate adequate returns in line with the risks associated with lending to MSMEs. In 2010, this helped place Inecobank among the top three Armenian banks in terms of efficiency ratios. The overall impact of ADB’s loan to Inecobank on private sector development is rated satisfactory. The loan was successful in terms of helping Inecobank extend additional loans at slightly longer tenors to its borrowers. The cumulative effect of the ADB loan and financial support provided by various IFIs and foreign lenders contributed in some measure towards helping Inecobank sustain its growth, enhance its MSME lending activities, and expand its geographical reach into other areas of Armenia. While the ADB loan was small compared to the overall size of Inecobank, it was disbursed at the onset of the global financial crisis when Armenian banks had limited alternative sources for long-term funding. Inecobank’s business and economic performance is rated excellent. Inecobank has capitalized on demand for loans from MSMEs, with significant portfolio growth and high interest margins. Its steady earnings have enabled it to increase its capital base. Moreover, its portfolio emphasis on productive business lending and away from consumption-based retail lending is noteworthy. Overall, it is a successful case study of microfinance banking in a developing country that has attracted the attention of many international development organizations. Inecobank is well

regarded in the market and its relationships with various IFIs have helped it to weather the financial crisis and optimize its cost structure with low-cost funding, while being able to lend at commercial rates. The project’s environmental, social, health, and safety performance is rated satisfactory. Under its Environment Policy (2002), ADB’s loan to Inecobank was classified in the financial intermediary category. Inecobank adopted an environmental management policy consistent with the standards of ADB and other IFIs. The policy was integrated into Inecobank’s loan appraisal process, and included an exclusion list and processes to assess and mitigate environmental and social risks. ADB’s loan was classified as category C for impact on indigenous peoples. No involuntary resettlement of indigenous peoples has resulted from Inecobank's activities. ADB’s work quality, for the loan approved and disbursed to Inecobank, is rated satisfactory based on (i) screening, appraisal, and structuring; (ii) monitoring and supervision; and (iii) ADB’s role and contribution. ADB’s lending facility permitted a small institution such as Inecobank to access low-cost debt at the onset of the global financial crisis when funding for such institutions was severely limited. To some extent, the longer tenor of ADB’s loan contributed to better matching of maturities of Inecobank’s assets and liabilities. The large unutilized portion of the MFI facility points to some shortfalls in ADB’s monitoring processes, specifically in the context of utilization of approved limits. Of the original $20 million approved limit under the program, only one loan of $3 million was disbursed to a single recipient. ADB’s additionality is also rated satisfactory. ADB’s loan played a role during the financial crisis in helping Inecobank to maintain its MSME onlending levels. While the size of ADB’s loan was not large, the timing of the loan was helpful to Inecobank because alternate sources of funding, such as short-term deposits or commercial loans, had contracted during the crisis and the costs of such funding began to escalate rapidly. Overall, this report rates ADB’s loan to Inecobank successful. As the project concluded with Inecobank’s full repayment of the loan in September 2012, one of the lessons learned was the need to calibrate the design and monitoring framework during project conceptualization to adequately define and measure the impact and potential benefits of the proposed project on the intermediary bank and its borrowers. The performance targets of the design and monitoring framework applicable to ADB’s loan to Inecobank could have been adjusted to realistically account for the small size of the loan, its specific purpose, and the loan duration. ADB has recently approved a proposal to continue supporting Inecobank through a $10 million senior unsecured 5-year loan for MSME onlending. This new facility draws from the satisfactory experience of the previous loan to Inecobank and ADB’s first nonsovereign exposure in Armenia. The new loan will strengthen both ADB’s relationship with Inecobank and ADB’s private sector development agenda in Central and West Asia.

I. THE PROJECT

A. Project Background 1. In October 2007, the Board of Directors of the Asian Development Bank (ADB) approved a regional loan and guarantee facility of up to $20 million to microfinance institutions (MFIs) and small-business banks (SBBs) in ADB’s developing member countries in Central and West Asia.1 The program aimed to provide wider access to debt financing for MFIs and SBBs, which have limited access to funds from commercial lenders because of perceived risks associated with their operations. The project initially identified a $1.5 million loan to Bank Eskhata in Tajikistan, a $3.0 million loan to Inecobank Closed Joint Stock Company (Inecobank) in Armenia, and a $3.5 million loan to Ineximbank in the Kyrgyz Republic. These three institutions were the first among various institutions to be chosen under the MFI loan and guarantee facility. 2. ADB’s MFI facility was structured in a scalable manner to support ADB’s microfinance development strategy, which includes developing financial infrastructure and building viable financial institutions.2 The nature of individual transactions necessitated the disbursement of multiple smaller-scale loans, of a standardized structure, under one program facility. As ADB had little experience working with financial institutions of this size, and it would be the first time that ADB would lend directly to MFIs in Central and West Asia, it was prudent at the time to create a balanced portfolio of small loans. In August 2008, ADB disbursed its first loan under the facility to Inecobank for onlending to micro, small, and medium-sized enterprises (MSMEs) in Armenia.

3. The scope of this report covers only a review of ADB’s loan to Inecobank. Bank Eskhata decided not to avail itself of the proposed $1.5 million loan because of the negative impact of the global financial crisis of 2008–2009 on its lending activities. The proposed $3.5 million loan to Ineximbank was put on hold because further due diligence was required by ADB. Ineximbank was eventually removed as a potential borrower under the MFI facility, with the intention that ADB would initiate a separate transaction comprising both debt and equity.

B. Key Project Features

4. ADB’s MFI facility was its first nonsovereign lending facility for private sector financial institutions in Central and West Asia. The facility was structured as a program using a portfolio approach, with predefined eligibility criteria, assessment parameters, approval procedures, and subborrower reporting requirements. This approach allowed smaller and creditworthy financial institutions to participate in the program. These institutions may have been excluded for separate or stand-alone facilities, given their smaller borrowing requirements and higher transaction costs.3 5. The program allowed MFIs and SBBs such as Inecobank to avail themselves of longer-tenor loans on favorable terms, with commensurate structural features and covenants to 1 ADB. 2007. Report and Recommendation of the President to the Board of Directors: Proposed Loans and

Guarantees, Micro- and Small Enterprise Financing Facility. Manila. 2 ADB. 2000. Finance for the Poor: Microfinance Development Strategy. Manila 3 The report and recommendation of the President (footnote 2) enumerated the following criteria for a private

financial institution to qualify under the MFI facility: It must be a commercial organization that (i) will use the ADB funding for MSME onlending, (ii) will face a genuine constraint on accessing term loans from commercial sources, (iii) will work with recognized auditors, (iv) has a clear shareholding structure, (v) has (or will develop) acceptable risk management systems and other operational structures, and (vi) has existing investors or creditors that include international finance institutions (IFIs) which demand transparency and information disclosure.

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mitigate risks for ADB.4 The loan to Inecobank had a tenor of 4 years, including a 1-year grace period, and was priced at the London interbank offered rate (LIBOR) plus a credit margin. The loan was disbursed at the onset of the global financial crisis, when access to finance for such institutions was severely limited. An additional feature of the program was that both funded and nonfunded facilities were offered. ADB would provide partial credit guarantees to MFIs and SBBs to cover credit risks on the loans disbursed to their MSME borrowers. This feature was novel in its flexible provisions and was unusual among facilities offered by ADB at that stage. C. Progress Highlights 6. Second only to ACBA Credit Agricole Bank in terms of microfinance lending volume in Armenia, Inecobank remained profitable throughout 2007–2011, even while the Armenian economy was adversely affected by the 2008–2009 global economic crisis.5 After a lending lull in 2009, Inecobank accelerated its lending at an average rate of 52% during 2010–2011, putting a strain on the bank’s capitalization. During this time, the Central Bank of Armenia passed critical regulations as countercyclical measures to ensure sustainable loan growth and strengthen capitalization of the banking system. 6 However, Inecobank’s high net interest margins from its microfinance focus allowed it to generate adequate returns, in line with the risks associated with lending to MSMEs. In 2010, Inecobank was placed among the top three Armenian banks with the highest efficiency ratios.7 7. Inecobank embarked on significant expansion of its branch network to cater to a fast-growing portfolio of retail customers. From just eight branches in 2007, Inecobank expanded its network to 14 branches and one representative office as of the end of 2011, and increased its staff from 250 full-time employees in 2007 to 473 in 2011.

8. In March 2009, Inecobank made its first venture into capital markets through the issuance of AMD2.7 billion worth of corporate bonds, listed on the NASDAQ OMX Armenia stock exchange. The bonds were 50% guaranteed by the United States Agency for International Development and carried an annual yield of 9.5% over maturities of 12–18 months. During 2007–2011, Inecobank expanded its network of international partners, which now includes several international financial institutions (IFIs) and multilateral development banks. 9 This

4 The loan was originally structured as a senior loan secured by Ineco’s loan assets by way of an assignment

agreement. One year before the loan was fully repaid, the assignment agreement was cancelled as ADB’s response to concerns raised by nonsecured lenders of Ineco, who by then accounted for a bigger share of Ineco’s creditors.

5 Mix Market. 2011. Microfinance in Armenia: Country Profile. http://www.mixmarket.org. 6 The Central Bank of Armenia amended Regulation 2 in its Decision N54 on 19 March 2010, which set the limit of

retained earnings that can be included in the calculation of total capital at a maximum of 150% of statutory capital. The central bank also increased the risk weighting on loans denominated in foreign currency to a maximum of 150%.

7 Inecobank’s return on average assets of 4.1% in 2010 was ranked second among comparable banks in Armenia; its return on average equity of 19.2% was ranked third. Source: Bankscope. Bureau van Dijk Electronic Publishing.

9 These include: Asian Development Bank, Austrian Development Bank, Black Sea Trade Development Bank, European Bank for Reconstruction and Development, German Investment Corporation, International Finance Corporation, OPEC Fund for International Development and the United States Agency for International Development, as well as international investors such as Blue Orchard, Developing World Markets, PlaNet Finance Group, responsAbility Global Microfinance and Symbiotics Group. Further, in 2012 Ineco obtained funding from the European Fund for Southeast Europe, Green for Growth Fund, and Habitat for Humanity.

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development increased the proportion of its unsecured debt to total debt, which in turn allowed Inecobank to augment its borrowing from the financial markets as it had adequate capital that could be leveraged.

II. EVALUATION A. Project Rationale and Objectives 9. A significant part of business activity in Armenia is in the MSME industry, forming an important economic base for employment generation. While the need for MSME financing is immense, access to finance is constrained by the reluctance of banks to extend financial support to such entities, stemming from insufficient understanding of this segment of borrowers, and the perceived risks regarding the business environment in which MSMEs operate (footnote 1). In addition, the high cost and administrative burden of MSME lending limits the participation of banks in short-term working capital loans and collateral-based loans to such borrowers. Lack of access to conventional finance is one of the main hurdles in sustaining MSME growth. MFIs and SBBs play a role in filling this gap but are constrained by their own limited financing sources. ADB’s MFI facility was intended to provide direct financial support to these institutions, or encourage commercial lenders to extend funding to them, by providing them with partial credit guarantees. 10. MFIs and SBBs also face a mismatch in the maturities of their assets and liabilities. The long-term nature of ADB’s MFI facility was intended to help address maturity gaps faced by these lenders. The program had intended to establish a portfolio of borrowers to achieve economies of scale and risk diversification. However, the loan to Inecobank was the only loan to eventuate under the MFI facility. Notwithstanding this outcome, the loan to Inecobank remained aligned with ADB’s microfinance development objectives and demonstrated the program’s viability in developing MFIs that would promote the commercialization of microfinance services (footnote 3). B. Development Impact 11. The development impact of the investment is rated satisfactory based on the parameters of (i) private sector development; (ii) business success; (iii) economic sustainability; and (iv) environmental, social, health, and safety aspects.

1. Private Sector Development

a. Overall Assessment of Private Sector Development 12. The overall assessment of private sector development of ADB’s loan to Inecobank is rated satisfactory. The loan was successful in terms of helping Inecobank extend additional loans at moderately long tenors to its borrowers. The cumulative effect of the ADB loan and financial support provided by various IFIs and foreign lenders contributed in some measure towards helping Inecobank sustain growth, enhance its lending activities, and expand its reach into other areas of Armenia. However, a precise assessment of the incremental effect of ADB’s loan is not feasible, given its small size in the context of Inecobank’s balance sheet and overlapping benefits of similar facilities from other institutions during the same period.

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b. Beyond Company Impact

13. Due to Inecobank’s participation in multiple IFI lending and assistance programs (footnote 9), as well as its debut bond offering in 2009, it is not feasible to isolate the impact of ADB’s loan on Inecobank and its borrowers. As this was ADB’s first private sector loan in Central and West Asia, and because it was a loan of limited size to an unconventional borrower, ADB replicated the prevalent structure of loans raised by Inecobank from other IFIs. This helped simplify the transaction structure and accelerate the processing of the loan for both Inecobank and ADB. This also added to the cumulative development impact of ADB’s loan, in conjunction with other IFI lending platforms, on Armenian MFIs and SBBs as well as MSMEs.

14. Armenian financial institutions rely mostly on foreign borrowings to support growth in lending because of the limited size of domestic deposit markets. ADB’s loan comprised about 10% of Inecobank’s long-term borrowings as of 2007. Following the financial crisis of 2008–2009, Inecobank’s prudently managed MSME lending business and strong financial performance allowed it to increase its borrowings from other financial institutions. While the success of Inecobank’s MSME lending cannot be attributed entirely to ADB’s loan, Inecobank’s performance, along with that of the Armenian banking industry in general, attracted more investors to the market, as shown by the significant rise in the industry’s debt–gross domestic product (GDP) ratio and foreign equity participation in the banking system’s capital.10

15. Inecobank’s stable operating performance allowed it to double the volume of debt raised from financial institutions during 2008–2011, a trend which also matched credit growth in Armenia’s banking industry (Appendix 3, Chart A3.3). This trend, however, was not directly linked to ADB’s intervention as it aggregated all the IFI loans raised by Inecobank and other Armenian banks in that period. Inecobank, through easier access to funding from IFIs, was able to establish its presence in areas outside the capital city of Yerevan, where it previously had none (e.g., Charentsavan, Ashtarak, and Vanadzor). Inecobank’s market expansion made financial services available to MSME borrowers and potentially created downstream effects such as additional investment and employment.

c. Direct Company Impact

16. At the time of ADB’s loan disbursal to Inecobank in August 2008, the global financial crisis was in its incipient stages. Lending activity in Armenia had become muted and selective because of market uncertainties and, like many Armenian banks, Inecobank had been cautious to lend during 2008–2009. Inecobank’s lending remained flat in 2008–2009 (Appendix 1, Figure A1.1), in line with the trends of the Armenian banking industry (Appendix 3, Figure A3.3). The high dollarization of loan accounts on Inecobank’s balance sheet also heightened its vulnerability to currency-induced credit risk during this volatile period.11

17. Inecobank’s long-term borrowings declined by AMD2.8 billion, or 20%, during 2008–2009 (Appendix 4). Because of rapid depreciation of the dram during 2009 (Appendix 3, Figure A3.1) the decrease in long-term borrowings represented a decline in US dollar terms of one-third, from $45 million to $30 million. ADB’s long-term loan of $3 million, which was priced based on the intrinsic risks of Inecobank and did not reflect short-term crises-induced aberrations,

10 The Central Bank of Armenia reported that the banking system’s total debt–GDP ratio increased from 15% to 32%

during 2007–2011, while the ratio of foreign participation in Armenian banking capital rose from 58% to 75% during the same period. Central Bank of Armenia. 2012. Financial Stability Report 2011. Yerevan.

11 The dram depreciated by about 18% in early March 2009 when the Central Bank of Armenia stopped supporting the currency to defend pressures on foreign exchange reserves.

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played a role in helping Inecobank to maintain its lending levels of 2008. While the volume of ADB’s loan was not significant, the value in terms of timing was noteworthy, as alternate sources of funding such as short-term deposits and commercial loans began to contract during the crisis.

18. Inecobank’s lending growth resumed in 2010 as the effects of the crisis began to wane. Its loan portfolio rapidly accelerated, with the volume of loans to small and medium-sized enterprises (SMEs) nearly quadrupling during 2008–2011 (Appendix 1, Figure A1.1). With limited deposit markets in Armenia to fund portfolio growth, Inecobank and other Armenian banks relied heavily on overseas funding to fill this gap. For this purpose, ADB and other IFIs provided direct financial support to help expand Inecobank’s MSME portfolio. During this time, Inecobank expanded its lending activities and introduced new products—such as uncollateralized microloans with third-party guarantee and credit lines, and “point-of-sale” loans to MSMEs—to capture additional market share.

19. Competition for deposits remains tight in Armenia, given the widespread coverage of banks offering these services, resulting in deposits becoming a somewhat more expensive source of financing. 12 Inecobank maintains program-specific and general purpose lending 13 relationships with a large network of IFIs (footnote 9), providing it with access to a lower-cost source of long-term funding, as compared to deposits. While Inecobank’s sound reputation and growth cannot be credited solely to ADB, the presence of IFIs, including ADB, has complemented Inecobank’s strategy of increasing its loan book through superior pricing and flexible lending terms. Because of its external funding sources, Inecobank’s loan portfolio grew at a compounded annual growth rate (CAGR) of 32% during 2007–2011, matching overall bank deposit growth in the economy (Appendix 3, Figure A3.3). During this time, Inecobank’s market share of deposits remained at 3% of the Armenian banking industry, which highlights the contribution of IFIs as a prominent source of funding for its expanding loan portfolio.

20. ADB’s loan had other potential beneficial effects for Inecobank. The loan helped Inecobank narrow the gap between the tenor of its assets and liabilities, though the impact is not significant given the small size of the facility. In 2008, the average tenor of Inecobank’s loan portfolio was less than the ADB’s loan term of 4 years, including a grace period of 1 year. In addition, ADB and the loan covenants of other IFIs have improved Inecobank’s corporate governance standards by improving disclosure, transparency, and compliance with best practices and standards.

2. Business Success

21. Inecobank’s business success is rated excellent, and its financial performance has been robust during 2007–2011. The bank’s total assets grew at a CAGR of 25.1%, while net interest income increased 2.4 times from AMD2.1 billion to AMD5.1 billion during the same period. Despite increasing competition, Inecobank maintained a healthy net interest margin during 2007–2011. With total assets of AMD87.3 billion in 2011, Inecobank is competitively positioned 12 In addition, Armenian civil law allows term deposits to be withdrawn prior to maturity without penalty to the

depositor. 13 Program-based assistance from international lenders is geared towards specific projects. For example, in 2012

Habitat for Humanity provided a loan of AMD11 million to Ineco to introduce housing renovation loans to support 200 low-income families living in multi-apartment buildings. In the same year, the Green for Growth Fund provided a $10 million loan for an energy efficient lending program, combined with technical assistance from the fund. In 2010, the International Finance Corporation released $700,000 of performance-based grants to Ineco. These grants are structured in tranches, whereby microfinance institutions are rewarded for achieving specific development targets.

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as the second-largest microfinance lender in Armenia after ACBA Credit Agricole Bank, a large financial institution with strong rural and microfinance networks (footnote 5). In 2011 Inecobank’s loan portfolio increased at a CAGR of 32.3% from AMD20.3 billion in 2007 to AMD62.2 billion, despite a brief hiatus in lending during the financial crisis.

22. Overall, Inecobank is a successful case study of MSME-focused banking in a developing country that has attracted the attention of many international development organizations. It is well regarded in the market and its relationships with various IFIs have helped it to mitigate the impact of the 2008–2009 financial crisis and optimize its cost structure with low-cost funding, while being able to lend at commercial rates. Inecobank has capitalized on the demand for loans by MSMEs. Its consistent earnings have enabled it to build its capital, while complying with the Armenian central bank’s regulation on eligibility of retained earnings to be included as Tier 1 capital (footnote 6). During 2007–2011, Inecobank’s share capital grew significantly at a CAGR of 49.5%.

3. Economic Sustainability 23. Economic return on invested capital. The excellent rating is exemplified in Inecobank’s lending mix. In 2007, retail customers accounted for almost 59% of Inecobank’s loans, whereas SMEs comprised 29% (Appendix 1, Figure A1.1). By 2011, these numbers had reversed—retail loans were only 32% and SMEs accounted for 56% of Inecobank’s lending. Including larger corporate borrowers, Inecobank’s business lending accounted for 68% of its portfolio in 2011. In comparative terms, Inecobank’s retail portfolio grew at an annual rate of 13.5% between 2007 and 2011, whereas SME and corporate lending grew at 50.0% per year over the same period. The shift away from consumption-based retail lending towards productive business lending is expected to contribute towards a more sustained economic impact.

4. Environmental, Social, Health, and Safety Performance

24. The project’s environmental, social, health, and safety performance is rated satisfactory. ADB’s loan was classified category Fl under ADB's Environment Policy (2002) and category C under its Involuntary Resettlement Policy (1995) and Policy on Indigenous Peoples (1998).14 In the pursuant loan agreement, Inecobank committed to (i) establish, implement, and operate an environmental management system (EMS) that is satisfactory to ADB in accordance with the procedures and guidelines of ADB; and (ii) submit annual environmental and social monitoring reports to ADB. Inecobank has complied with these conditions.15 Inecobank also certified that the subloans extended under ADB’s loan during 2008–2011 were in compliance with national laws and all applicable requirements, there were no significant environmental and social issues arising as a result of Inecobank’s financing, and all subprojects maintained compliance with safety regulations. 16 Inecobank has established an environmental and social management system that was designed and aligned with the social and environmental requirements of the Armenian government and IFI standards (Appendix 5).

14 A project categorized FI involves a credit line or an equity investment to a financial intermediary, where an

environmental management system is required unless all subprojects will result in insignificant environmental impact. Category C means the project did not result in any involuntary resettlement or impact on indigenous peoples.

15 The signed copy of the annual environmental and social monitoring report for 2010 was submitted in May 2013. 16 The signed certificate of compliance was submitted in May 2013.

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C. ADB Investment Profitability

27. ADB’s investment profitability is rated satisfactory. ADB’s loan to Inecobank was priced at the 6-month London interbank offered rate (LIBOR) plus a credit margin, with a tenor of 4 years. The pricing was benchmarked against various US dollar loans extended to Inecobank during 2006–2007 by IFIs.

28. Inecobank’s loan has been paid down as per schedule, with the final payment received in September 2012.

D. ADB Work Quality

29. ADB’s work quality is rated satisfactory based on its (i) screening, appraisal, and structuring of the project; (ii) monitoring and supervision; and (iii) role and contribution.

1. Screening, Appraisal, and Structuring of the Project

30. ADB’s work in screening, appraisal, and structuring the loan to Inecobank is rated satisfactory. ADB’s lending program under the MFI facility was its first nonsovereign facility for private sector financial institutions in Central and West Asia. The facility was structured as a program to include smaller financial institutions such as Inecobank, which have much smaller capital bases and borrowing requirements and were not appropriately positioned for stand-alone credit facilities. The MFI facility was aligned with ADB’s Microfinance Development Strategy, where loans similar to that to Inecobank could be replicated to other small banks as a means to improve MFI access to institutional financing, and as an effective strategy to reduce poverty (footnote 2). The structuring also provided for both funded and nonfunded (partial credit guarantee) facilities.

31. Prior to project conceptualization, Inecobank was already a recipient of both equity investments from private equity funds and loans from IFIs. Inecobank was an investee of ShoreCap International, where ADB committed $2.5 million in equity investments in 2004.17 ADB’s indirect investment in Inecobank, through ShoreCap International, facilitated the flow of information to ADB through periodic monitoring of portfolio investments. This process provided ADB with information including the financial, operational, and management profile of Inecobank as a commercially viable and sustainable bank, which would qualify Inecobank as a borrower under the parameters set forth during the concept clearance stage.

2. Monitoring and Supervision

32. ADB’s monitoring and supervision is rated satisfactory. The Private Sector Operations Department has regularly monitored Inecobank’s business and financial performance through quarterly covenant compliance reports and borrower end-use reporting requirements from Inecobank. There were, however, some delays in receipt of reports relating to environmental and social compliance.

33. The large unutilized portion of the MFI facility points to some shortfalls in ADB’s monitoring processes. Of the original $20 million approved under the program, only one loan of $3 million was disbursed to a single recipient. This reduced the potential impact envisaged when the facility was structured and approved, and represents a lost opportunity in terms of 17 ADB. 2004. Report and Recommendation of the President to the Board of Directors: Proposed Equity Investment in

Shorecap International, Ltd. Manila.

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efficient utilization of capital and resources. At the same time, it increased ADB’s risks since the diversity across borrowers and countries that was envisioned during project conceptualization was not achieved. The monitoring processes adopted by the Private Sector Operations Department have been realigned subsequently to track utilization of such program-based limits.

3. ADB’s Role and Contribution

34. ADB’s role and contribution is rated satisfactory. ADB replicated the prevalent structure of loans raised by Inecobank from other IFIs as a measure of risk mitigation and enhancing efficiency as the loan was small, it was to a new class of borrowers, and it was ADB’s first nonsovereign loan in Central and West Asia. The replication was acceptable practice from a risk management perspective. It also accelerated loan negotiation and processing, which reduced transaction costs and facilitated speedier access to long-term funding for both Inecobank and its MSME subborrowers. Under the prevailing circumstances, the contribution made by ADB through this loan facility was important. To some extent, the longer-term tenor of ADB’s loan also contributed to better matching of maturities of Inecobank’s assets and liabilities.

E. ADB’s Additionality

35. ADB’s loan of $3 million played a role in helping Inecobank to continue its onlending to MSMEs. While the ADB loan was not large, the timing of it was helpful to Inecobank, as alternate sources of funding such as short-term deposits or commercial loans began to contract during the global financial crisis, and the costs of such funding began to escalate.

F. Overall Evaluation

36. ADB’s loan to Inecobank is rated satisfactory overall (see table).

Evaluation of the Senior Unsecured Loan to Inecobank Closed Joint Stock Company

Item Unsatisfactory Less than

Satisfactory Satisfactory Excellent A. Development Impact √ 1. Private sector development √ 2. Business success √ 3. Economic sustainability √ 4. Environment, social, health, and

safety √

B. ADB Investment Profitability √ C. ADB Work Quality √ 1. Screening, appraisal, and structuring √ 2. Monitoring and supervision √ 3. ADB's role and contribution √ D. ADB's Additionality √

Overall Rating Successful

ADB = Asian Development Bank.

III. ISSUES, LESSONS, AND RECOMMENDED FOLLOW-UP ACTIONS

A. Issues and Lessons

37. Lending to microfinance institutions as a strategy. ADB had envisioned that the MFI facility would be scalable, and it would generate a portfolio of MFIs and SBBs across several

9

countries. The small individual loan size ($1.5 million−$3.5 million) was premised on the fact that the MFI facility was untested and ADB had little experience working directly with nondiversified financial institutions in Central and West Asia. As the Inecobank loan progressed towards maturity, it became evident that a well-managed MFI can be resilient and perform well despite difficult economic conditions. Inecobank exemplified this through its robust financial performance and continued expansion of MSME lending activities during 2007–2011, notwithstanding the difficult operating environment created by the global financial crisis. ADB should continue to support small and medium-sized banks such as Inecobank, either through larger stand-alone engagements to optimize monitoring and administration costs, or under a program approach where small transactions are aggregated and utilization under the program is adequately monitored.

38. Objectives scaled to loan size. For program facilities that involve multiple borrowers and small loan amounts for each entity, there is a need to more finely calibrate the design and monitoring framework at concept clearance stage so as to adequately define and measure the impact and potential benefits of the proposed project. In the case of Inecobank, the performance targets and/or indicators of the design and monitoring framework applicable to the loan could have been adjusted to account for the small size of the loan.

B. Recommended Follow-Up Actions

39. Inecobank has continued to grow and expand its MSME lending activities. It has demonstrated a strong track record in MSME lending and a long-term commitment to MSMEs, both in its business strategy and in its lending operations. In December 2012, ADB’s Board approved a proposal to continue supporting Inecobank through a $10 million senior unsecured 5-year loan for MSME onlending, which will strengthen both ADB’s relationship with Inecobank and ADB’s private sector development agenda in Central and West Asia.

10 Appendix 1

PROJECT-RELATED DATA

Table A1.1: Inecobank Financial Highlights, 2007–2011

Indicator 2007 2008 2009 2010 2011

Gross Loans (AMD million) 20,600 27,530 27,383 39,281 63,618

Total Assets (AMD million) 35,597 45,315 48,757 58,683 87,230

Total Liabilities (AMD million) 28,497 36,076 37,968 45,906 72,231

Shareholders' Equity (AMD million) 7,100 9,239 10,789 12,777 14,999

Net Income (AMD million) 1,192 1,728 1,075 2,170 2,603

Gross NPL Ratio per Inecobank (%) 2.8 5.7 4.7 3.3 2.2

Return on Average Total Assets (%) 4.2 4.3 2.3 4.0 3.6

Return on Average Equity (%) 17.8 21.2 10.7 18.4 18.7

NPL = nonperforming loan. Source: Inecobank, Asian Development Bank.

Figure A1.1: Inecobank’s Loan Portfolio, 2007–2011*

12,115 14,36911,351

15,10120,091

5,879

9,07310,440

20,690

35,400

2,608

4,089 5,592

3,489

8,127

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

2007 2008 2009 2010 2011

AM

D m

illion

Corporate

SME

Retail

27,530 27,383

39,281

63,618

20,600

* Figures may not sum up due to rounding differences SME = small and medium-sized enterprise Source: Inecobank Audited Financial Statements 2007–2011

Appendix 2 11

PRIVATE SECTOR DEVELOPMENT INDICATORS AND RATINGS – FINANCIAL INTERMEDIARIES

Indicators Ratings

a Justifications

Monitoring indicators can be partly derived from RRPs. Several indicators are essentially judgmental. Their use and ratings should consider the operating context and ADB aims, strategies, and project proportions.

1. Beyond Intermediary and Subborrower Impacts

1.1 Private sector expansion and institutional impact 1.1.1. Contributes to an increased private sector share

and role in the economy, and to sustainable jobs or self-employment

1.1.2. Contributes to expanded SME lending with good portfolio and subborrower performance

1.1.3. Contributes to institutional change by (i) improving supply and access generally to formal credit and banking service to SMEs (ii) influencing a more enabling environment for SMEs via lobby activity, policy dialogue, or otherwise in which the bank(s) become more engaged

Satisfactory The loan is rated satisfactory for private sector development because the loan contributed to signaling confidence in the Armenian banking system as well as the response measures of the government during the 2008–2009 global financial crisis. ADB’s loan, in conjunction with other IFI loans, contributed towards the growth and expansion of Inecobank’s MSME loan portfolio and MSME lending activities.

1.2. Competition. Contributes to new competition for SME business among local banks (including new product and service offerings and local currency products) and/or contribution to increased competition in key subborrower markets

Satisfactory Inecobank is well-known in the market for • high-quality customer service; • flexible approach; and • fast turnaround time.

1.3. Innovation. Contributes to new ways of offering effective banking services to SMEs (including new products, services, and technologies) in ways that are replicated by other banks and in the financial system (item 2.2)

Satisfactory Inecobank is well known in the market for continuous innovation and quick time-to-market to offer new products that cater to its customers’ evolving needs.

1.4. Linkages. Contributes to local savings and deposits mobilization via networks of participating bank(s), and/or relative to size of subportfolios; contribution to notable upstream or downstream link effects to subborrowers’ businesses in their industries or the economy

Not Applicable According to Inecobank, because of the strong brand name and reputation of ADB, having ADB as one of its IFI partners has supported Inecobank’s access to additional international funding, though this impact is difficult to quantify. The loan may have contributed towards increasing the confidence of Inecobank’s depositors and, indirectly, contributed towards Inecobank’s portfolio and lending growth.

1.5. Catalytic element. Contributes to mobilization of other local or international financing to SMEs, and to positive demonstration to market providers of debt and risk capital to SMEs

Satisfactory Inecobank’s total loans from IFIs increased significantly during 2007–2011.

1.6. Affected laws, frameworks, regulation. Contributes to improved laws, regulation, and inspection affecting formal SME banks and banking services to SMEs in the local financial system

Not Applicable The loan is too small to have impact on laws, frameworks, and regulation.

1.7. Wider demonstration of new standards. Contributes to raised standards in the finance sector or in subborrower industries and sectors in corporate governance, transparency, and stakeholder relations

Not Applicable There is no evidence that the loan had impact on wider demonstration of new standards.

12 Appendix 2

Indicators Ratingsa Justifications

2. Participant Banks and Subborrower Impacts

2.1. Skills with wider impact potential. Contributes (i) to improved SME credit approach at all stages in the participant bank(s) in ways that will be replicated by other providers of SME finance and banking service; and (ii) via the participating bank(s) to improved subborrower skills in operation of their businesses, e.g., via good appraisal and monitoring by the bank(s)

Satisfactory Inecobank’s strong financial performance, healthy interest margins, and moderately low level of nonperforming loans provide a good example that MSME lending can be attractive, and may have encouraged other market players to enter the market or increase their lending activities to MSMEs. In addition, during 2007–2011, Inecobank continuously invested resources to expand its MSME lending activities. The loan provided by ADB played a limited but important role in Inecobank’s funding strategy and, therefore, contributed to development of MSME lending in Armenia.

2.2 Demonstration and new standards-setting potential. Demonstrates potential through improved and achieved standards in corporate governance and transparency, stakeholder relations, and ESHS spheres

Not Applicable The loan is too small to have impact on demonstration and new standards-setting potential.

Overall Rating Satisfactory

ADB = Asian Development Bank; ESHS = environmental, social, health, and safety; IFI = international financial institution; MSME = micro, small, and medium-sized enterprise; SME = small and medium-sized enterprise; PSD = private sector development; RRP = report and recommendation of the President. a Ratings scale: excellent, satisfactory, partly satisfactory, unsatisfactory. The rating is not an arithmetic mean of the individual indicator ratings, which have no fixed weights. Source: ADB, Inecobank. 2012. Inecobank CJSC Extended Annual Review Questionnaire. Yerevan.

Appendix 3 13

ECONOMIC AND BANKING SECTOR OVERVIEW A. ARMENIA ECONOMIC OVERVIEW

1. Armenia was one of the countries hardest hit by the 2008–2009 global economic crisis.1 The Central Bank of Armenia was forced to devalue the dram by 18.0% in March 2009, which was followed by a 14.1% contraction in the Armenian economy in 2009.2

Figure A3.1: Exchange Rate: Armenia

290.

310.

330.

350.

370.

390.

410.

1/2007 1/2008 1/2009 1/2010 1/2011 1/2012

AM

D /

US

D

AMD per USD (inverted scale)

Source: Bloomberg.

2. While the economy stabilized in 2010, the impact of the global economic crisis was still being felt throughout the country in 2012.3 The percentage of the population living under the national poverty line increased from 27.6% in 2008 to 35.8% in 2010.4 Although Armenia’s registered unemployment rate was 6.2% as of the end of 2011, the actual unemployment rate was estimated to be 18.4% as of the end of 2011 and 20.9% as of March 2012.5

Figure A3.2: Selected Economic Indicators for Armenia

-20

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GDP growth (annual %, right scale)

GDP = gross domestic product. Source: World Bank.

1 World Bank. 2010. The 2008–09 Global Economic Crisis, Policy Responses and Household Coping Strategies.

Washington, DC. 2 ADB. 2011. Country Operations Business Plan: Armenia, 2012–2013. Manila. 3 Economist Intelligence Unit (EIU). 2012. EIU Country Report: Armenia. London. May. 4 World Bank. http://data.worldbank.org/. Extracted 25 June 2012. 5 National Statistical Service of the Republic of Armenia. http://www.armstat.am/en//. Extracted 25 June 2012.

AMD per US$ (Inverted Scale)

AM

D/U

S$

US

$ B

illi

on

Appendix 3

14

3. The Armenian economy began recovering in 2010. Real gross domestic product (GDP) grew by 2.1% in 2010 and more strongly (4.7%) in 2011.6 The economy is expected to continue to strengthen, albeit at a slower pace, primarily because of weak economic prospects in Europe (which accounts for about 60% of exports) and the possible spillover to the Russian Federation (which accounts for 80% of remittances).7 Softer global demand for commodities may also adversely impact Armenian exports (mineral products and base metals accounted for 57.4% of exports as of the end of 2011) (footnote 3). Real GDP is forecast to grow at 3.8% in 2012 and 4.0% in 2013.8 4. Although the Armenian economy is gradually improving, the 2008–2009 global economic crisis has highlighted certain vulnerabilities. The economy is constrained by the small population (3.27 million) and its undiversified structure that is heavily reliant on commodities and remittances from abroad.9 Geopolitical risks simmer from the long, unresolved tensions that the landlocked nation has with neighboring Azerbaijan and Turkey (footnote 3). Armenia also suffers from weak institutions and high corruption levels—the country was ranked 129 out of 182 on the Transparency International Corruption Perception Index in 2011.10 B. BANKING SECTOR OVERVIEW 5. The Central Bank of Armenia is the regulator and supervisor of the finance sector in Armenia, which includes commercial banks, credit organizations, insurance companies and brokerages, foreign currency dealer and exchange agents, money transfer companies, and payment organizations. The banking system is the largest player in the finance sector and accounted for 91.0% of financial system assets as of the end of 2011 (in 2010 the figure was 91.9%). In 2011, the bank assets–GDP ratio increased by 9.1 percentage points from 45.0% as of the end to 2010 to 54.1% as of the end of 2011, which is significantly above the 2008 figure of 28.0% and indicates marked improvement in the level of financial intermediation of the banking system. However, domestic credit to the private sector (as a percentage of GDP) in Armenia was 33.1% as of the end of 2011, which is lower than the 46.9% reported in other developing countries in Europe and Central Asia, indicating that Armenia still lags behind its peers in terms of financial intermediation.11 6. As of the end of 2011, there were 21 commercial banks (with 442 branch offices) in Armenia.12 Foreign ownership is the norm for Armenian banks, with 74% of the banking system owned by nonresidents and 17 out of 21 banks controlled by foreign entities. The top four banks account for 38% of banking system assets and the top 10 banks for 75% as of the end of 2010. No single bank holds more than a 13% asset market share.13 7. The Armenian banking sector is characterized by increasing competition, interest margin compression, and industry consolidation.14 During 2011, total loans grew strongly (33.7%) from AMD959.1 million as of the end of 2010 to AMD1.27 billion as of the end of 2011 (2010 loan growth was 26.6%). Total deposits grew by 34.4% from AMD761.5 million as of the end of 2010 6 ADB. 2012. Asian Development Outlook 2012. Manila; Economist Intelligence Unit (footnote 3). 7 ADB (footnote 6). 8 International Monetary Fund. 2012. IMF World Economic Outlook. Washington, DC. 9 Sources include ADB. 2012. Asian Development Bank and Armenia: Factsheet. Manila; Economist Intelligence Unit

(footnote 3); Moodys. 2011. Moody’s Credit Opinion: Armenia, Government of. November. 10 Transparency International. 2011. Corruption Perception Index 2011. Berlin. 11 World Bank. http://data.worldbank.org/indicator/FS.AST.PRVT.GD.ZS. Extracted 25 July 2012. 12 Central Bank of Armenia. March 2012. Annual Report 2011. Yerevan. 13 ADB. 2012. Trade Finance Program (TFP): Armenia Country Report. Manila. 14 Inecobank Closed Joint Stock Company. 2012. Program of Perspective Development for 2012–2014. Yerevan.

Appendix 3 15

to AMD1.02 billion as of the end of 2011 (2010 deposit growth was 18.6%). The composition of the deposits and loans of commercial banks reflects the dollarized nature of the Armenian economy. As of the end of 2011, 30.2% of deposits (and 39.0% of loans) were denominated in dram, while 69.8% of deposits (and 61.0% of loans) were denominated in foreign currency. The largest economic sector concentrations were trade (23.0% of total loans), industry (22.4%), consumer loans (18.1%), mortgage loans (9.2%), construction (8.2%), agriculture (6.2%), and services (4.8%). The strongest loan growth rates were posted in communications (65.7% in 2011 and 66.3% in 2010), trade (49.2% in 2011 and 27.0% in 2010), services (41.4% in 2011 and 36.2% in 2010) and agriculture (40.2% in 2011 and 18.5% in 2010).15

Figure A3.3: Selected Financial Market Indicators for Armenia

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Net domestic credit (AMD billions, left scale)

Domestic credit provided by banking sector (% of GDP, right scale)

Bank liquid reserves to bank assets ratio (%, right scale)

GDP = gross domestic product. Source: World Bank.

8. During 2011, asset quality in the banking system declined as banks competed for loans. The ratio of sector-wide nonperforming loans to total gross loans increased to 4.9% as of November 2011 from 3.0% as of the end of 2010 (the 2009 figure was 4.9%). Profitability of the banking system also declined during 2011 because of increased competition amongst banks for loans, and margin compression as lending rates generally fell amidst rising deposit rates. Return on assets fell to 1.8% as of the end of 2011, compared to 2.8% as of the end of 2010 and 1.0% in 2009. Return on equity fell to 12.0% as of the end of 2011, compared to 12.3% as of the end of 2010 and 4.8% in 2009. Liquidity in the banking system remains strong: liquid assets–total assets was 28% as of November 2011, and liquid assets–short-term demand liabilities was 122.7% as of November 2011 (footnote 15). 9. Sector-wide capital adequacy ratios (CARs) declined in 2011 amidst robust loan growth. However, the banking system remains well capitalized. The total regulatory capital–risk-weighted assets ratio (total CAR) was 18.6% as of November 2011, compared to 22.2% as of the end of 2010 and 28.4% in 2009. The regulatory Tier 1 capital–risk-weighted assets ratio (Tier 1 CAR) was 16.9% as of November 2011, compared to 20.2% as of the end of 2010 and 26.7% in 2009 (footnote 15).

15 Central Bank of Armenia. 2011. Financial Stability Report 1H2011. Yerevan. August; Central Bank of Armenia.

Armenian Core FSI Indicators (http://www.cba.am/en/). Extracted 15 July 2012; Central Bank of Armenia (footnote 12).

Appendix 3

16

C. SMALL AND MEDIUM-SIZED ENTERPRISE SECTOR OVERVIEW 10. A small or medium-sized enterprise (SME) is legally defined in Armenia as a legal entity or a private entrepreneur that employs a maximum of 250 people and meets one of the following two criteria: (i) total assets as of the end of the previous year do not exceed AMD1.0 billion, or (ii) profit for the previous year does not exceed AMD1.5 billion. 11. SMEs play an integral role in the Armenian economy. They contributed to 42.5% of GDP and 42.2% of employment in 2009, when there were 132,923 SMEs accounting for 97.7% of the registered legal entities and sole proprietors in Armenia. In terms of geographic concentration, 46.5% of SMEs were located in Yerevan and 53.5% were located in the marzes (regions) outside Yerevan.16 SMEs were most active in domestic trade, agriculture food processing, and industry, followed by transport and communication and services. Relative to large enterprises, SMEs contributed to a small share of foreign trade and 17.7% of exports in 2009.17 12. Access to finance is the greatest obstacle for Armenian SMEs.18 The challenges in this area include high financing rates, lack of medium- to long-term loans, collateral and guarantee requirements, and complicated loan application procedures. In addition, seed financing and/or start-up capital is nonexistent in Armenia. The lack of access to finance is felt even more sharply by SMEs in rural provinces because commercial banks charge these SMEs financing rates that are several percentage points higher than those based in Yerevan. 19 Additional challenges include a lack of business development and marketing skills, ambiguities in some licensing regimes, and a lack of transparency and financial literacy.20 Armenian SMEs also tend to suffer from high input, transaction, and investment costs.

16 SME Development National Center of Armenia. 2010. SME Sector in Armenia 2007–2009. Yerevan 17 SME Development National Center of Armenia. (footnote 16); SME Development National Center of Armenia.

http://www.smednc.am. Extracted 25 June 2012. 18 World Bank. 2011. Supporting SME Development in Armenia. Washington, DC. 19 American Chamber of Commerce in Armenia. 2011. The Armenian Face of Small and Medium Business. Yerevan. 20 World Bank. 2011. Supporting SME Development in Armenia. Washington, DC.

Appendix 4 17

COMPARATIVE FINANCIAL STATEMENTS, 2007–2011 (AMD million)

Balance Sheet 2007 2008 2009 2010 2011

Customer Loans, Net 20,313 26,991 26,726 38,383 62,254 Other Earning Assets 8,040 9,462 12,220 10,250 10,919 Fixed Assets, Net 2,751 3,561 3,494 3,731 3,957 Other Non-earning Assets 4,493 5,301 6,317 6,318 10,100 TOTAL ASSETS 35,597 45,315 48,757 58,683 87,230 Total Deposits & Money Market Funding 15,002 14,346 17,933 20,355 29,503 Other Liabilities 1,113 1,376 750 1,314 1,375 Other Money-Market Funding 1,645 6,588 8,310 4,328 9,192 Long-term borrowings: 10,738 13,767 10,974 19,909 32,161 TOTAL LIABILITIES 28,497 36,076 37,968 45,906 72,231 Common Stock (including capital surplus) 2,353 2,353 2,353 4,431 7,894 Retained Earnings 3,473 5,129 6,228 5,511 3,611 Reserves 1,273 1,757 2,208 2,835 3,494 TOTAL EQUITY 7,100 9,239 10,789 12,777 14,999 TOTAL LIABILITIES AND CAPITAL 35,597 45,315 48,757 58,683 87,230

( ) = negative. Source: Inecobank

Profit and Loss Statement 2007 2008 2009 2010 2011 Net interest income 2,097 2,941 2,942 4,139 5,114 Net fee and commission income 583 539 282 576 629 Net total other operating income 419 1,088 680 516 639

Net trading income 428 990 372 424 563 Gains less losses on investments available for sale (2) 2 (1) 0 0 Net other operating income (6) 96 309 92 76

Impairment charge for credit losses (189) (447) (621) (300) (374) Staff and general administrative expenses (1,416) (1,975) (1,908) (2,209) (2,797)

Profit before income tax 1,494 2,145 1,375 2,723 3,212 Income tax expense (302) (417) (300) (553) (609) Profit for the year 1,192 1,728 1,075 2,169 2,603

( ) = negative. Source: Inecobank

Appendix 5

18

ENVIRONMENT AND SOCIAL MANAGEMENT SYSTEM 1. On 6 June 2005, the board of directors of Inecobank Closed Joint Stock Company approved the bank’s environmental management policy (EMP), which provided guidance, procedures, and broad classification of projects with respect to environmental and social impacts of the bank’s lending activities. The EMP was subsequently revised to conform to the requirements of local laws, regulations of the Central Bank of Armenia, and international financial institutions including the International Finance Corporation and European Bank for Reconstruction and Development. In June 2011, the Regulation on Environmental Protection was adopted by Inecobank as part of its EMP. 2. As part of the loan approval process, Inecobank evaluates the borrower’s level of exposure to environmental and social risks, and determines the appropriate measures needed to mitigate risks. Such exposure is determined based on the borrower’s industry classification, loan amount, term, and security. The head of Inecobank’s Credit Department has the overall function of implementing the EMP, along with the bank’s personnel involved in the lending process, who are trained in-house and coached by experts in environmental and social protection.

3. Inecobank adheres to an exclusion list as a means to determine the environmental and social risks of the project. As a rule, a loan is prohibited to projects indicated in the exclusion list which pose environmental hazards and have negative social impacts. Loan applications for projects that are not included in prohibited activities are classified as follows:

(i) High risk: Significant environmental and social impacts, and associated risks require a detailed environmental impact assessment.

(ii) Medium risk: Defined environmental and social impacts, and associated risks are mitigated using standard means.

(iii) Low risk: Insignificant environmental and social impacts.

4. Inecobank’s environmental and social management process starts with a risk assessment of a project proposal. A project is considered low risk if the intrinsic risk elements affecting the environmental and social aspects are insignificant, if the loan does not exceed $100,000, or the maturity period is up to 12 months. These projects do not require an environmental impact assessment but should remain compliant with the applicable environmental and social protection laws and regulations. An environmental impact assessment is required for all projects which are considered medium to high risk and where loans are for more than $100,000. 5. An environmental impact assessment is a comprehensive study of potential environment and social impacts of a proposed project. It will be used as the basis for preparing an environmental and social risk management program (ESRMP). The ESRMP describes the risk mitigation process required of the project for compliance with the laws and regulations of Armenia. For complex high-risk projects, Inecobank may secure the services of environmental and social experts who can assist in the preparation of an environmental impact assessment and ESRMP. Based on the results of environmental and social risk evaluation, Inecobank may decide to (i) include environmental protection clauses in the loan agreement with the borrower; (ii) change the standard terms in the loan agreement with respect to amount, term, and interest rate; or (iii) not approve the loan.

6. Throughout the loan term, Inecobank conducts periodic monitoring of the project with regard to environmental and social impacts and how the borrower maintains its risk mitigation controls in accordance with the agreements embodied in the ESRMP.