ASIAN DEVELOPMENT BANK RRP: PNG 32472

REPORT AND RECOMMENDATION

OF THE

PRESIDENT

TO THE

BOARD OF DIRECTORS

ON A

PROPOSED LOAN

TO THE

INDEPENDENT STATE OF PAPUA NEW GUINEA

FOR THE

MICROFINANCE AND EMPLOYMENT PROJECT

September 2000

CURRENCY EQUIVALENTS(as of 15 September 2000)

Currency Unit – Kina (K)K1.00 = $0.370$1.00 = K2.703

The kina floats freely. For calculations in this report, an exchange rate of K2.5 to $1.00 hasbeen used, which was the rate prevailing at the time of appraisal.

ABBREVIATIONS

ADB – Asian Development BankAusAID – Australian Agency for International DevelopmentBPNG – Bank of Papua New GuineaEU – European UnionIBBM – Institute of Banking and Business ManagementLLDAT – Lik Lik Dinau Abitore TrustMCC – microfinance competence centerMFI – microfinance institutionMSC – microfinance steering committeeNCD – National Capital DistrictNGO – nongovernment organizationNWCP – National Women’s Credit ProjectPNGBC – Papua New Guinea Banking CorporationPIU – project implementation unitPNG – Papua New GuineaRDB – Rural Development BankRFF – revolving finance facilityROSCAS– rotating savings and credit associationsSLS – saving and loan societySOE – statement of expendituresTA – technical assistanceVFL – Village Finance LimitedUNDP – United Nations Development ProgrammeZOPP – Ziel-Orientierte Projekt Planung

NOTES

(i) The fiscal year of the Government and its agencies ends on 31 December.(ii) In this report, "$" refers to US dollars.

CONTENTS

Page

LOAN AND PROJECT SUMMARY ii

MAP vi

I. THE PROPOSAL 1

II. INTRODUCTION 1

III. BACKGROUND 1

A. Poverty Conditions 1B. Sector Description 3C. Government Policies and Plans 11D. External Assistance to the Sector 11E. Lessons Learned 12F. ADB’s Sector Strategy 13G. Policy Dialogue 14

IV. THE PROPOSED PROJECT 14

A. Rationale 14B. Objective and Scope 16C. Cost Estimates 20D. Financing Plan 20E. The Executing Agency 21F. Implementation Arrangements 21G. Environmental and Social Measures 25

V. PROJECT JUSTIFICATION 26

A. Financial and Economic Analyses 26B. Impact on Poverty 27C. Risks 28

VI. ASSURANCES 28

A. Specific Assurances 28B. Conditions for Loan Disbursement 29

VII. RECOMMENDATION 29

APPENDIXES 31

LOAN AND PROJECT SUMMARY

Borrower Papua New Guinea (PNG)

Project Description The Project will assist the Government enhance privatesector-led economic growth and employment creation. Thiswill be achieved through the provision of sustainablemicrofinance services to viable enterprises as well assavings facilities to the population at large. The Project willstrengthen the institutional capacity of at least 40potentially sustainable existing and new microfinanceinstitutions (MFIs). It will establish a microfinancecompetence center to provide training and on-sitecounseling to MFIs; develop, test, and implement newclient-oriented saving services and loan products; andestablish a revolving finance facility to provide neededcapital to MFIs for onlending. Reduction of poverty byintegrating the poor into the mainstream developmentprocess is the goal.

Classification Primary: poverty reductionSecondary: economic growth

EnvironmentalAssessment

Category CEnvironmental implications were reviewed, and no adverseenvironmental impacts were identified.

Rationale Poverty is of increasing concern to the Government.Approximately 31 percent of the population live below thepoverty line of $1 per day. To a large extent this can beattributed to the incomplete transition from a purelysubsistence economy to a modern cash-based economy.Poverty in PNG is directly linked to the inability to earnsufficient cash income to pay for school fees, health care,and other nonfood items, and to save for futurerequirements and times of hardship.

The formal sector can only provide a small number of jobs.Income-earning opportunities for the majority of thepopulation will need to come from smallholder agriculture,and micro and small enterprises in agroprocessing andtrading. The growth of the micro and small enterprisesector is currently inhibited by (i) lack of vocational skills,(ii) deterioration of the law and order situation, (iii) poorinfrastructure, and (iv) limited provision and restrictedaccess to financial services. Efforts are under way toovercome the first three of these impediments. Sustainablemicrofinance services are still needed.

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PNG’s financial system displays a significant institutionalgap, which leaves micro and small enterprises,semisubsistence farmers, and poor households without anyfinancial services. MFIs are scattered across PNG, andoperate in isolation and without clear perspectives. Theknowledge of microfinance best practice is limited. Theability to design appropriate savings and loan products tosuit clients’ needs is nonexistent. None of the existingservice providers have the institutional capacity to achievesustainability in the near to medium-term.

Microfinance initiatives require support measures toenhance their institutional capacity to ensure thesustainable delivery of microfinance services to a largenumber of micro and small enterprises, and to providesavings facilities to the poor and currently unservedpopulation. The Project is designed to address these needsthrough the establishment of a microfinance competencecenter and a revolving finance facility for MFIs.

Objective and Scope The objective of the Project is to provide sustainablemicrofinance services to viable enterprises and savingsservices to the population at large. The project strategy toachieve this objective is based on building the institutionalcapacity of potentially sustainable MFIs. The Projectcomprises three components: component A, establishmentof a microfinance competence center; component B,development, testing, and implementation of new savingsand loan products; and component C, establishment of arevolving finance facility. The Project will provide thenecessary expertise, training, counseling, and someequipment to enhance the MFIs’ institutional capacity. Studytours and visits to successfully operating MFIs in Asia, andin-country conferences and workshops will provideexposure to best practices in microfinance. Resources willbe made available to fund a pilot microbanking schemeand the revolving finance facility.

Cost Estimates The total cost of the Project is estimated at $20.5 millionequivalent, comprising $9.1 million in foreign exchangecosts and $11.4 million equivalent in local currency costs.

Financing Plan Proposed ADB financing is estimated at $9.6 millionequivalent (47 percent of total cost). Government financingwill amount to $4.7 million equivalent (23 percent of totalcost). Counterpart funding of $1.2 million will be provided bythe Institute of Banking and Business Management and $0.5million by the Bank of PNG. The MFIs’ contribution isestimated at $3.7 million equivalent. Grant cofinancing willbe provided by the Australian Agency for InternationalDevelopment ($0.9 million).

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Loan Amount andTerms

Based on the present allocation of funding, the loan wouldamount to $9.6 million from the ADB’s Special Fundsresources. The loan would bear a 32-year maturity, includingan 8-year grace period, with 1 percent interest charge duringthe grace period and 1.5 percent during the remainingperiod.

Period of Utilization Until 31 December 2006

Executing Agency Bank of Papua New Guinea (BPNG, the central bank)

ImplementationArrangements

The Institute of Banking and Business Management will bethe Implementing Agency for components A and B, andBPNG will directly implement component C. BPNG will setup a project steering committee to guide and coordinateimplementation. A project implementation unit will beestablished for day-to-day administrative andimplementation matters.

Procurement Procurement of goods and services financed under theProject will be in accordance with ADB’s Guidelines forProcurement. Procurement of vehicles, computers, andother office equipment will be subject to internationalshopping procedures. Furniture, training materials, andrelated service contracts, each below $100,000 equivalent,will be awarded on the basis of direct purchaseprocedures.

Consulting Services The Project will require an estimated 144 person-months ofinternational consulting services to assist in (i) building MFIinstitutional capacity, (ii) developing curriculum and trainingfor MFIs, (iii) developing microfinance products, and (iv)establishing a revolving finance facility. In addition,domestic consultants to support project implementation, andtraining and on-site counseling of MFI staff will render 240person-months of services. All consultants to be financed byADB will be selected and engaged in accordance with ADB’sGuidelines on the Use of Consultants and otherarrangements satisfactory to ADB on the engagement ofdomestic consultants. The international consultants will beengaged as a team from a firm.

Estimated ProjectCompletion Date

30 June 2006

Project Benefits andBeneficiaries

More than 45,000 people will directly benefit from theProject. These beneficiaries comprise poor households,micro and small enterprises, and semisubsistence farmers.At least 40 potentially sustainable, existing, and new MFIs

v

will benefit from the Project. The MFIs will provide reliablesavings facilities and access to tailor-made loan productsto the people.

vi

I. THE PROPOSAL

1. I submit for your approval the following Report and Recommendation on (i) a proposedloan to the Independent State of Papua New Guinea (PNG) for the Microfinance andEmployment Project (Project); and (ii) proposed administration by the Asian Development Bank(ADB) of a grant for the Project to be provided by the Australian Agency for InternationalDevelopment (AusAID).

II. INTRODUCTION

2. At the request of the Government, ADB provided technical assistance (TA)1 to preparethe Microfinance and Employment Project for possible ADB financing in 2000. The TA startedwith the Microfinance Best Practice conference in February 2000 in Lae with broad participationfrom a wide range of stakeholders and practitioners. Field surveys covering three of the fourregions of PNG were carried out to assess the credit needs of micro and small enterprises, thedemand for saving facilities, and the capacity and weaknesses of current microfinanceproviders. The resulting report was discussed during a participatory project planning workshopin March 2000, during which the goal-oriented project planning (ZOPP)2 method was appliedand resulted in the project framework given in Appendix 1. Participants included representativesfrom national and provincial government agencies, microfinance institutions (MFI), savingsgroups, savings and loan societies (SLSs), the central bank, commercial banks, the Institute ofBanking and Business Management (IBBM), private sector, and bilateral and multilateralassistance agencies. The ADB Loan Fact-Finding Mission was fielded 19–30 March 2000. Thiswas followed by the Appraisal Mission from 19 June – 7 July 2000.3 In addition, the Missionvisited Bulolo and Wau in the Momase region, and in Wau, discussed in detail the possibility ofpilot testing a microbanking scheme. The national and district governments expressed stronginterest in and support for the proposed Project.

III. BACKGROUNDA. Poverty Conditions

3. After 25 years of political independence and some economic and social progress, a largepercentage of the people of PNG remain poor. The human poverty index for PNG is at the level ofBurundi and Mali, which are among the most poverty afflicted nations in the world. The 1996household survey indicated that 31.0 percent of PNG’s population live below the poverty line of $1per capita per day.4 The incidence of poverty is high compared with countries with similar percapita income levels. Approximately 17 percent of the population cannot meet the basicrequirement of 2,200 calories per day per adult equivalent, even if they spend all their income onfood.

4. The poverty coexists with wealth. The richest 10 percent of the population account for 36percent of consumption, whereas the poorest 50 percent account for just 20 percent. The Gini 1 TA 3315-PNG: Microfinance and Employment, for $150,000, approved on 29 November 1999.2 ZOPP, from the German term “Zielorientierte Projekt Planung” is a project planning and management method that

is based on two techniques — matrix building and stakeholder workshops. The main output of a ZOPP session is aproject planning matrix equivalent to a project logical framework, to provide in-depth analysis of project objectives,outputs, activities, and performance indicators and risks. It encourages brainstorming, strategizing, informationgathering, and consensus building among stakeholders.

3 The mission comprised A. Iffland, Project Economist and Mission Leader; and O. Tiwana, Counsel. The Missionwas assisted by T. Schiller, staff consultant.

4 World Bank. 1999 Papua New Guinea: Poverty and Access to Public Services, Report No. 19584-PNG. The $1 aday is at 1985 prices converted to the national currency at a purchasing power parity exchange rate.

2

coefficient of 0.461 is high by comparison with countries of similar income levels. This is in largepart a reflection of the dualistic pattern of growth during the postindependence period. Growth hasbeen led by a capital-intensive minerals sector generating state revenues used in part to support alarge public service. The semisubsistence sector on which the vast majority of the populationdepends has shown little growth. Per capita real gross domestic product in the nonminingeconomy grew at the average rate of just 0.2 percent per annum during 1978–1998.

5. Poverty in PNG has an important regional dimension with the vast majority of the poor(93.3 percent) living in rural areas. The incidence and extent of poverty vary significantly acrossthe five major regions (Table 1). The Momase and North Coast region exhibits the highestincidence of poverty, with 45.8 percent of the population living below the poverty line. Povertyrates in the regions of Papua and South Coast, the Highlands, and the New Guinea Islands areclustered slightly below the national average, ranging from 33.2 to 35.8 percent. The urbanizedNational Capital District (NCD) accounts for only 3.8 percent of the poor; only a quarter of theNCD’s population lives below the poverty line. The depth of poverty, measured by the povertyseverity index,5 is twice as high in the poorest Momase and North Coast region as in the NCD.

Table 1: Poverty Measures by RegionRegion Headcount Index Poverty Severity % of total

PopulationIndex Contribution to

total (%)Index Contribution

in total (%)

NCD 25.8 3.8 3.3 3.3 5.5Papua and South Coast 33.2 13.2 5.5 14.7 14.9Highlands 35.8 38.3 5.3 38.0 40.1Momase and NorthCoast

45.8 35.5 6.6 34.2 29.2

New Guinea Islands 33.6 9.2 5.3 9.8 10.3PNG Total 37.5 100.0 5.6 100.0 100.0Urban 16.1 6.5 1.6 4.2 15.1Rural 41.3 93.5 6.3 95.8 84.9

NCD = National Capital District, PNG = Papua New Guinea.Source: Papua New Guinea. 1996. Household Survey. Port Moresby.

6. The distribution of poverty can also be viewed in terms of the regional distribution ofnational poverty. The Momase region accounts for almost 36 percent of the poor in PNG, but hasonly 29 percent of the population. The Highlands, with about 40 percent of the population,accounts for 38 percent of the poor. Hence, over three quarters of the poor population of PNG livein these two regions. Measuring poverty with the distributionally sensitive poverty severity indexindicates the same two regions account for over 70 percent of PNG’s poverty.

7. The incidence of poverty in PNG is linked to the ability to earn cash income to pay fornonfood items, to vary and improve diets, and to permit savings for times of economic difficulty(e.g., drought). Almost 17 percent of the poor population live in households where the householdhead earns no cash income, relying entirely on subsistence production (and perhaps gifts ofcash). The poverty rate for these households is 47 percent. Almost 8 percent of the poor live in

5 The poverty severity index is a distributionally sensitive poverty measure that takes into account the distribution of

consumption of those falling below the poverty line. This index shows that poverty is significantly deeper in ruralareas of PNG than in urban areas.

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households, whose main source of cash income is hunting, gathering, and fishing. The povertyrate for these households is 57 percent. Poverty rates are also above the national average forhouseholds that earn cash income from tree crops (44 percent) and commercial agriculture (42.7percent). These households account for 42.5 percent and 19.0 percent of the poor population,respectively. Where household heads earn cash income from running a business or wageemployment, poverty rates are much lower (at 25 percent and 17 percent, respectively). Althoughthe latter households collectively account for 29 percent of PNG’s total population, they accountfor only 14 percent of the poor population. In general, increased provision of opportunities forearning secure cash incomes is needed to reduce the incidence and severity of poverty.

8. Both the extent of income-earning opportunities and the ability to respond to suchopportunities are determined to a significant degree by access to the basic public services oftransport, utilities, health, education, and financial services. The PNG population as a wholeexpressed considerable dissatisfaction with access to services in 1996, and it is highly likely thatthe degree of dissatisfaction increased during the late 1990s as a result of a widely acknowledgeddeterioration in service provision. Poverty reduction requires improved service delivery to ruralareas. This was the intention of provincial and local government reforms introduced under theOrganic Law of 1995, but effective implementation of devolution has been limited by capacity andfunding constraints.

9. The fundamental and long-recognized development challenge for PNG is to achievesustained economic growth with equity. The poorest 40 percent of the population must participatein, and benefit from, the growth process if poverty is to be reduced. Hence, poverty interventionshave to be primarily targeted at rural areas where the vast majority of the poor live. There aresevere development constraints, including the rugged terrain of PNG’s 462,000 square kilometers,the complexity of land tenure systems, the dispersal of 4.5 million people collectively speakingwell over 700 languages, limited and deteriorating physical infrastructure, a major law and orderproblem, and the low level of human resource development. Nonetheless, some key developmentconstraints can be eased over time through appropriate government action, notably for investmentin human capital, better service delivery including access to finance by the rural areas, andinfrastructure improvement. The Government is committed to addressing these issues to reducepoverty and socioeconomic inequalities through private sector-led growth and employmentcreation (para. 33).

B. Sector Description

1. The Financial System

10. Banking history in PNG dates back to 1916, when the Bank of New South Wales opened abranch in Port Moresby. It was set up mainly to carry out payment transactions, and to meet thecredit needs of the modern business sector, the working capital needs of plantations, and theforeign trade sector. Until after the Second World War, no other bank established branches in thecountry. Up to 1974 the system was essentially a small extension of the Australian system withpolicies decided by management outside the country. With independence, the PNG branch of theCommonwealth Banking Corporation was transferred to the Government and started to work asthe first PNG-owned bank under the name of Papua New Guinea Banking Corporation (PNGBC).Although, there was little utilization of trade or credit facilities by the local population, considerableuse was made of savings account facilities. In 1970, Papua New Guineans held nine tenths of thetotal number of 400,000 savings accounts, which accounted for one third of the total value. From1973 to 1986, PNGBC systematically extended the banking network to all provinces. While allforeign-owned banks were incorporated locally by 1976, it took 20 years until the first nationally

4

owned private bank was created. On the basis of shares sold by the National Bank of Australia, alocal consortium founded the Bank of South Pacific in 1993. At present six commercial banksoperate in PNG.6

11. The Bank of Papua New Guinea (BPNG, the central bank) distinguishes four tiers ofinstitutions forming PNG’s financial system (Figure 1).

Figure 1: Regulated and Non-Regulated Financial Institutions

B a n k o fP N G

C o m m e r c i a l B a n k s

F in a n c eC o m p a n ie s

M e r c h a n tB a n k s

S a v in g s &L o a n

S o c i e t i e s

I n v e s t m e n t a n dP e n s i o n

F u n d s

I n s u r a n c eC o m p a n ie s

a n d B r o k e r s

S t o c k E x c h a n g e

R u r a l D e v .B a n k

R O S C A S M i c r o f i n a n c e N G O s I n f o r m a l S a v i n g s G r o u p s

12. Besides BPNG, the system comprises three regulated tiers and one nonregulated. Thecommercial banks form the first tier. As creators of secondary money, they are an important linkbetween BPNG and the remainder of the financial system, as well as with the nonfinancialsectors of the economy. Commercial banks are important for the conduct of monetary and fiscalpolicy in PNG, as reserve requirements and Treasury bills are the most importantmacroeconomic instruments. The second-tier institutions are bank-like financial institutions, e.g.,finance companies, merchant banks, and SLSs, which play an important role in mobilizingsavings. As opposed to banks, they are not allowed to conduct cheque deposits. The third-tiercomprises nonbank financial institutions, including investment and pension funds, insurancecompanies and brokers, the stock exchange, and the Rural Development Bank. Nonbankfinancial institutions do not engage in deposit taking. The nonregulated financial institutions forma separate category and include microfinance nongovernment organizations (NGOs) andinformal savings groups that provide financial services without any form of regulation orsupervision.

13. The formal financial sector is supported by IBBM,7 which was created in 1965 by theReserve Bank of Australia as the Banker’s College. It’s overall objective is to enhanceprofessional expertise in commerce, banking, finance, and business management by providingtraining and education that meets national needs and international standards. IBBM isconducting various residential and nonresidential short- and long-term training courses in 6 The six banks are PNG Banking Corporation, the Bank of the South Pacific, Australia and New Zealand Bank,

Westpac, Bank of Hawaii, and Maybank (PNG) Ltd. of Malaysia.7 IBBM was officially established in 1974 under the Associations Incorporation Act of PNG.

NGO = nongovernment organization, PNG = Papua New Guinea, ROSCAS = rotating savings and creditassociations.Source: Bank of Papua New Guinea. Money and Banking in PNG. Port Moresby, p.125.

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banking, finance, and business management for staff of commercial banks in PNG and thePacific region, and private sector enterprises. All commercial banks in PNG, the central bank, aswell as the Teachers Savings and Loan Society, the largest SLS in PNG, are members of IBBM.

14. The structure of this potential market for microfinance services is shown in Figure 2.

Figure 2: Toward Mainstream Financial Services

15. The upper end of the market, the peak of the pyramid, comprises people that haveaccess to financial services, and the lower end of the market, the base of the pyramid, consistsof people engaged in nonremunerated subsistence activities. The potential market formicrofinance services is between those two market segments with an estimated number of851,000 potential customers. Taking a conservative stand, it can be assumed that at least onethird of this market has actual demand for credit.8 This amounts to 255,000 potential borrowers.Based on an average loan size of $240 the total demand for credit would amount to $61 million.Using a loan size of $800, more appropriate for microenterpises and small farmers, the amountincreases to $200 million. Appendix 2 provides details on the micro and small enterprise sector.

16. With regard to savings, existing regulated and nonregulated financial institutions areoffering deposit-taking facilities to some extent. PNGBC plays the dominant role in savingsmobilization with a total of 465,765 passbooks and transaction accounts, and an averageaccount balance of $141. PNGBC expanded its network of branches in urban centers andagencies in remote areas until the mid-1980s. The worsening security situation increased thecost of operations to an unsustainable level and subsequently forced PNGBC to reduce itsnetwork substantially. From 407 agencies in 1984, only 87 remained in operation in 1997. Thewithdrawal of this financial service, particularly from the rural and more remote areas, hascreated a vacuum and at the same time a niche for informal savings groups to be established.

2. Providers of Microfinance Services

17. Microfinance providers can be found in each of the different tiers that comprise thefinancial system. Among the first tier institutions, there are currently two commercial banks 8 Results of the sample survey of micro and small enterprises and their perceived credit needs, part of the TA

(footnote 1), as well as information provided by commercial banks on the requests received for personal loanssuggest that the demand for credit is in the range of 300,000 potential borrowers.

Banks and Financial Institutions

MicrofinanceInstitutions

Credit Savings Insurance

Upgrading

Downscaling

High-End Market

Low-End Market

16.800 (1%)

851.000 (55%)

691.000 (44%)

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offering financial services suitable for the microfinance market, PNGBC and to a lesser extent,the Bank of the South Pacific. Both banks offer deposit services, with PNGBC playing the keyrole in mobilizing savings in PNG. From a total of $415 million of PNGBC’s demand and termdeposits, $127 million correspond to a total of 465,765 passbook and transaction accounts, withan average account balance of $141. Compared with the strong involvement in mobilizing smallsavings, PNGBC is not significantly active in the field of microcredit. Of a total loan portfolio of$257 million, only an outstanding balance of approximately $1.2 million (0.18 percent) belongsto nearly 800 credits disbursed to the microfinance sector. According to PNGBC’s estimates,about 40 percent of the corresponding portfolio is at risk. Based on this performance and theGovernment’s plan to privatize PNGBC, its engagement in microcredit will decrease in thefuture.

18. The bank-like financial institutions, the second tier, the SLSs, and Village FinanceLimited (VFL) provide microfinance services. While the commercial banks were always orientedto the modern economy, the SLSs were originally conceived in the 1960s by the Reserve Bankof Australia to promote financial education and development in rural areas, encourage savings,provide credit, and support small capital formation. After independence the system of SLSscame under the supervision of BPNG. Most SLSs are affiliated with the PNG Federation ofSavings and Loan Societies. Notwithstanding the original rural orientation of the SLSs, urban-based societies became increasingly important during the 1980s. Generally, urban societies arecentered on common employment, and often secure contributions through payroll deductionschemes. During the 1980s many SLSs ran into problems with high loan delinquencies due tomismanagement and inexperienced staff. As a consequence, today most SLSs are eitherdormant or were liquidated by BPNG. As of December 1998, there were 21 SLSs in the countrywith a total membership of 64,025 and a savings balance of $47 million equivalent to anaverage savings balance of $737 per member. Since 1998, BPNG has carried out arevitalization program and introduced five new regional SLSs. To avoid the problems of thepast, almost all SLSs have established a maximum loan amount equivalent to the amount ofindividual savings held with the institution. A considerable amount of savings deposits ischanneled either as deposits to the commercial banks or is invested in Government bonds.While SLSs are important service providers, particularly to the urban middle class, the size ofthe system, in terms of assets and loans, is insignificant when compared with the commercialbanks.

19. VFL was founded in 1998 as a wholly owned subsidiary of PNGBC with initial capital of$400,000. It is a special purpose financial institution established to deliver microfinance servicesthroughout PNG. In 1999, VFL obtained a financial institutions license, which requires targetingthe underprivileged and returning all profits for investing in microfinance. VFL started fieldoperations in 1999. With a group lending methodology, the company targets poor women inrural and urban areas. By December 1999, there were 156 outstanding loans with an averagesize of $144 and a portfolio at risk of less than 5 percent. On the savings side, 376 compulsoryand voluntary savings accounts exist, with an average balance of $19. As of March 2000, VFL isauthorized to extend individual loans of up to $12,000.

20. As part of the third tier comprising nonbank financial institutions, the Rural DevelopmentBank (RDB), founded in 1967, is one of the Government’s financial instruments to promotedevelopment in urban and rural areas. RDB maintains a small network with seven branches and11 representative offices. It has always been a credit supply institution with no deposit facilitiesfinanced by the national Government budget. Unlike other development banks, it was neverused as a conduit for foreign investment, although during the 1980s the World Bank and ADBestablished credit lines for onlending for approved agricultural development projects. Like many

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other development banks, RDB has a bad loan portfolio with large credits targeted to priorityprojects and granted on subsidized interest rates. Because of its poor repayment rates in 1998,RDB had to write off $8 million of a total loan portfolio of $24 million. To save RDB, theGovernment provided capitalization with a one-off transaction of $12 million. In the future RDBwill concentrate on priority banking for the most profitable clients of the existing loan portfolio. Atthe end of 1998, RDB’s total assets were valued at $35 million, with $12 million in loans andadvances and an even higher amount invested in profitable Government T-bills ($13.5 million).The portfolio at risk lies in the range of over 70 percent. Approximately 12 percent of theoutstanding loans, or 2,400 credits with an average loan size of $1,225 correspond to themicrofinance market. These loans form part of a small loan program established to financesmall capital investments like outboard motors, basic capital equipment, and farming supplies.

21. The nonregulated financial institutions form the fourth tier of the financial system andcomprise various microfinance and microcredit schemes. The Papua New Guinea NationalWomen’s Credit Project (NWCP), a project initiative of the Department of Home Affairs and theNational Council of Women, was established in response to the 1987 National Women’s Policyto deliver credit to underprivileged poor women. While several pilot phases had rather poorperformance, with the exception of the program in the Western Highlands, in 1996 the NWCPwas implemented nationwide with total funding of $1 million. The NWCP seeks to strengthenwomen’s associations at the district level to serve as conduits for servicing credit needs of groupbased, noncollateralized, rural and urban women borrowers. To date, the NWCP is operationalin approximately 41 districts. By December 1999, the estimated value of the loan portfolio wasabout $120,000, with 1,250 loans outstanding and an average loan size of $112. The portfolio atrisk is in the range of above 50 percent. Approximately 8,200 women are affiliated with thewomen’s district credit associations for the purpose of credit.

22. Lik Lik Dinau Abitore Trust (LLDAT), the best-known and most-documented NGOengaged in microfinance in PNG, emerged from the collaboration of seven parties, includinggovernment departments: PNGBC; United Nations Development Programmme (UNDP);National Council of Women; and the Foundation of Law, Order, and Justice. The LLDAT beganoperation in 1994 with the objective to provide savings and credit facilities to very poor mainlyrural women. It was founded explicitly to replicate the Grameen Bank model. After a promisingbeginning, LLDAT’s performance was severely affected by the lack of institutional capacity andliquidity problems. To date, there are 2,704 group members affiliated with the trust. ByDecember 1998, LLDAT had an outstanding loan balance of $85,000, with 1,493 groupmembers and an average loan size of $195.9 According to recent estimations, the portfolio atrisk is above 50 percent.

23. The North Simbu Rural Development Project established a microcredit scheme with thesupport of the provincial government, the provincial council of women, and the AustrianVolunteers Service. The scheme targets women and applies a group approach, with loans givento individual members of the group. During the 16 months since inception, the project processeda total of 630 loans, with 36 currently outstanding. The overall repayment rate is 94 percent, theaverage loan size $200.

24. In response to the lack of adequate rural finance facilities, in 1995 the LutheranDevelopment Service initiated the Putim na Kisim Project. It aims to establish savings cells atthe village level as the basis for the development of rural saving and loan societies. The project

9 According to the last audited financial statements from December 1999.

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is seen as a pure bottom-up approach, and thus as an alternative to the governmentrevitalization program for SLSs. A vital role in the project concept is played by the integratedYangpela Didiman Program, run by the Lutheran Development Service for more than 25 years.Village people are trained to serve at the village level as volunteer development workers. In theirrole of multipliers, their aim is to improve agricultural and basic livelihood skills and to fosterspiritual development throughout their community. To date, there are more than 3,000volunteers in hundreds of villages. The Putim na Kisim Project relies on this existing structure toadd village banking to the multipurpose program portfolio of the Yangpela Didiman Program.Currently, there are 20 saving cells operating in the framework of the pilot phase. The savingcells have 817 members, with total savings of $29,000. The average individual savings balanceis $31. Lending is to start in 2000, and the methodology will be similar to that applied by theSLS: the loan amount will be determined by the individual savings balance, interest rates will bein the range of 10 percent per annum.

25. The VVN Saving Society in East New Britain Province is an example of the informalsavings schemes that exist throughout PNG. The society was established in 1997 through theinitiative of a member of the village community. The 700 members save voluntarily, with acurrent savings balance of $40,000. Funds are held in a group savings account with PNGBC.There are no minimum balance requirements, and withdrawals can be made without limitationsthree days per week.

26. All MFIs and budding microfinance initiatives have a number of characteristics incommon. They are scattered all over PNG, mainly in rural areas, and operate in isolation andwithout clear perspectives. The knowledge of microfinance best practice is rather limited, whichis reflected by a microfinance landscape dominated by Grameen Bank replications irrespectiveof their appropriateness and suitability for PNG. The ability to design appropriate savings andloan products to suit the needs of the clients is generally very weak. The majority of MFIs sufferfrom lack of well-defined and transparent governance and management structures, and theabsence of an effective management information system. The managers and the loan officerslack even basic training to adequately carry out their jobs. MFIs are undercapitalized and haveno mechanism to raise additional funds for onlending through deposits or from formal financialinstitutions. Taking all these factors into account, it is not surprising that none of the MFIs haveachieved financial viability and have no vision on how to achieve it. Details are in Appendix 3.

3. Demand for Microfinance Services

27. The size and structure of the potential market for microfinance services is based on thestructure of the economically active population. Figure 3 distinguishes between wage income,nonwage earning, and income in-kind.

9

AssetsAssets LiabilitiesLiabilities

MoneyClaims from WantokTools and EquipmentAnimalsUsing rights of LandCoffee/Palm treesGardensHouse

• Claims of Wantok

• Credit of supplier

• Credit from MFI

• Equity

Figure 3: Regional Distribution of Income per Capita (1996 in Kina)

NCD = National Capital DistrictSource: Papua New Guinea. 1996. Household Survey.

In 1996, the average per capita income in the provinces, excluding the NCD, amounted to about$400 (K1.000). The importance of monetary wage income as compared with monetary nonwageincome is decreasing in the more remote areas where income in-kind is the predominantsource. In more than twothirds of the provinces, the average monetary income is clusteredaround the poverty line of K46110 per adult equivalent per year. While wage earners in theprovinces are potential clients for savings products, their ability to use credit for nonconsumptivepurposes is limited. The nonwage earners receive their income from agricultural production andother business activities, and have an articulated demand for credit to be used for workingcapital and investments in their businesses.

28. A closer look at the assets and liabilities of a potential client will provide a betterunderstanding of the demand for microfinance services. This is done in a generic way and resultsin the balance sheet structure given in Figure 4.

Figure 4: Generic Balance Sheet of MFI-Clients

10 This poverty line of K461 is based on the cost of a food consumption basket that meets a minimum energy

requirement of 2,200 calories per adult equivalent per day and reflects the dietary pattern of the lower incomegroups (food poverty line).

- 200.0 400.0 600.0 800.0 1,000.0 1,200.0 1,400.0 1,600.0 1,800.0 2,000.0

Gulf

E/Sepik

New Ireland

Madang

W/Sepik

Manus

E/Highlands

Enga

Morobe

NCD

Wage Nonwage In Kind

10

29. Most striking is the important role of claims and liabilities that are related to the extendedfamily network of the wantok. These relationships are only partly valued in money and follow morethe logic of social reciprocity. Within the framework of PNG’s traditional culture, claims of thewantok are of higher priority than legal obligations outside the wantok system. This has to beunderstood as part of the social safety net of the traditional culture that is still predominant inalmost all parts of PNG society. From an economic point of view this allows a smallholder tohandle external shocks such as a draught by attending obligations within the wantok in a flexibleway. A wantok works as a form of extended equity that assumes part of the risk as well asparticipates in the return of an investment. For the purpose of demand targeting, this has to betaken into account. It would not be wise to try to compete or even to substitute the relationshipswithin the wantok with those of formal or semiformal financial institutions. As in the moderneconomy, the majority of funding for a small business would be related to equity, in the traditionaleconomy of PNG—with good reason—this most likely relates to the wantok. In both cases afinancial institution would always try to avoid the risk related to equity financing, and rather wouldinsist that existing equity covers the risk of a bank loan. The same is true when it comes to thewantok system, where an assessment is needed as to whether the wantoks stand ready to takesome of the credit risk or whether there is only a potential claim that actually increases the risk ofthe borrower.

30. With regard to savings products, the wantok system leads to the need for highly liquidproducts, and also for less liquid term deposits. As obligations toward wantok members may haveto be attended to on short notice, some liquidity is important, but at the same time, less liquid termdeposits can protect individual savings from being siphoned off by the wantok system.

31. The following figures on the structure of the economically active population in PNG givesome indication of the demand and the potential market for microfinance services. Table 2distinguishes between remunerated and nonremunerated economic activities.

Table 2: Economically Active Population

Persons Target

Monetary 1990 1996 % % Persons %

Wage Job 240,763 277,418 24 9

Business 14,580 1 6,800 1 1 16,800 1

Self-Employed 67,082 77,295 7 3 77,295 5

Professional Farm/Fish 671,954 774,256 68 27 774,256 50

Total 994,379 1,145,769 100Nonmonetary

Subsistence Farm/Fish 600,342 691,742 39 24 691,742 44

Student 347,469 400,370 23 14

Housework 275,567 317,521 18 11

Retired 63,965 73,703 4 3

Handicapped/Disabled 11,859 13,664 1 0

Unemployed 133,612 153,954 9 5

Others 107,840 124,258 7 4

T o t a l 1,540,654 1,775,213 100 100Population over 10 years 2,535,033 2,920,982 1,560,093 100

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32. Within the remunerated part of the economically active population, 24 percent areclassified as employees receiving a wage income, 1 percent as entrepreneurs, 3 percent asself-employed, and 68 percent as engaged professionally in farming or fishing. Within thenonremunerated part of the total economically active population, 39 percent are in the categoryof subsistence farm or fishing activities. On the basis of the poverty assessment it can beassumed that at least the two last-mentioned categories comprise the poor. According to thisclassification, the target market for microfinance loan products (nonconsumption loans) willcomprise businesspersons, self-employed, and professional and subsistence farmers andfisherfolk. Based on the 1990 census, an estimated 1,5 million people will be in this group. Withregard to savings products, an additional 0.3 million people or 30 percent of the remainingeconomically active population, considered to not be integrated in the cash economy, can beadded.11

C. Government Policies and Plans

33. In the Medium-Term Development Strategy, 1997-2002, which was reconfirmed by thenew Government in 1999 and is reviewed annually, the Government emphasizes theimportance of private sector development for the future of PNG. This development priority wasreconfirmed during the National Dialogue in 2000. The development of a vibrant micro, small,and medium-size enterprise sector to spearhead economic growth is of specific importance tothe Government. This is reflected in the Small and Medium Enterprise Policy, approved in 1998.To improve the business environment, the policy identifies and addresses key issues andconstraints hindering business development. The Government aims to focus on the weaknessesof the financial system to improve the provision of financial services for private sectordevelopment. The Government perceives access to financial services as a key to enhancing theeconomic integration of micro and small enterprises and those who want to save money forfuture financial needs. Hence, the regulatory framework for banks and other financial institutionshas been revised, and new Central Bank and Banks and Financials Institutions acts weregazetted this year. A microfinance workgroup involving major stakeholders was established toprepare a microfinance policy to be submitted for Government approval by the end of 2000. Thedraft Microfinance Policy Paper is given in Appendix 4.

D. External Assistance to the Sector

34. The financial sector is receiving support at the macro level under the overall structuraladjustment program. This comprises advisory services by the Reserve Bank of Australia toreview PNG’s monetary policy. The World Bank is assisting BPNG with banking supervision,including nonbanks and SLSs. The International Monetary Fund has assisted with thedevelopment and introduction of the new Central Bank Act, and Banks and Financial InstitutionsAct.

35. In comparison with the support provided to BPNG, external assistance for microfinanceis rather fragmented. It ranges from setting up revolving credit funds as a part of largecomprehensive rural development projects and sector programs, to the provision of seed moneyto village communities and women’s groups. Most initiatives aim at reducing poverty anduplifting underprivileged groups of society, particularly women. International NGOs andvolunteer organizations, church-based institutions, private companies, and individuals are

11 Since the last census in 1990, the cash-based economy has strongly advanced. It can therefore be safely assumed

that a much larger percentage of the economically active population is partially or fully integrated.

12

involved. Neither the Government nor any other institution has an overview of the various actorsand the assistance provided.

36. LLDAT, the best-known and most-documented microfinance provider in PNG, was setup with TA and seed capital from UNDP. Insufficient funding and managerial and institutionalcapacity constraints led AusAID to provide rescue assistance. This includes capital and short-term advisory assistance. AusAID also provided support for a nine-month pilot project inBouganville, the Bouganville Haus Moni. The support focused on creating awareness forsavings, training community leaders, and establishing savings cells in selected districts.AusAID is considering providing assistance to the urban-based ItaKara development project todeliver financial and business development services in an integrated approach.

37. The European Union (EU) provided seed capital to the Bougainville Provincial Council ofWomen to set up a microcredit scheme. Implementation is rather slow and a recent progressevaluation suggested the redesign of the scheme, which will be implemented shortly. The EU isalso supporting the design and planning of a rural credit scheme for smallholder cocoa andcopra farmers in Bougainville.

E. Lessons Learned

38. During 1988-1998, ADB approved 15 microfinance projects, 6 projects with microfinancecomponents, and 34 TAs to support microfinance operations in the Asian and Pacific Region.ADB recently completed a review of its microfinance operations during this period.12 While TAhas been an important element in ADB’s microfinance activities, TAs suffered from a number ofdrawbacks: (i) lack of adequate sector analysis, (ii) insufficient institutional analysis and lack of acoherent long-term approach to institutional development, (iii) limited involvement ofstakeholders in the design of TA leading to problems of ownership, and (iv) lack of measurableand monitorable indicators to assess performance. The project preparatory TA for this Projectaddressed these shortcomings and emphasized the building of local ownership for the Project.

39. ADB’s microfinance project loans have improved over time. The early projects, the firstgeneration projects, in general (i) focused on microcredit delivery; (ii) allowed subsidizedinterest rates; (iii) paid little attention to financial viability; and (iv) were very poorly targeted. Inrecent years, the projects support a wider array of institutions, go beyond credit services toprovide voluntary savings on a limited scale, emphasize market-oriented interest rates, and paymore attention to financial viability.

40. Although it is difficult to reliably measure the development impact of finance services,assessments of the operations of already completed microfinance projects and review reportson the ongoing projects offer some important insights on the development impact of ADB’smicrofinance assistance. These projects provide a wealth of information and experiences. Themain lessons learned form the key areas of ADB’s Microfinance Development Strategy13:

(i) A financial systems development approach14 is the key to achieving sustainableresults and to maximizing development impact.

12 Asian Development Bank. 1999. Review of Asian Development Banks’ Microfinance Portfolio. Manila.13 Asian Development Bank. 2000. Finance for the Poor: Microfinance Development Strategy. Manila14 This approach emphasizes an enabling policy environment, financial infrastructure, and the development of

financial intermediaries that are committed to achieving financial viability and sustainability within a reasonableperiod and that can provide a variety of financial services.

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(ii) Microfinance clients are more concerned about access to adequate services thanthe cost of the services.

(iii) A broad range of microfinance service providers is required to respondadequately to the diversity of demand for financial services and to expand theoutreach.

(iv) Considerable TA for capacity building is needed to build strong retail institutionswith a commitment to outreach and sustainability.

(v) The demand for savings services by poor households and microenterpises is asstrong, if not stronger, than the demand for credit. Expansion of the outreach ofsavings services can have a significant impact on both institutional sustainabilityof MFIs and poverty reduction.

41. An analysis of the microfinance projects supported by AusAID and the EU in PNGprovide insights on operational issues and requirements for microfinance services. Lessonslearned identify the following as important requirements for a successful microfinance project inPNG:

(i) transparent governance and management structure outside the influence ofGovernment,

(ii) business plan and a management information system to monitor keyperformance indicators,

(iii) training of management and loan officers,(iv) flexible savings and loan products based on the requirements of the clientele,(v) adequate equity to allow expansion.

42. The lessons learned and the insights gained from AusAID and EU-assisted microfinanceschemes, ADB’s completed and ongoing microfinance projects, as well as international bestpractice in microfinance as disseminated by the Consultative Group to Assist the Poor have hada strong influence on the design of all project components, which aim to provide microfinanceservices to the poor while achieving financial viability of MFIs.

F. ADB’s Sector Strategy

43. The ADB’s current country operational strategy for PNG was discussed by the Board inOctober 1998. It is in line with the Government’s Medium-Term Development Strategy andADB’s Medium-Term Strategic Framework and Strategy for the Pacific.

44. The strategy emphasizes the importance of financial services for economic and socialdevelopment in PNG. It recognizes the need to improve access to financial services particularlyin rural areas and for the poorer strata of the population. On the deposit side, limited access tomodern savings and transaction mechanisms, force the poor to hold cash and have an adverseeffect on the already serious law and order problem. On the funding side, very limited access tocredit continues to be a serious impediment to private sector development and sustainablegrowth. Better access to financial services will assist the poor to create microenterpises andgenerate broad-based income. This will lead to new employment opportunities, a keydevelopment objective of PNG. In the context of PNG and the rather limited success of variousmicrocredit schemes, institutional strengthening and capacity building of existing serviceproviders is crucial for the provision of sustainable microfinance services. The Project reflectsthese features, which are key elements of ADB’s microfinance strategy, and is designed toassist the Government in addressing identified shortcomings.

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G. Policy Dialogue

45. Policy dialogue with the Government in this area was initiated in 1998 in conjunction withADB’s microfinance strategy. It was followed by a detailed sector analysis and studies coveringvarious aspects of microfinance, which provided the Government with valuable backgroundinformation and formed the basis for a continued dialogue with ADB microfinance specialists.With the mushrooming of microcredit schemes and revolving loan funds and their rather limitedsuccess, the Government is aware of the need to develop a common understanding ofmicrofinance issues and to provide general guidelines. The conference, Microfinance BestPractice in February 2000 (para. 2), supported this view and initiated the drafting of amicrofinance policy paper, that was discussed at the stakeholder workshop in March 2000. Thedraft policy paper is in Appendix 4.

46. At present MFIs are operating in an unregulated environment and without supervision.Recent experiences with money pyramid schemes has forced the Government to tighten theregulatory framework for financial institutions. While this is an important step toward a soundfinancial sector, the increased capital requirements of $600,000 equivalent restrict thepossibilities of microfinance providers acquiring a banking license and, thus, take deposits. Anagreement was reached by the stakeholders at the two workshops (para.2) that a regulatoryand supervisory framework for MFIs needs to be drawn up to facilitate service delivery and tosafeguard clients’ deposits. The Project will assist in drafting appropriate legislation for aregulatory and supervisory framework for MFIs to facilitate sustainable growth of microfinanceservices while proceeding with the much needed institutional capacity building of MFIs.

IV. THE PROPOSED PROJECT

A. Rationale

47. Poverty in PNG is an increasing concern of the Government. In 1996, 31 percent of thepopulation lived below the international poverty line of $1 per capita per day and evidencesuggests the situation is worsening. To a large extent this has to be attributed to the incompletetransition from a purely subsistence economy to a modern cash-based economy. The incidenceof poverty is directly linked to the inability of families to earn cash income to pay for school fees,health care, and other nonfood items, and to save for future requirements and times of hardship.

48. The formal private sector can only provide for a small number of jobs. Income-earningopportunities for the majority of the population will be in the agriculture sector, and inestablishing micro and small enterprises in manufacturing and trading. However, the growth ofthe private sector as a whole, and the micro and small enterprise subsector in particular, isinhibited by key factors; (i) lack of vocational and entrepreneurial skills; (ii) deteriorating law andorder situation; (iii) poor infrastructure, particularly rural roads; and (iv) limited provision andrestricted access to financial services.

49. The lack of vocational and entrepreneurial skills is a serious constraint to theestablishment of micro, small, and medium-size enterprises. Most enterprises are not in aposition to satisfy required quality standards, reliable delivery, or to offer competitive prices fortheir products. Apart from assistance provided by the EU and the AusAID, ADB is providingassistance through the Employment-Oriented Skills Development Project.15 Regarding

15 Loan 1706-PNG(SF), Employment-Oriented Skills Development, for SDR14,591,000, approved on 28 October

1999.

15

agricultural production and the need to improve the farming systems of small semisubsistenceand cash crop farmers, ADB is assisting through the Smallholder Support Services PilotProject.16

50. The deteriorating law and order situation has been cited as a significant deterrent tolocal as well as foreign investment, and adds to the high cost of doing business. As a result,commercial banks have closed many of their branches in the rural and more remote areas.

51. Poor infrastructure, particularly rural access roads, seriously restricts market access forboth agricultural and manufacturing products. Many provinces have no road links to neighboringprovinces. Others provinces experience frequent traffic interruptions due to poor maintenance ofexisting road links. This increases the isolation of rural communities and leads to significantlosses in export earnings and business income. Infrastructure improvements feature high on theGovernment’s development agenda and receive substantial support from all major bilateral andmultilateral assistance agencies. ADB is providing assistance through the Road Upgrading andMaintenance Project.17

52. Limited access to financial services for micro and small enterprises is another majorimpediment to private sector development (Appendix 2). PNG’s financial system displays aninstitutional gap that leaves micro and small enterprises, semisubsistence farmers, and poorhouseholds with barely any financial services. Commercial banks cater to the credit needs ofmedium and large enterprises, and with the exception of PNGBC, offer deposit facilities only toformally employed people with a regular salary. Various microfinance schemes have emergedover the past 10 years, the majority almost exclusively target poor women in the subsistencesector. By December 1999, there were less than 10,000 loans outstanding that can be classifiedas micro loans, in comparison with a potential demand for credit by approximately 255,00018

potential borrowers (para.15).

53. In principle there are two institutional strategies to introduce new financial services toPNG: (i) downscaling commercial bank operations and their products, and (ii) upgradingmicrofinance institutions. Both strategies have been discussed with the Government and aresupported by the microfinance policy framework currently being prepared. The Project followsthis approach and combines both institutional strategies.

54. To reduce the institutional gap and to expand and strengthen the microfinanceinstitutional landscape, the existing MFIs have to fulfill a dual mission: they have to achievefinancial self-sustainability, as well as increase outreach, both in scale (number of clients) and indepth (service delivery to the lowest income population possible). This will ultimately determinethe MFI’s contribution to the economic and social development of PNG. The challenge of anMFI consists thus in striking a balance between those two, at first glance opposing, objectiveskeeping in mind that the level of financial self-sustainability of an MFI will determine the scale ofits outreach. To be financially viable and to achieve considerable outreach with its services,MFIs must possess an adequate institutional capacity. Appendix 3 gives details on the strengthand weaknesses of MFIs in PNG.

16 Loan 1652-PNG, Smallholder Support Services, for $7.6 million, approved 10 December 1998.17 Loan 1709-PNG, Road Upgrading and Maintenance, $63 million, approved on 16 November 1999.18 These make up one third of the economically active population, which is classified as integrated in the cash

economy, self-employed, or engaged in professional farm/fishing.

16

55. None of the existing MFIs have the necessary institutional capacity to achievesustainability in the near future. All depend on seed money from either Government orassistance agencies for their lending operations. Without a banking license, MFIs are notpermitted to mobilize savings for onlending and other sources of funds are not available. Thisseverely restricts their operations in increasing outreach and achieving financial self-sustainability.

56. MFIs are scattered across PNG, and operate in isolation and without a clear perspective.In comparison with Asian countries, PNG’s microfinance sector is at an early stage ofdevelopment. The knowledge of microfinance best practice is rather limited and the ability todesign appropriate savings and loan products to suit the needs of the clients in PNG isnonexistent. Hence, Grameen Bank replications dominate the microfinance landscape. Whilethere are some promising features in a number of MFIs, none of the existing service providershas emerged as a market leader. All MFIs and microfinance initiatives in PNG require varioussupport measures to enhance their institutional capacity to ensure sustainable delivery ofmicrofinance services to a large number of micro and small enterprises, and to provide savingsfacilities to the poor and currently unserved population segment. The Government is aware ofthe shortcomings, is proceeding with the finalization of the microfinance policy, and has askedthat the Project foster the development of the microfinance sector.

B. Objective and Scope

57. The overall objective is to contribute to economic growth through private sectordevelopment, employment creation, and development of the financial system. The goal is toreduce poverty and integrate the majority of the poor19 into the mainstream developmentprocess. The Project’s specific objective is to provide sustainable microfinance services toviable formal and informal enterprises, and savings services to the population at large.

58. The Project comprises three main components: component A, capacity building of MFIsthrough a microfinance competence center; component B, development, testing, andimplementation of new savings and loan products and delivery methods; C, establishment of arevolving finance facility (RFF) for MFIs. In addition, the Project will establish a projectimplementation unit (PIU) to support the implementation of the three components.

59. The Project, through these three components, will build the institutional capacity ofvarious providers of microfinance services, who are the Project’s institutional target group. Inturn these MFIs, enabled to deliver sustainable services, will provide small business loans20 forworking capital and investment purposes to micro and small enterprises, particularly in ruralareas, where the vast majority of MFIs are operating. Savings services will be available tohouseholds in rural areas, where the majority of the poor live.

1. Microfinance Competence Center (Component A)

60. The Project will assist the Government to establish a microfinance competence center(MCC) within IBBM to enhance the institutional capacity of potentially sustainable MFIs. Theseinclude banklike institutions, e.g., SLSs and VFL, and nonregulated financial institutions, e.g.,NGO and government-run microfinance and microcredit schemes, ROSCAS, and informal

19 The Project targets poor households that earn cash income from horticultural and agricultural production, and from running a small business. These account for 75.5 percent of the poor population. 20 The average loan amount of each MFI portfolio will not exceed $2,000.

17

community savings groups. The MCC will set up a network of existing microfinance serviceproviders and thereby create a forum for policy implementation. By establishing the MCC theProject will institutionalize local capacity building needed to provide the required expertise andtechnical skills to expand financial services. The MCC will provide the following services:

(i) Public awareness and public relations activities will be developed for allmicrofinance service providers and their potential clients. Emphasis will beplaced on developing internal communication mechanisms between existingservice providers, through the formation of an MFI network. Through schools andother existing community channels, the network will publicize the basic conceptsof banking and the benefits of savings, and advertise the availability ofmicrofinance services. The MCC will assist MFIs in conceptualizing publicrelations strategies.

(ii) In-house training courses will broaden the understanding of microfinance andimprove the technical and organization skills of MFI staff involved in providingmicrofinance services. Study tours and in-country conferences and workshopswill facilitate upgrading of MFIs.

(iii) On-site TA and training will be designed to suit the specific requirements of anMFI, ranging from start-up assistance for newly formed MFIs, support programsto achieve sustainability of operations, specific assistance geared to expandservices, to guidance in the formalization process to acquire the status of aformal financial institution.

(iv) A consultative process between the network of MFIs and BPNG will be initiatedand facilitated to establish a regulatory and supervisory framework for MFIs.

(v) A rating system for microfinance service providers will be designed on the basisof internationally accepted best practices. MCC staff will be trained to carry outthe MFI assessments. The rating determines if an MFI will have access to theRFF (component C of the Project).

61. The Project will (i) provide international and domestic expertise, computer equipment,training materials, and upgrading of trainers to establish the MCC; and (ii) finance in-housetraining and on-site consultancies for MFIs, as well as study tours, workshops, and conferences;and support MCC management to develop a business plan and a strategy to achieve financialviability by the end of project implementation.

2. New Savings and Loan Products (Component B)

62. This component will develop and test new savings and loan products and deliverymethods for financial services, and will support MFIs in implementing them. Specific attentionwill be given to linking community savings groups with financial institutions. A pilot test willinvolve downscaling commercial banks. Microfinance products oriented to target groups will bedesigned, and MFIs will be advised on appropriate delivery mechanisms. One pilotmicrobanking scheme will be designed, and established and operated in Wau, a remote town inMomase, PNG’s poorest region. The Project will provide international expertise, equipment, andtraining to develop, test, and implement new savings and loan products, and equity for the pilotmicrobanking scheme. Specifically, the Project will

(i) establish dialogue between commercial banks and informal savings groups, anddesign detailed linkage modalities;

(ii) advise MFIs on appropriate microfinance products;

18

(iii) identify commercial banks interested in providing microfinance services, andprovide support in downscaling products and delivery methodologies;

(iv) design tailor-made savings and loan products for MFIs, and provide support andbackstopping to MFIs during initial implementation;

(v) design delivery mechanisms and marketing concepts for microfinance productsaddressing specific target groups;

(vi) monitor the performance of the delivery methods and disseminated information tothe MFI network; and

(vii) establish, operate, and document one pilot microbanking scheme.

63. Downscaling of commercial banks requires a variety of institution-building measures to(i) overcome the significant cultural gap between the formal financial sector and the boundariesof economic life of the rural population, and (ii) link business practices of the traditional economywith the principles of modern banking. Communities and community leaders must be activelyinvolved to provide information on borrowers, which is otherwise not available to formal banks.This underscores the need to develop a lending technology that takes into account a client’swhole socioeconomic environment. The creation of VFL by PNGBC is one example ofdownscaling. Latin American countries are at the forefront of successfully downscalingcommercial banks; some examples can also be found in Asia.

64. The pilot microbanking scheme will demonstrate the application of new savings and loanproducts and delivery mechanisms, based on international best practice and modified to PNG’sspecific requirements. All stages of the development process of the pilot scheme will bedocumented in detail to be used as a guide for new MFIs.

3. Revolving Finance Facility (Component C)

65. This component will establish the RFF, which will provide the necessary funding for MFIsto achieve sustainability and expand their loan portfolios. Credit lines and equipment loans willbe made available to eligible MFIs for onlending to micro and small enterprises. The projectinputs comprise short-term international expertise to finalize the details of these financialinstruments during the first eight months of project implementation, subject to approval by ADB,and prior to disbursement of loan proceeds to the RFF. The RFF will be set up withcontributions from the Government (60 percent) and ADB loan proceeds (40 percent).

66. To access the RFF, MFIs must meet the following eligibility criteria: (i) registration withthe MCC and satisfactory rating (not older than six months) issued by the MCC; (ii) satisfactoryloan repayments, as established by an on-time repayment rate of at least 85 percent; (iii) adetailed plan for operational and financial self-sufficiency with a strategy for improvements overthe next year and agreed performance targets; (iv) adequate management information andaccounting systems in place to ensure successful expansion, efficiency improvements, andsatisfactory performance of the loan portfolio; and (v) average loan amount of the MFI portfolioto be funded does not exceed K5,000 ($2,000). The maximum exposure of the RFF to onesingle MFI will not exceed 40 percent.

67. The conditions of credit lines are (i) credit lines to MFIs are made available in kina or indollars provided the MFI is able—on the discretion of the management agent—to hedge therelated foreign exchange risk; (ii) for credit lines extended in dollars the interest rate will be theapplicable 3-month LIBOR21 plus a reasonable margin to cover costs, and for credit lines

21 LIBOR = London interbank offered rate.

19

contracted in kina the interest rate will be the most recent kina auction rate 22 plus a reasonablemargin to cover costs; (iii) interest rates are payable on a monthly basis over the outstandingbalance; (iv) a penalty fee is charged in the event of late interest payments (arrears of more than30 days) of an additional 3 percent per annum; (v) a commitment fee of 0.25 percent per month ispayable by the respective MFI to the RFF for contracted but not yet disbursed balances of thecredit line; (vi) maximum maturity of the credit lines is 5 years; and (vii) maximum credit lineamounts are determined by the management agent on the basis of MFIs’ stage of development.The conditions of the credit lines are subject to periodic review by the management agent.Modifications of the conditions and the change of the interest rate are subject to approval by themicrofinance steering committee (MSC).

68. The MFIs will apply the following conditions for onlending to micro and small enterprises:(i) only business loans will be extended; (ii) the maximum maturity for loans to be used for workingcapital is up to 12 months and for fixed assets, equipment, or livestock (investment loans) up tothree years; (ii) loans are only granted in kina; (iii) the interest rate will be the kina auction rate ofthe BPNG plus a margin to be defined by the MFI on the basis of market rates ensuring thefinancial sustainability of the respective MFI.

69. BPNG, the Implementing Agency, will hold the funds of the RFF in a separate account,similar to previous arrangements with the World Bank and the EU. It will outsource the day-to-day management of the RFF to a private sector management agent, e.g., a private financeinstitution or other relevant private entity based in PNG. The selection of the management agentwill be in accordance with competitive procedures acceptable to ADB. This guarantees thenecessary independence, as well as efficient management of the funds. It also underscores theintended private sector orientation of microfinance in general and of this Project in particular.The management agent will be paid on a fixed fee basis and will carry out the following tasks: (i)financial management of the funds; (ii) administration of the RFF’s financial instruments; (iii)monitoring of MFI performance ensuring that performance targets are met; and (iv) quarterlyreporting to BPNG on performance of the RFF and the participating MFIs. The detailed terms ofreference for the management contract will be finalized during the first six months of projectimplementation. Detailed procedures for reporting and auditing will be put in place to ensuretransparency of operations.

70. ADB will disburse the first installment of $280,00023 direct to a special account managedby the management agent under the supervision of BPNG, provided the following conditions arefulfilled: (i) a management contract (approved by ADB) has been signed and is legally effectivebetween PBNG and the management agency, and (ii) a model agreement for onlendingbetween the management agent and MFIs has been approved by BPNG and ADB. Appendix 5provides details on the implementation arrangements.

4. Project Management

71. In support of the Executing and Implementing Agencies and to facilitate successfulimplementation of the three components, the Project will (i) build the capacity of the PIU by

22 The kina auction facility is a monetary management instrument introduced on 1 May 1995 in which BPNG can

accept deposits (buy kina) from commercial banks or lend (sell kina) to the commercial banks. BPNG announcesthe auction volume and the rate (kina auction rate) is determined by the market through competitive bidding. Therate is a weighted average of the successful bids received and allocated.

23 The first installment is 10 percent of ADB’s total contribution of $2.8 million and is the initial contemplated level ofdisbursement to MFIs within the first three months of operation of the RFF. The total amount of the RFF is $7million. ADB loan proceeds contribute 40 percent and the Government 60 percent to the RFF.

20

engaging domestic consultants, and (ii) establish a project monitoring and evaluation systemand a management information system for components A and B. Office furniture, computer, andother office equipment and transport will be provided to ensure that the PIU is able to carry outthese activities.

C. Cost Estimates

72. The total cost of the Project, including taxes and duties and interest during projectimplementation, is estimated at $20.5 million equivalent. The cost estimates are summarized inTable 3 and details are given in Appendix 6.

Table 3: Project Cost Summary($’000)

ComponentsForeign

ExchangeLocal

CurrencyTotal Cost

A. Microfinance Competence Center 3,217 2,669 5,886B. New Savings and Loan Products 1,879 1,666 3,454 B.1 Development and Testing (891) (1,604) (2,495) B.2 Pilot Microbanking (988) ( 62) (1,050)C. Revolving Finance Facility 3,050 4,535 7,585D. Project Implementation Unit 234 581 815

Subtotal (Base Cost) 8,380 9,451 17,831

E. Physical Contingencies 266 263 529F. Price Contingencies 247 1,665 1,912G. Interest during Project Implementation 240 - 240

Total 9,133 11,379 20,512Base costs as of 30 March 2000. Physical contingencies calculated at 5 percent of base costs, excluding revolvingfinance facility. Price contingencies calculated using estimated annual escalation of 2.4 percent for international pricesand 5 percent for local cost components. In preparation of these estimates an exchange rate of 1$ = K2.6 was assumed.Figures may not add up to total due to rounding.Source: Staff estimates.

D. Financing Plan

73. The Government has asked ADB to provide a loan of $9.6 million equivalent, or about 47percent of the total project cost, from its Special Funds resources. The loan would bear a 32-yearmaturity, including a grace period of 8 years, and 1 percent interest charge during the graceperiod and 1.5 percent thereafter.

74. AusAID will provide grant cofinancing to be administered by ADB, specifically for the pilotmicrobanking in Wau and training under the MCC. In the event that AusAID grant financing is notforthcoming, the Government will make arrangements to obtain the additional funding from othersources.

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Table 4: Financing Plan($’000)

Source ForeignExchange

LocalCurrency

Total Cost

Amount % Amount % Amount %Government - - 4,669 41.0 4,669 22.8Bank of PNG 11 0.1 423 3.7 434 2.1Institute of Banking 78 0.9 1,147 10.1 1,225 6.0MFIsa 396 4.3 3,284 28.9 3,680 17.9AusAID 594 6.5 315 2.8 909 4.4ADBb 8,054 88.2 1,541 13.5 9,595 46.8

Total Project Cost 9,133 44.5 11,379 55.5 20,512 100.0ADB = Asian Development Bank, AusAID = Australian Agency for International Development, MFIs = microfinanceinstitutions, PNG = Papua New Guinea.a The contributions from the MFIs refer to their recurrent costs in expanding their operations and staffing levels as a result of capacity building under the Project.b Including interest during project implementation. Figures may not add up to total due to rounding.

E. The Executing Agency

75. BPNG will be the Executing Agency for the Project. It will be responsible for the overallcoordination and implementation of the Project. Although BPNG has been involved in variousexternally funded projects and has the knowledge and skills to oversee implementation, itsresource capacity is limited. To enhance the effectiveness and efficiency in project coordinationand management, the Project will support two domestic consultants to work as the projectmanager and project assistant. The project organizational structure is in Appendix 7.

F. Implementation Arrangements

1. Microfinance Steering Committee

76. A microfinance steering committee (MSC),24 with broad stakeholder representation, willprovide overall policy guidance and coordinate activities between national, provincial, and locallevel government agencies, MFIs, nonfinancial service providers, and private sector stakeholdergroups. The MSC will be chaired by the governor, BPNG, and will include one seniorrepresentative each of the Department of Finance and Treasury, Department of National Planningand Monitoring, IBBM, nonfinancial service providers,25 the private sector/MFI clients, and tworepresentatives from MFIs. The MSC will oversee project planning, organization, administration,implementation, and monitoring. The MSC will meet as often as required, but at least once everythree months.

2. Implementing Agencies

77. Components A and B will be implemented by IBBM with the support of short- and long-term international consulting (122 person-months) and domestic consulting/on-site trainers (120person-months). IBBM will provide a director for the MCC and initially four counterpart staff, withthe possibility of increasing the number to six during project implementation. IBBM will provide

24 The MSC is the project steering committee. It was established prior to board consideration.25 The representing institution will be nominated by the Department of Trade and Industry.

22

office space, administrative support, training and conference facilities, and equipment. Officesupplies and communication costs will be borne to a maximum of $25,000 equivalent duringproject implementation. The MFIs will contribute to training activities by making relevant staffavailable and providing their related transport and other costs. A project agreement betweenIBBM, BPNG, and ADB details project implementation arrangements.

78. Component C will be implemented by BPNG. With the support of international consulting(12 person-months), the RFF modalities will be finalized. BPNG will provide counterpart staff,office space and supplies, communication facilities, access to computer equipment, and transportto the consultant. The RFF management will be contracted out to a private finance institution orother relevant entity. The tender documents and management contract, including themanagement fee, will be prepared and the RFF will be established within the first eight months ofloan effectiveness. The management fee will be paid from the income generated by the facility.The management agent of the RFF will report to and be answerable to BPNG. BPNG will contractan auditing firm acceptable to ADB to carry out annual auditing of the RFF.

3. Project Implementation Unit

79. The PIU will be established by BPNG within one month after loan effectiveness and will bephysically located on IBBM premises.26 With MSC guidance, the PIU will handle the day-to-dayproject administration and implementation matters of components A and B, and prepare loanwithdrawal applications and consolidate other relevant documentation for component C. The PIUwill provide and facilitate delivery of the required goods and services to the different componentsand activities of the Project. It will be headed by a full-time national project manager withextensive administrative experience, at a senior level, and knowledge of the PNG financial sector.The project manager together with a project assistant form the PIU.

80. The PIU’s tasks will include (i) liaising with ADB and other stakeholders; (ii) carrying outproject budgeting and accounting, preparing loan withdrawal applications, and submitting auditedaccounts to ADB; (iii) recruiting and supervising consultants; (iv) procuring equipment and otherinputs; (v) preparing (including consolidating data) and submitting quarterly and other reports, theproject midterm review, and the project completion report on a timely basis; and (vi) providingsecretariat services to the MSC. IBBM will provide office space, access to communicationfacilities, and accounting services, and lend general support to the PIU. The Project will supportproject implementation costs, including equipment and operating costs until project completion.

4. Implementation Schedule

81. The Project will be implemented over five years and be completed by mid-2006. Theimplementation schedule is summarized in Appendix 8. To minimize possible delays duringimplementation, detailed procedures and the time frame for each of the main project activitieshave been discussed and agreed to by all parties and ADB.

5. Procurement of Goods and Services

82. Procurement arrangements have been discussed extensively with BPNG. All procurementunder the Project will follow ADB’s Guidelines for Procurement. The PIU will be responsible for allprocurement related to its establishment and operation. Vehicles, computer equipment, and otheroffice equipment will be procured subject to international shopping procedures. Furniture, training

26 The Government selected a project manager prior to board consideration.

23

materials, and related service contracts, each below $100,000 equivalent, will be awarded onthe basis of the direct purchase procedure. Details are in Appendix 9.

6. Consulting Services

83. All consultants to be financed by ADB will be engaged in accordance with ADB’sGuidelines on the Use of Consultants and other arrangements satisfactory to ADB on theengagement of domestic consultants. A total of 144 person-months of international consultingservices will be provided by a microbanking adviser, a curriculum development and trainingspecialist for component A; a microfinance product development specialist and microfinanceinstitutional development specialist for component B; and a finance facility specialist forcomponent C. The international consultants will be engaged as a team from a firm. Individualdomestic consultants (240 person-months) will be engaged for project management and theimplementation of on-site training and counseling of MFIs. A summary of consulting services,including domestic consulting, is shown in Appendix 10.

7. Advance Action

84. To expedite implementation of the Project, advance action for the selection of consultantsunder the Project has been approved. No retroactive financing is envisaged; accordingly, ADB willnot finance any expenditure incurred prior to loan effectiveness. The Government has beeninformed that ADB approval of such advance action does not imply any commitment on the part ofADB to approve the project loan.

8. Disbursements and Imprest Account

85. To expedite project implementation through the timely release of funds, an imprestaccount will be established with PNGBC. Government contributions to the Project will bemaintained in a separate counterpart account. Items eligible for financing under the imprestaccount are the local currency expenditures (including indirect foreign exchange costs, and smallforeign exchange expenditures). BPNG, through the PIU, will operate, manage, replenish, andliquidate the imprest account in accordance with ADB’s Loan Disbursement Handbook. In view ofthe large number of small contracts involved, statement of expenditures (SOE) procedures will beused for all categories covered by the imprest account. The initial amount to be deposited into theimprest account will not exceed the equivalent of $200,000. After the initial deposit, the accountwill be simultaneously liquidated and replenished on a regular basis to ensure that sufficient fundsare always available. Disbursement of loan proceeds of $125,000 for equity for the microbankingpilot will be made directly and in one installment at the beginning of project implementation.Disbursements of loan proceeds to the RFF will be made directly and in installments spaced overthe project implementation period. Conditions for loan disbursement to the RFF are in para. 110.Subsequent disbursements from the RFF to the MFIs will be made according to procedures andcriteria agreed to by the Government and ADB, which will be finalized within the first eight monthsof loan effectiveness. Details are given in Appendix 5.

86. Any individual payment to be reimbursed or liquidated under the SOE procedure will notexceed the equivalent of $20,000. Detailed arrangements for the establishment and operation ofthe imprest account and the SOE procedure will be made in accordance with ADB’s LoanDisbursement Handbook.

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9. Accounting and Auditing

87. The Government, acting through BPNG, will maintain consistent records and accountsadequate to identify goods and services financed from the proceeds of the loan. BPNG will(i) maintain separate accounts for the Project; (ii) ensure that accounts and related financialstatements are audited annually in accordance with sound auditing principles by auditorsacceptable to ADB; and (iii) submit to ADB, not later than six months after the close of each fiscalyear, certified copies of the audited accounts and the report of the auditor. This includes separateannual audit reports on the use of the imprest account and SOE. Loan funding of $80,000 forauditing and project-related costs of the Auditor General’s Office has been included in the Project.The auditor’s selection and engagement for such services will be in accordance with competitiveselection procedures acceptable to ADB.

10. Reporting

88. The PIU will prepare quarterly progress reports for the Project for the periods ending 31March, 30 June, 30 September, and 31 December each year, and will submit them to ADB notlater than 30 days after the end of the relevant period. The reports will be in a format acceptable toADB and include (i) progress made against established targets, including quality aspects;(ii) delays and problems encountered, and actions taken or proposed to resolve problems; (iii)compliance with loan covenants; (iv) proposed programs of activities to be undertaken during thenext three months; and (v) expected progress during the succeeding period. The focus willnormally be on routine project monitoring and hence on input indicators from the projectmanagement information system. In addition, the PIU will produce a report on the results of themidterm review and a project completion report for submission to ADB not later than three monthsfollowing physical completion of the Project. The PIU will also submit to ADB all reports producedby consultants under the Project.

11. Reviews

89. Because of the importance of the Project and its linkages with ongoing ADB projects, ADBwill devote special attention to project performance. ADB will review progress through quarterlyprogress reports and regular review missions. In addition, special reviews will be undertaken bythe Government and ADB (i) prior to loan disbursement to the RFF, (ii) after 30 months of projectimplementation with regard to the business and sustainability plan for the MCC, and (iii) at suchother intervals as the Government and ADB may agree. These special reviews will assess thestatus and achievements of the Project in relation to its objectives, focusing on key projectindicators, and will identify remedial actions needed. Participatory stakeholder workshops form anintegrated part of these review missions.

12. Performance Monitoring and Evaluation

90. The PIU will establish a performance monitoring and evaluation system, further detailingthe qualitative and quantitative indicators specified in the project framework, within six months ofloan effectiveness. These will be used to monitor project activities and achievements; be relatedto the corresponding specific project objectives, outputs, and activities outlined in Appendix 1; andconsist of progress and impact indicators. Monitoring procedures will be refined, finalized, andagreed upon with ADB within the first year of project implementation.

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G. Environmental and Social Measures

1. Environment

91. The Project is classified in environmental category C. Environmental implications werereviewed and no adverse impacts were identified. The micro and small enterprise sector in PNGcomprises labor intensive businesses with low energy-use investments, a large percentage ofwhich are in trading of agricultural produce and imported nonfood items, as well as repair andmaintenance services. The survey of micro and small enterprises (para. 2) provides evidencethat microenterpises manufacture goods by recycling waste products, using local raw materials,and preserving perishables. Details on the micro and small enterprise sector are in Appendix 2.The training provided by the MCC to the microfinance service providers will incorporatesensitization of environmental issues to be considered when assessing loan applications ofmicro and small enterprises.

2. Social and Participatory Measures

92. The project design is based on a participatory approach. Project preparationcommenced with the conference, Microfinance Best Practice (para. 2). The conference attractedwide interest and more than 90 people paid their way to take part. The participants includedrepresentatives from various well-known and less-known27 microfinance providers, national andprovincial government agencies and departments, women’s groups, informal savings groups,SLSs, the central bank, commercial banks, IBBM, private sector representatives, and bilateraland multilateral assistance agencies. This provided a first indication of the extent of interestplaced on microfinance in PNG. It was at this conference that the need to formulate amicrofinance policy for the country was expressed; a committee was appointed to prepare a firstdraft for discussion at the participatory project planning workshop.

93. The goal-oriented project planning method (footnote 2) was used during the five-dayparticipatory project planning workshop, which marked the end of the TA. The project conceptwas discussed in detail and the participants agreed on all aspects of the project design. Thisprocess built trust and confidence among Government and microfinance practitioners, and laidthe foundation for project ownership.

94. Social analysis was undertaken in the course of project preparation. It confirmed that thepopulation strata in most need of microfinance services consists of the poorer households inurban and particularly rural areas. The Project applies a self-targeting mechanism (para. 105) toreach these beneficiaries. An analysis of the micro and small enterprise sector and theirperceived credit needs was also undertaken as part of the TA. It confirmed that this segment ofthe private sector is neither served by commercial banks, which perceive them as high-riskcustomers with no bankable collateral, nor by the currently operating credit schemes, whichprovide credit mainly to underprivileged women. In actual fact, the loans provided by the MFIsoften do more harm than good, as the loans are usually restricted to K500 or less, and there isno flexibility for MFIs to provide loans based on the business requirements of the borrower.Because these amounts only partially cover the needed working capital and investment costs,this often delays and even prevents the borrower from actually starting their business. This does

27 These include the VNN Saving Society in East New Britain Province and revolving loan schemes initiated by the

provincial governments of Milne Bay and Western Province.

26

not imply that small loans are counterproductive. The loan amounts have to correspond with thecapital requirements of the microenterprise, working and/or investment capital, to avoidundercapitalization.

V. PROJECT JUSTIFICATION

A. Financial and Economic Analyses

1. Financial Viability

95. The project strategy chosen to provide microfinance services in PNG focuses oninstitutional capacity building. The three project components are designed to upgrade existingMFIs and to establish new MFIs, which are the institutional beneficiaries of the Project. TheProject will strengthen at least 40 microfinance service providers during project implementation,and through these, reach a minimum of 45,000 clients. The average maximum loan size of eachparticipating MFI is set at $2,000.

96. The participating MFIs will be strengthened to reach the following targets during projectimplementation:

(i) satisfactory loan repayment: >85 percent,(ii) portfolio at risk maximum level: <10 percent,(iii) average savings accounts growth rate: >30 percent,(iv) average lending activities growth rate: >25 percent,(v) staff productivity (outstanding loans/loan officer): >100,(vi) operating self-sufficiency: within 5 years, and(vii) financial self-sufficiency: within 7 years

97. These performance criteria and targets for MFIs follow international standards inmicrofinance. The Project will assist MFIs to reach these targets, and thus reach financialviability. Details are provided in Appendix 5.

2. Sustainability

98. The objective of the Project is to provide sustainable microfinance services. This will beachieved through a number of measures, that form an integrated part of the project design. Theassistance provided by the MCC to existing and new microfinance service providers is geared toachieve financial viability (para. 95). The process of achieving this goal will be closely monitoredby MCC, and tailor-made training packages will help to overcome identified institutionalweaknesses.

99. The scope of component A, the establishment of the MCC, stipulates that the MCC must(i) prepare a full-fledged business plan within the first two and half years of projectimplementation, and (ii) provide a detailed strategy to achieve financial viability by the end ofproject implementation. Possible strategies to be explored in detail include user-pay initiativesand expansion and marketing of services to MFIs in other Pacific island countries. The Projectwill assist the MCC in this process. Appendix 1 and 5 provide details.

100. The new savings and loan products, which will be developed and tested undercomponent B.1 of the Project, form part of the services renders by MFIs. The Project will ensurethat only viable savings and loan products, and delivery mechanism will be implemented. The

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establishment of pilot microbanking under component B.2 serves as demonstration and willbreak-even after seven months of operation.

101. The RFF, component C of the Project, has to achieve a positive return on capital afterthe first year of operation. This requires the RFF to charge MFIs an interest rate, that (i) coversadministrative and management costs, (ii) provides for defaulted loans, and (iii) and is above thenational inflation rate. These guidelines will ensure that the funds are fully protected and theRFF becomes a self-sustainable revolving fund and continues operation also after projectcompletion.

3. Economic Analysis

102. An economic rate of return for the Project is difficult to quantify as the beneficiaries andend-users of the microfinance services, particularly the micro and small enterprises, cannotaccurately be determined at this stage. The MFIs will assess the viability of the micro and smallenterprise investments based on sound economic principles. The know-how to carry out theseassessments will be transferred from the MCC, and the training provided by the Project.

103. The number of project beneficiaries, or borrowers of MFIs, and the respective type ofmicro and small enterprises to be financed will ultimately be determined by market forces andcannot be forecast with confidence. However, benefit-cost analysis of some typicalmicroenterpises was carried as part of the TA (footnote 1). These include smallholder farming,honey and poultry production, trading of agricultural products and seafood, sewing, smallrestaurants, rural and urban food stalls, and trading of secondhand clothes. Production costsand production values are based on the information provided by the owners/operators of themicroenterpises and reflect only cash transactions in an annual production cycle. The majorityof these sample microenterpises have been in operation for 3–8 years. The production costsinclude hired labor, raw materials, transport, and other cash expenditures, but exclude “free”family labor, cost of the owner/operator of the microenterprise, and depreciation of equipment.The cost of land is only included if it is leased. Based on this, microenterpises display attractivebenefit-cost ratios between 7 percent and 24 percent. Given the short period of the productioncycles, the total impact of these investments on the economy should be high.

B. Impact on Poverty

104. The assessment of poverty and the development of interventions to reduce povertyrequire a multidimensional approach in which access to cash income or equivalent economicbenefits is a major part. The Project will facilitate this process by providing microfinanceservices to establish and expand micro and small enterprises, particularly in rural areas wherethe majority of MFIs operate. This will create much-needed employment opportunities,particularly in rural areas, with a direct effect on poverty. Through the enhanced growth of themicro and small enterprise sector, goods and services will be more accessible, particularly forthe poorer strata of the population.

105. A self-targeting mechanism will ensure that MFIs provide services to the poor. The loanportfolio of each MFI participating in the Project is limited to a maximum average loan size ofK5,000, or approximately $2,000. Ninety-five percent of the loans will be in the range of $200 to$400. Only a small number of loans, mainly for equipment and transport, will exceed themaximum average of K5,000. The portfolio mix, even though dominated by microloans, willsupport MFIs in reaching financial sustainability, while providing services to the poor.

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106. The Project will also provide savings facilities to poor households currently unserved,and hence, enable them to securely accumulate resources for times of hardship. The targetedclientele for loan and saving products represent 75 percent of the poor in PNG. They comprisehouseholds that are part of the cash economy and earn income from tree crops, commercialagriculture, micro and small businesses, and wage employment (para.5).

107. The project design is based on a process approach, which will enable MFIs to increasetheir outreach and provide services to segments of the population otherwise unserved. It willprovide microfinance services to at least 45,000 people. The socioeconomic impact and theachievement of this target will be closely and continuously monitored to enable timely correctivemeasures to be taken if necessary.

C. Risks

108. The key risks to successful project implementation and the achievement of the projectobjective were identified by the stakeholders during the participatory project planning workshop.They include the following:

(i) Political stability and consistency of Government policies are a major concernand have a considerable influence on private investments. The current situationis considered to more stable than in previous years, and the current Governmentmakes considerable efforts to assure the business community that it will continuein its current direction.

(ii) During previous years, agricultural production was seriously affected by naturaldisasters. As the majority of the rural population rely to various degrees onfarming, for subsistence and cash income, the loss of a harvest can have adetrimental effect on the portfolio of microfinance service providers. While naturaldisasters cannot be avoided, encouraging the establishment of nonfarmingactivities will spread the risks for the borrower as well as the lender.

(iii) High inflation rates with corresponding high interest rates have a negative impacton private sector investments. MFIs stress that their potential clients are lesslikely to borrow when interest rates are perceived to be high.

(iv) The development of viable micro and small enterprises does not only depend onthe availability of financial services. Nonfinancial services, e.g., businesscounseling, training and marketing information, and business linkages areequally important. The provision of these services has been irregular in the past.The Small Business Development Corporation, a major provider of nonfinancialservices throughout PNG, was abolished in 1999 only to be revived in 2000.28

The risk of losing these services again can be reduced through continuouslobbying by the business community.

VI. ASSURANCES

A. Specific Assurances

109. The Government has given the following assurances, in addition to the standardassurances, which have been incorporated in the legal documents:

28 The previous government abolished the Small Business Development Corporation in 1998 due to budgetary

constraints. The current Government, elected in 1999, reversed this decision and reinstated the corporation.

29

(i) timely and regular (a) requests for budgetary appropriations will be made for thecounterpart funding requirements of the Project during each year of projectimplementation; and (b) release of appropriated funds will be made to facilitateproject implementation;

(ii) for external training financed under the Project, that the relevant institutions areselected and engaged in accordance with procedures acceptable to ADB, takinginto account considerations of economy and efficiency;

(iii) it will (a) adopt a microfinance policy statement in accordance with internationalbest practice in microfinance, in form and substance satisfactory to ADB, no laterthan 6 months after loan effectiveness; (b) within 12 months of loaneffectiveness, submit to ADB for review, draft legislation or implementingregulations, as necessary to establish a regulatory framework for microfinance;and (c) within 24 months of loan effectiveness, enact such legislation and issuethe relevant regulations, as applicable;

(iv) within 6 months of loan effectiveness, BPNG will establish a project monitoringand evaluation system based on specified performance indicators to be agreedwith ADB and, within 12 months of loan effectiveness, refine the system in amanner satisfactory to ADB.

B. Conditions for Loan Disbursement

110. No withdrawals will be made from the loan account:

(i) for any initial contribution to the RFF under component C of the Project until (a)BPNG has selected and engaged a management agent to manage, administer,and operate the RFF in accordance with an agreement satisfactory to ADB andcompetitive selection procedures acceptable to ADB; and (b) the operationalprocedures and guidelines for the RFF, including MFI eligibility criteria, and theterms and conditions of model onlending agreements between MFIs and theRFF, have been agreed to by BPNG and ADB; and

(ii) for any subsequent contribution to the RFF under component C of the Projectuntil an amount of not less than 70 percent of the previous contributions to theRFF from the loan proceeds and the corresponding counterpart contribution tothe RFF by the Government is disbursed to the MFIs. For these purposes, eachcontribution to the RFF will be funded under the loan and through correspondingcounterpart contributions in the proportions of 40 percent and 60 percent,respectively, up to an aggregate amount of $7,000,000 equivalent.

VII. RECOMMENDATION

111. I am satisfied that the proposed loan would comply with the Articles of Agreement ofADB and recommend that the Board approve:

(i) the loan in various currencies equivalent to Special Drawing Rights 7,357,000 tothe Independent State of Papua New Guinea for the Microfinance andEmployment Project, with a term of 32 years, including a grace period of 8 years,and with an interest charge at the rate of 1 percent per annum during the graceperiod and 1.5 percent per annum thereafter, and such other terms andconditions as are substantially in accordance with those set forth in the draftLoan and Project Agreements presented to the Board; and

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(ii) the administration by ADB of a grant not exceeding the equivalent of $909,000 tobe provided by the Australian Agency for International Development to theIndependent State of Papua New Guinea for training under component A and fora pilot microbanking scheme under component B of the Project.

TADAO CHINO22 September 2000 President

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APPENDIXES

Number Title Page Cited on (page, para.)

1 Project Framework 32 1,2

2 Micro and Small Enterprise Sector 36 5, 15

3 Microfinance Institutions – Changes In Financial Self-sufficiency in PNG 39 8, 26

4 The Government’s Draft Microfinance Policy 45 11, 33

5 Detailed Implementation Arrangements 48 19, 70

6 Cost Estimates and Financing Plan 56 20, 72

7 Project Organizational Structure 60 21, 75

8 Implementation Schedule 61 22, 81

9 Indicative Contract Packages 62 23, 82

10 Outline Terms of Reference for Consulting Services 63 23, 83

SUPPLEMENTARY APPENDIXES(available on request)

A Detailed Project Costs by Component

PROJECT FRAMEWORK

Design Summary Performance Targets Sources of InformationMonitoring System

Assumptions and Risks

Development Goal

Poverty is reduced by integrating the poorto the mainstream, monetizeddevelopment process.Private sector-led economic growth andemployment creation is enhanced and theoverall financial system is deepened.

National statistical data

Project Purpose/Objectives

Formal and semiformal microfinanceinstitutions provide sustainablemicrofinance services to viable formal andinformal enterprises of all sectors andsavings services to the population atlarge.

Outreach• By Jun 2006, at least 40 MFIs

have participated in variousproject activities.

• By Jun 2006, MFIs have reachedat least 30,000 borrowers and15,000 depositors.

• MFIs do not exceed the averagemaximum loan size of K5,000 atany time.

Sustainability• On average, the portfolio at risk

of all participating MFIs does notexceed 10 % at any time after thesecond year of participation.

• Each participating MFI showsannual improvement of itsoperational self-sufficiencyindicator to reach 100 %operational self-sufficiency within4 years.

• At least three of the five largestparticipating MFIs, with regard toportfolio outstanding, reachoperational self-sufficiency within2 years after participating in theProject, and two reach financialself-sufficiency within 4 years.

• PIU and MCC reports• MFI reports

• MFI reports• Audited financial

statements of MFIs

• Adequate nonfinancialservices provided by otherservice providers areaccessible.

• Inflation rate is notincreasing excessively.

• Climatic conditions arefavorable.

• There is political stabilityand consistency ofGovernment policy.

Risk• The Government provides

counterpart funds.

Appendix 1, page 1

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PERFORMANCE TARGETS SOURCES OF INFORMATIONMONITORING SYSTEM

IMPORTANTASSUMPTIONS/RISKS

Output 1

The capacity of MFIs is strengthenedthrough a newly established micro-finance competence center.

• The MCC is established andoperational six months after projectstart.

• The MCC conducts on average 1,500person-training-days per year.

• At least 80% of participating MFIsreceive on-the-job training.

• At least 50% of participating MFIsoperate effective MIS within 2 yearsafter MCC training and at lest 80 %after 3 years.

• At least 80 % of the participatingMFIs are rated annually.

• MFI network is established after oneyear of project implementation, andregulatory framework for MFIs issuccessfully negotiated within twoyears.

• Business plan for the MCC is drawnup within 2 years of projectimplementation outlining path tofinancial sustainability by the end ofyear 4 of project implementation.

• On-site visit and assessmentby MCC

• PIU/MCC reports

• PIU reports

• Training impact evaluation report

• Files of BPNG

• MCC reports.

• Skills and knowledgeacquired by MFIs throughMCC training are applied.

Activities Major Input 1

1.1 Establish the MCC within the Institute of Banking and Business Management andstart operations.

1.2 Prepare a business plan for the MCC.1.3 Provide training of trainers opportunities abroad.1.4 Organize study tours, national conferences, and workshops on microfinance issues.1.5 Design and implement in-house and on-the-job training for MFI staff.1.6 Assist MFIs in formulating business plans and expansion strategies.1.7 Establish a network of MFIs, create linkages with nonfinancial service providers,

and create awareness among network institutions.1.8 Develop governance guidelines for MFIs.1.9 Establish a consultative process between MFIs and BPNG, and establish a

conducive regulatory and supervisory framework for MFIs.1.10 Design and conduct public awareness on basic concepts of banking and the

benefits of savings, and provide information on available microfinance services.1.11 Design and apply detailed national rating system for MFIs.1.12 Provide information on MFI rating to the revolving finance facility.1.13Design and apply a project monitoring and evaluation system.

• International and domesticconsulting services

• Vehicles, computer equipment,other office equipment andtraining materials

• Training of trainers, in-houseand on-the-job training

• Study tours, conferences, andworkshops;

• Public awareness• O&M

Appendix 1, page 2

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PERFORMANCE TARGETS SOURCES OF INFORMATIONMONITORING SYSTEM

IMPORTANTASSUMPTIONS/RISKS

Output 2 New savings and loan products, anddelivery methods are developed, tested,and implemented.

• At least one new product each forsavings, loans, and other financialservices is introduced each year.

• At least 2 downscaling pilot MFIservices are operational duringproject implementation.

• At least 10 linkages between semi-formal MFIs and formal financialinstitutions are established.

• Pilot microbanking is legallyestablished and managementstructure is in place within 6 monthsof project start.

• Business plan for pilot microbankingis formulated within 12 months ofproject start.

• At least 70% of initial equity of thepilot banking is lent out within oneyear of operation.

• Pilot banking extends an average of800 loans annually.

• Operational self-sufficiency isreached after year one of operation.

• PIU/MCC reports• Records of pilot banking.

Activities Major Inputs 2 2.1 Develop, test, and implement new savings and loan products. 2.1.1 Establish dialogue between community and informal savings groups and commercial banks. 2.1.2 Advise MFIs on appropriate microfinance products. 2.1.3 Advise interested commercial banks on strategies to downscale operations. 2.1.4 Design target group-oriented microfinance products. 2.1.5 Develop appropriate target group-oriented delivery mechanisms and marketing concepts for microfinance products. 2.1.6 Monitor performance of delivery mechanism and disseminate information through MFI network. 2.2 Establish, operate, and document pilot microbanking.

2.2.1 Establish legal framework and management structure. 2.2.2 Design savings and loan product and delivery mechanism. 2.2.3 Set up office and operations. 2.2.4 Develop business plan. 2.2.5 Deliver microfinance services. 2.2.6 Document process of establishment and operations.

• International and domesticconsulting services

• Vehicles, computer equipment,other office equipment, andtraining materials

• Equity• O&M

Appendix 1, page 3

34

PERFORMANCE TARGETS SOURCES OF INFORMATIONMONITORING SYSTEM

IMPORTANTASSUMPTIONS/RISKS

Output 3

A revolving finance facility for MFIs isprovided.

• Finance facility is established andoperational after 8 months of projectstart.

• 10 credit lines are established withinfirst 3 years of projectimplementation.

• There is positive return on capitalafter the first year of operation.

• PIU reports

• RRF reports

• Audited financial statementsof RRF

Activities Major Inputs 2 3.1 Finalize selection and eligibility criteria, and mechanism for MFIs. 3.2 Design operational guidelines for a finance facility. 3.3 Establish monitoring mechanism. 3.4 Select a management agent. 3.5 Create public awareness of the finance facility. 3.6 Provide finance to MFIs.

• International consultingservices;

• Funds for finance facility

BPNG = Bank of Papua New Guinea, MCC = microfinance competence center, MFI = microfinance institution, MIS = management information system, O&M = Operations and Maintenance,PIU = project implementation unit, RRF = revolving finance facility

Appendix 1, page 4

35

Appendix 2, page 1

MICRO AND SMALL ENTERPRISE SECTOR

A. Defining Micro and Small Enterprises in Papua New Guinea

1. Based on the assumption that the priorities of the Government of Papua New Guinea(PNG) for micro and small enterprise (MSE) development relate to economic factors and thestrengthening of the private sector, the definitions and guidelines were developed (Table A2.1):

Table A2.1: Defining Guidelines for Micro and Small Enterprise Sector in PNGEnterprise Definition/Guidelines Rationale

Microenterprise Any commercial enterprise that isundertaken on a regular basis,involving annual sales between$2,400 - $16,000 per annum.

While this definition captures a largenumber of entrepreneurs that wouldnot be included in a targeted credit orbusiness assistance program, theregular commercial activity criteriawould exclude part-timeentrepreneurs. The upper limit of$16,000 turnover is arbitrary but thiscould be regarded as a realisticdividing line in PNG (that should beincreased over time).

Small Businesses A permanent commercial enterprise(whether formally incorporated or not)with an annual turnover of between$16,000 - $80,000 per annum.

Incorporation should not be used as acriterion, as most small businesses inPNG are not incorporated. The upperincome level is a more appropriatecriterion. Due to the inflationarypressures in PNG, a turnover of closeto $240,000 per annum nowrepresents a small business. It shouldalso be appreciated that many smallbusinesses, even with a turnover inexcess of $160,000, find it difficult tosecure credit from a commercial bank..

2. These definitions are provided as a guideline. The division between microenterprise andsmall businesses becomes academic if a single business assistance package is provided forthis sector of the economy. Under such a scenario, the key issues are the separation ofmicroenterpises from informal entities and, in turn, small businesses from medium-sizedenterprises.

B. Size of MSE Sector

3. Based on the above definitions, the estimated number of enterprises in the twosegments1 are as follows: 100,000–120,000 microenterpises and 12,000–15,000 small

1 These estimates are drawn from discussions with provincial government officials and private sector

representatives. Official statistics are not available and the business name/company registrations at the InvestmentPromotion Authority do not all relate to active enterprises.

36

Appendix 2, page 2

businesses. Figure A4.1 summarizes the private sector in PNG and attempts to categorize andestimate the number of private enterprises based on their annual turnover.

Figure A4.1: Categories and Numbers of Private Sector Enterprises

p.a. = per annumSource: Staff estimates (see footnote 1)

D. Characteristics of the MSE Sector

4. The characteristics of micro and small businesses in PNG, and their implications foreffective microfinance and business development schemes are outlined in Table A2.2.

Majority of the population

700 - 800 enterprisesturnover >K3,000,000 p.a.

3,000 - 3,500 enterprisesturnover K600,000 - K3,000,000 p.a.

12,000 - 15,000 enterprisesK40,000 - K600,000 p.a.

100,000 - 120,000 enterprisesK6,000 - K40,000 per year

300,000 - 350,000 entrepreneurs< K6,000 p.a.

Informal Sector /Subsistence Farming

LargeEnterprises

Medium-SizeEnterprises

Small Businesses

Microenterpises

Part Time Entrepreneurs

37

Table A4.2: Characteristics of Microenterpises and Small Businesses

Activities KeySectors

Market BusinessStructure and

Assets

Savings Access toFinance

Implications

Microenterprises Primarily involvedin sale of producefrom own gardens,seafood, and homecooked orproduced itemsPredominatelyinvolve femaleentrepreneurs

Gardenvegetables,sewing, homecooking, retail(including village-based tradestores), smallholders, copradrying and sale,small-scale poultryand livestock,secondhandclothing, fishing,local transport

Mainly localmarkets—weaklinkages outside ofimmediate area

Usually no formalstructure but somehave registeredtrading namesFamily or clanbased andincludes somevillage-basedbusiness groupsRarely any tangibleassets as land isnot formallyregistered

Most income spenton family or villageconsumablesLittle or no savings

Informal lendingfrom family orfriendsSome financethrough existingmicrofinanceschemesCommercial banksnot prepared toprovide credit tothis sector

A large anddispersed groupthroughout thecountry that wouldbe difficult toserviceFew havecommitment todevelop genuinebusiness and mosthave no clearunderstanding ofbusiness practicesSecurity for anycredit would bedifficult to obtain

SmallBusinesses

Primarily involvedin retail, wholesale,transport, andother servicesOnly a relativelysmall percentageof the larger smallbusinesses areinvolved inmanufacturing

Retail, wholesale,ground and seatransport, timber,seafood, small-scale mining,coffee, copra,poultry

Primarily localmarket area butsome of the largerenterprises alsosell nationallyVery few involvedin direct exports

Smallerenterprises usuallyoperate undertrading name only,while largerbusinesses havebeen formallyincorporatedMainly family orclan-based butlarger retailoperators employup to 10 peopleSmallerenterprises havelimited assets andlarger companies'assets are oftenrestricted to stock

Weak cashflow forsmaller businessesalso eroded byfamily/socialobligationsEven the largersmall businessesgenerally havevery limitedsavings

This sector ispoorly serviced bythe commercialbanks and mostsmall businessesare excluded frommicrofinanceschemes.

Still a relativelylarge anddispersed groupand security forcredit will bedifficult to obtainBusinessknowledge/experience islimited and supportservices areneeded badly.There are,however, a higherproportion ofentrepreneurs inthis segment withthe commitmentand capabilities togrow.

Appendix 2, page 3

38

Appendix 3, page 1

MICROFINANCE INSTITUTIONS – CHANGES TOWARDS FINANCIALSELF-SUFFICIENCY IN PNG

A. Profile of Microfinance Providers

1. To define the profile and evaluate the performance of the microfinance providers inPapua New Guinea (PNG), the indicators and standards shown in Table A3.1 are applied

Table A3.1: Performance Indicators and International StandardsObjective Performance Indicators Performance Standards

Outreach1. Average loan size � < Countries annual per capita

income2. Average deposit size

� Depth

3. Percentage of Women � > 1/3 of customer base4. Size of customer base5. Number of outstanding loans

� Scale

6. Number of savings accountsSustainability

� General information

7. First year of operation

8. Nominal interest on loans9. Effective interest on loans

10. Interest on savings� Portfolio quality 11. Portfolio at riska

� < 10%� Self-sufficiency 12. Operational self-sufficiencyb

� 100% within 3 – 7 years� Productivity 13. Staff productivity � > 100 outstanding loans/loan

officera Portfolio at risk = balance of loans over 30 days late/total outstanding loansb Operational self sufficiency = Income / operational and risk costs

2. In comparison with standards of international best practice (Table A3.1), theperformance of microfinance providers in PNG lags in all areas. Table A3.2 gives an overview ofPNG microfinance providers.

3. The average loan size range from K281 to K3,067. According to different sources, theactual demand for microcredit lies in the range of K500 (working capital) up to K30,000 (fixedassets). The bottom end of less than K300 as an average loan size is the result of creditschemes that target start-up businesses in the subsistence sector. These low credit amounts donot, on average, necessarily reflect the low income group that is served. They are sometimesthe result of rationing the credit supply due to an excess of demand while there is a shortage ofseed capital.

4. The average deposit balance lies between K39 and K662. Licensed financial institutionsrequire normally an opening balance around K20, whereas most of the microcredit schemesapply compulsory group accounts with minimal weekly contributions per group member.

5. The existing microcredit schemes are almost exclusively targeting women, which is theresult of the Grameen Bank lending methodology that is wide-spread in PNG. Only theregulated financial institutions do not use gender as an eligibility criteria for clients.

39

Table A3.2: Profile of Microfinance Providers of Papua New Guinea a

Key Performance Indicators as of 31 December 1999

PNGBC RDB ENB SLS MorobeSLS VFL LLDAT NWCP NSRDP PnK VVN Sav

Soc Total

Outreach1. Average loan size K2,913 K3,067 K685 K825 K361 K487 K281 K500 - - K281 – K3,0672. Average deposit size K352 - K662 K268 K48 K176 n.d. K39 K89 K143 K48 – K6623. Percentage of

women n.d. n.d. n.d. n.d. 97% 100% 100% 100% ? 50% 50%- 100%

4. Size of customerbase (credit)

Approx.70,000

Approx.3,000

Approx.4,700

Approx.1,000 376 2,704 8,200 600

Approx.500

Approx.250

91,330 (21,330)

5. Number ofoutstanding loans 796 2,400 Approx.

2,000 Approx. 490 156 1,495 1,250 35 - - 8,622

6. Number of savingsacc. 465,765 - 12,039 1,873 376 2,704 8,200 98 817 700 492,572 (26,807)

Sustainability7. First year of

operation 1974 1967 1993 1999 1999 1994 1996 1998 1995 1997

8. Nom. interest onloans p.a. 18,25% d.b. 5% - 22%

flat 12% d.b. 12% d.b. 30% flat 35% flat 10% - 20%flat

20% - 25%flat - - 5% - 35%

9. Effec. interest onloans p.a. n.d. n.d. n.d. n.d. n.d. n.d. n.d. n.d. n.d. n.d.

10. Interest on savings 2,5% / 4% - 6% 0% 6% 5% 2,5% 2,5% 2,5% 0,1% 0,1% - 6%11. Portfolio at riskb

Approx. 40% 60,30% < 1% < 1% 3,97% > 50% > 50% < 10% - - < 1% - > 60%

12. Operat. self-sufficiencyc n.d. n.d. 100% n.d. 18,51% < 30% n.d. n.d. n.d. n.d. 18,51% - 100%

13. Staff productivity n.d. n.d 700 173 26 135 6 18 n.d. n.d. 6 - 700

a ENB, LLDAT = Lik Lik Dinau Abitore Trust, NSRDP = North Simbu Rural Development Project, NWCP = National Women’s Credit Project, PNGBC = Papua New Guinea

Banking Corporation, PnK = Putim na Kisim, RDB = Rural Development Bank, SLS = saving and loan society, VFL = Village Finance Limited.b Portfolio at risk = balance of loans over 30 days late/total outstanding loans.c Operational self sufficiency = income / operational and risk costs.

40

Appendix 3, page 2

Appendix 3, page 3

6. While the potential demand for microcredit is about 300,000 borrowers for all of PNG, theanalyzed institutions could cover an estimated potential demand of nearly 100,000 borrowers ifthey would use their institutional capacity at full potential. Without Papua New Guinea BankingCorporation (PNGBC), however, the client base for credit would still be around 20,000. Thispotential demand is only met by the existing microfinance providers with a total of 8,622outstanding loans. The lack of credit funds and overall highly insufficient institutional capabilitiesexplain the low outreach of microcredit in PNG.

7. Contrary to the supply of credit, saving facilities are wide-spread throughout the country.Nearly half a million people have a savings account, which falls in the category of microfinance.The bulk of the accounts is held by PNGBC as the “people’s bank” and of the savings and loansocieties. If those two institutions were discharged, nonlicensed savings accounts would comedown to less than 10,000.

8. Interest rates charged on credit range between 5 percent per annum flat and 35 percent,equivalent to effective interest rates of up to more than 70 percent. Considering all of the costsinvolved in obtaining a standard group loan in one of the women credit schemes, an effectiveinterest rate of 168 percent was calculated. Taking the existing high demand for credit, it becomesevident that, as in most other countries, PNG microborrowers are not interest-sensitive, access toadequate credit facilities in terms of convenient access, speedy procedures, timely disbursement,uncomplicated procedures, etc. is more important than the direct financial costs. Additionally, theinterest rates charged indicate that microfinance providers in PNG could become self-sustainableif they dispose of an efficient and effective management and institutional capacity.

9. Interest on savings is negative in real terms. The current inflation rate is around 18percent, while financial institutions pay only up to a maximum of 6 percent per annum for savings.The fact that savings accounts are widely spread over PNG indicates that security is the mainmotive to save. The findings corroborate similar results found in other countries, where thephysical security of deposits, and convenience to deposit money and to withdraw it at any timewhen needed are the most crucial factors for depositing in financial institutions.

10. The quality of the loan portfolio in microfinance is far from acceptable, even whenstandards below international best practices are applied. Apart from a few examples whereacceptable repayment rates are achieved on the costs of low productivity, the portfolio at risk liesin the range of over 50 percent. In international best practice discussions on microfinance, theloan portfolio at risk is generally below 10 percent. An explanation for this worrying result lies inthe target group definition (finance of start-up businesses of poor women of the subsistencesector), the lack of systematic lending methodologies, and the general perception of microfinanceas a mainly social issue.

11. Absence or deficiencies in accounting are common among the existing microcreditschemes. The institutions do not use a standard chart of accounts and have no audited financialstatements, which makes it difficult to compare the results. Even the regulated financial institutionsdo not account for microcredit operations separately and mix it up with their regular lendingbusiness. This makes it difficult, if not impossible, to obtain reliable information on the operationaland financial self-sufficiency of the microcredit schemes. Village Finance Limited (VFL) and Lik LikDinau Abitore Trust (LLDAT), the most professional microfinance institutions (MFIs), only reach alevel of 18,51 percent (VFL) and nearly 30 percent (LLDAT) of operational self-sufficiency, afterone (VFL) and six years (LLDAT) of operation.

41

Appendix 3, page 4

12. In addition, the low level of staff productivity indicates a lack in overall institutional capacity.Apart from the savings and loan societies, which reach considerable levels in productivity becausetheir lending procedures are very simple, all microcredit schemes lie in the range of less than 30outstanding loans per field officer. Only LLDAT reaches 135 loans with the cost of a portfolio atrisk of more than 50 percent. Considering that most MFIs that have been analyzed rely on group-lending technologies, these figures are far below international standards, where the borrower perloan officer ratio in MFIs applying individual lending techniques is 250-300, and about 450-500when group-lending predominates.

B. Institutional Changes Toward Financial Self-Sufficiency

13. The main challenges to become both financially self-sufficient and to provide financialservices with considerable outreach are in the following areas: (i) governance structure, (ii) targetmarket, (iii) credit methodology, (iv) savings methodology, (v) growth strategy, and (vi) financialand human resource management.

14. Governance Structure. Microfinance in PNG has been developed almost exclusively underan integrated development or mainly social approach. Accordingly, cross-sectoral issues, (e.g.,gender, community development, real sector development, business training, etc.) with theinvolvement of the according government departments determine the governance structures ofmost of the microfinance schemes of PNG. Consequently, social and poverty reduction goalsdominate the governance structure of the existing microcredit schemes. To overcome thissituation and to reach both the financial objectives and the social mission of an MFI, existinggovernance structures should be reviewed under the following aspects:

(i) A coherent set of overall goals must be defined. The actual coexistence of theobjectives “reaching the poorest of the poor” and “achieving financial self-sustainability in the short run” hampers the development of a clear organizationalprofile and leads to poor performance. Thus, international funding agencies andnational government departments in their role as funders and technical assistanceproviders have to define priorities to develop a coherent set of guidelines andstandards for microfinance organizations.

(ii) Stakeholders have to be aware of the genuine services an MFI can provide best:tailor-made, cost-covering credit and savings facilities. The profile of thegovernance structure should clearly reflect that orientation.

(iii) Overly complex governance structures are ineffective and produce informal andthus nontransparent management structures. Governance structures should bekept lean and simple to produce appropriate incentives.

15. Cross-sectoral governance structures that are characterized by a general lack ofmicrofinance skills are dysfunctional. Investment in human resources to incorporate the technicalknowledge on microfinance is necessary. At the same time stakeholders from the financial andprivate business sectors should be included in governance structures.

16. Target Market. MFIs in PNG have drastically changed their market approach. Up to thepresent microfinance has been dominated by an integrated poverty reduction approach, measuressuch as means testing derived from the Grameen Bank have been taken to assure that theborrowers belong to the poorest segments of the society. But it should be common understandingthat credit is not an adequate means or panacea to solving the social and economic problems ofthe poorest members of a society. Grants, social aid, and welfare instead of indebtness would be

42

Appendix 3, page 5

more adequate for them. To become financially self-sustainable and to reach the target group formicrofinance, the MFI-sector of PNG should consider the following aspects:

(i) Markets have to be targeted. While savings facilities can be offered to the broadpublic, credit services should be directed to those elements of the markets thathave the highest probability to be able and willing to repay a loan.

(ii) Eligibility criteria should be set in a consistent way. To systematically exclude 50percent of the potential market by applying strict gender eligibility criteria, might bejustifiable under social and political aspects for a special purpose MFI, but is notacceptable for the whole MFI sector of a country.

(iii) Targeting only start-up businesses raises the risk exposure of the MFI. Sectoraldiversification and a shift to experienced microbusinesses is highly recommended.

(iv) Markets should not be targeted under the existing slightly paternalistic beneficiaryculture, but under a clear client service culture.

(v) Market research has to be introduced as a means of identifying profitable markets.(vi) Profitability and target group orientation must be combined to identify new market

segments.

17. Credit Methodology. To overcome the structural deficits of MFIs in PNG concerning theircredit methodology, the following recommendations should be considered:

(i) In general terms, MFIs have to develop the profile of a pure provider of financialservices, and accordingly of a reliable and thus strict lender that disciplines willfuldefaulters and enforces these loans.

(ii) Screening mechanisms should be redefined. The actual procedures—based on thecriteria “no business experience”, “monthly income of less than K200/$70” and“absolute poor living conditions”—produce an adverse selection of potentialborrowers, with the consequence of loan losses up to 50 percent.

(iii) Individual, cash flow-oriented lending methodologies have to be systematized andexpanded. To date, the most profitable segment of the microfinance sector is highlymarginalized—from both traditional finance institutions and MFI.

(iv) As in-kind collateral can be found in even the smallest farming household of PNG,the credit institution should accept in-kind collateral to secure loan recovery and tostrengthen its image by the community of a strict lender.

(v) The client-MFI relationship should be long-term—working capital is an ongoingneed in any business activity. A single capital injection will not enable the borrowerto graduate as a client of traditional financial institutions, as assumed by somemicrofinance schemes. Client graduation requires time, but, once achieved,produces mutual benefits: better lending conditions for the borrower and higherprofitability for the MFI.

18. Savings Mobilization. In PNG, savings mobilization through microfinance appears to bemuch more successful than the lending business. The following recommendations should beconsidered especially by the pure microfinance institutions to enhance their services regardingsavings mobilization:

(i) MFIs have to become profitable to gain customer confidence and to obtain a licenseas a deposit-taking institution.

(ii) MFIs should promote voluntary savings schemes and establish linkages betweentheir target group and formalized, deposit-taking institutions.

43

Appendix 3, page 6

(iii) Hidden interest costs of compulsory savings should be made transparent tocustomers.

(iv) Successful community savings schemes should be replicated and linked to theformal financial system.

19. The supervisory function of the Federation of Savings and Loan Societies must bestrengthened to successfully continue the revitalization project of community-based savings andloan societies.

20. Growth Strategy. All institutions analyzed will have to strengthen their institutional capacityprior to further growth. The application of standardized accounting procedures, a clear definition ofthe target market, as well as a revision and systematization of lending methodologies are justsome areas that require concentration if a consistent growth strategy is to be defined. Additionally,intensive growth should be given priority over to extensive growth: client graduation and portfoliodiversification to the nonsubsistence sector offers high market potential for the existing branchesand agencies.

21. Financial Management: The implementation of basic management information andaccounting systems is one key activity to be considered in order to professionalize the existingMFIs in PNG. But there is also a high need for training in accounting and in understanding of thekey indicators applied to microfinance. Improvement of the existing financial managementcapacities will be focused on the following aspects:

(i) Standardized, computer-based accounting systems are to be implemented.(ii) Key ratios for financial management are to be defined and produced on a regular

basis.(iii) All MFIs have to implement basic management information systems.(iv) Interest rates have to be set on a cost-recovery basis.

44

Appendix 4, page 1

THE GOVERNMENT’S DRAFT MICROFINANCE POLICY

Redefining Microfinance Towards Mainstream Financial ServicesPapua New Guinea’s Microfinance Policy

(Draft)

A. Background

1. The vast majority of the population in PNG has almost no access to financial servicescurrently provided by Commercial Banks and Finance institutions. To some extent this is due toa lack of infrastructure, and a low integration of significant parts of the society into the casheconomy. But, the Government of PNG also perceives inadequateness of existing financialproducts and services. As a consequence, important sectors of the PNG economy are still cutoff from the modern economy or have to face conditions that do not allow developing on thebasis of existing abundant resources.

2. The Government has expressed in the MTDS and in the National Dialog that privatesector development is paramount for the future of PNG. The Government has also stressed bythe recently adopted SME-Policy the important role of small and medium enterprises. As a nextstep, it is the aim of the Government to address the weakness of the financial system in order toimprove the provision of financial services needed for private sector development. Therefore,the legal framework for Banks and other Financial Institutions has been revised and importantchanges are under way. Now it is important that this new framework leads to enhancedeconomic integration of micro, small and medium enterprises through better access tosustainable financial services for micro and small enterprises as well as for those who want tosave money for future financial needs.

3. The Microfinance Policy is conceived as an open forum that provides a framework forexisting or future institutions to either upgrade existing credit schemes or downscale financialproducts towards mainstream financial services: Microfinance Institutions should aim to amaximum of outreach thereby covering all the costs incurred by delivering this service.Underscoring its private sector orientation, the Government of PNG understands its role as afacilitator for private service provider.

B. Objectives

4. It is the objective of the Microfinance Policy to establish a framework that leads microfinance provider towards enhanced institutional capacity, better access to refinancingmechanisms in order to assist and support the development of existing enterprises currentlyexcluded from mainstream financial services. By targeting profitable enterprises it is theintention to foster private sector development and to contribute to the social and economicintegration of marginalized households in PNG.

C. Principles

5. The Microfinance Policy of the Government is guided by the following fundamentalprinciples:

(i) “Finance” is defined in terms of services or products in the field of equity, credit,savings and insurance. Financial institutions and markets provide those services

45

Appendix 4, page 2

through financial intermediation. Financial institutions and their services areconsolidated by the financial system. In a cash economy, a well functioningfinancial system is an important precondition for economic growth.

(ii) The role of Microfinance is to provide access to financial services to a wide rangeof people living on lower income and small and micro enterprises that currentlyfind it difficult to access those services, due to different reasons.

(iii) The development of viable, private Microfinance Institutions is seen as a crucialtarget to enhance the capacity of the total financial system

(iv) In order to be sustainable, Microfinance-Services have to be designed andprovided on a cost-covering basis. Quick operational sustainability is paramountfor organizations to expand their services, and to be able to meet existingdemand on a wide scale. Financial sustainability is required to survive on themarket.

(v) Subsidies (of installation cost or financial costs) may be necessary—especiallyduring the initial stages of institutional development—but should be given in atransparent way not arbitrarily interfering with the price mechanism of financialmarkets.

(vi) Competition between different service provider is necessary to improve theefficiency of microfinance services and thus of the financial system as a whole.

(vii) Access to refinancing funds should be granted to all service providers on thebasis of performance, reflecting the financing conditions and the respective costsincluding the perceived risk of an individual institution.

(viii) Microfinance is one aspect of private sector development that needs to besupported and complemented by additional services of non-financial nature to bedelivered by appropriate organizations as highlighted in the SME-Policy.

D. Best Practices

6. The Microfinance Policy aims to enhance the institutional capacity of existing and futureservice providers. Recognizing the different stages of development of existing organizations, theMicrofinance Policy of PNG takes into account internationally accepted best practices in order todevelop a national Microfinance Industry Standard for PNG:

(i) The Government of PNG intends to support the development of Microfinance bycreating the appropriate regulatory framework as well as by the provision ofadequate refinancing mechanisms for the private sector to deliver new credit andsavings products to the mass of the population that today has difficult access tofinancial services. On the basis of existing best practices, the Government ofPNG invites private service providers to develop those microfinance servicesincorporating the social, cultural and economic condition prevailing in PNG.

(ii) Community acceptance is crucial for successful microfinance institutions.Therefore the Government calls on the civil society to support and fostercommunity acceptance of microfinance service providers.

(iii) The provision of microfinance services requires lean management in order toreach operational and financial sustainability as quickly as possible. Theoperation should be managed in a transparent and accountable manner andcomply with international best practices in microfinance. While recognizing theimportant social objectives of microfinance, continuing operating losses ofmicrofinance service providers are not acceptable, particularly whenever thoseinstitutions administer public funds.

46

Appendix 4, page 3

(iv) A lean management calls for responsible managers and loan officers able toassess and to manage the individual risk of each borrower. Therefore modernmanagement procedures and tools as well as the employment of moderncomputer technology are crucial tools. The Government of PNG calls oninternational organizations to contribute to the development of nationalmicrofinance competence.

(v) An important factor of success is the design of microfinance products that meetthe demand of the population. This embraces credit schemes that allow for cashflow oriented lending as one approach to compensate for lack of bankablecollateral as well as savings products that are not tied to minimum deposits.

(vi) Sustainability is the most important factor for increased access to finance andexpansion of the financial sector. Therefore the microfinance policy underscoresthe importance of high outreach and interest rates that allow for a financialequilibrium. In this framework, competition is paramount in order to deliver thoseservices as efficient as possible.

E. Instruments

7. The government of PNG welcomes the initiative of a microfinance network open to allorganizations interested in extending sustainable financial services to a wide range of economicactivities of the population.

8. As a principle, the government of PNG seeks to involve private sector organizations asmuch as possible in the implementation of this policy.

9. Future policy instruments should address the following key areas:

(i) Financial resources to finance microfinance operations.

(ii) Technical assistance to increase access to international best practice.

(iii) Institution and capacity building to mainstream microfinance operations.

(iv) Suitable provisions with respect to the risk classification of microfinance

portfolios.(v) Temporary tax incentives for financial institutions to start up microfinance

operations.

10. The government of PNG will maintain active dialogue with international agencies in orderto win technical and financial support for the development of suitable policy instruments.

47

Appendix 5, page 1

DETAILED IMPLEMENTATION ARRANGEMENTS

A. Project Management

1. The Executing Agency

1. The Bank of Papua New Guinea (BPNG, the central bank) was established under theCentral Bank Act of 1973, which is based on Australian central banking legislation. The Head ofState appoints the governor of BPNG, while the minister of the Department of Finance andTreasury appoints the deputy governor on the advice of the governor. The policy of the centralbank is set by its board, whose members comprise the governor, deputy governor, the secretaryof the Department of Finance and Treasury, and other members appointed by the Head ofState. Within the context of the general framework of the policy objectives of the Government, itis the function of the central bank to (i) ensure that its monetary and banking policy is directed tothe greatest advantage of the people of Papua New Guinea; and (ii) direct its efforts topromoting monetary stability and a sound and effective financial structure.

2. BPNG’s relationship with the banking system is governed by the Banks and FinancialInstitutions Act, which covers the duties of commercial banks and licensed financial institutions,licensing requirements. BPNG supervises commercial banks and “bank-like” institutions. Itrecently imposed a cash deposit requirement on commercial banks, stipulating a proportion ofcommercial bank liabilities to be kept as a deposit with BPNG. It administers savings and loansocieties (SLS) under the Savings and Loan Societies Act. With the exception of the SLS, thecentral bank imposes no interest rate controls on the institutions it supervises. The supervisionof the Rural Development Bank, and superannuating and other contract savings funds is not theresponsibility of BPNG.

3. BPNG will be the Executing Agency of the Project as well as the Implementing Agencyfor the revolving finance facility (RFF). It will be responsible for overall coordination andimplementation of the Project and, in accordance with established government procedures, willbe the official contact point of ADB.

2. The Microfinance Steering Committee

4. BPNG will establish a microfinance steering committee (MSC)1 to administer andcoordinate implementation of the three components and activities of the Project. The MSC willprovide overall policy guidance and coordinate activities between microfinance institutions(MFIs), nonfinancial service providers, commercial banks, and national and provincialgovernment agencies. The MSC will be responsible for the administrative and financialimplementation of the Project, and will oversee project planning, organization, implementation,and monitoring. It will meet as often as required, but at least once every three months. Thechairperson will be the governor of BPNG. Members will be senior representatives, one eachfrom the Department of Finance and Treasury, Department of National Planning and Monitoring,the private sector/MFI clients, nonfinancial service providers, and two representatives fromMFIs.

1 The MSC is the project steering committee.

48

Appendix 5, page 2

3. The Project Implementation Unit

5. The project implementation unit (PIU) will be established by and operated under theguidance of BPNG. It will be physically located in the Institute of Banking and BusinessManagement (IBBM). It will handle the day-to-day project administration and implementationmatters. The PIU will provide and facilitate the required goods and services to the differentcomponents and activities of the Project. It will be headed by a full-time project manager, andsupported by a project assistant.

6. Performance monitoring and evaluation (PME) activities will be undertaken to ensurethat project resources are managed effectively and that project benefits are maximized. The PIUwill monitor and evaluate project performance and benefits for (i) internal efficiency (includinginputs, processes, and outputs); (ii) outreach by MFIs, (iii) satisfaction of demand formicrofinance services by the clients; and (iv) operational and financial self-sufficiency of MFIs.

7. The PIU will establish, within six months of loan effectiveness, a set of qualitative andquantitative indicators to determine realistic, controllable, and measurable targets that reflect theanticipated project benefits. Utilizing the PME system, the MSC will periodically compare actualand projected performance, and recommend measures for immediate corrective action. Thesuccess of the Project in terms of actual and forecasted benefits will be compared with thetargets. Based on the results, BPNG and MSC will consider adopting short-, medium-, and long-term actions, strategies, and policies to improve the efficiency and effectiveness of the Project.

4. The Implementing Agency

8. The IBBM is the Implementing Agency of component A and B of the Project and willphysically accommodate the PIU. The history of IBBM dates back to 1965 when the Banker’sCollege, as it was called then, commenced training and development programs under theauspices of the Reserve Bank of Australia. In 1974 the college was officially established underthe Associations Incorporation Act as Papua New Guinea Banker’s College Inc. Until the mid-1990s the institute focused on training of bank staff. In 1998 the constitution was changed toinclude business management training. As a consequence, the name was changed to thePapua New Guinea Institute of Banking and Business Management Inc.

9. IBBM has four different categories of membership: (i) member banks, (ii) corporatemembers, (iii) associate corporate members, and (iv) personal and professional members. Allcommercial banks in PNG are either member banks or associate corporate members, as well asthe Teaches Savings and Loan Society, the largest savings and loan society in PNG. In addition358 personal members are registered with IBBM.

10. The objectives of IBBM are as follows:

(i) promote and enhance the professional status of those engaged in banking,finance, and business management throughout PNG;

(ii) facilitate the exchange and acquisition of knowledge, skills, and techniques in thetheory and practice of banking, finance, and business management;

(iii) promote the training and education of people within the banking, financial, andbusiness management sectors of PNG;

(iv) encourage and foster fellowship and opportunities for the exchange of views andideas among members; and

49

Appendix 5, page 3

(v) maintain a college and faculty to meet and fulfill the educational, training, anddevelopment needs of people in the banking, financial, and businessmanagement sectors of PNG.

11. IBBM conducts various residential and nonresidential short- and long-term trainingcourses. The logistical facilities comprise (i) a fully equipped conference room for up to 80participants; (ii) two fully equipped training rooms for up to 16 participants; (iii) meeting andsyndicate rooms; (iv) supporting printing and audiovisual services; (v) a library and resourcecenter; (vi) 18 twin-share rooms; and (vii) a kitchen and dining facilities.

B. Project Components

1. Microfinance Competence Center (Component A)

12. The Project will establish the microfinance competence center (MCC) within the Instituteof Banking and Business Management. The institute will initially provide four counterpartstaff/trainers with the possibility to increasing the number to six during project implementation.The institute will also provide office facilities and administrative support for components A and Band the PIU. Office supplies and communication costs will be borne to a maximum of $25,000equivalent during the project implementation period. In-house training will be conducted in thetraining rooms of the institute, and the conference facilities will be utilized for meetings of thenetwork of MFIs. The Project will assist the institute to prepare a full-fledged business plan after30 months of project implementation, and to provide a detailed strategy to achieve financialviability by the end of project implementation.

13. The MCC will carry out public relations activities for the benefit of all microfinanceservice providers and their potential clients. Emphasis will be given to developing internalcommunication mechanisms between existing service providers and rural communities, and toadvertising basic concepts such as the benefits of savings and the availability of microcredit.The Project will address the following aspects:

(i) microfinance network: the MCC will assume the role of a technical coordinationbody for a network of service providers, national and provincial Governmentrepresentatives and assistance agencies;

(ii) awareness building: the MCC will create awareness among rural communitiesfor suitable savings products and other financial services that are alreadyavailable;

(iii) banking education: the MCC will engage strategic target groups (multiplierssuch as teachers) in the development of banking education programs, includingthe preparation of suitable advertising material; and

(iv) public relations strategies: the MCC will support microfinance serviceproviders in designing public relations and marketing strategies for theirrespective services.

14. The Project will enable the MCC to conduct various in-house training courses,workshops, and seminars aimed at broadening the understanding of microfinance and toimprove the skills of people involved at different levels in the provision of microfinance services.The knowledge and skills of the MCC trainers will be upgraded to perform these tasks. Adetailed curriculum will be developed and will include the following subjects:

50

Appendix 5, page 4

(i) introductory courses will include topics on (a) microfinance and principles ofgovernance, (b) microfinance and principles of management, (c) introduction tomicrofinance for loan officers, and (d) starting a self-help microfinance scheme;

(ii) technical skills training will focus on (a) financial analysis, (b) financialcalculation, (c) cash flow-oriented risk assessment, (d) bookkeeping andaccounting procedures for MFIs, (e) presentation of balance sheet information,and (f) performance indicators for MFIs; and

(iii) organization development will address issues with regard to (a) efficientdelivery systems (group lending versus individual loans), (b) monitoring andmanagement information systems, (c) loan management, (d) branchmanagement, (e) personnel and incentive systems, (f) organizational upgrading,and (g) downscaling of financial services.

15. In addition to in-house training, technical assistance (TA) packages will be developed toimprove the implementation capacity and the absorption capacity of existing MFIs. The TApackages will be designed for each stage of institutional development. Using the number ofactive clients or outstanding loans as a measure, Figure A5.1 shows a typical developmentpath.

Figure A5.1: Stages of MFI Institutional Development

Source: Staff estimates based on international best practice in microfinance.

16. Four different stages can be defined: (i) start-up, (ii) infant, (iii) expansion, and (iv)maturity. Based on the different stages of institutional development each TA-package willconsist of a variety of training courses and short-, and medium-term on-site consultancies:

(i) Start-up package. It will assist newly established MFIs with little experience inmicrofinance to develop into small but professional MFIs, prepared to embark ona growth path toward sustainability. The main tasks are to define a simpleproduct; introduce a professional delivery methodology, and standard accountingprocedures; select and carry out on-the-job training of newly recruited loanofficers and support the management in the initial decision-making process.

(ii) Sustainability package. Having successfully passed the infant stage ofinstitutional development and entered the expansion phase, this package isdesigned to quickly reach operational sustainability and to pave the way forfinancial sustainability as the portfolios of the MFIs grow. It focuses on

0

10000

2000

4000

6000

8000

12000

14000

16000

Act

ive

Clie

nts

Start-u p Infant Expansion Maturity

P N G

51

Appendix 5, page 5

organizational productivity, and adequate product design, and introduction of acomputerized loan tracking system.

(iii) Expansion package. With operational sustainability accomplished, the next stepis to improve the outreach and to increase the market penetration of MFIs. Acrucial aspect of this package is to revise the institution’s organizational structureto set up branches. At this stage, a comprehensive monitoring and informationsystem (MIS) will be introduced.

(iv) Formalization package. For successful MFIs extending to become formalfinancial institutions and to apply for a banking license to diversify their fundingstructures, this package concentrates on legal requirements and the need forinternal adjustment of existing procedures.

17. A dialogue with the relevant regulatory body will be facilitated to ensure a conduciveenvironment for deepening the financial sector. The Project will develop governance guidelinesand a rating system for microfinance service providers on the basis of internationally acceptedbest practices. MCC staff will be trained to carry out the respective assessments and managethe rating system. The rating system is linked to the finance facility, component C of the Project,and requires each MFI wanting to access the finance facility to obtain a satisfactory rating fromthe MCC.

2. New Savings and Loan Products (Component B)

18. Component B will develop, test, and implement new savings and loan products anddelivery methods for financial services. Specific attention will be given to linking communitysavings groups with financial institutions. The Project will provide international expertise, andtraining to develop, test, and implement microfinance services focused on target groups.Specifically, the Project will

(i) establish dialogue between commercial banks and informal savings groups, andwill design detailed linkage modalities;

(ii) advise MFIs on appropriate microfinance products;(iii) identify commercial banks interested in providing microfinance services, and

provide support in downscaling products and delivery methodologies;(iv) design tailor-made savings and loan products for MFIs, pilot test products, and

provide support and backstopping to MFIs during the initial implementation stage;and

(v) monitor the performance of the delivery methods and disseminated information tothe MFI network.

19. One pilot microbanking scheme will be designed, established, and implemented in Wauto demonstrate the application of new savings and loan products, and delivery mechanisms.The development process of the Wau pilot microbanking scheme will be documented in detail tobe used as a demonstration of microfinance best practice and a guide to new MFIs. Theselection of Wau for the pilot microbanking scheme is based on the analysis of the recent WorldBank report on Poverty and Access to Public Services. It takes into account the high degree ofdiversity of the local economy, e.g., small-scale mining, vegetable, coffee, timber, livestock,trading, and other services in which a large part of the poor population is engaged. The Waupilot banking scheme will be provided with equity of $250,000 and one internationalmicrofinance institutional development specialist for 36 person-months. The following tasks willbe completed during the first six months of project implementation prior to the start of thelending operations:

52

Appendix 5, page 6

(i) establishment of a legal framework and management structure;(ii) design of savings and loan products and delivery mechanism;(iii) set up of office and operations;(iv) selection and training of loan officers; and(v) development of a business plan.

20. The District Administration of Bulolo/Wau will provide office space and security servicesfor the Wau pilot banking scheme.

3. Revolving Finance Facility (Component C)

21. The establishment of the RFF forms component C of the Project with BPNG as theImplementing Agency. The facility will provide the necessary funding for MFIs to achievesustainability and expand their loan portfolios. Credit lines will be tailored to the refinancingneeds of individual microfinance service providers. In addition, loans for the purchase oftechnical equipment needed to expand operations will be available to MFIs up to a consolidatedamount of 5 percent of the total funds foreseen for the RFF. Those financial instruments willonly be available in conjunction with TA-packages provided by the MCC under component A ofthe Project.

22. BPNG will outsource the day-to-day management of the RFF to a private sectormanagement agent, e.g., a private financial institution or other relevant entity based in PNG.The selection of the management agent will follow established national competitive biddingprocedures acceptable to the Government and ADB. This guarantees the necessaryindependence as well as efficient management of the funds. It also underscores the intendedprivate sector orientation of microfinance in general and of this Project in particular. Themanagement agent will be paid either on a fixed fee basis or on a percentage basis for theoutstanding balance of the credit lines. The management agent will carry out the following tasks:(i) financial management of the funds, (ii) administration of the financial instruments of the RRF,(iii) monitoring of MFIs’ performance ensuring that performance targets are met, and (iv)quarterly reporting to BPNG on performance of the facility and the performance of theparticipating MFIs. The detailed terms of reference for the management contract will be finalizedin the framework of a 12-month consultancy at the beginning of project implementation. Thefinance consultant will support BPNG in evaluating the proposals and negotiating themanagement contract. Detailed procedures for reporting and auditing will be put in place toensure transparency of operations.

23. ADB will disburse the first installment of $280,000 direct to a special account managedby the management agent under the supervision of BPNG, provided the following conditions arefulfilled: (i) a management contract (approved by ADB) has been signed and is legally effectivebetween PBNG and the management agency, and (ii) a model for onlending agreementsbetween the management agent and MFIs, indicating MFI credit line disbursement conditions,has been approved by BPNG and ADB.

24. The Government contributions will be made through the account of BPNG to the specialaccount of the management agent.

25. Disbursement of subsequent installments to the special account may be requested bythe management agent to ADB through the PIU in accordance with the financial implementation

53

Appendix 5, page 7

of the Project, provided the management agent has disbursed more than 70 percent ofpreviously received funds to MFIs on the basis of onlending agreements.

26. The operation of the RRF will be guided by the following policies and procedures:

(i) Purpose of funds: Qualified MFIs will use the resources made available fromthe RRF exclusively for loans to microenterpises, smallholders, and smallbusinesses of all economic sectors, and in accordance with the Government‘sMicrofinance Policy and the Small and Medium Enterprise Development Policy.

(ii) Eligibility of MFIs: To access the facility, MFIs must meet the following criteria:(a) registration with the MCC and satisfactory rating (not older than six months)issued by the MCC, whereas the MFI fulfills the development targets set by theMCC; (b) satisfactory loan repayments, as established by on-time repayment rateof at least 85 percent.; (c) average loan amount of the portfolio to be refundeddoes not exceed K5,000; (d) a detailed plan for operational and financial self-sufficiency, with a strategy for improvements over the next year and performancetargets is presented; (e) adequate management information and accountingsystems are in place to ensure successful expansion, efficiency improvements,and satisfactory performance of the loan portfolio; (f) the maximum exposure ofthe RFF to one single MFI will not exceed 40 percent of the total amountdisbursed to the RFF at any time.

(iii) Conditions of credit lines: The following conditions apply: (a) credit lines toMFIs are made available in kina or in dollars provided the MFI is able, on thediscretion of the management agent, to hedge the related foreign exchange risk;(b) for credit lines extended in dollars, the interest rate will be the applicable 3-month LIBOR plus a reasonable margin to cover costs, and for credit linescontracted in kina, the interest rate shall be the most recent kina auction rate plusa reasonable margin to cover costs; (c) interest rates are payable on a monthlybasis over the outstanding balance; (d) a penalty fee is charged in the event oflate interest payments (arrears of more than 30 days) of additional 3 percent perannum; (e) for contracted, but not yet disbursed balances of the credit line, acommitment fee of 0.25 percent per month is payable by the respective MFI tothe RRF; (f) the maximum maturity of the credit lines is five years; and (g)maximum credit line amounts are determined by the management agent on thebasis of MFIs’ stage of development. The conditions of the credit lines aresubject to periodic revisions by the management agent. Modifications of theconditions can only be applied by the management agent prior approval by theMSC.

(iv) Conditions of subloans: MFIs agree to onlend the received funds only forbusiness loans under the following conditions: (a) the maximum maturity forcredits to be used for working capital is up to 12 months and for fixed assets,equipment, or livestock (investment loans) up to 3 years; (b) subloans are onlygranted in kina; (c) the interest rate will be the kina auction rate of the BPNG plusa margin to be defined by the MFI on the basis of market rates, ensuring thefinancial sustainability of the respective MFI.

(v) Application process: A formal letter of request submitted by the MFI to themanagement agent of the RRF will contain the following information: (a) amountof credit line with portfolio and cash-flow projections for the requested period; (b)legal documents including latest financial statements, organization chart, andregistration certificate of MCC; (c) policy and management documents; and (d)rating by MCC not older than six months.

54

Appendix 5, page 8

(vi) Review and approval process: The management agent will review thedocuments and verify information with the MFI as needed within three weeksafter the request has been received. Following the review process, themanagement agent approves or declines the request for financing. Thepreparation of the finance agreement will take no longer than five working days. Ifthe request is declined, the MFI will be notified and provided with the reasons forrejection.

(vii) Disbursement and repayment: Disbursements to the MFI will be made intranches according to a disbursement schedule developed on the basis ofportfolio projections and planned cash flow; (d) MFIs can request disbursementof the subsequent tranch only when (a) 70 percent of the previous tranch hasbeen disbursed to clients; (b) average repayment rate over the past six monthshas been at least 90 percent; (c) all necessary reporting documents are provided.Disbursements will be made through bank transfer to the bank account of theMFI. MFIs will make interest payments to the facility on their outstanding creditlines on a monthly basis. The management agent has the right to withhold initialand subsequent disbursements, if the MFI has not met agreed quantitative andqualitative eligibility criteria and standards of performance.

(viii) Monitoring and reporting: MFIs accessing the RRF agree to provide monthlyreports within 10 days after the end of each month, including portfolioinformation, balance sheet, income statement, and cash flow. The managementagent has the right to conduct an annual audit of each MFI accessing the facility.Further, each participating MFI agrees to inform the management agentimmediately in the event of any material changes that affect or that couldmaterially affect the successful operations of the MFI. These matters particularlyrefer but are not limited to (a) significant external factors, including naturaldisasters, economic crises, or severe security problems in the region where theMFI operates; (b) significant internal factors, such as actual or planned changesin the management composition of the MFI, or internal systems and procedures;(c) significant actual or anticipated deterioration in financial performance or in theMFI’s ability to reach performance targets, caused by internal or external factors;

(ix) Legal arrangements: The core documents to be used to operate the financefacility are (a) a statement of policies and operating procedures for the RRF; and(b) finance agreements between the facility and each participating MFI.

55

Institute of Microfinance Local Bank of PNG AusAID Banking ADB Institutions The Government Total (Excl. Duties &

Item Amount % Amount % Amount % Amount % Amount % Amount % Amount % For. Exch. Taxes) Taxes

I. Investment Costs

A. Vehicles - - - - - - 170.0 100.0 - - - - 170.0 0.8 170.0 - -B. Equipment

Computer Equipment - - - - - - 107.0 100.0 - - - - 107.0 0.5 107.0 - -Other Office Equipment - - - - - - 102.4 95.5 - - 4.8 4.5 107.2 0.5 102.4 4.8 -Training Materials - - - - - - 330.2 100.0 - - - - 330.2 1.6 330.2 - - Subtotal (B) - - - - - - 539.6 99.1 - - 4.8 0.9 544.4 2.7 539.6 4.8 -

C. Consulting Services

International Consultants - - 293.8 12.3 - - 2,088.2 87.7 - - - - 2,382.0 11.7 2,382.0 - -Domestic Consultants - - - - - - 681.3 100.0 - - - - 681.3 3.4 - 681.3 -Unallocated Consultancies - - - - - - 331.0 100.0 - - - - 331.0 1.6 255.5 75.5 -

Subtotal (C) - - 293.8 8.7 - - 3,100.5 91.3 - - - - 3,394.4 16.7 2,637.5 756.8 -D. Training

Trainer Upgrading Abroad - - - - 49.9 10.0 449.4 90.0 - - - - 499.3 2.5 441.8 57.5 -In-house Training - - 491.0 30.0 - - 491.0 30.0 654.7 40.0 - - 1,636.7 8.1 585.1 1,051.6 -On-the-job Training - - - - - - 177.2 60.0 118.1 40.0 - - 295.3 1.5 195.1 100.2 -

Subtotal (D) - - 491.0 20.2 49.9 2.1 1,117.6 46.0 772.8 31.8 - - 2,431.3 12.0 1,222.0 1,209.3 -E. Networking

Study Tours - - - - - - 241.9 85.0 42.7 15.0 - - 284.5 1.4 235.2 49.3 -Workshops & Conferences 5.0 1.9 - - 23.8 9.1 145.1 55.3 83.7 31.9 5.0 1.9 262.5 1.3 132.7 129.8 -

Subtotal (E) 5.0 0.9 - - 23.8 4.3 386.9 70.7 126.4 23.1 5.0 0.9 547.0 2.7 367.9 179.2 -F. Public Awarness 18.2 3.6 - - - - 220.3 44.2 144.2 28.9 116.2 23.3 498.9 2.5 223.0 276.0 -G. Finance Funds - - - - - - 2,800.0 39.1 - - 4,368.0 60.9 7,168.0 35.4 2,800.0 4,368.0 -H. O & M

Office Supplies and Communications 11.2 5.1 - - 29.3 13.3 180.1 81.7 - - - - 220.5 1.1 157.9 62.6 -Project Accounting Services - - - - 40.1 100.0 - - - - - - 40.1 0.2 - 40.1 -Office Space 18.6 23.6 - - 46.8 59.4 - - - - 13.4 17.0 78.7 0.4 - 78.7 -Security Services - - - - - - - - - - 26.7 100.0 26.7 0.1 - 26.7 -Travel - - - - - - 302.6 92.6 11.3 3.5 12.7 3.9 326.6 1.6 205.7 120.9 -Vehicles O&M - - - - - - 289.7 100.0 - - - - 289.7 1.4 207.5 82.2 -Steering, Review, Reporting & Auditing 33.4 12.0 - - - - 122.7 44.0 - - 122.7 44.0 278.9 1.4 111.6 167.3 -

Subtotal (H) 63.2 5.0 - - 116.1 9.2 895.0 71.0 11.3 0.9 175.5 13.9 1,261.2 6.2 682.7 578.5 -I. Equity - - 125.0 50.0 - - 125.0 50.0 - - - - 250.0 1.2 250.0 - -

Subtotal (I) 86.3 0.5 909.9 5.6 189.8 1.2 9,355.0 57.5 1,054.7 6.5 4,669.5 28.7 16,265.2 80.2 8,892.7 7,372.6 -II. Recurrent Costs

A. Staff 240.5 6.8 - - 868.4 24.6 - - 2,424.2 68.6 - - 3,533.0 17.4 - 3,533.0 -C. Office Space 66.8 50.0 - - 66.8 50.0 - - - - - - 133.6 0.7 - 133.6 -D. Travel - - - - 33.4 20.0 - - 133.6 80.0 - - 167.0 0.8 - 167.0 -E. O & M 40.1 23.1 - - 66.8 38.5 - - 66.8 38.5 - - 173.7 0.9 - 173.7 -

Subtotal (II) 347.3 8.7 - - 1,035.3 25.8 - - 2,624.6 65.5 - - 4,007.3 19.8 - 4,007.3 - Total Disbursement 433.7 2.1 909.9 4.5 1,225.1 6.0 9,355.0 46.1 3,679.3 18.1 4,669.5 23.0 20,272.5 100.0 8,892.7 11,379.8 -

ADB = Asian Development Bank, AusAid = Australian Agency for International Development, O&M = Operations and Maintenance, PNG = Papua New Guinea.Source: Staff estimates.

Appendix 6, page 1

COST ESTIMATES AND FINANCING PLAN

Table A6.1: Expenditure Accounts by Financiers($ '000)

56

(Kina '000) ($ '000) % % Total % % Total

Foreign Base Foreign BaseComponent Local Foreign Total Exchange Costs Local Foreign Total Exchange Costs

A. Microfinance Competence Center 6,938.6 8,365.0 15,303.6 55 33 2,668.7 3,217.3 5,886.0 55 33B. New Savings & Loan Products & Delivery Mechanisms

Development and Testing of New Products 4,170.4 2,316.6 6,487.0 36 14 1,604.0 891.0 2,495.0 36 14Pilot Microbanking 162.5 2,567.5 2,730.0 94 6 62.5 987.5 1,050.0 94 6 Subtotal (B) 4,332.9 4,884.1 9,217.0 53 20 1,666.5 1,878.5 3,545.0 53 20

C. Revolving Finance Facility 11,791.0 7,930.0 19,721.0 40 43 4,535.0 3,050.0 7,585.0 40 43D. Project Implementation Unit 1,511.9 607.1 2,119.0 29 5 581.5 233.5 815.0 29 5

Total Baseline Costs 24,574.4 21,786.2 46,360.6 47 100 9,451.7 8,379.3 17,831.0 47 100Physical Contingencies 682.7 692.8 1,375.5 50 3 262.6 266.5 529.1 50 3Price Contingencies 3,192.5 -247.3 2,945.1 -8 6 1,665.6 246.9 1,912.4 13 11 Total Pro ject Costs 28,449.6 22,231.6 50,681.2 44 109 11,379.8 8,892.7 20,272.5 44 114Interest During Construction - 599.9 599.9 100 1 - 240.0 240.0 100 1Commitment Charges - 513.7 513.7 100 1 - 205.5 205.5 100 1 Total Costs to be Financed 28,449.6 23,345.2 51,794.8 45 112 11,379.8 9,338.1 20,717.9 45 116

Source: Staff Estimates

Appendix 6, page 2

Table A6.2: Components Project Cost Summary

57

58 Appendix 6, page 3

New Savings & Loan Products & Delivery Mechanisms

DevelopmentMicrofinance and Testing Revolving ProjectCompetence of New Pilot Finance Implementation

Item Center Products Microbanking Facility Unit Total

I. Investment Costs

A. Vehicles 63.8 26.6 53.1 - 26.6 170.0B. Equipment

Computer Equipment 43.3 21.3 21.3 - 21.3 107.0Other Office Equipment 53.5 21.3 21.3 - 11.2 107.2Training Materials 220.8 109.3 - - - 330.2 Subtotal (B) 317.6 151.8 42.5 - 32.5 544.4

C. Consulting Services

International Consultants 948.5 587.7 587.7 258.1 - 2,382.0Domestic Consultants 160.3 - - - 521.0 681.3Unallocated Consultancies 137.8 137.8 55.4 - - 331.0

Subtotal (C) 1,246.7 725.5 643.1 258.1 521.0 3,394.4D. Training

Trainer Upgrading Abroad 499.3 - - - - 499.3In-house Training 1,636.7 - - - - 1,636.7On-the-job Training 295.3 - - - - 295.3

Subtotal (D) 2,431.3 - - - - 2,431.3E. Networking

Study Tours 284.5 - - - - 284.5Workshops & Conferences 237.7 - - 24.8 - 262.5

Subtotal (E) 522.2 - - 24.8 - 547.0F. Public Awarness 480.7 - - 18.2 - 498.9G. Finance Funds - - - 7,168.0 - 7,168.0H. O & M

Office Supplies and Communications 117.0 22.8 22.7 11.2 46.8 220.5Project Accounting Services - - - - 40.1 40.1Office Space 46.8 - 13.4 18.6 - 78.7Security Services - - 26.7 - - 26.7Travel 183.8 56.7 22.7 - 63.5 326.6Vehicles O&M 116.3 58.2 56.7 - 58.5 289.7Steering, Review, Reporting & Auditing - - - 33.4 245.5 278.9

Subtotal (H) 463.8 137.7 142.1 63.2 454.4 1,261.2I. Equity - - 250.0 - - 250.0

Subtotal (I) 5,526.1 1,041.6 1,130.8 7,532.3 1,034.4 16,265.2II. Recurrent Costs

A. Staff 1,422.3 1,870.3 - 240.5 - 3,533.0C. Office Space 66.8 - - 66.8 - 133.6D. Travel 33.4 133.6 - - - 167.0E. O & M 66.8 66.8 - 40.1 - 173.7

Subtotal (II) 1,589.2 2,070.7 - 347.3 - 4,007.3 Total 7,115.3 3,112.3 1,130.8 7,879.6 1,034.4 20,272.5

Taxes - - - - - -Foreign Exchange 3,545.0 971.2 1,049.8 3,068.9 257.8 8,892.7

O&M = Operations and Maintenance.Source: Staff estimates.

Table A6.3: Expenditure Accounts by Components - Totals Including Contingencies ($ '000)

59 Appendix 6, page 4

Totals Includin g Contin gencies

Item 2001 2002 2003 2004 2005 Total

I. Investment Costs A. Vehicles 170.0 - - - - 170.0B. Equipment

Computer Equipment 95.6 - - 11.4 - 107.0Other Office Equipment 96.2 5.4 5.6 - - 107.2Training Materials 63.8 108.8 111.4 22.8 23.4 330.2

Subtotal (B) 255.6 114.3 117.0 34.2 23.4 544.4C. Consulting Services

International Consultants 896.8 631.1 646.2 102.7 105.2 2,382.0Domestic Consultants 123.3 129.5 135.9 142.7 149.9 681.3Unallocated Consultancies 66.6 109.1 83.4 57.2 14.7 331.0

Subtotal (C) 1,086.7 869.6 865.6 302.7 269.8 3,394.4D. Training

Trainer Upgrading Abroad 145.4 199.1 102.2 52.5 - 499.3In-house Training 301.9 314.0 326.8 340.1 354.0 1,636.7On-the-job Training 55.3 57.1 59.0 60.9 62.9 295.3

Subtotal (D) 502.6 570.3 488.0 453.5 416.9 2,431.3E. Networking

Study Tours 54.2 83.6 57.3 59.0 30.3 284.5Workshops & Conferences 60.8 74.0 64.6 37.3 25.8 262.5

Subtotal (E) 115.0 157.6 122.0 96.3 56.1 547.0F. Public Awarness 102.6 144.6 150.1 101.6 - 498.9G. Finance Funds 716.8 1,433.6 1,433.6 2,150.4 1,433.6 7,168.0H. O & M

Office Supplies and Communications 51.2 49.5 48.7 36.2 34.8 220.5Project Accounting Services 7.3 7.6 8.0 8.4 8.8 40.1Office Space 22.8 14.7 15.4 12.6 13.2 78.7Security Services 4.8 5.1 5.3 5.6 5.9 26.7Travel 87.5 98.3 74.6 32.5 33.7 326.6Vehicles O&M 60.5 68.0 81.8 45.2 34.2 289.7Steering, Review, Reporting & Auditing 40.1 53.5 80.1 45.1 60.1 278.9

Subtotal (H) 274.2 296.7 314.0 185.6 190.7 1,261.2I. Equity 250.0 - - - - 250.0

Subtotal (I) 3,473.6 3,586.6 3,490.2 3,324.3 2,390.5 16,265.2II. Recurrent Costs

A. Staff 563.3 629.6 701.0 778.1 861.0 3,533.0C. Office Space 24.2 25.4 26.7 28.0 29.4 133.6D. Travel 30.2 31.7 33.3 35.0 36.7 167.0E. O & M 31.4 33.0 34.7 36.4 38.2 173.7

Subtotal (II) 649.1 719.7 795.7 877.4 965.4 4,007.3 Total 4,122.7 4,306.3 4,285.9 4,201.7 3,355.8 20,272.5

O&M = Operations and Maintenance.Source: staff estimates.

Table A6.4: Expenditure Accounts by Years -- Totals Including Contingencies($ '000)

60 Appendix 7

. Bank of PNG (1) - Chair

. Representative of IBBM (1). Representative of MFIs (2). Representative of Non-financial Service Providers (1). Private Sector Representatives (1)

. Microbanking Specialist/TL . Microfinance Product . Financing Specialist. Curriculum Development Specialist Development Specialist. Institutional Dev. Specialist

Clients Clients Clients Clients Clients

MFI = microfinance institution, PNG = Papua New Guinea.

. Project Manager.Project Assistant

Competence CenterMicrofinance

Government of PNG(Department of Finance and Treasury and

Department of National Plannin g and Monitorin g)

PROJECT ORGANIZATIONAL STRUCTURE

New Saving &Loan Products

Bank of PNG(Executin g Agency)

Project Implementation Unit

. Department of National Planning and Monitoring (1)

. Department of Finance and Treasury (1)

Component A

Institute of Banking & Business Management

(Implementing Agency)

Clients Are Formal And Informal Enterprises And Savers

Microfinance Steering Committee

Component B Component C

Microfinance Institutions (MFIs)

RevolvingFinance Facility

Bank of Papua New Guinea(Implementing Agency)

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2

A. Microfinance Competence Center

1 Establish MCC, start operation, and prepare business plan.

2 Provide training of trainers opportunities abroad.

3 Organize study tours, national conferences, and workshops.

4 Design and implement in-house and on-the-job training for MFI staff.

5 Assist MFIs in formulating business plans and expansion strategies.

6 Establish network of MFIs and create linkages with other providers.

7 Develop governance guidelines for MFIs.

8 Establish conducive regulatory and supervisory framework for MFIs.

9 Design and conduct public awareness activities.

10 Develop and apply MFIs rating system and link with RRF.11 Design and apply a project monitoring and evaluation system.

B. New Saving and Loan Products Development

1.0 Develop, test, and implement new savings and loan products.

1.1 Establish dialogue between savings groups and banks.

1.2 Advise MFIs on appropriate microfinance products.

1.3 Advise commercial banks on downscaling strategies.

1.4 Design target-group oriented products and delivery methods.

1.5 Monitor performance and disseminate information to MFIs.

2.0 Establish, operate and document pilot mirobanking.

2.1 Establish legal framework and management structure.

2.2 Design savings and loan product and delivery mechanism.

2.3 Set up office and operations, and develop a business plan.

2.4 Deliver microfinance services.

2.5 Document process of establishment and operations.

C. Revolving Finance Facility

1 Finalize selection and eligibility criteria and mechanisms for MFIs.

2 Design operational guidelines for finance facility.

3 Establish monitoring mechanisms.

4 Select management agent.

5 Create public awareness on finance facility.

6 Provide refinance to MFIs.

MCC = microfinance competence center, MFI = microfinance institution, RRF = revolving finance facility.

2005

61

2006

Appendix 8

IMPLEMENTATION SCHEDULE

ComponentYear and Quarter of Im plementation

2001 2002 2003 2004

Appendix 9

INDICATIVE CONTRACT PACKAGES

Contract PackagesEstimated

Value($)

ProcurementMethod a

A. Vehicles 170,000 IS

B. Equipment 544,400

1. Computer Equipment 107,000 IS2. Furniture and other Office Equipmentb 107,200 IS4. Training Materials 330,200 DP

C. Consulting Services 3,394,300

1. International Consulting Servicesc

a. Microfinance Competence Center 948,500 CSb. New Savings and Loan Products 1,175,400 CSc. Revolving Finance Facility 258,100 CS

2. Domestic Consultants 681,300d CS3. Unallocated Consulting Services 331,000e CS

____________________________________________________________________________a IS = international shopping, DP = direct purchase, CS = consulting services.b Comprises equipment to establish pilot savings and loan products, and to provide basic, start-up packages for new microfinance providers, which will be purchased in four stages. Each procurement package will therefore be below $100,000.c Comprises 144 person-months to be engaged as a team from a firm and to implement project components A,B,C.d Comprises 240 person-months to support project component A and the project implementation unit.e Comprise predominantly domestic consultants for short-term assignments to respond to specific needs of all project components identified during project implementation.

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Appendix 10, page 1

OUTLINE TERMS OF REFERENCE FOR CONSULTING SERVICES

A. International Consultants

1. Microbanking Adviser/Team Leader (48 person-months)

1. The consultant will assist the project manager, the Institute of Banking and BusinessManagement (IBBM), and the Bank of Papua New Guinea (BPNG) in planning, implementing,monitoring, and evaluating project activities. The specific duties and responsibilities are asfollows:

(i) review existing banking regulations with regard to microfinance, organizestakeholder workshops, and support a consultative process betweenmicrofinance institutions (MFI) and BPNG to elaborate required regulatory andsupervisory framework for MFIs, and assist in the preparation of appropriatelegislation;

(ii) facilitate the creation of a microfinance network as a technical coordination bodyamong MFIs, nonfinancial service providers, and Government agencies;

(iii) conceptualize measures to create awareness about existing microfinanceschemes, and design a banking education program and savings mobilizationstrategy;

(iv) assist IBBM in establishing the organizational, operational, and financial structureof the microfinance competence center (MCC), and provide guidance in thepreparation of the business plan for the MCC;

(v) develop governance guidelines for MFIs, design a detailed national rating systemfor microfinance providers, and train MCC staff in applying the rating system;

(vi) organize study tours for key stakeholders in microfinance, and a nationalconference and workshops on current microfinance issues;

(vii) support the project implementation unit (PIU) in the design and application of aproject monitoring and evaluation system (PME);

(viii) monitor the development of curriculum, the establishment of the MCC and therevolving finance facility, and ensure that all such activities are fully integratedinto overall project objectives; and

(ix) provide professional leadership, direction, and support for all consulting servicesunder the Project; coordinate the inputs of the international and domesticconsultants; assist in the effective placement of counterpart staff; and ensure thetimely and effective preparation of equipment lists and equipment procurement.

2. The qualifications are (i) a higher degree in business administration or economics with afocus on development management and planning; (ii) minimum of 10 years experience at asenior level in a finance institution; and (iii) minimum of 5 years experience in internationaldevelopment projects in the field of microfinance with a focus on regulatory and supervisorframeworks for MFIs.

2. Curriculum Development and Training Specialist (12 person-months)

3. The consultant will be assigned to the MCC and will work under the guidance of themicrobanking adviser. The consultant’s primary task will be to design a training curriculum andtraining material for MFI staff, to train local microfinance trainers, and to outline technicalassistance packages to build the overall institutional capacity of MFIs. The specific tasks are asfollows:

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Appendix 10, page 2

(i) develop a microfinance curriculum, training material, and self-teaching kits basedon international best practices and coordinated with existing training programs ofother relevant training providers in PNG;

(ii) design a marketing strategy and other support mechanisms for microfinancetraining courses;

(iii) establish administrative procedures to organize the course program, to cost andprice the training, and to monitor overall training activities;

(iv) design a set of TA packages for on-site training, and counseling of MFIs staffincluding goals, tools, time frame, and cost structure;

(v) establish training needs of MCC staff and contracted trainers;(vi) design specific training of trainers course in microfinance;(vii) support the microbanking adviser in the selection of appropriate training of

trainers opportunities abroad; and(viii) provide on-site counseling for trainers.

4. The consultant must have (i) a higher degree in business administration or banking, (ii)extensive experience in microfinance and the design of training curricular in microfinance, (iii) aproven track record of conducting microfinance training programs, and (iv) a minimum of fiveyears experience in microfinance in developing countries.

3. Microfinance Product Development Specialist (36 person-months)

5. The consultant will work under the guidance of the microbanking adviser and in closecollaboration with the institutional development specialist. The primary task will be to helpimplement component B, in particular the development, testing, and implementation of new loanproducts. The specific duties and responsibilities are as follows:

(i) advise MFIs on appropriate microfinance products and delivery mechanisms,design microfinance products focused on target groups and marketing concepts,and advise MFIs on all respective organizational, financial, and human resourceimplications;

(ii) assist commercial banks and MFIs in formulating policies and procedures forsavings product focused on target groups, including interest rates and liquidity;

(iii) develop and support implementation of product marketing, savings collection,disbursement, calculation of interest rates, and documentation of savingsbalances and develop required forms, manuals, and passbooks;

(iv) advise on the integration of new savings and loan products into existingaccounting procedures, taking into consideration the need for decentralizedmanagement information of savings groups;

(v) advise on the selection and training of staff, develop a performance-basedincentive scheme for savings and loans officers, and support MFI management inthe preparation of reports;

(vi) liaise with community leaders and provincial government representatives toestablish contacts to new potential savings groups, and establish dialoguebetween community and informal savings groups and formal financial institutionsto facilitate contractual cooperation;

(vii) train new, and continuously coach existing, savings groups;(viii) advise interested commercial banks on the strategy to integrate new products

focusing on target groups into their existing organizational structure; and(ix) help implement procedures for product promotion; appraisals of loan

applications; evaluation of collateral; decisions on loan proposals,

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Appendix 10, page 3

disbursements, and repayments; and credit monitoring; and design forms andmanuals for MFI staff.

6. The qualifications are (i) a higher degree in business administration or economics; (ii)minimum of 10 years experience at a senior level in a finance institution; and (iii) minimum offive years experience in international development projects in the field of microfinance with afocus on downscaling of commercial banks, mobilization of savings groups, and design of loanproducts oriented to target groups.

4. Microfinance Institutional Development Specialist (36 person-months)

7. The consultant’s primary task will be to establish, operate, and document the pilotmicrobanking in Wau under component B of the Project. Under the guidance of themicrobanking adviser and in close collaboration with the microfinance product developmentspecialist, the consultant will have the following duties and responsibilities:

(i) establish an appropriate legal entity, register the Wau pilot banking, and set upthe management structure;

(ii) design appropriate savings and loan products and delivery mechanisms;(iii) set up an office and operations, and select and train loan officers;(iv) develop a business plan;(v) supervise the delivery of microfinance services; and(vi) document the process of establishing the Wau pilot banking and its operations.

8. The consultant will have (i) a higher degree in business administration or economics; (ii)extensive experience in microfinance; and (iii) a proven track record of at least five years insetting up microfinance operations in developing countries.

5. Finance Facility Specialist (12 person-months)

9. The consultant will assist BPNG in designing and establishing the revolving financefacility. In collaboration with the network of MFIs and the microbanking adviser, the consultantwill finalize the design of the financial instruments of the revolving finance facility (RRF). Thespecific tasks are as follows:

(i) finalize the design of the RRF’s financial instruments, e.g., determine theconditions for equipment loans and credit lines;

(ii) review draft eligibility criteria and finalize them;(iii) design a management information system and a performance evaluation system

for MFIs;(iv) design reporting system, procedure and formats for MFIs to report to the RRF,

and aggregate reporting for the facility to BPNG;(v) draft tender documents for the management agent;(vi) propose evaluation criteria for the bidding process for the management agent,

and advise BPNG on the evaluation of bids;(vii) advise BPNG on the elaboration and negotiation of the management contract;(viii) support the management agent in the initial stage of operation;(ix) help the microbanking specialist establish the consultative process between MFIs

and BPNG.

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Appendix 10, page 4

10. The consultant will have (i) a higher degree in banking or business administration, and(ii) minimum of 10 years experience in financial institutions with a focus on finance facilities.

B. Domestic Consultants

1. Project Manager (60 person-months)

11. The project manager will oversee project implementation, handle the day-to-day projectadministration and implementation matters, and provide or facilitate the provision of logisticsupport to the Project. Under the guidance and direction of the governor, BPNG, the managerwill be responsible for the direction and control of the activities of the PIU, ensuring that alltimetables and procedures are adhered to, action plans are implemented properly and on time,and effective supervision is carried out at all times; and accept full responsibility for the work ofthe PIU. The specific duties are as follows:

(i) be responsible for the implementation, control, and administration of the Project:(ii) ensure the efficient and effective use and administration of loan funds and other

resources through proper management, control, monitoring, and reporting;(iii) assist in enhancing project success through efficient and timely provision of

logistic support;(iv) as appropriate and necessary, provide advice in improving the project focus and

its direction, implementation, and management;(v) ensure timely preparation of project budget estimates, reports, and other financial

documents;(vi) supervise the preparation of the annual budget estimates for the Project and

maintain proper records of expenditure and payments from project funds;(vii) supervise the preparation of periodic financial reports for submission to the

Government and all agencies requiring these reports and other documents tofacilitate funding release or reimbursements;

(viii) evaluate the financial performance of the Project, and provide appropriate advicefor improvement;

(ix) develop and maintain, as necessary, an information system relevant to thefinancial activities of the Project ;

(x) assume all other responsibilities over the Project as directed and as required byBPNG and Asian Development Bank; and

(xi) act as secretary to the project steering committee, and prepare and distributeprogress reports to appropriate agencies interested in the Project.

12. The manager must have (i) extensive experience, i.e., not less than 10 years, inmanagement, banking and/or microfinance in a senior position, preferably with a degree inbusiness administration, economics, or a related field; and (ii) ability to identify, plan, and carryout projects and programs independently.

2. Project Assistant (60 person-months)

13. Under the direction and supervision of the project manager, the project assistant willinitiate and facilitate the procurement of consulting services and goods under the Project,ensuring that the required goods and services are procured according to the project timetable,and that proper Government and ADB procurement procedures and regulations are followed.The specific duties are to

66

Appendix 10, page 5

(i) provide secretarial and logistic support and assistance to the internationalconsultants and specialists recruited under the Project;

(ii) be responsible for the proper maintenance and upkeep of the office, officeequipment, furniture, vehicles, and other project assets; maintain proper and up-to-date records and registers; and ensure proper maintenance for vehicles andequipment; and

(iii) be responsible for the procurement and distribution of furniture, equipment, andother assets, office materials and supplies, and training materials required for theProject, and for maintaining appropriate levels, proper controls, and records ofstock.

14. The project assistant must have (i) at least two years experience in administrative,clerical, and logistic procedures, preferably with a degree in business administration, finance, orrelated field; and (ii) working knowledge of Government procurement policies and procedures.

3. Training Specialists (2 for 60 person-months each)

15. The training specialists will be recruited locally. Under the supervision and guidance ofthe microbanking specialist and the curriculum development and training specialist, the primarytask will be to conduct on-site training and counseling, and occasional in-house training for MFIstaff; and design and implement follow-up measures. Where appropriate and required, assistthe microfinance product development specialist in implementing community training courses inbanking and financial management.

16. The training specialist will have (i) a qualification in accounting or businessmanagement; (ii) experience in training accounting and business-related subjects; and (iii)working experience in microfinance, which will be a particular advantage.

67