PROGRAM-FOR-RESULTS INFORMATION DOCUMENT (PID) CONCEPT STAGE Report No.: 91426 (The report # is automatically generated by IDU and should not be changed) Program Name Finance for Rural Egypt Program Region Middle East and North Africa Country Arab Republic of Egypt Sector Finance Lending Instrument Program for Results Program ID P151116 Borrower(s) Arab Republic of Egypt Implementing Agency The Central Bank of Egypt Date PID Prepared August 11, 2014 Estimated Date of Appraisal March 10, 2014 Completion Estimated Date of Board April 15, 2014 Approval Concept Review Decision Following the review of the concept, the decision was taken to proceed with the preparation of the operation. Introduction and Context A. Country and Macroeconomic Context 1. Egypt is about to complete the political roadmap announced in July 2013. A newly amended constitution was ratified, the presidential elections were held in end-May 2014, and parliamentary elections – the final step in the current transition period – are expected to be held after the summer. Despite such progress, the political scene remains intense with ongoing terrorist incidents that target the police and military. 2. Egypt’s economy continues to be negatively affected by the prolonged political tensions since 2011. Annual Gross Domestic Product (GDP) growth has averaged only two percent since fiscal year (FY) 11, and the latest data indicate that growth remains subdued at 1.6 percent during the first nine months of FY14. It is expected to be around 2 percent for the whole FY14. Lower investment and net exports continued to be a major drag on growth. Private consumption has held up because of resilient remittances and households’ reliance on previous year’s savings. Public consumption grew in light of the accommodative fiscal policy stance. As a result, the national saving ratio has been on a declining path and is expected to reach six percent in FY14. The last quarter of FY14 is expected to witness a boost in economic activity, as the government accelerates its stimulus spending (especially on investments), and as the performance of key sectors (such as tourism and extractive industries) is expected to improve. 3. Fiscal consolidation and expenditure restructuring measures are finally being adopted. The overall budget deficit is expected to decline to 10 percent of GDP in FY15, compared to an expected outturn of 12 percent in FY14. Yet more efforts are needed to bring the fiscal and debt paths back on a sustainable track. Early in July 2014, the newly elected president approved a wide range of structural and long awaited reforms. It mainly increased and/or enacted new taxes, as well as streamlined electricity and fuel subsidies in an attempt to restore confidence in the Egyptian economy and to address the wide macroeconomic imbalances especially the large fiscal deficit, explosive debt dynamics and an acute energy crisis. These significant measures are expected to generate fiscal savings of around EGP80 billion (some 3.5 percent of the FY15 projected GDP), and would bring the deficit down to 10 percent of GDP in FY15, compared to an expected outturn of 12 percent of GDP in FY14. Of these projected fiscal savings, some EGP27 billion, will be directed (in light of new constitutional pledges) to enhance spending on health, education and scientific research and to enhance social spending. Also, the government is targeting an ambitious capital expenditure program worth 2.8 percent of projected FY15 GDP, some 40 percent higher than expected outturns in FY14 (2.4 percent of GDP). The government has already announced that the electricity subsidy will be further reduced gradually over the coming four years. 4. Inflationary pressures are mounting due to the recent fuel and electricity price hikes, after a short-lived period of moderate inflation. The latest figures indicate that annual urban headline CPI inflation reached 8.2 percent in June 2014, similar to the previous month, but down from an average 11 percent during the first half of FY14. Annual food and beverage inflation remained elevated at 11.3 percent in June 2014, but has decreased around 4 percentage points from its average during the first half of FY14. The higher food prices disproportionately affect the poor and vulnerable segments of the population. The recent decline in headline inflation rates may be attributed to favorable base effects and the stability of the exchange rate. The effects of the recently implemented subsidy cuts and tax hikes are expected to kick in starting July 2014, with the average annual headline inflation expected to exceed 15 percent in FY15. 5. Since the beginning of July 2013 political transition, Egypt has been benefiting from large-scale exceptional financing from the Gulf. This has provided a buffer for the authorities to jumpstart the economy, it lowered the cost of borrowing, it offered buoyancy to foreign reserves after declining for two years, and partially helped to finance the country’s growing energy and food needs. Saudi Arabia, UAE, and Kuwait have committed around $20 billion aid to Egypt, of which some $15-16 billion were received, as of end-June 2014. These funds lowered the cost of domestic borrowing by some 400 basis points in FY14 and enabled the interim governments, appointed since July 2013, to embark on two economic stimulus packages, amounting to a total of 3 percent of GDP1, two thirds of which were dedicated to investments spending, while the rest went to finance civil servants’ wage increases and (temporary) social measures. 6. Overall social conditions have been deteriorating, in tandem with the economic downturn since 2011, with Upper Egypt particularly vulnerable. The unemployment rate stabilized at an elevated rate of 13.4 percent during January-March 2014 (similar to the previous two quarters); yet up from 9.1 percent in the same quarter in 2010. The labor market continues to suffer from higher informality, in addition to a lower labor force participation rate (currently at 48 percent of the adult population; around 2 percentage points lower than its level in 2010). Of the 3.7 million unemployed, 32 percent are well-educated, with at least an undergraduate degree, and some 70 percent are aged between 15 and 29 years old. The latest poverty data indicate that 26.3 percent of the population has been living below the national poverty line in FY13. The poor are concentrated in Upper Egypt, in particular in rural areas where the poverty rate is 50 percent, with limited options to work outside subsistence agriculture 1 Half of the stimulus spending was financed by a drawdown on the government’s deposits at the Central Bank of Egypt, while the other half is being financed by a grant and project financing from the UAE. 7. Structural and emerging risks need to be addressed immediately to maintain economic and social stability. Stability and security need to be gradually restored ahead of the forthcoming parliamentary elections. Further, a rebound in national investments and saving ratios is required to address the urgent infrastructure gaps and to enhance Egypt’s growth potential. With the size of public debt approaching GDP, interest payments also absorb a large and increasing share of the budget. Financing of the fiscal deficit has relied largely on domestic sources, in particular the banking system with commercial banks absorbing a large share of what has been mostly short-term debt instruments and the central bank providing monetary financing. This accommodative monetary policy combined persisting supply-side bottlenecks, has generated high and chronic inflation further undermining poverty reduction and greater sharing of prosperity. B. Sectoral and Institutional Context of the Program 8. Agriculture remains an important sector for Egypt and despite the economic slump since 2011, the agriculture sector has been showing a high degree of growth resilience, and has also posted a growing share of total employment. The agriculture sector posted a stable growth rate of three percent during FY11–FY13, outperforming the feeble average growth rate of two percent for the entire economy. Its share in total GDP has been stable at around 14-15 percent of GDP, yet it has a higher employment share of slightly less than one quarter of total official employment. In addition, related industries, such as food processing and input supplies, account for a further substantial share of employment and around 20 percent of GDP. Half of Egypt’s population resides in rural areas, where they depend significantly on agriculture and subsistence. Agriculture is a crucial sector for Egypt’s development. 9. Further, poverty is concentrated in the Figure 1: Concentration of Poverty by Economic agriculture sector and more than 80 percent of the Sector extreme poor are in rural areas. Overall, the % 40 percentage of the poor in agriculture is more than one 35 34.6 third (34.6 percent), surpassing the poverty rates in 30 any other economic sector (Figure 1). Rural poverty 25.1 25 in Egypt is often associated with very small land 20 15 15.5 17 17.1 holdings; where 81 percent of farmers own less than 15 9.6 12.4 three feddans (1.26 hectares) accounting for just 10 6.6 38 percent of total landholding. Hence, the 5 agriculture sector requires more support, but has 0 great potential in alleviating poverty in rural Egypt. 10. Agriculture is also significant from a gender Source: Household Income, Expenditure, and Consumption perspective. Egyptian women play a major role in Survey (HIECS), 2013. agriculture. In rural Egypt, approximately 60 percent of the food for household consumption and sale in local markets is produced by women. Nevertheless, female farmers are constrained in terms of access to services, largely due to traditions and cultural barriers. Only seven percent of women farmers have an account at a formal financial institution, and only 3.6 percent have taken a loan, compared to 12 percent and 6.1 percent for men respectively (Findex, 2012). There is a strong gender dimension in developing the agriculture sector and improving rural areas access to finance for women (Box 1). Box 1: Agriculture, Access to Finance, and Gender in Egypt Women play an active role in the agriculture sector and in rural areas in general. They are responsible for sowing the seeds, weeding, cultivating, harvesting the crops and selling the surpluses, in addition to tending the gardens. In spite of the important role and impact of women in agriculture, there is still an unsettling disparity in the support they receive in comparison to men. While credit is highly necessary to acquire land, machinery, fertilizers, irrigation, and seeds, as well as to hire labor, women’s access to finance is limited and more challenging compared to men’s. Rural females are especially disadvantaged when it comes to borrowing, where the percentage of formal borrowing is 3.6 percent as opposed to 6.1 percent for rural males, and still even lower than urban females at 6.5 percent (Figure 1.1). In terms of savings, the percentage of rural female savers is very low, in comparison to rural male savers, as well as urban females (Figure 1.2). Women in rural areas often do not have sufficient collateral which constraints their access to finance. Traditions, in some cases, give women little control over their own assets, and in many cases they are unable to use them as collateral, being under the guardianship of a male member of the family. In addition, banks impose higher collateral requirements for women as they are perceived as more risky; particularly due to the social culture that places them as the key family members responsible for taking care of the household, leaving them limited time for work. Moreover, cultural barriers and norms limit women’s mobility, constraining their entrepreneurship opportunities. Figure 1.1: Gender Disparities for Figure 1.2: Gender Divergence for Borrowers in Rural and Urban Egypt Savers in Egypt urban female rural male rural female 35 0 30 5 6.1 6.5 3.6 -2 25 20 -4 15 -3.7 -3.5 27 25.3 25.3 -6 10 22.5 5 -8 0 -8.6 urban male urban female rural male rural female -10 Informal Borrowing Formal borrowing urban female rural male rural female Source: Findex (2012). Source: Findex (2012). Enhancing rural women’s access to finance and providing them with an equal opportunity is critical. In addition to empowering them, improving their access will contribute to boosting their agricultural productivity, allowing for the development of income-generating activities in parallel with their production activity. Through increasing their economic purchasing power, rural women will have the opportunity to be organized more efficiently, and thus be capable of participating in the decision-making process and elaboration of policies that pertain to them, and of defending their own interests before public authorities and relevant institutions, as well as those of their families. 11. The agriculture sector in Egypt suffers from several challenges that hinder the sector’s development. These challenges span (i) agricultural land tenure, which is depicted in agricultural land; loss of fertile agricultural land to urban encroachment; and difficulties to access new state- owned land for land reclamation projects. Another set of challenges relate to (ii) lack of governance within the sector particularly within agricultural cooperatives. The existing cooperative law continues to restrict the development of the cooperative sector and provides little flexibility for cooperatives to develop self-reliance, marketing activities or to enter into contracting arrangements with private sector. In addition this law hinders the reduction of transaction costs and the bargaining power of small farmers. These challenges are augmented by (iii) low productivity and limited competitiveness due to the adoption of obsolete irrigation technologies with a very low efficiency, shortage of fertile land, lack of appropriate supply chain logistics, high levels of risk associated with market uncertainties, limited diversification of cropping patterns triggered by distortionary pricing of many crops including wheat and cotton. The agriculture sector in Egypt also suffers from an inefficient and limited financial market in rural areas. 12. Development of the rural sector and the Figure 2: Lending by Economic Activity reduction of rural poverty, also remain constrained 40% by lack of access to finance. Responding to the development needs of rural areas requires a multi- 30% pronged approach. Global literature has amply demonstrated that one of the key elements is the 20% provision of quality financial services to the country’s cultivated areas. Better access to financing of 10% essential inputs will help in the enhancement of crop productivity, which would then contribute to poverty 0% 2006 2007 2008 2009 2010 2011 2012 2013 reduction and to economic growth. However, in Agriculture Industry Egypt, the agricultural sector receives only one Trade Services percent of total lending compared to 38 percent and Unclassified sectors 26 percent for industry and services respectively Source: Central Bank of Egypt (2014). (Figure 2), while agriculture provides direct and indirect livelihood for approximately 55 percent of Figure 3: Association of Rural Access to Formal the population. Finance and Savings 13. The lack of finance impedes agriculture (percentage of population age 15+) 35 productivity enhancements and exposes farmers to risks as they borrow from informal sources to meet 30 Malaysia Saved in the Past Year their financing needs for timely purchase of 25 agricultural inputs, especially for the high-cost inputs 20 required to produce high-value products. This lack of 15 Indonesia funds often leads to “tied” transactions, as small 10 farmers must secure finance from the trader, who 5 Yemen. Sudan Jordan Turkey Algeria binds them to unfavorable arrangements. Lack of 0 Egypt access to financial services in rural areas in Egypt, 0 20 40 60 relative to its peer countries (Figure 3), limits rural Account at a Formal Financial Institution deposits and remittances from Egyptian cities and Source: Global Findex, (2012). abroad. The current operation will focus on the enhancing rural access to financial services and ensuring that an adequately capitalized and efficient PBDAC is in place to support rural poor farmers and help with the overall development of the agriculture sector. 14. Egypt’s financial sector has little interest in rural or agricultural finance. Financial intermediation in Egypt is in general low, and it is much worse for the agriculture sector. This is evident in the share of agriculture sector deposits-to-total deposits ratio at 0.4 percent in June 2013, which is the lowest compared to all other sectors (CBE, 2014). The banking sector, which accounts for more than 90 percent of the financial system’s assets generally, does not finance the agricultural sector, other than post-harvest sale of agricultural products. The main reason lies in the rural finance market policy distortions which are key reasons underlying the lack of interest of banks. Critically, the provision of interest subvention only to PBDAC provides for an uneven competitive market place; and the periodic debt waivers undermine credit culture significantly. This adverse rural banking policy environment Figure 4: Bank Branch Network in Egypt perpetuates a vicious cycle that contributes to Private Public underdevelopment of this part of the financial market. Banks Sector 32% Sector 30% stay away and do not invest in capacity to respond to the Private & needs of rural markets. Further, ‘lazy and easy banking’ Joint opportunities available in urban areas means that the Venture 3% imperative to look at rural areas remains low. Consequently banking retail presence, other than PBDAC’s, is virtually PBDAC 35% non-existent in rural areas especially of foreign and private Source: CBE (2014). banks, and even the three large, state-owned commercial banks have very few branches in rural villages. The non- bank financial institutions (NBFIs) are underdeveloped and Figure 5: Distribution of Branches hardly serve rural Egypt. 400 310 15. The Principal Bank for Development and 300 234 250 Agriculture Credit (PBDAC) is rural Egypt’s most 200 important financial institution, the only bank that lends to 103 112 100 53 70 individual, small farmers, and thus the sole bank that can 49 reach the rural poor. PBDAC accounts for 70 percent of 0 all formal institutional lending to the agriculture sector. It is Minya Assuit Sohg Qena the only bank present in most rural areas, with 1,210 PBDAC branches Poorest villages branches, accounting for 35 percent of the total bank Source: PBDAC (2013). branches in Egypt (Figure 4), of which 44 percent are located in Upper Egypt (Figure 5). PBDAC has at least one Figure 6: Distribution of Village Bank Branches branch in every Governorate. PBDAC’s branch network is widespread over Egypt, clustered around the agricultural areas. Its network has the highest accessibility to the poorest villages in Egypt (Figure 6), with 45 percent of its branches located in six Governorates with the highest poverty rates Annex 9). PBDAC has around 2.7 million depositors and 1.7 million borrowers2, with around 47 percent clients located in the poorest areas. In addition to the financial services, PBDAC also caters non-financial business development services for the farmers. 16. Nevertheless, PBDAC effectiveness in serving the Egyptian farmers and the agriculture sector in general has been very limited. This is largely due to significant government interference in its operations and lending, as Source: PBDAC (2013). 2 Although its outreach is far more than any other bank, a large part of the 10.7 million households (53 percent of Egypt’s 20 million households) who are located on rural areas, still do not have financial services. well as on account of poor systems and weak institutional capacity. A major drain on PBDAC has been sporadic Government debt forgiveness, in addition to untargeted, low, government-set lending rates and interest subventions on PBDAC’s loans. These policies have hurt PBDAC’s balance sheet and its lending capacity, weakened rural credit culture and which also crowded out other lenders. PBDAC has also been involved in selling inputs to agriculture and buying agricultural output at highly subsidized, Government-set prices, thereby serving a ‘public utility’ function, without adequate compensation. Essentially PBDAC has not historically acted as a rational financial institution, but rather as a mechanism for the government to distribute poorly targeted and politically motivated subsidies to rural farmers and others. PBDAC’s legacy politicized model and its inefficient operations have created huge costs for the government while doing little to positively change the paradigm for poor farmers in Egypt. 17. As a result of these policies and compounded by the recent economic turmoil, PBDAC’s key financial performance indicators are significantly weak, and deteriorating. Capital is negative with capital adequacy ratio (CAR) at negative 8.1 percent as of June 2013, compared to negative 2.2 percent in 2012. PBDAC operations were loss-making with poor asset quality and substantive provisioning needs, evident in the high ratio of non-performing loans (NPLs) to total loans at around 36.3 percent, and the provision-to-total loans ratio at 17.6 percent in 2013 (Table 1). PBDAC role in financial intermediation has been limited, as evident in the loans-to-deposits ratio at 61 percent in 2013, falling from 75 percent in 2012. Table 1: PBDAC Key Performance Indicators (percent) Key Performance Indicators (end of fiscal year—June) 2011 2012 2013 Capital adequacy -7.47 -2.15 -8.14 Interest margin 16.40 2.97 5.30 NPLs-to-total loans 31.73 28.03 36.32 Loan-to-deposits 63.02 74.55 61.19 Provisions-to-total loans 16.53 14.87 17.63 Return-on-assets -2.30 -3.30 -7 Source: PBDAC (2014). 18. PBDAC’s poor functioning and unsuccessful legacy approach have failed to strengthen financial intermediation sufficiently among rural farmers. PBDAC has over the years built a base of small depositors: As of June 2013, about 2.7 million depositors held deposits of LE 29 billion, an average deposit size of about LE 10,000. These small depositors have been put at risk by PBDAC’s loss of capital, creating a large liability for the government and possible a systemic risk for the sector. At the same time, PBDAC has lent LE 21 billion to about 2 million borrowers. One third of these are subsidized crop loans (LE 7 billion) averaging around LE 7,000 to about one million clients. Many of these have been subject to sporadic debt forgiveness and are frequently rolled over, damaging client credit culture. The other two thirds of the portfolio comprise investment loans of LE 14 billion to more than 700,000 borrowers, averaging around LE 20,000. The investment loans, which include car loans and other non-agricultural credits, suffer from higher default rates than the crop loans, given both PBDAC’s lack of experience in investment credits as well as the farmers’ desire to retain creditworthiness for continued crop financing. PBDAC’s pricing on both sides tends to be irrational, with a primitive asset liabilities management (ALM) function recently set up but without sufficient data to support rational pricing decisions. In an effort to attract new clients, PBDAC is currently underpricing the market, charging less for credit and paying more for deposits than competitors, thereby further exacerbating PBDAC’s existing negative operational cash flow. 19. Moreover, the credit subsidy provided through PBDAC is currently universal, lacking transparency and any targeting mechanism. All crop loans borrowers (30 percent of PBDAC’s credit portfolio) are eligible to subsidized credit regardless of their wealth, and as a result, large agriculture corporations are among the recipients of subsidized loans. This poorly targeted subsidy is likely to have benefitted rural borrowers with higher incomes rather than those who are truly struggling. 20. Despite PBDAC’s poor record, the Egyptian government cannot close PBDAC or keep the situation as is, ignoring the legitimate needs of the farmers for access to services and the urgency of addressing rural-urban inequity. Closing PBDAC would be unfeasible because of its extensive branch network, and wide deposit base, especially of the poor families in rural areas. PBDAC remains the only substantial financial presence in most rural areas. Other banks do not lend to the agriculture sector due to the rural finance market distortions discussed above, and the high transaction costs, and risk aversion associated with agriculture credit. Other banks lack the incentive to lend to the agriculture sector, since PBDAC provides subsidized credit to farm loans that are far below the cost of capital. The Egyptian Post Office offers time deposits, but these are limited by restrictions, and the Post Office does not offer credit. The very low penetration of other financial players, including other commercial banks and NBFIs, would mean that PBDAC’s departure and the continuance of distortionary rural finance policies of debt waivers and interest subventions, would threaten the already low levels of financial intermediation in rural areas, likely further exacerbating the gaps between rural and urban Egypt. 21. Given the lack of agricultural finance and given PBDAC’s unique position in this sector and its potential, an effort to transform agriculture finance through strengthening PBDAC has emerged as a key priority for the Government, especially to reach small farmers. With the importance of agriculture and the rural economy to Egypt’s growth and development, strengthening and reforming PBDAC provides a unique opportunity to address rural poverty through the financial sector, by taking advantage of PBDAC’s extensive branch network. In that setting, the restructuring of PBDAC was an integral part of the “Sustainable Agriculture Development Strategy” (2010– 2030), launched in 2011 by the Ministry of Agriculture and Land Reclamation, which aims at achieving sustainable and growing agriculture sector. The Strategy includes better forward and backward linkages, enhanced use of technology and improved agriculture extension services and infrastructure—being pursued by the Ministry of Agriculture and Land Reclamation as parallel development actions to the proposed PBDAC transformation program discussed below. What is clear, that supporting PBDAC is the only short- to medium-term response to building a thriving agriculture finance market, and would be complemented by efforts to develop the agriculture sector in Egypt under the leadership of the Ministry of Agriculture and Land Reclamation. 22. Consequently, a comprehensive time-bound “Finance for Rural Egypt Program” (2015– 2020), aiming at strengthening and transforming PBDAC into a commercially run agriculture- focused bank serving rural Egypt was launched in June 2014. The recently appointed cabinet recognized the opportunity provided by PBDAC in improving the agriculture financial services, and in contributing to achieving inclusive growth, and serving marginalized areas in rural Egypt. The program aims at improving PBDAC’s role in economic development by reducing the significant government interference in its operations and lending, which have perversely hampered the development of agricultural finance, and by improving its poor systems and weak institutional capacity, including by better leveraging its huge branch network. Building on previous reforms initiated in 2008, Prime Minister Mehleb revived the restructuring of PBDAC in May, 2014. The Government’s commitment to reform was reiterated at the highest political level in the inaugural speech of President Abdel Fattah Al-Sisi in June 2014, which underlined the importance of restructuring PBDAC to better serve the Egyptian farmers. Accordingly, a time-bound program with clear bench marks was developed in late June 2014 through an extensive consultative process, with representatives from the Ministry of Finance, Ministry of Agriculture and Land Reclamation, the Central Bank of Egypt (CBE), Farmers Cooperatives, civil society, private sectors, bankers, and PBDAC clients. Key pillars of the program are aligned with the recommendations put forward in the joint IMF-World Bank 2008 Financial Sector Assessment Program (FSAP). 23. A PBDAC Restructuring Steering Committee, headed by CBE, was immediately formed to lead the reforms. These include, as a key upfront measure, legal and regulatory reforms, which would transfer the ownership and control of PBDAC from the Ministry of Agriculture and Land Reclamation to the Ministry of Finance, and make the bank subject to CBE’s regulation and supervision, on par with other commercial banks operating in Egypt. The measures will include reforming the subsidy system and instilling a transparent subsidy mechanism based on a governmental updated database for the poor, the farm size and other social and demographic criteria that will lead to a more efficient subsidy targeting to contribute positively to the well-being of poor farmers. Furthermore, to ensure the financial sustainability of PBDAC, the government through the Ministry of Finance shall transfer any desired subsidy to PBDAC before being provisioned to poor farmers. Reforming the subsidy targeting mechanism and enhancing its transparency is an integral determinant to the success of PBDAC’s transformation. In addition, upfront commitments from the Ministry of Finance to avoid debt waivers, and where announced, fully fund them, will form part of the reforms. These actions would be undertaken upfront and would be followed by a comprehensive program to transform the bank to a commercially sustainable institution. Support for enhancing governance, financial, institutional and information technology (IT) capacity are key areas of the program for creating a stronger and better managed PBDAC that can provide better quality financial services in rural areas in Egypt. Institutional strengthening will also include shifting the remaining legacy non-financial services from PBDAC to its subsidiary the Egyptian Company for Agricultural and Rural Development (ECARD), and efforts to strengthen ECARD’s operations. The Government is aware of the need to ensure that on a sustainable basis PBDAC reforms maintain, the access of farmers to financial and non-financial services in support of the agricultural sector—a priority of the reform agenda and the strategy. 24. By its new legal mandate, PBDAC will be a rural focused viable commercial institution and, by virtue of this mandate, will target the bulk of its activities at the rural economy . By doing so rationally and profitably, as its new mandate requires, PBDAC’s successful transformation will help to redress the grave imbalance between urban and rural financial activity in Egypt and improve access to financial services for rural areas, which, as discussed above, accounts for the majority of Egypt’s poor. This will happen both as a result of PBDAC’s enhanced ability to engage in financial intermediation in rural areas itself but also by removing the serious distortions its legacy incarnation placed on rural finance, e.g. by crowding out competitors with irrational pricing or by sustaining distortionary practices. Improved access to finance, as literature has clearly shown, is associated with reduction of poverty and positive growth effects. The time-bound program will enable PBDAC to improve financial inclusion by better leveraging its uniquely wide reach in rural communities, including through its extensive branch network and also by innovating other distribution mechanisms such as phone banking. PDBAC’s extensive distribution system can be used to make deposits more available to the poor (financial inclusion), pool more savings, make remittance services more accessible and cheaper, and, in the future, could be used to carry out conditional cash transfers to the poor, as is now done in Morocco and Turkey. All these improvements in PBDAC’s services will contribute to more equitable growth in Egypt, as they have done in other countries. 25. If successful, PBDAC’s new role will catalyze a more effective delivery of financial services, including both credit and savings products, to the rural population, thereby increasing financial inclusion and contributing to the reduction of rural poverty. Simply by acting as a rational bank focused on agriculture, and therefore the rural economy, a reformed PBDAC will channel financial resources to those activities in the agricultural sector that are viable, profitable, and most likely to bring long-term growth to the sector. PBDAC will also be obliged to fund itself rationally and will therefore develop mechanisms to better leverage its rural presence among depositors, both in terms of volume and pricing of deposits but also for other allied activities, such as transfers and remittances. As a state-owned bank focused on agriculture, PBDAC will have an explicit mandate to make itself viable within this under-served (and more volatile) sector. To do so, PBDAC will have to identify market failures and lobby for and/or channel state support to mitigate sector risks (e.g. through such efforts as crop insurance) to help raise the viability of individual farmers and related business and therefore of the overall sector. By playing this leadership role in agricultural financial intermediation, PBDAC will also serve as a conduit to the Government of Egypt of needed support, reforms, or policies to raise the overall creditworthiness of agricultural borrowers (given PBDAC’s need to remain viable). 26. In that context, the World Bank Group was requested by the Government of Egypt on July 17, 2014 to support the program. The proposed operation is to support the many specific steps in this complex and bold program, over a five-year period. The program will take advantage of PBDAC’s branch network to reach more of the rural community, and is expected to not only create a stronger and more viable financial institution focused on the agriculture sector, but ultimately lead to access to better financial and non-financial services for farmers and other rural clients. Further, the upfront changes in policies related to debt waivers and interest subventions, will, alongside benefiting PBDAC, also improve financial market conditions and level the playing field and thereby support the larger goal of broad based development of rural finance markets, and over the medium to long term, a more competitive rural finance market. C. Relationship to CAS/CPS 27. The World Bank Group has recently launched the public consultations which will help develop the Country Partnership Framework (CPF) for its partnership with the Arab Republic of Egypt during the period of 20152019. This is part of a larger exercise that includes a Systematic Country Diagnostic (SCD), which constitutes the analytical basis for the formulation of the CPF. The proposed operation is closely linked to the SCD, and the outcomes of the CPF consultations. The SCD assesses the potential role of the agriculture sector in contributing to sustained economic growth, job creation and poverty alleviation. Rural development, private-sector-led job creation and agriculture—given that around 55 percent of Egyptians’ livelihoods are dependent on this sector and poverty is concentrated in rural areas—are key drivers of progress towards achieving the twin goals. Furthermore, developing the agricultural sector, linking it to markets and creating sustainable job opportunities through the private sector, were again two main outcomes of the CPF consultations held in June 2014, with the objective of agreeing on developmental priorities for Egypt. In addition, the operation is in line with the 2014 Middle East and North Africa (MENA) Regional Strategy. D. Rationale for Bank Engagement and Choice of Financing Instrument 28. PBDAC’s transformation into a stronger institution will yield better provision of financial services to farmers, contributing to achieving the twin goals of ending extreme poverty and boosting shared prosperity. Poverty in Egypt is heavily concentrated in the rural agricultural sector and the gap between this sector and other economic sectors has been widening, while delivery of financial services to rural areas has declined. PBDAC for the time being remains, in most cases, the only financial institution serving and interacting with farmers3, its improvement thus represents a key policy instrument for improving the welfare of poor rural farmers. The Government has expressed its strong commitment to rural finance and to the key role it assigns to a transformed PBDAC, as a clear indication of its commitment, it has drawn-up a comprehensive time-bound action plan. A transformed PBDAC will aim to maintain its focus on rural areas even while transitioning to a more commercially oriented institution with great focus on credit quality, pricing, new product development, business growth, improved institutional capacity including IT and better governance and management – to remain financially sustainable, under commercially driven leadership, while at the same improving service delivery to the rural sector. The process will include a substantive strategic change, including better alignment with the broader financial sector, and the development of new, creative approaches for instance in the use of mobile technology to reduce costs, developing Islamic finance products, women specific products, etc. 29. PBDAC’s new board of directors will first be responsible for making the ban k financially sustainable. PBDAC will not be a development bank. Although PBDAC will have an agricultural mandate and a rural focus, both by legacy and by decree, it must still first develop a strategy that allows it to become and remain viable, i.e. capital sustaining. Creating a commercially viable bank within the niche of agricultural finance will be challenging, and PBDAC will have to balance its agricultural policy mandate with its prime objective of viability. The Bank’s new board will first work to develop a strategy that is commercially viable within the confines of its mandate, however specifically its owner, the Ministry of Finance, defines it (‘agricultural focus’ is not yet rigorously defined). PBDAC may find that, to remain viable, it must migrate towards more profitable agricultural ventures and away from the most marginal farmers. Even so, a successful Egyptian bank in the agricultural space will inevitably raise the volume and quality of investment in agriculture in Egypt which, in turn, will help the farming community. 30. PBDAC’s transformation should help catalyze broader financial interaction with the agricultural sector. PBDAC’s current functioning actually negatively impacts financial intermediation in the agricultural sector by: prolonging unproductive legacy patterns, crowding out rational competitors, and mis-channeling financial resources. PBDAC’s restructuring must be seen as part of a broad attempt to better channel productive financial intermediation to the rural and agricultural economy. As such, the Government of Egypt will need to identify market failures (e.g. in structure, land use, market patterns) that inhibit the success of small farmers – and of the agricultural sector more broadly – and seek ways to mitigate them, whether financial or otherwise. This mitigation may include support or reforms completely independent of the financial system 3 The only other institutions are the Egypt Post that is only providing savings accounts, and no lending; and the three commercial state-owned banks (National Bank of Egypt, Banque du Caire, Banque Misr) that have very limited presence in poor rural villages. (e.g. changes in subsidy patterns) and/or may include support targeted at agricultural borrowers, such as crop insurance programs, agricultural extensions, or credit guarantees. This independent support may be via PBDAC, as a future leader in rural financial intermediation, or via all Egyptian financial institutions: PBDAC may be a leader in and catalyst of the agricultural sector but must not be a monopoly. As previously noted, any government support must be accounted for in such a way as to not burden PBDAC’s (or any other bank’s) financial viability. The specificity of any social targets resulting from PBDAC’s transformation (e.g. ‘small deposit acquisition’) must be preliminary at this stage and must finally await the development of PBDAC’s strategy for commercial viability, along with any social objectives expected of it. All of this must go hand in hand with the government’s emerging strategy for the agricultural sector. 31. PBDAC’s new structure and resulting new governance and strategy significantly raises its likelihood of success. In its new role as a true commercial bank (as validated both by the Ministry of Finance and CBE), PBDAC is expected to support the rural farmers. The restructured bank would have a positive impact on rural areas simply by acting as a rationally functioning bank focused on agriculture and thereby channeling depositor funds to qualified agricultural (and therefore rural) businesses. Unlike under the prior regime, any such subsidies or support would be transparent and paid for in advance, without jeopardizing PBDAC’s own capital. Bank support to this complex and critical transition of rural finance markets will enable bringing its international experiences of similar initiatives from around the world, and improving program credibility and commitment. 32. Thus, in terms of the World Bank Group’s (WBG) partnership with Egypt, this five-year program offers a critical avenue to support pro-poor equitable growth and development, while complementing other ongoing initiatives. Such support from the Bank and other potential partners, will solidify PBDAC’s capital, increase depositor confidence in PBDAC and, over the longer term, fill a critical gap in rural financial service delivery in Egypt, as well as, put provision of key non- financial services on a more sustainable basis. 33. Given the existence of a well-defined Government program, a Program-for-Results (PforR) was considered to be the most suitable option for Bank support. First, it can support the Government’s expenditure program needed to transform PBDAC through governance and institutional capacity building, financial strengthening, and IT enhancement, which will enable it to improve its operational performance, efficiency and delivery of financial services. Second, during discussions with the staff, the client expressed strong preference for the PforR, and there was agreement that the PforR focus on results, including the use of disbursement-linked indicators (DLIs), will provide a strong incentive to sustain the program’s implementation across the key areas of focus, and avoid any irreversibility. Third, given the anticipated medium-term nature of the program, the PforR instrument will provide appropriate incentives over that time span as it links disbursements to progress against key results—particularly appropriate given the political economy that surrounds agriculture credit. Moreover, the PforR instrument focuses on strengthening the institutional capacity needed for the program to achieve its desired results, and thereby enhancing development impact and sustainability of the reforms, especially during political and economic uncertainty. Program Development Objective(s) A. Program Development Objective(s) 34. The program’s development objective is to enhance access to financial and non-financial services to farmers in rural areas through the transformation of PBDAC into a viable agriculture commercial bank and fostering competition in the financial sector. 35. The program will support PBDAC through building financial, institutional and IT capacity and through strengthening governance to transform the institution into a viable agriculture-focused bank. Through such a transformation, the program will enable improved provision of financial services to Egypt’s rural areas, in particular its farmers, including the small and marginal farmers and those located in remote areas (Annex 2: Results Framework provides detailed targets and expected outcomes). Financial services will include a broad range of credit, deposit, and transactional services aimed primarily at PBDAC’s agricultural base and targeted at their needs. PBDAC will have the possibility of adding new products and services to cater to both small farmers and private sector agribusinesses, such as harvest finance, season finance, leasing and factoring (see Annex 1 table 1.1 for details about the potential products and services that PBDAC can offer). Non-financial services would include such activities as business development services, delivered directly by PBDAC or channeled from other sources, to help raise the viability of PBDAC’s client base. Such efforts at improved financial service delivery will ultimately contribute to agriculture productivity enhancements and growth and will thereby contribute to reducing rural poverty and supporting the twin goals of the Bank of ending extreme poverty and boosting shared prosperity. Any desired social targets, for example number of small farmers served, are highly speculative at this time, given the lack of both internal (PBDAC) and external (sector) baselines and will in any case be set by PBDAC’s new board of directors in the context of PBDAC’s twin mandates of financial sustainability and agricultural focus. 36. The ultimate long term objective of this program is to foster a sounding and competitive financial sector serving the agriculture sector. The program shall promote competition and level the playing field for banks and NBFIs to serve the agriculture sector and fill the gap in agriculture finance market. It will promote competition among banks and NBFIs, encouraging them to go down market, and will enable new information and instruments allowing for further gains in agriculture and rural financing. 37. Based on preliminary assessment, projections and discussions with the authorities, Steering Committee, the number of farmers that access PBDAC financial products and services is expected to increase to reach three million customers by the fifth year, including 1.5 million customers in Upper Egypt and 300 thousand female customers, as well as entering of new financial institutions (banks and NBFIs) to finance the agriculture sector. Our preliminary findings indicate that access to finance is positively associated with agriculture productivity and hence incomes in poor quintiles. Moreover, an exogenous increase by 1 percent in agriculture income in Egypt reflects on a 4.1 rise in Sen’s welfare index. B. Key Program Results 38. The time-bound program to strengthen PBDAC will be founded on strong legal reforms that place PBDAC under the ownership and control of the Ministry of Finance (from the Ministry of Agriculture and Land Reclamation), and make PBDAC subject to national commercial banking legislation and regulations supervised and enforced by CBE. The new Egyptian Agriculture Bank (EAB) law4, which is expected prior to the approval of the Bank loan, is essential for the success of the ensuing expenditure program in governance, institutional capacity, financial strengthening and IT, which will result in a stronger institution, with enhanced financial and operational capacity to achieve the objective of the provision of improved financial services in rural areas. The program will have the following key result areas (see detailed Results Framework in Annex 2). Governance 39. Key Result 1: Enhanced governance and risk management capacity of PBDAC. Improvements in PBDAC’s governance are an integral part of this operation. This includes a revamped corporate governance structure to address any potential conflict of interests (Board of Directors composition, selection process, clear distribution of responsibilities among Board, management, shareholders, committee structure, etc.); improved and more transparent reporting mechanisms and internal controls; disclosure and transparency; promoting compliance and accountability; and strengthened risk management functions. This would include meeting the ‘fit and proper’ criteria of CBE Regulations for Corporate Governance, and promoting the interest of the bank as a company, without being unduly influenced by political or other forces. In that context, the program would also ensure efficient, transparent and targeted subsidies for poor farmers. 5 Key indicators include: the formation of a new Board, implementation of new risk management and control policies, and publication of quarterly financial statements—all of which would enhance governance and risk management. Financial Capacity and Performance 40. Key Result 2: Enhanced financial capacity and performance of PBDAC. Capitalization and efforts to strengthen its financial performance through better credit management and improved systems, and efforts at recovery of delinquent loans will be reflected in improvements in the asset quality ratio. Since PBDAC’s main business is the provision of financial services, improved asset quality will be a critical result for the program to achieve, which will also enable it to expand its financial capacity to undertake increased lending to agricultural areas. A financially stronger PBDAC will underpin and enable PBDAC to increase the outreach of financial services and serve its clients better, and also improve confidence in PBDAC, and reduce risks to depositor protection. Key indicators that would be monitored include capital adequacy, return-on-assets, and improved asset quality reflected in the decline of non-performing loans (NPLs). 41. Key Result 3: Improved efficiency of operations of PBDAC. The program would ensure that the bank becomes financially sustainable and performing efficiently. A new business model would be adopted, reflecting its focus on financial sustainability within its agricultural mandate. The program is designed to support the development of this new business model, building a strategy in context of the broader financing needs of Egypt’s agricultural sector. The program’s various elements will lead to improved financial performance evidenced in profitable operations of PBDAC. In addition, intermediate indicators will track operational cost efficiency. 4 The law has been prepared by PBDAC Restructuring Steering Committee in consultation with the stakeholders in June 2014, and then it was then transferred to the Council of State which approved it in early July. On July 9, the draft law was submitted by the Governor of CBE to the Prime Minister and is on course for Cabinet approval. The next step would be to submit the draft law to the President for ratification. 5 To ensure a transparent and effective subsidy mechanism, the unified national database of the Government of Egypt would be used to identify the eligible farmers and beneficiaries in rural areas. The Ministry of Finance will pay upfront the subsidy to PBDAC prior to transferring it to the poor farmers. Institutional Capacity and Organizational Strengthening 42. Key Result 4: Enhanced institutional capacity of PBDAC. This will be measured through assessing the numbers of staff who are successfully trained in core banking operations. In addition, intermediate indicators will measure the results in terms of outreach and quality of capacity building efforts on key specific functional areas including the capacity to appraise and develop products. IT Capacity 43. Key Result 5: Number of distribution points providing services to clients. Improved IT, together with a more rational distribution system (both in terms of branch locations, delivery methods and improved staff skills) is critical for PBDAC to offer better quality services to its clients. The establishment of the core banking system to support better data management and internal controls, as well as real time access to customers’ funds across the system, will be the first key activity and the indicator will capture the use of such a system in offering more convenient services to clients. Once a business strategy is defined, PBDAC management will determine how best to optimize customer services through various client interface approaches, including mini- branches, automated teller machines (ATMs—their own and existing), and mobile and telephone banking (Details in Annex 1—Operational Restructuring). Indicators will monitor the new financial products offered, including special products and services for women, and outreach mechanism for underserved segments and marginalized areas. Enhancing Access to Financial Services 44. Key Result 6: Coverage of credit to farmers in rural areas. Financial inclusion will be increased, as measured by an increase in the volume of credit to farmers in rural areas through innovations in product development as well as outreach mechanisms. The development of financial “literacy” support and broadening of access to Islamic products will be key. Increased access to Islamic finance products, microfinance and better-designed lending and deposit products, which meet the needs of the population, together with non-financial services to improve the quality and quantity of crops, will all help in increasing PBDAC’s outreach to the agricultural community. Monitoring indicators include women borrowers, and those served from the marginalized villages with high poverty rates. 45. Key Result 7: Coverage of deposit accounts in rural areas. The indicator will measure the outreach of deposit products in the poorest Governorates, and to women. In addition, intermediate indicators will capture provision of other financial products, thereby enabling clients in rural areas access to an enhanced suite of financial products. Program Description 46. The Government’s Finance for Rural Egypt Program (2015–2020), and its approach in transforming PBDAC entails legal and regulatory reform as a foundation and starting point for an expenditure program focused on four priority areas of governance, financial capacity and performance, institutional capacity and organizational strengthening and IT capacity . Legal reform will entail transferring control from the Ministry of Agriculture and Land Reclamation to the Ministry of Finance and would be achieved through the passing of a new law. The law also stipulates the merger of the two existing subsidiaries for Upper and Lower Egypt (currently they are state-owned banks with their own Boards) into PBDAC, which will continue to be an agricultural- focused bank. The law also explicitly makes PBDAC subject to Law 88 of 2003 on the same terms as other commercial state-owned banks and private banks, making PBDAC subject to CBE supervision.6 The PBDAC will also be subject to all other relevant banking regulations, including the 2011 Corporate Governance Regulations, strengthening its corporate governance, transparency, and accountability, restoring market discipline. The law has been discussed and reviewed by the World Bank, who found it satisfactory, and consistent with the joint IMF-World Bank 2008 FSAP recommendations. The draft law has also gone through extensive consultations with various stakeholders (Ministry of Agriculture and Land Reclamation, Ministry of Finance, banks, farmers, civil society, private sector from the agribusiness, Farmer Cooperatives, Agriculture Committees in the Bankers Association and the Federation of Industry, etc.). 47. There has been good progress in the legal and regulatory reforms, especially over the past month. After internal legal review at the CBE, the long awaited law was approved by the PBDAC Restructuring Steering Committee in late June 2014. It was then transferred to the Council of State, which approved it in early July. On July 9, the draft law was submitted by the Governor of CBE to the Prime Minister and is on course for Cabinet approval. The next step would be to submit the draft law to the President for ratification, rather than wait for the Parliament ratification that might take till late 2014. The Government indicated that this is a priority law, along with other financial laws and regulations all of which were ratified in mid-July 20147, and that EAB Law would follow and would be ratified soon. 48. These actions will be supplemented by the development of a transparent legal mechanism to ensure prompt funding to PBDAC of any future Government announcement of debt waivers, debt forgiveness, write-offs and subsidies, to ensure that PBDAC’s capital and lending capacity is not depleted by such Government activities. Agreement on this mechanism has already been reached at the PBDAC Restructuring Steering Committee, and Circular was issued by the CBE Governor in agreement with the Ministry of Finance in late July in that regard. The agreement entails that any debt waivers or loan forgiveness will be paid upfront by the Government to PBDAC to preserve the capital of PBDAC and ensure that it will not bear the burden of these waivers. As for the subsidy, based on subsidy targeting mechanisms such as an updated governmental database of beneficiaries, farm size and other social and economic criteria, the Ministry of Finance will pay upfront to PBDAC the amount subsidy to be transferred to end beneficiaries. Further, the interest subvention scheme for PBDAC has been assessed and will be undertaken with a better targeted mechanism that is not distortionary (the redesign is discussed in the technical assessment). Key elements include better targeting and the focus on small and marginal farmers and for small loans. Its redesign will make the subsidy back-ended as an incentive to such farmers who pay on time. In addition, it will be desirable to open this program to all banks, including PBDAC, which makes eligible agriculture loans to small and marginal farmers. These redesigns will also help to change the often prevailing view of PBDAC as a ‘free’ government program, a view that impedes development of a strong credit culture. 49. The new model would ensure efficient, transparent and well-targeted subsidies. This would require that any government support to be transparent and prepaid, unlike the legacy 6 Central Bank and Banking Law 88 of 2003’s main articles stipulate: (i) significantly strengthened prudential regulations and developed a mechanism to monitor compliance; (ii) raised substantially minimum capital requirements; (iii) eliminated barriers to bank operational flexibility (such as the distinction between specialized, business, and commercial banks); (iv) discontinued the special treatment of public banks, to enhance competition; (v) asserted the right of private sector parties to own shares in public banks; and (vi) established principles for loan settlements and workouts. 7 This includes the ratification of the Social Housing Law 33 of 2014, and amendments of the Real Estate Finance Law 148 of 2001. PBDAC, where subsidies were borne by the bank and no effort was made to gauge their impact. The new approach would prevent the mingling of state intervention with PBDAC’s commercial success while at the same time raising the likelihood of transparent measurement of subsidy impact. Indeed, the new forced transparency and prepayment of subsidies will also raise the likelihood that any such subsidies may not necessarily be channeled uniquely via PBDAC but may instead be delivered through other mechanisms, such as agricultural extension programs or crop insurance funds available to all banks. However PBDAC’s focus on rural agriculture sector and its physical outreach will make it the most involved in any such subsidies. It is expected that given: (i) the huge need; (ii) the extreme lack of existing services; and (iii) PBDAC’s future rational functioning, the measurable impact of its new business model on rural farmers (and on the agricultural sector generally) will be substantial (details provided in Section IV: Preliminary Assessment). 50. In terms of legacy non-banking services, including marketing of production inputs and grain storage, these functions are expected to be fully separated from PBDAC’s banking ser vices. This would be both in terms of their impact on PBDAC’s financial results, as well as, staff deployment. Currently, most of these services are under a separate subsidiary company, the Egyptian ECARD, and it is expected that both the institutional structure, as well as the governance and mechanisms for provision of services will be subject to a parallel reform process which will seek to increase the role of the private sector in providing these services to farmers—such as through voucher programs for inputs or contracted purchasing activities—while maintaining service outreach to smaller farmers and farmer organizations in poorer areas. In principle, all of PBDAC’s non-banking services will remain guided by the 2010–2030 Strategy of the Ministry of Agriculture and Land Reclamation. 51. Strengthening ECARD will be critical—and part of the program with upfront commitment from the Government to support its activities—to achieving the objective of improving the delivery of non-financial services (an important result of the program and captured in the Results Framework in Annex 2) to complement PBDAC, which will specialize in financial service delivery. Necessary reforms include: developing a dynamic business plan that extends beyond the focus on traditional crops to include high value horticulture crops; strengthening the hiring process to ensure fairness and competitiveness; developing an efficient marketing system that better responds to the needs of farmers, encouraging decentralization efforts with greater autonomy for governorate-level branches to reach a wider customer-base; and improving staff capacity through relevant training and workshops. However, the biggest challenge revolves around assessing various options to enable ECARD to assume the entire production sector currently with PBDAC, mainly dealing with loss- making wheat storage activity. In addition to moving it under ECARD, wheat storage needs a revision of the storage fees. Another key challenge is the 4,000 PBDAC employees dealing with these non-financial services, which would require looking at various options such as raising staff capacity, and offering voluntary retirement schemes, as well as the option of providing a government subsidy to the company to cover the costs of redundant workers till they reach retirement, since laying-off will not be a politically feasible option at this transition phase in Egypt. 52. A transparent mechanism for funding promptly subsidies granted to the agricultural sector via the PBDAC or other government actions which impair capital (debt forgiveness, interest rate subsidies, etc.) will be developed to ensure that PBDAC’s capital is not depleted by these activities in the future. These combined actions will ensure that the bank operates on the same basis as other commercial banks in Egypt with respect to governance and transparency and is not unduly burden by loss-generating activities on behalf of the Government. These actions are designed to place the bank on a sound commercial basis to ensure that they are able to support the Government’s agricultural policy by providing enhanced banking services (both credit and deposit mobilization) to the rural communities thus contributing to poverty alleviation and boosting shared prosperity. In context of the new EAB Law, the Ministry of Finance will establish transparent procedures for promptly reimbursing the PBDAC for any non-commercial transactions effected on behalf of the government. Any temporary credit extended by the PBDAC on behalf of the Government will be promptly reimbursed and will carry commercial interest rates. 53. The expenditure program on: (i) governance, (ii) financial, (iii) institutional, and (iv) IT capacity, which will follow, is summarized below and of these, priorities (i)–(iii) will be supported under the PforR Program. As previously noted, the four expenditure program priorities are interlinked to support PBDAC’s transformation into a viable bank and fostering competition in the financial sector, with the main objective of enhancing the provision of financial and business development services to the rural areas (see Annex 1 for a detailed description of the Program). The authorities are keenly aware of the need to ensure that the transformation is sustainable, hence the clear focus on governance and operational transformation of the bank. (i) Strengthening governance, internal control and strategic to strengthen PBDAC’s operations and risk management. Governance and transparency will be increased by transferring ownership and control of PBDAC from the Ministry of Agriculture and Land Reclamation to the Ministry of Finance and by placing PBDAC under the supervision of CBE and requiring it to adhere to the landmark Corporate Governance Regulations (CBE Board decision of July 5, 2011) that promote good governance in the banking sector. The regulations will require PBDAC to nominate a new General Assembly and adopt new Articles of Association that clarify PBDAC’s requirement to focus on providing financial services to the agriculture sector while preserving capital. Equally important, it will require the appointment of a new and balanced Board of Directors with executive, non-executive, and independent members following good practices based on fit and proper criteria. A key task for the new Board will be to develop a comprehensive business strategy, based on PBDAC’s new mandate, which ensures long-term viability. All the actions that PBDAC needs to take to ensure that it is able to transform into a profitable institution will be identified. Box 2: Corporate Governance Improvement Plan for PBDAC A Corporate Governance Improvement Plan (CGIP) for PBDAC is being developed, which will define specific actions and timeframes needed to help transform the bank into a commercially-oriented, state- owned bank consistent with the CBE regulations. The CGIP will follow IFC Corporate Governance methodology, leveraging global expertise that has helped financial institutions establish well-structured governance frameworks, focusing on:  Commitment to Good Corporate Governance. The commitment of the Egyptian government, PBDAC, and other key stakeholders in setting up and maintaining a sound governance framework for the bank, based on CBE requirements and international best practices, where appropriate.  Board Structure & Functioning. The existence of a competent, autonomous, and well-structured board, including recommendations related to the roles, responsibilities, composition, committee structure, director duties, and work procedures of the board.  Control Environment & Processes. The presence of an environment facilitating sound internal control, risk management, compliance, conduct/conflict, and audit practices in the bank.  Disclosure & Transparency. The availability of timely, accurate, and relevant financial and non- financial information to shareholders and stakeholders.  Shareholder Practices. Well-defined rights and authorities of shareholders and the procedures by which they are executed. Based on prior experience in working with ‘corporatizing’ SOEs, it is anticipated that much training and education will need to occur with the Government and the bank throughout the process to help emphasize and achieve buy-in of the new governance structure. For example, it will be important to emphasize that the State’s actions in PBDAC should be taken via proper shareholder channels—as will be defined in the Articles of Association—versus direct interventions in the bank by the government or specific political bodies/individuals. It will be further emphasized that the shareholders should appoint a board of directors via a transparent, objective process and grant the board sufficient autonomy to run the business, including the authority to appoint senior executives and take decisions on major business matters. Shareholders should only get involved in particular reserved matters, per the Articles of Association. Emphasis will be placed on selecting directors that possess the proper technical skills and experience needed to guide the bank as a commercial entity, avoiding appointments for political purpose or influence. Directors will need to meet CBE ‘fit and proper’ criteria and, collectively, adhere to the independence requirements. Particular committees will need to be setup per CBE requirements and the workings of those committees vis a vis the full board will need to be articulated. Further emphasis will be placed on ensuring directors understand their core duties of loyalty and care, promoting the interests of PBDAC as a company, without being unduly influenced by political or other forces. At the management level, emphasis will be placed on defining clear authorities, accountabilities, and incentives of the senior management team, geared towards improving the bank’s commercial orientation and long-term sustainability. Further emphasis will be placed on establishing risk management and internal control frameworks that are aligned with leading practices of commercial banks. The Board’s role in and procedures for providing sound oversight will need to be emphasized, particularly in the area of risk governance. Among other items, the team will also emphasize the importance of having capable, independent audit and compliance functions to help provide necessary assurances to shareholders and stakeholders. Specific recommendations for PBDAC will align with the 2011 CBE Corporate Governance Regulations for the banking sector, which introduced significant improvements to the regulatory environment. However beyond CBE compliance, other international best practices for commercial banks which may be appropriate for PBDAC will also be take into account. The expenditure program will support the development and implementation of this strategy. Implementation of the strategy will include establishing and strengthening appropriate committees on compensation, and audit., developing and implementing policies related to related party lending and redressing grievances, developing a strategy for building financial, institutional and IT capacity, operational business plan (Box 2 above, provides details on the measures to be taken to strengthen governance and promote transparency). In addition, emphasis will be placed on the development of comprehensive risk management process (including effective Board and senior management oversight) to identify, measure, evaluate, monitor, report and control or mitigate all material risks on a timely basis and to assess capital adequacy and liquidity in relation to PBDAC’s risk profile and market and macroeconomic conditions. Greater transparency will be achieved by the preparation of the bank’s financial statements in line with international standards and their quarterly publication. These activities will contribute to strengthening PBDAC and through this contribute to creating a better managed institution, with better prospects for institutional sustainability and scaling up financial services. (ii) Enhancing financial capacity and performance, including the capital base of PBDAC and asset quality to improve its financial soundness and efficiency, which are essential for its sustainability, as well as for the provision of enhanced financial services. Phased capitalization will include both capital injections by the Government and internal efforts by the PBDAC. The latter centers on the achievement of performance-linked financial and operational targets; for instance on asset quality and operational efficiency, as well as on the sale of unutilized assets. Developing the capacity of staff in NPLs recovery and implementing recovery drives will be also be supported. Strong financial capacity and performance is critical for PBDAC, not just from a regulatory perspective, but to enable PBDAC to offer increased volumes of financial services in rural areas. Re-capitalization of PBDAC, and avoiding any future de-capitalization, are critical to maintaining PBDAC's lending capacity and avoiding any depositors concern's regarding the safety of deposits in PBDAC. Without capital, PBDAC's capacity to lend is limited, particularly once it is subjected to the regulations that apply to all commercial banks and the supervision of the CBE. Even more important, a de-capitalized PBDAC would face increasing risks that depositors will become concerned about the safety of their deposits. Such depositor concerns could lead to depositors' withdrawals from PBDAC. Such a run on PBDAC could even spread to the rest of the banking system, in the worst case, a key systemic risk. (iii) Developing institutional capacity to broaden PBDAC’s product suite, rationalize staffing and build human resource capacity, and strengthen its operations and capacity to deliver services. In line with the business plan that will be formulated by the new Board, a program of capacity building will include training and workshops on a range of topics, including NPL management, risk management, product development (both financial products and complementary non-financial services), diversification, accounting, financial analysis, and use of technology to better serve PBDAC’s financial developmental goals. Branches in poor Governorates will receive special attention on capacity building, focusing on the provision of microfinance for small farmers and Islamic products that are needed in Upper Egypt, especially (Box 3). Streamlining the operations of the bank will result in the merger of the Upper and Lower Egypt banks to eliminate unnecessary duplication and provide better oversight by the Board of Directors but also an improved organization structure within PBDAC that promotes efficiency and better operations, as well as reporting channels and accountability. Streamlining will also include reorganization of existing departments to better serve the requirements of the new business plan that will be formulated. Based on its business plan and this streamlining, a staffing plan will be evolved. Once a new Board of Directors is selected, PBDAC will first need to develop a new strategy reflecting its goal of financial sustainability and its agricultural mandate, as well as achieving any state-sponsored directives, if any. Once the broad strategy has been agreed, the board must develop specific sub-strategies to deal with the most pressing challenges, above all improving asset quality and addressing PBDAC’s staffing mismatch and the extremely poor information environment. These strategies will include a staff redeployment program as well as major investment in IT, including an appropriate core banking system. PBDAC’s new strategy will also have to consider how to optimize distribution to its current and future client base, including how to use its existing branch network, streamlined as necessary, and/ or other more innovative approaches, such as mobile branches and phone banking. All of these operational changes must be rooted in the goal of financial sustainability, within a framework of rational risk management, as a prime measure of board success Organizational strengthening will also include segregating the non-financial activities of the production unit into PBDAC’s subsidiary focused on the non-financial business (ECARD), including staff relocation, and transferring the assets to ECARD. Strengthening ECARD will be critical—and part of the program with upfront commitment from the Government to support its activities—to achieving the objective of improving the delivery of non-financial services (which is an important result of the program and captured in the Results Framework in Annex 2) to complement PBDAC, which will specialize in financial service delivery. Please see Annex 1 for more details on the likely path of PBDAC’s operational restructuring. Box 3: Shari’ah Compliant Products Provision of Shari’ah compliant services remains an opportunity for expanding PBDAC’s services to underserved segments particularly in Upper Egypt. Islamic banking is currently provided at 22 Governorate-level branches, but not at the smaller town or village branches. At the same time, demand appears to be high with up to a third of customers expressing interest with higher demand in Upper Egypt (47 percent of active accounts and 40 percent of loan portfolio). PBDAC is also providing Islamic microfinance services through its network, with Upper Egypt leading in terms of number of clients (54 percent of microfinance clients are from Upper Egypt, accounting for 51 percent of the Islamic finance loan portfolio). Limited capacity and knowledge of the industry’s latest developments, as well as the lack of information systems are impairing the bank’s ability to further expand this service. Currently, the bank does not have the IT capacity to provide Shari’ah compliant services to non-provincial centers and no mechanisms exist for delivering them to rural areas. The introduction of a robust core banking system will be key to extend service delivery to village branches and expand the range of beneficiaries of the service. Expanding Islamic financial services will also enhance financial inclusion and resource mobilization through Shari’ah compliant savings schemes, since evidence indicates that many of Egypt’s unbanked are Shari’ah sensitive; expanding Shari’ah compliant services is more likely to bring in new, unbanked clients than to cannibalize from existing ones. However, expanding such services still requires designing a well-structured business plan for the introduction of Islamic financial services, which is an integral component of the current reform program and PBDAC’s new strategy. This effort will have to be augmented by a comprehensive capacity building program to sharpen staff skills related to the introduction of Islamic financial services.* * These tasks will be undertaken in collaboration with IsDB under the Regional MENA MSME Facility. (iv) Boosting IT capacity as an enabler to achieve the above objectives of a stronger and better-managed institution providing better quality financial services in rural areas. A core banking solution will be an integral part of this. For the institution, this means better data management and analysis and internal control and for clients this would be reflected in better financial services, including through applying new channels of delivery (such as ATMs and mobile banking) to reach clients.8 54. The causal relationship between the four preceding program pillars and the key program results listed in Section II.B above is described in the Results Chain (Figure 7) . As shown in the diagram, some key outputs, intermediate and final outcomes will derive directly from specific pillars. Conversely, a number of service delivery outcomes will result from the combined interaction of all program pillars. 9 Figure 7: Results Chain of the Finance for Rural Egypt Program 55. The five-year PforR Program will contain Disbursement-Linked Indicators (DLIs), reflecting a combination of actions, outputs, and outcomes driven by the intended Key Results. At the Concept Note stage, Table 2 below provides a list of tentative DLIs that are under consideration, but will be rationalized to 8–10 DLIs during the Technical Assessment. 8 The Bank-IFC Regional MENA TA Facility will provide technical support for this activity, which will also be supported by other funders. 9 Outcomes: outcomes linked directly to specific program pillars. Cross-cutting outcomes: outcomes resulting from the combined interaction of all four pillars. Table 2: Preliminary Disbursement Linked Indicators for the Program Program Area Preliminary DLIs Governance  Establishment of a new and balanced Board of Directors, based on CBE requirements,  Shareholder approval of PBDAC new business strategy, compliant with new legislation  Implementation of Risk Management Function and making Risk Management Committee operational.  Preparation and publication of Quarterly Financial Statements following CBE requirements Financial capacity and  Capital adequacy ratio (capital base-to-risk-weighted assets) performance  Efficiency ratio (operating expenses-to-income)  Asset quality ratio (NPLs-to-total loans ratio) Institutional capacity to  Number of newly introduced products targeted to farmers deliver financial and  Number of microfinance loans in rural areas non-financial services  Number of deposit accounts from households in rural areas (disaggregated by gender).  Number of farmers benefitting from non-financial services  Client survey satisfaction rate (percent) Initial Environmental and Social Screening 56. The proposed program is limited to capital injection to PBDAC and capacity development, and will not include any physical activities or civil works; thus the program will not involve any land acquisition and will have no direct environmental effects expected. However, an ESSA will be prepared to ensure that the on-lending projects supported by PBDAC follow the core environmental and social principles of OP/BP 9.00. The ESSA will include, but not limited to, the following: (i) documentation of the environmental and social management procedures, standards of PBDAC; (ii) assessment of PBDAC capacity to manage the likely environmental and social effects as per Egypt's own requirements; and (iii) recommendation of specific actions for improving PBDAC's own procedures and process to address the relevant environmental and social issues involved in the program supported by PBDAC. Tentative financing Source: Borrower/Recipient ($m.)390,000,000 IBRD 500,000,000 IDA Others (specify) 300,000,000 Total 1,190,000,000 Contact point World Bank Contact: Sahar Nasr Title: Lead Financial Economist and Task Team Leader Tel: +202-2574 1188 Email: snasr@worldbank.org Borrower/Client/Recipient—Government of Egypt Contact: Mohamed Hammam Title: Assistant to the Minister in charge of International, Regional and Arab Financing Institutions and Organizations Tel: +202 3912815 Email: mehammam@gmail.com Implementing Agencies—Central Bank of Egypt Contact: Gamal Negm Title: Deputy Governor Tel: +202 27702770 Email: gamal.negm@cbe.org.eg For more information contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-4500 Fax: (202) 522-1500 Web: http://www.worldbank.org/infoshop