Performance Evaluation Report

PPE: VIE 27145

Rural Credit Project (Loan 1457-VIE[SF]) in the Socialist Republic of Viet Nam

November 2005 Operations Evaluation Department

Asian Development Bank

CURRENCY EQUIVALENTS Currency Unit dong () At Appraisal August 1996 $0.000091 11,025 At Project Completion October 2002 $0.000065 15,364 At Operations Evaluation September 2005 $0.000063 15,886

1,000 $1.00

= =

ABBREVIATIONS AB ADB CAR CCF EA GDP IA IAS OCR OEM PBME PCF PCR PFI PPTA RRP SBV VAS VBSP AgriBank Asian Development Bank capital adequacy ratio Central Peoples Credit Fund Executing Agency gross domestic product Implementing Agency international accounting standards ordinary capital resources Operations Evaluation Mission project benefit monitoring and evaluation peoples credit fund project completion report participating financial institution project preparatory technical assistance Report and Recommendation of the President State Bank of Viet Nam Vietnamese accounting standards Viet Nam Bank for Social Policies

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

Director General Director Team Leader Team Members

B. Murray, Operations Evaluation Department (OED) R.K. Leonard, Operations Evaluation Division 1, OED Qiaolun Ye, Senior Evaluation Specialist, Operations Evaluation Division 1, OED O. Nuestro, Evaluation Officer, Operations Evaluation Division 1, OED O. A. Badiola, Senior Operations Evaluation Assistant, Operations Evaluation Division 1, OED Operations Evaluation Department, PE-669

CONTENTS Page BASIC DATA EXECUTIVE SUMMARY MAP I. INTRODUCTION A. Evaluation Purpose and Process B. Project Objectives DESIGN AND IMPLEMENTATION A. Formulation B. Rationale C. Cost, Financing, and Executing Arrangements D. Procurement, Construction, and Scheduling E. Design Changes F. Outputs G. Consultants H. Policy Setting PERFORMANCE ASSESSMENT A. Overall Assessment B. Relevance C. Effectiveness D. Efficiency E. Sustainability OTHER ASSESSMENTS A. Impact B. ADB Performance C. Borrower Performance ISSUES, LESSONS, AND FOLLOW-UP ACTIONS A. Issues B. Lessons C. Follow-up Actions iii iv vii 1 1 1 1 1 2 2 2 3 3 4 4 4 4 4 5 8 9 10 10 10 10 11 11 13 14

II.

III.

IV.

V.

The guidelines formally adopted by the Operations Evaluation Department (OED) on avoiding conflict of interest in its independent evaluations were observed in the preparation of this report. Michael Lloyd was the staff consultant/financial specialist, who prepared Appendixes 57 as well as assessments on efficiency and sustainability in the main text. He was not involved in assessing the Project. To the knowledge of the management of OED, there were no conflicts of interest of the persons preparing, reviewing, or approving this report.

APPENDIXES 1. 2. 3. 4. 5. 6. 7. Major Findings of the Operations Evaluation Mission Appraisal and Actual Project Costs Summary Design and Monitoring Framework Growth in Overall Economy and the Agriculture Sector Financial Performance of AgriBank Financial Performance of Central Peoples Credit Fund Indicative Subprojects Financed by the ADB Loan 15 24 25 29 31 39 43

BASIC DATA Rural Credit Project (Loan 1457-VIE[SF])

Project Preparation TA No. TA Name 2286 Rural Finance Key Project Data ($ million) Total Project Cost ADB Loan Amount1/Utilization ADB Loan Amount/Cancellation

Type PPTA

Person-Months 23

Amount ($) 586,000

Approval Date 12 Jan 1995 Actual 72.30 46.02 0.06

As per ADB Loan Documents 75.8 50.0 50.0 Expected

Key Dates Fact-Finding Appraisal Loan Negotiations Board Approval Loan Agreement Loan Effectiveness First Disbursement Project Completion Loan Closing Months (effectiveness to completion) Borrower Executing Agency Mission Data Type of Mission Fact-Finding Appraisal Inception Review Project Completion Operations Evaluation

17 Jan 1997 31 Dec 2000 30 Jun 2001 47.5 Socialist Republic of Viet Nam State Bank of Viet Nam

Actual 4 Mar20 Mar 1996 3 Jun19 Jun 1996 12 Aug14 Aug 1996 12 Sep 1996 18 Oct 1996 03 Apr 1997 18 Jul 1997 30 Oct 2002 30 Oct 2002 67

No. of Missions 1 1 1 4 1 1

No. of Person-Days 102 51 6 80 42 15

ADB = Asian Development Bank, TA = technical assistance, No. = number. 1 The ADB loan was provided in Special Drawing Rights, which was equivalent to $46.08 million at loan closing.

EXECUTIVE SUMMARY The Rural Credit Project (the Project) was financed by a loan of $50 million from the Asian Development Bank (ADB). The loan was approved in 1996 and implemented from 1997 to 2002. With goals to promote economic growth, diversify the rural economy, and reduce rural poverty, the Project aimed to improve household income, expand rural employment, and strengthen the rural financial system through the provision of long-term funds to participating financial institutions (PFIs), which included the AgriBank (AB)a large state bank accounting for 92% of the formal financial market in rural Viet Namand peoples credit funds (PCFs), which were then newly formed and privately owned by members. The Project is rated relevant. It was, and still is, consistent with the development strategies of the Government and the operational strategies of ADB at the project design and postevaluation stages. The project design correctly identified rural households lack of access to formal credit as the key constraint, with the primary cause being the PFIs shortage of long-term funds. Based on the problem diagnosis, the project interventions tackled the key constraint by providing long-term credit to PFIs to channel subloans to rural borrowers. Since AB already had an extensive retail network covering all rural areas, the project design used the existing financial infrastructure instead of creating new institutions. Furthermore, the design did not restrict the use of its credit line to a particular subsector or particular regions, but intended to cover all rural areas in the country. On the downside, however, the Project narrowly limited its subloans to those for productive investment, denied borrowers requests for loans for childrens education and for emergencies, and thereby missed the opportunity to address these two primary causes of poverty and reversion to poverty status. The inclusion of two add-on components in the Projectlending to the poor and institutional strengtheningdid not work due to a lack of client demand. The Project is rated highly effective. It provided the intended resources to AB and PCFs, and substantially exceeded its target of extending rural credit to 102,000 rural borrowers. Partly due to support from the Project, ABs clients increased from less than 3 million at appraisal to more than 9 million in 2004. As a result, it provided services to a large number of previously unbanked rural residents. The quality of ABs services was also improved, with fast processing, good repayment rates (above 95%), small amount of overdue loans (1.74% as of 2004), and flexibility in repayment scheduling. During the project period, Viet Nam experienced rapid economic growth and substantial reduction in rural poverty. While the achievements were the results of many factors, fieldwork found that rural credit played a key role in poor households exit from poverty by enabling private investment in animal raising and thereby enhancing the opportunity for self-employment by the poor and near poor. AB and PCFs made a significant contribution to poverty reduction by making formal credit easily available to a large number of rural residents. The Project is rated less efficient, however. It was implemented in an economic environment in which optimal allocation of resources was precluded by government control on interest rates. While the Project, through its design and implementation, contributed to the removal of this policy distortion, the use of its resources was less than efficient during the implementation period. Furthermore, the project funds were re-lent to PFIs at interest rates below the cost of funds from other sourcesboth borrowing from commercial banks and deposits from clients. The low cost of the ADB funds stimulated high demand for them and resulted in equal distribution to all PFIs of scarce long-term funds that should have been used exclusively for financing medium- and long-term lending to end borrowers.

The Projects sustainability is rated likely. Financial analyses of the PFIs indicate that at the national level these institutions are sustainable. At the local level, the performance of individual PCFs varies. With close supervision and strong support from the State Bank of Viet Nam, prudential standards enforced, and continued growth of the PCF system in terms of loans, deposits, and membership outreach, the sustainability of the PCF system is likely. Evaluation of illustrative subprojects and subborrowers suggests that the sustainability of these subprojects is likely, given their technical and financial viability, borrowers ability to respond to market signals, loan repayment performance, and declared desire to continue borrowing. The sustainability of subprojects is supported by both statistical and anecdotal evidence collected during fieldwork. Based on a weighted average of the above individual ratings, the overall Project is rated successful. Four issues are discussed in this report: (i) restrictions on lending, (ii) remaining policy distortions, (iii) capital adequacy of AB, and (iv) non-optimal use of ADB funds. Detailed analyses of the issues are given in Appendix 1, including an in-depth analysis of the underlying causes as well as potential alternatives proposed. Several lessons were identified that may contribute to better design of similar projects in the future: First, depending on the local realities in a particular country, supporting a large and well-established rural financial institution and using its extensive network to channel loans to a large number of rural households may be an efficient and effective way to reduce rural poverty in a sustainable manneralbeit indirectly and unquantifiablybecause access to formal credit enables private investment and facilitates self-employment, thereby enhancing access to opportunities for the poor and near poor. Second, without sufficient demand from clients, the special components of subsidized loans for the poor and institutional strengthening for PFIs, while satisfying ADBs wishes, did not work in practice. Future projects should avoid repeating similar mistakes. To be effective, poverty-reduction interventions need to be designed based on local realities as well as demand from clients. Third, the Projects restriction on providing loans for productive investment prevented these funds being used for other purposes (e.g., high school education; emergency purposes). As a result, the Project missed the opportunity to address some causes of persistent rural poverty and reversion to poverty status. Future projects should provide credit based on borrowers demand and repayment capacity as well as the availability of funds. No restrictions should be imposed on loan use, size, term, or number of loan extensions by governments or ADB. Flexibility in these areas should be left to the participating financial institutions. Fourth, in areas with a high demand for medium- and longterm loans and a severe shortage of their supply, revolving credit or overdraft may be introduced to agricultural lending to enable the use of short-term funds to finance long-term investment. Finally, moneylenders provide quick and flexible lending services needed by households but not yet served by formal financial institutions. Outlawing moneylenders will not lead to their disappearance as long as demand for such services is not met by formal financial institutions. Rather, making moneylenders illegal will increase the costs of their operation, resulting in higher interest charges to borrowers. If there are concerns about potential negative impacts of moneylenders, specific measures should be developed to address the concern instead of simply attempting to ban all moneylenders. A better alternative may be to encourage formal financial institutions to provide loans with appropriate flexibility regarding terms of loan use, maturity, repayment scheduling, and loan extensions. Bruce Murray Director General Operations Evaluation Department

I. A. Evaluation Purpose and Process

INTRODUCTION

1. The Rural Credit Project (the Project) was the first credit line from the Asian Development Bank (ADB) to Viet Nam. While the Project was randomly selected by ADB for postevaluation, it was deliberately selected as a case for in-depth study under a Special Evaluation Study on Poverty Exit and the Effectiveness of Poverty Reduction Interventions. To conduct fieldwork for that study, an Operations Evaluation Mission (OEM) visited Viet Nam in AprilMay 2005, finding that rural credit played a key role in facilitating poor households exit from poverty. 2. A Project Completion Report (PCR) for the Project was prepared by ADB in September 2003. The PCR was well written with detailed information about project performance. The PCR rated the Project as successful. 3. To prepare this Project Performance Evaluation Report, an OEM visited Viet Nam in September 2005 and conducted fieldwork in selected project areas. Major findings of the OEMs fieldwork are presented in Appendix 1. In completing this report, the views of ADBs concerned departments and offices as well as those of the Executing Agency (EA) and Implementing Agencies (IAs) of the Government were considered. B. Project Objectives

4. As summarized in the Project Framework in the Report and Recommendation of the President (RRP), the development goals of the Project were to promote economic growth, diversify the rural economy, and reduce rural poverty. The Projects purpose was to improve household income, expand rural employment, and strengthen the rural financial system. The Projects outputs included (i) subproject investment by increasing resources to the AgriBank (AB)1 and peoples credit funds (PCFs) to finance short- and medium-term loans to end borrowers; (ii) strengthening the rural financial system by providing staff training for the State Bank of Viet Nam (SBV), AB, the Central Peoples Credit Fund (CCF), and PCFs; providing computer software to PCFs; and establishing an environmental unit in AB; and (iii) project management by establishing a management unit and a project benefit monitoring and evaluation (PBME) system in SBV, and implementation units in AB and CCF. The Project intended to benefit 102,000 rural households and generate 63,000 person-years of employment. II. A. Formulation DESIGN AND IMPLEMENTATION

5. A project preparation technical assistance (PPTA) for the Project was approved in January 1995 and completed in January 1996. The outputs of the PPTA provided a solid basis for the Fact-Finding Mission conducted in March 1996 and the Appraisal Mission in June 1996. To process the Project, these missions consulted a wide range of stakeholders, including the EA and IAs, other international agencies, nongovernment organizations, and beneficiaries.

AgriBank was established on 7 January 1988 by separating the rural financing function from the State Bank of Viet Nam. It was renamed the Viet Nam Bank for Agriculture in 1990, the Viet Nam Bank for Agriculture and Rural Development in October 1996, and the current name in 2005.

2 B. Rationale

6. The Project was consistent with the development strategies of the Government and the operational strategies of ADB at the time of project design and at postevaluation, and still is. At both stages, the Government emphasized the importance of rural development as a means to reduce poverty, and the critical role of rural credit as a means to accelerate agricultural growth and rural development. At project design in 1996, ADBs country operational strategy focused on sustainable growth with equity, poverty reduction, and environmentally sound development. At postevaluation in 2005, ADBs country strategy and program for Viet Nam emphasized promotion of economic growth, employment generation, and socially inclusive development, with geographic focus on the central region, which was one of the project areas. 7. At appraisal, rural households lack of access to formal credit was identified as the key constraint to agricultural development, with the primary cause being ABs lack of adequate longterm funding. Consequently, the Project aimed to increase long-term resources for AB. To enhance competition in the rural finance market, the Project also supported PCFs, which were newly formed at the time of appraisal, privately owned by members, and strongly supported by SBV. C. Cost, Financing, and Executing Arrangements

8. Total project cost was estimated at $75.8 million equivalent at appraisal, to be financed by a loan of $50 million equivalent (Special Drawing Rights 34.1 million) from ADB; $10.8 million from endborrowers; and $15 million from participating financial institutions (PFIs), including SBV, AB, CCF, and PCFs. At completion, the actual project cost was $72.3 million equivalent, 4.6% lower than the appraisal estimation. As shown in Appendix 2, the credit componentthe largest, accounting for 98% of the total project costexperienced a slight cost-underrun of 1.8%. The cost-underrun was substantial in the less important items such as vehicles, equipment, training, and consulting services. These changes reflect overestimation of project cost for these items, which seemed to be supply-driven by ADB, with insufficient demand from clients (paras. 1314). 9. The Project assigned SBV as the EA, with AB and CCF acting as the IAs. At the midterm review, ADB found that the project management unit in SBV was very weak and did not serve as the focal point for project implementation. Furthermore, the engagement of SBV in commercial lending contradicted its role as the Central Bank. In practice, AB worked as the focal point for ADBs loan review missions. 10. Most of the loan covenants were complied with except for the following: First, two subcomponents did not function well, and loan proceeds for them were reallocated to the credit component, with approval from ADB (paras. 1314). Second, the PBME system was not established in SBV as planned, although SBV conducted a detailed survey of borrowers and local branches of AB and PCFs in 2000. Finally, the environmental unit was established in AB as required but was disbanded in 2000 due to a lack of need. The OEM considers the above adjustments appropriate and practical in the circumstances, despite the fact that PBME and the establishment of the environmental unit were required by ADB. D. Procurement, Construction, and Scheduling

11. No construction occurred under the Project, and procurement was insignificant. Compared with many projects financed by ADB, this Project was processed rather quickly: the

PPTA was completed within 1 year of its approval, and the subsequent project processing was completed within 9 months. Loan effectiveness was delayed by 2.5 months due to the slow signing of subsidiary loan agreements between the Government and AB/CCF. The Project was to be implemented in 4 years from January 1997 to December 2000, with a loan closing date of June 2001. While the primary component (the credit line) was fully disbursed before the target date, the slow disbursement of the institutional strengthening component (para. 14) led to a 16month delay in the loan closing date. E. Design Changes

12. The executing arrangements were changed during implementation, as discussed in para. 9. The project areas were also changed. According to the RRP, the Project intended to cover all rural areas outside Hanoi and Ho Chi Minh City. Since the World Bank also provided a similar credit line to AB, AB assigned 27 provinces to receive credit support exclusively from ADB, with the remaining provinces receiving credit from the World Bank and other aid agencies. 13. To ensure the impact on poverty reduction, the Project design earmarked a credit line of $2 million to finance subsidized loans for poor members of PCFs without collateral. This ADBdriven add-on component was not implemented as designed, as the maximum loan size of $100 was considered by borrowers as too small to be useful. 14. Another credit line of $2 million was allocated for institutional strengthening, including financing of staff training and a pilot program to computerize PCF operations. Disbursement of this credit line experienced serious delays and many difficulties. First, PCFs refused to borrow at commercial interest rates to computerize their operations, as the cost of $9,000 per PCF was considered too high, and the charter of PCFs prohibited them from spending more than 40% of their equity on equipment. Second, the training component overlapped many training programs provided by other aid agencies, as AB was the largest recipient of foreign assistance in Viet Nam, with 68 externally funded projects as of May 2003.2 By the end, most of this credit line was reallocated to the credit component to onlend to end borrowers. 15. According to the RRP, the ADB credit line would relend to AB and CCF at a variable interest rate equal to the quarterly weighted average cost of funds in the banking system, which in any case will not be less than the rate of ADBs ordinary capital resources (OCR) loans. At the midterm review in early 2000, the quarterly weighted average cost of funds was 4.2% per year, less than ADBs OCR rate. Since the World Bank provided a similar credit line to AB without a minimal relending rate, the midterm review mission raised the concern that the minimal rate set by ADB would have immobilized the Project. In practice, the minimum rate was not applied. F. Outputs

16. The outputs targeted at appraisal were (i) resources to AB and PCF for subproject investment; (ii) strengthening of financial systems including staff training for SBV, AB, CCF, and PCFs; a pilot program to computerize PCF operations; and establishment of the environmental unit in AB; and (iii) project management, including establishment of the PBME system and project implementation units.

AgriBank 2004: Annual Report 2003.

4 17. At project completion, the actual amount of the Projects credit line to AB and CCF for subproject investment was similar to what had been planned at appraisal (para. 24). However, the outputs under the institutional component had not been delivered. A large number of financial staff were trained, but under programs financed by other aid agencies (para. 14), who provided grants for the training. From the viewpoints of the IAs, it was a rational decision to use grant funds rather than loan funds to finance such training. Better knowledge of the programs of other funding agencies and freedom to design the Project based on local realities instead of ADB desires might have led to better design of this component. The pilot program of computerizing PCF operation did not materialize, as PCFs refused to borrow commercial loans to finance the acquisition of computers. The environmental unit was established but disbanded (para.10). The PBME system was not established, although project management systems in AB and CCF were established and functioned well. The value added of a project-specific PBME system was questionable, as increasingly being recognized by government and ADB staff. G. Consultants

18. No technical assistance grant was provided under the Project, which, however, financed a credit specialist/trainer to develop a training manual and materials, and a rural financial specialist to conduct a study on transaction costs of AB and CCF. The performance of the consultants was rated highly satisfactory by the PCR prepared by ADB. Due to the departure of key informants in the EA/IAs, the OEM was unable to confirm the PCR rating. Since the consultant inputs actually provided under the Project were small (Appendix 2), and most of the staff training was financed by other aid agencies, the impact of the consultants on the Project was insignificant. H. Policy Setting

19. At appraisal, one cause of the shortage of medium-term loans was an inverted structure of interest rates resulting from government regulations, with lower rates for medium-term loans than for short-term ones. This interest rate structure provided little incentive for banks to expand medium-term lending. The inverted interest rate structure was partly corrected as a result of policy dialogue undertaken during project processing. In May 2002 (close to project completion), the Government removed its restrictions on interest rates. III. A. Overall Assessment PERFORMANCE ASSESSMENT

20. Overall, the Project is rated successful. The overall rating is a weighted average of the individual ratings given on four criteriarelevance, effectiveness, efficiency, and sustainability. As discussed in detail in the following sections, the Project is rated relevant, highly effective, less efficient, and with likely sustainability. B. Relevance

21. The Project was consistent with the development strategies of the Government and the operational strategies of ADB at the time of project design, and still is at the time of postevaluation (para. 6). The project design was based on a comprehensive analysis of the local realities in the project areas. The RRP provided detailed discussions on the structure and characteristics of the rural economy, the institutional structure of the rural finance sector, and development potential and constraints. In addition to a description of the formal and informal

players in the rural finance sector, the RRP provided a detailed performance evaluation of AB and the PCF system, including their formation, history, capital and human resources, and lending operations. The project design correctly identified the key constraint in the project areas as rural households lack of access to formal, particularly medium- and long-term credit, and the primary cause as PFIs shortage of long-term funds. Based on the problem diagnosis, the project interventions tackled the key constraint by providing long-term credit to PFIs to finance rural lending. Since AB already had an extensive retail network covering all rural areas prior to the Project,3 the project design used the existing financial infrastructure instead of creating new institutions, which could have been expensive, with uncertain sustainability. The project design did not restrict the use of the Projects credit line to a particular subsector or particular regions (which is the case with many ADB-financed credit projects in other countries), but intended to cover all rural areas in the country. The OEM considers the above design appropriate. 22. The OEM has, however, identified the following weaknesses in the project design: First, due probably to ABs general lending policy and an established practice in ADB (which assumed that repayment capacity came only from the invested subproject per se), the Project narrowly focused on the provision of credit for productive investment in agriculture and agroprocessing. The OEM noted that, in addition to productive investment, rural households need credit in times of emergency to cushion themselves against external shocks; some households also need loans to invest in high school education for children. The OEM observed cases where the lack of access to formal credit for emergency purposes forced some poor and near-poor to borrow from moneylenders, resulting in high debt that led to distressed sale of farmland and resulted in them slipping back or falling further into poverty. In some poor households visited, inability to finance high school education for children resulted in their inability to break the vicious cycle of inherited poverty. The Project could have made a better contribution to poverty reduction if it had financed lending for education and emergencies. 23. Second, the design of the add-on components ($2 million for lending to the poor members of PCFs, and $2 million for institutional strengthening) seemed to be supply-driven by ADB; the lack of client demand for such subcomponents led to their being dysfunctional (paras. 13-14). Considering that the less relevant subcomponents accounted for only 8% of the project loan, the Project, on balance, is rated relevant. C. Effectiveness

24. Appendix 3 provides a comparison of the Projects achievements anticipated at appraisal with those realized at completion. At completion, the Project provided $30 million to AB and $14.7 million to CCF, similar to the project design amounts of $32 million to AB and $15 million to CCF. With a target outreach of 102,000 rural households, the Project extended rural credit to 135,000 rural borrowers at completion, exceeding its target by 32%. From 1996 to 2004, ABs net portfolio increased from 17,690 billion to 129,204 billion, equivalent to an average annual growth of 28%. Over the same period, deposits from customers increased from 7,965 billion to 92,212 billion, an average annual growth of 36%. 25. As a result of the rapid growth in outreach, AB provided services to a large number of previously unbanked rural residents. At the time of project appraisal in 1995, AB served only 29% of the 10 million rural households (RRP, para. 12). A survey conducted during the PPTA found that, based on the survey sample, 73% of all household loans were from informal sources, with moneylenders accounting for 33% of the loans supplied (RRP, para. 29). While no
3

At appraisal in 1996, AB had 1,792 branches covering all rural areas in Viet Nam (RRP, para. 12).

6 similar survey has been conducted since then, the PCR prepared in September 2002 estimated that AB had 8 million clients, accounting for 67% of the 12 million rural households in the country. In 2004, the number of AB clients exceeded 9 million.4 According to a recent ADB study,5 as of December 2003, AB had provided total lending of 117.87 trillion (equivalent to $7.6 billion) in rural Viet Nam, accounting for 92% of the formal financial market, while the Viet Nam Bank for Social Policies (VBSP) and PCFs accounted for 6% and 2%, respectively, of the market share. 26. In addition to the fast growth in outreach, the quality of financial services from PFIs also improved. Loan repayment rates were above 95% in both AB and PCFs, higher than the appraisal target of 80%. Overdue loans were relatively small. According to data provided by the Head Office of AB, overdue debts were 2,472 billion in 2004, accounting for 1.74% of the total outstanding loans. Loan processing time was reduced, as reported by most of the borrowers interviewed by the OEM. In many villages visited, flexibility in the repayment of principal and interest charges had been introduced; borrowers were allowed to decide, based on their cash flow patterns, if they would like to repay the principal and interest charges by month, by quarter, by crop season, or at the end of the loan period. In the best cases visited in Phu Yen Province, borrowers were allowed to repay any amount of both principal and interest at any time on or before the due date. In some AB branches visited, farmers can borrow loans of up to 30 million without collateral (while Government policy encourages lending without collateral up to 10 million). 27. In some unusual cases visited, the Projects restriction on loans for only productive investment was not strictly applied, and the results observed by the OEM were positive and encouraging. For example, some PCFs visited provided lending for education and emergency purposes; such services effectively reduced borrowers reliance on moneylenders in times of urgency. In one village, the OEM was told that moneylenders disappeared after the PCF started to provide loans quickly with few formalities. In other cases, the OEM was told that interest rates charged by moneylenders declined sharply after AB or PCF began operating in their villages. In Phu Yen Province, an AB district branch financed 11 small-scale rural infrastructure projects.6 Such lending enabled beneficiaries to invest in rural infrastructure that was crucial to them; they were willing to borrow because the infrastructure was urgently needed, while grant financing from the Government was limited. Due to a lack of long-term funds, however, loans for infrastructure investment were limited to a maturity of only 3 years. 28. The Project realized its development goals of contributing to economic growth, diversifying the rural economy, and reducing rural poverty. During the project implementation period, the country experienced rapid economic growth. As shown in Appendix 4, from 1997 to 2002, gross domestic product (GDP) increased by 35.4%, equivalent to an annual rate of 6.2%. In the agriculture sector, GDP increased by 29% during the same period, equivalent to an annual growth rate of 5.2%. While sufficient data on the diversification of the rural economy are not available, there is evidence that the output of cash crops grew much faster than grain production during this period, resulting in changes in their respective shares in agricultural GDP. As shown in Table 4.3 of Appendix 4, from 1997 to 2002, rice production increased at an annual rate of 4.4%, and the annual growth rates of cash crops were higher: 31.5% for black pepper, 12.2% for both soybean and rubber, 10.4% for coffee, and 8% for sugarcane. By contrast,
4 5 6

Data provided to the OEM by the Head Office of AB in September 2005. ADB. 2003. Making Markets Work Better for the Poor in Viet Nam. Hanoi. Such loans were issued to individuals (usually commune leaders), who borrowed on behalf of a large number of beneficiaries to invest in small-scale infrastructure (rural roads or irrigation systems), while grants from governments financed 4060% of the total investment cost.

coconut experienced negative growth, probably due to its low value. As a result, the share of food crops in agricultural GDP fell by 1.6% during this period, and that of cash crops increased by 1.5% (Table 4.4, Appendix 4). 29. Poverty was reduced substantially during the project implementation period. At the time of project appraisal, the RRP reported a rural poverty rate of 57% without specifying which year (RRP, para. 8). According to government statistics, nationwide poverty fell from 58.1% in 1993 to 37.4% in 1998 and 28.9% in 2002, while the incidence of rural poverty was reduced from 66.4% in 1993 to 45.5% in 1998 and 35.6% in 2002.7 According to World Bank estimates, using a $1 per day purchasing power parity poverty line, the proportion of people living in poverty declined from 23.6% in 1996 to 13.6% in 2002 and 10.6% in 2004.8 The OEMs fieldwork also found substantial reduction of rural poverty in the villages visited.9 30. The good economic performance and decline in poverty are the results of many factors, and cannot be attributed solely to the Project. Nevertheless, the OEMs fieldwork found that rural credit played a key role in facilitating poor households exit from poverty; AB and the PCFs made a significant contribution to poverty reduction by making rural credit easily available for a large number of rural residents. In the villages visited in the Northern Uplands, the OEM found that rural credit is now readily available to most rural households, including mostly low-income families and some poor as well. The access to formal credit enabled these families to raise one or two livestock, such as cows and buffaloes, which made a significant difference in their cash income because they previously depended on subsistence farming with a small amount of land and limited access to nonfarm employment. In the Central Highlands and some southern areas visited where farmers engage in commercial agriculture and require large, long-term loans, however, shortage of credit remains a major concern. 31. The OEM also noted that the $50 million loan from the Project accounted for only a small fraction of the funding resources in the PFIs (Appendix 1). Nevertheless, the long maturity of the credit from ADB was highly appreciated by the Government and PFIs, given the severe shortage of long-term funds in the country. Furthermore, the success of the Project triggered ADBs provision of another credit project to Viet Nam to continue its support to AB, CCF, and PCFs. Overall, it is clear that ADB did the right thing in Viet Nam, and the Project contributed to rural economic growth and poverty reduction, albeit in an indirect and unquantifiable manner. 32. The appraisal target of allocating $2 million in subsidized loans to the poor members of PCFs was not fulfilled due to the unrealistic design of this subcomponent, which provided interest subsidy and limited the loan size to less than $100. The OEM found that the subsidy was not necessary, and borrowers interviewed considered such loans too small to be useful. Since this add-on subcomponent was not relevant, the nonrealization of its target is understandable. 33. Similarly, the pilot program of computerizing PCF operations was not implemented as planned. This is also understandable, because such a program did not match well the demand
7

The official poverty line in Viet Nam was increased substantially in August 2005, from 100,000 ($6.30) to 200,000 ($12.60) per person per month for rural areas, and from 150,000 ($9.50) to 260,000 ($16.50) per person per month for urban areas. According to the new poverty line, the nationwide and rural poverty rates in 2002 were adjusted to 23.0% and 26.9%, respectively (General Statistics Office of Viet Nam). Viet Nam Development Report 2004: Poverty, Joint donor report to Viet Nam Consultative Group Meeting, Hanoi, December 2003. http://www.worldbank.org.vn/news/VDR04%20Poverty.pdf, page 15. ADB: Poverty Reduction and ADB Projects Targeting Poverty, Country Report: Viet Nam, draft available upon request.

8 of the PCFs. Reallocation of the $2 million loan for this subcomponent to the credit component is considered appropriate. Overall, the Project is rated highly effective. D. Efficiency

34. The RRP did not estimate an overall economic internal rate of return on the basis that it is impossible to determine in advance the type and number of subprojects that would be financed, given the objective that use of the project line of credit should be demand driven. Instead, the approach adopted at appraisal was to undertake analyses of a list of illustrative subprojects that might be financed by the Project with the assumption that, if such subprojects appeared viable when judged against the opportunity cost of capital, then the overall returns from the Project should be positive. This approach has limitations in that individual subborrowers face different personal, social, and economic conditions that render the use of generic models ineffective to predict the viability of subprojects actually financed. The same is true for evaluation of the Project, it being impracticable to estimate the viability of some 130,000 individual and varied subprojects financed. This is particularly so for an evaluation of economic viability that depends upon incremental returns deriving from a subproject based on economic prices for subproject inputs and outputs. 35. A more appropriate but qualitative approach considered for evaluation is the degree to which the Project addressed market failures, principally the lack of access to medium- and longterm credit for households and enterprises in rural areas. While the Project provided long-term funds to PFIs, this was not reflected in the term of loans provided to subborrowers. Moreover, during project implementation, loan interest rates in the financial sector remained under the control of the Government, and project funds were re-lent from the Government to PFIs at artificially determined interest rates (para. 15). In this respect, given that prevailing interest rates were not market based, there is likely to have been less than optimal allocation of resources. 36. The removal of Government controls on interest rates in May 2002 (para. 19) that preceded the completion of the Project introduced market-based interest rates for project subloans. The financial and operational performance of the PFIs since that time suggests that, in general, financial resources are being allocated more efficiently, though there remains a shortage of longer term finance. Project funds, however, continue to be re-lent to PFIs at interest rates below the cost of funds from other sourcesboth borrowing from commercial banks and deposits from clients for comparable terms. Some distortion and less than efficient use of project funds may therefore prevail, although, given the limited contribution of the project funds to PFIs total resources, the negative impact may be considered marginal. 37. The Project was processed in less than 2 years from PPTA approval to loan approval. Compared with many projects financed by ADB, such rapid processing is considered efficient. While the credit component was implemented ahead of schedule, the problems in the institutional component caused a delay of 16 months (para. 11). In spite of the delay, the loan was almost fully utilized, with only $62,100 or 0.1% of the ADB loan unutilized at loan closing. This, again, is a laudable achievement, considering that many ADB-financed projects suffer substantial cost underrun and result in unnecessary costs to both ADB (by keeping loans idle) and governments (through commitment charges). 38. Since most of the ADB loan under this Project was distributed to the PFIs in a less efficient manner, on balance of the above considerations, the Project is rated less efficient. The OEM understands that the Project was implemented in an economic environment in which optimal allocation of resources was precluded by government policies on interest rates. While

the Project, through its design and implementation, contributed to the removal of government control on interest rates, the use of its resources was less than efficient during its implementation period, due primarily to contextual constraints. E. Sustainability

39. Detailed assessments of the financial performance of AB and CCF are given in Appendixes 5 and 6, respectively. Appendix 7 provides a description of a number of indicative subprojects financed by the ADB loan. The financial analyses of AB and CCF indicate that at the national level these institutions are sustainable. At the local level, the performance of individual PCFs varies, as indicated by the rating system applied by SBV. SBV pays particular attention to the supervision of PCFs to ensure their financial soundness and profitability, with the option of placing PCFs under administration by provincial special control committees where PCF performance does not meet SBV prudential standards, or, in extreme cases, revoking the license a PCF that consistently fails to perform. Such cases have been rare, with the majority of closures resulting from members decision to cease operations. These factors, which are reflected in the continuing growth of the PCF system in both the number and value of loans disbursed and deposits mobilized, as well as membership outreach and government support for the system, suggest that the sustainability of the PCF system is likely. At the operational level, there is generally a close relationship between PCFs and their borrowers based on member ownership, knowledge and trust of and by each party, ease of access, and speed of loan processing. These factors override the higher interest rates payable on PCF borrowing compared with alternative sources such as AB. 40. Evaluation of illustrative subprojects and subborrowers suggests that the sustainability of these specific subprojects is likely given their technical and financial viability, and for subborrowers their apparent ability to respond to market signals, loan repayment performance, and declared desire to continue borrowing to expand their operations. While both statistical and anecdotal evidence from branches visited by the OEM suggest that overall sustainability of their subprojects is also likely, it is difficult to draw this conclusion for the entire Project-funded portfolio. The OEM found examples where a large number of subborrowers were adversely affected by a dramatic decline in coffee prices in 2001 and were able to continue operating only as a result of a Government-backed rescue package involving a moratorium on principal and interest payments for a period of 3 years. Unforeseen shocks of this nature may continue to adversely affect the sustainability of individual subprojects and subborrowers. They are an unavoidable consequence of market forces that are generally beyond the capacity of rural subborrowers or their financial institutions to predict, rather than a flaw in the project design. 41. Adverse movements in commodity prices and their impact represent serious contagion risk for the financial institutions concerned in that, for instance, almost the entire portfolio of one AB branch visited in Dak Lak Province was provided for coffee production in 2001, with clear negative implications for the profitability of the branch and the expansion and sustainability of its services. Since that time, although almost all amounts outstanding on the affected coffee loans had been repaid by the end of 2004 following a rise in coffee prices to above break-even levels, the branch has diversified its portfolio such that coffee loans accounted for only 50% of the portfolio at the time of the OEM visit. Such diversification and improved risk management that will develop as financial institutions mature should ensure that the benefits of the Project are sustainable. Overall, the sustainability of the Project is rated likely.

10 IV. A. Impact OTHER ASSESSMENTS

42. ABs lending and deposits expanded at annual rates of 28% and 36%, respectively, from 1996 to 2004 (para. 24). The OEM observed continued growth in ABs rural operations in 2005. Since AB accounts for 92% of the formal financial market in rural Viet Nam, its fast growth contributed significantly to the outreach of formal credit to rural households. The OEM found that rural credit is now readily available in the northern areas visited, and has increased substantially in the central and southern areas visited, though it remains insufficient to meet the high demand from farmers who depend on commercial farming (such as coffee and rubber). The access to formal credit enabled many rural householdsboth poor and nonpoorto invest in animal raising or cash crop production, and facilitated their exit from poverty. The Project, by supporting ABthe largest financial institution in rural Viet Namand using its extensive network to channel loans to rural borrowers, contributed to poverty reduction on a significant scale, albeit indirectly. The OEM noted that the $50 million of credit line from the Project accounted for less than 2% of ABs total lending sources (Appendix 1). Thus, ABs achievements in outreach to a large number of rural households are attributed to its own efforts as well as strong support from the Government and many aid agencies including ADB, which financed not only this Project but also a follow-up credit project.10 Finally, the Projects impact on poverty reduction could have been larger if it had permitted the use of its subloans for investments in education and for emergenciestwo critical factors underlying persistent rural poverty (para. 22). B. ADB Performance

43. Overall, ADBs performance in project design and implementation was considered satisfactory. ADB designed the Project based on a thorough analysis of local factors as well as consultation with major stakeholders. The project interventions were appropriate with the exception of the add-on subcomponents (paras. 1314). ADB supervised project implementation closely. In particular, the midterm review mission identified the weaknesses of the project design in a timely manner, and made appropriate adjustments accordingly, including the reallocation of loan proceeds from the less relevant add-on subcomponents to the credit component, for which there was high demand. The PCR from ADB was well prepared, with detailed information about project performance, including a socioeconomic impact assessment of the Project based on a survey of 1,380 rural households (900 borrowers and 490 nonborrowers) in 15 provinces. The survey was conducted in 2000 before the midterm review, and no similar survey has been conducted since then. The PCR also included a detailed comparison of project outputs actually delivered against those anticipated at appraisal, although the comparison was limited to outputs only. Due to insufficient data, the PCR did not provide similar comparison of indicators reflecting the achievements in project objectives and goals. C. Borrower Performance

44. The Borrowers performance in project design and implementation was also considered satisfactory. While SBV participated in the project design and implementation, its role as the EA for the Project was inappropriate (para. 9). Consequently, AB played a major role in coordinating PFIs and facilitating ADBs loan review missions. While loan processing was relatively quick, its effectiveness was delayed by 2.5 months (para.11). The Projects
10

Loan 1802-VIE: Rural Enterprise Finance Project, for $80 million, approved on 12 December 2000.

11

implementation was delayed by 16 months due to the slow disbursement of the institutional strengthening component. This was more the result of inappropriate project design than weak implementation. Overall, AB, CCF, and PCFs implemented the Project smoothly and achieved the intended development objectives. V. A. Issues ISSUES, LESSONS, AND FOLLOW-UP ACTIONS

45. Restrictions on Lending. Due to the reasons discussed in para. 22, the Project restricted the use of its credit line to only productive investment in agriculture and agroprocessing. The OEM noted, however, that many rural households need loans for consumption as well, including in particular loans for high school education for children and for emergencies such as medical costs. The lack of access to such loans forces some households to borrow from moneylenders at high cost in times of urgency, resulting in large debts and/or distressed sale of animals and farmland. This has caused some households to slip back or fall further into poverty. The lack of collateral of some households, including in particular young couples who received land from parents but not separate red books, restricted the access of these households to formal credit. While some PCFs and AB branches provided noncollateral loans, their size was too small to fully meet the demand in many cases. This issue could have been identified at the project design stage. Efforts could have been made to increase the risk management skills of loan officers to allow a greater degree of cash flow-based lending, or lending supported by personal guarantees. Finally, given the need to develop infrastructure in rural areas, there is a need for financing investment in small-scale rural infrastructure when government funding is limited. The OEM observed cases of households contributing funds to upgrade small roads and bridges critical to them. In many cases, however, rural households cannot themselves raise sufficient funds to finance such investment. The provision of long-term loans to finance infrastructure investment, recovered from beneficiaries over a long period, will accelerate rural development. Lending for rural infrastructure has so far been limited. While some AB branches expressed their interest in such lending, the shortage of long-term funds is a major constraint. 46. Remaining Policy Distortions. The removal of government restrictions on interest rates in May 2002 has enabled AB to operate on a commercial basis and increased its profitability in recent years. However, two policies continue to restrict the commercial operation of formal financial institutions: First, institutions providing loans to households living in remote areas are required to do so at subsidized interest rates. While the subsidies are funded by the Government, reimbursement is reportedly delayed, which may have reduced ABs incentive to expand lending in remote areas. Second, loans provided by VBSP are capped by the Government at highly subsidized interest rates. This has negatively affected VBSPs incentive to mobilize deposits, as deposit interest rates are higher than the lending rates. The OEM feels, and international experience indicates, that interest subsidies are unnecessary and have negative impacts on the sustainability of financial institutions and, therefore, on borrowers in the long run. International experience also shows that poor people can, and are willing to, pay commercial interest rates, their priority being easy and quick access to credit in times of need rather than low interest rates. The OEMs interviews with poor households confirmed such findings. Since formal financial institutions did not provide loans for emergency purposes, many poor borrowed from moneylenders at a monthly interest rate of 3%, much higher than the rates of 1.15% from AB and 1.35% from PCF for commercial loans. Subsidized interest rates can therefore have the opposite effect of that intended by government policy by reducing the incentive and capacity of financial institutions to expand the supply of credit to the poor and

12 forcing the poor to borrow from moneylenders at interest rates significantly higher than prevailing commercial rates. Furthermore, subsidized loans are frequently captured by the nonpoor. In the long run, both AB and VBSP have to rely primarily on mobilizing deposits instead of borrowing from aid projects and government funds to sustain their operations on a commercial basis. To encourage savings mobilization and provide strong incentives to expand and sustain poverty lending, it may be better if the Government allows AB and VBSP to lend to poor borrowers on a commercial basis, charging interest rates high enough to cover their operational costs and lending risk associated with poverty lending. 47. Capital Adequacy. The rapid growth in ABs portfolio raises concerns over the sustainability of the institution, given that its capital has not kept pace with the resulting growth in assets. At the time of the OEMs visit in September 2005, ABs capital adequacy was well below the internationally accepted minimum of 8%. This gives rise to serious concerns over its solvency. While it may be argued that, as a state-owned bank, there is no immediate threat to ABs operation, long-term confidence in the banking sector, particularly among international finance institutions, may be adversely affected if such a large bank is allowed to remain undercapitalized for a long period. 48. Non-optimal Use of ADB Funds. Given the lack of long-term funds and the high demand for long-term loans, it was intended that the credit line provided by the Project, with a term of 40 years to the Government, should be used exclusively for medium- and long-term lending. However, the OEM noted that some ADB funds were used for short-term lending.11 The low interest rates attached to the ADB funds (0.77% per month to a PCF compared with 0.8 0.9% per month on deposits) may have negatively affected deposit mobilization and provided a strong incentive for AB branches and PCFs to borrow from the ADB line of credit.12 The limited supply of ADB funds appears to have led to an equal allocation of the funds to all participating AB branches and PCFs. A more commercially oriented and competitive allocation may have been achieved if the long-term funds from ADB had been auctioned among PFIs, with those with a strong demand for long-term funds offering higher interest rates and receiving a greater share. To address the concern over equity, the income earned from the auction could have been redistributed to branches located in poor regions to support their lending programs. The OEM observed a concern that auction of ADB funds could lead to adverse selection of PFIs, which might bid high prices to obtain funds for high-risk loans. While the concern is valid, the risk could be overcome by proper design of the auction system, such as requiring specification of a portfolio of loans to be financed by the ADB funds. In any case, this new idea needs to be pilot tested, followed by vigorous evaluation, before actual application. Finally, the ADB funds could have been used more effectively, and in line with the Projects objective of providing medium- and long-term lending, if they had been allocated to local branches of PFIs for 10 or more years rather than a maximum of 5 years. 49. More detailed analysis of the above issues is given in Appendix 1, including an in-depth analysis of the underlying causes. Potential alternatives are also outlined, which may deserve consideration and, if accepted, need to be pilot tested before full-scale implementation. Major suggestions in Appendix 1 include the following: First, replace the current policy of providing
11

In an extreme case, the OEM visited one PCF and found that ADB funds (from both this Project and the follow-up project) were provided for 5 years, which financed 2.8 billion of the 9.4 billion loan portfolio in the PCF. However, only 1% of its portfolio had been medium-term loans (23 years). 12 At the national level, the ADB funds accounted for only a small portion of the total resources of AB and CCF, and the negative impact of the cheap ADB funds might not be significant. At the local level, however, the ADB credit was very important to some PCFs and AB branches, as observed by the OEM. Under such cases, the low cost of the ADB credit might have reduced PFIs incentive to mobilize deposits from clients.

13

cheap loans to poor households by interest coupons issued and distributed to poor borrowers to allow them to pay commercial interest rates. Such a policy may allow banks to run poverty lending as a commercial business on a long-term basis, and therefore sustain poor peoples access to formal credit. Second, convert ADB loans into equity for AB and CCF to substantially increase the capital adequacy of these financial institutions, and thereby allow them to continue their expansion in rural lending on a sustainable basis. Third, auction the credit lines from ADB so that its long-term funds will be used exclusively for long-term lending. Fourth, introduce revolving credit or overdraft for agricultural lending to enable the use of short-term funds to finance long-term investment and ongoing business development. Fifth, borrow from ADB to provide long-term loans for education investment by parents and rural infrastructure investment by beneficiaries. Finally, legalize moneylenders to encourage competition in the provision of fast and flexible loans for emergency purposes. B. 50. Lessons The following lessons are identified from the experience of this Project: (i) Supporting a large and well established financial institution in rural areas and using its extensive network of local branches to channel loans to end borrowers may be an efficient and effective way to rapidly expand access to formal banking services for a large number of rural households with likely sustainability (para. 42). By making formal credit readily available to rural households to facilitate selfemployment or job creation, future projects may make a significant contribution to poverty reduction in a sustainable manneralbeit indirectly and unquantifiably. Without sufficient demand from clients, the add-on components of subsidized loans for the poor and institutional strengthening for PFIs (paras.1314) under the Project, while satisfying ADBs requirements, did not work in practice. Future projects should avoid repeating this mistake. To be effective, poverty-reduction interventions need to be designed based on client demand and local realities. The Projects restriction on providing loans for productive investment denied borrowers demand for loans for high school education for children and for emergency purposes, and missed the opportunity of addressing two critical causes of persistent rural poverty and returning to poverty (para. 22). Future projects may provide credit based on borrowers demand and repayment capacity as well as the availability of funds. No restrictions should be imposed on loan use, size, term, or number of loan extensions. The Project allocated its credit line to PFIs at costs below their alternative of mobilizing resources from client deposits or commercial borrowing, resulting in less efficient use of the scarce long-term funds from ADB. In areas with a high demand for medium- and long-term loans and a severe shortage of supply, revolving credit may be introduced to agricultural lending to enable the use of short-term funds to finance long-term investment and ongoing business development. The revolving credit establishes an annual credit limit for a customer but allows him or her to make multiple withdrawals and deposits to the account, subject to the agreed upon facility ceiling, with interest being paid only on the balance outstanding. This will enable a borrower to withdraw funds only when actually required, and extend the loan term easily when funds are

(ii)

(iii)

(iv)

(v)

14 available in the concerned financial institution. While certain uncertainty in the possibility of future loan extension is involved, borrowers may accept this risk when they do not have access to medium- and long-term loans. Concerns over risk and liquidity management within financial institutions may be overcome by appropriate product design and pricing. (vi) Moneylenders provide quick and flexible lending services needed by households not yet served by formal financial institutions. Outlawing moneylenders will not lead to their disappearance as long as demand for such services is not met by formal financial institutions. Rather, making moneylenders illegal will increase the costs of their operation, resulting in higher interest charges to borrowers. If there is any concern about the negative impact of moneylender operations, specific measures should be developed to address the concerns instead of simply banning all moneylenders.

C.

Follow-up Actions

51. No specific follow-up lessons were identified for the executing and implementing agencies and for ADB.

Appendix 1

15

MAJOR FINDINGS OF THE OPERATIONS EVALUATION MISSION A. Introduction

1. The Rural Credit Project (the Project) was financed by a loan of $50 million from the Asian Development Bank (ADB). The loan was approved in 1996 and implemented from 1997 to 2002. To postevaluate the Project, an Operations Evaluation Mission (OEM) from ADB visited Viet Nam on 116 September 2005. During its time in Viet Nam, the OEM held meetings with government officials from concerned agencies, including the State Bank of Viet Nam (SBV) the Executing Agency for the Projectthe AgriBank (AB)formerly the Viet Nam Bank for Agriculture and Rural Developmentthe Central Peoples Credit Fund (CCF), and the Viet Nam Bank for Social Policies (VBSP). In addition to meetings in Hanoi, the OEM conducted fieldwork in three provinces and visited provincial branches of SBV, local branches of AB, a local branch of CCF, peoples credit funds (PCFs), local governments, borrowers, and nonborrowers. Specifically, the OEM visited Dak Lak Province in the Central Highlands, Phu Yen Province in the South Coastal Region, and Dong Nai Province in the Southeast Region. In these areas, the OEM held detailed discussions with 48 financial officers from 14 branches (two provincial branches of SBV, three provincial and three district branches of AB, one branch of CCF, four PCFs, and one district branch of VBSP) and conducted in-depth interviews with 25 rural households and three village leaders in 12 villages. Most interviewees were selected randomly by the OEM without interventions from government officials. 2. Earlier, the Project was selected by ADB as a case study under a Special Evaluation Study on Poverty Exit and the Effectiveness of Poverty Reduction Interventions. To conduct fieldwork for that study, an OEM visited Viet Nam in AprilMay 2005. During its 29 days in the country, that OEM visited six provinces including Lang Son Province in the Northeastern Uplands, Bac Giang Province on the edge of the Red River Delta, Quang Nam Province in the Central Region, Tra Vinh Province in the Mekong River Delta, and Son La Province and Dien Bien Province in the Northwestern Uplands. Altogether, that OEM visited 39 villages and conducted 248 interviews randomly, including (i) in-depth interviews with 132 rural households (71 men, 48 women, and 13 couples), of which 32 were poor; (ii) in-depth interviews with 8 migrants who had moved from rural areas to cities (5 in Ho Chi Minh City and 3 in the capital of Lang Son Province, including 5 women); (iii) brief interviews with 30 traders in markets (1 man and 29 women); (iv) detailed discussions with 38 local government officials (1 district official, 18 commune officers, 15 village leaders, and 4 staff working in commune clinics); and (v) interviews with 40 field staff working in rural financial institutions (17 from AB, 8 from PCFs, and 2 from VBSP) or other government agencies (5 from water supply companies, 5 from irrigation management companies, 2 from market management offices, and 1 from a health insurance company). 3. Since the findings of the earlier OEM have been reported in a draft report,1 the following findings are primarily from fieldwork in September 2005 by the OEM for this report. However, findings from the earlier OEM in AprilMay 2005 are also used where appropriate. B. Major Findings

4. Growth in Portfolio and Outreach. The OEM noted fast growth in rural financial services provided by formal financial institutions in Viet Nam in the past decade. For example,
1

ADB. Special Evaluation Study on Poverty Exit and the Effectiveness of Poverty Reduction Interventions, Appendix 2: Country Report: Viet Nam. Manila (Upcoming, draft available upon request).

16

Appendix 1

ABs net portfolio increased from 17,690 billion in 1996 to 129,204 billion in 2004, equivalent to an average annual growth of 28%. Over the same period, deposits from customers increased from 7,965 billion to 92,212 billion, an average annual growth of 36%. As a result of the rapid growth in outreach, AB has provided services to a large number of previously unbanked rural residents. At project appraisal in 1995, AB served only 29% of the 10 million rural households (Report and Recommendation of the President [RRP], para. 12). A survey conducted during the project preparation stage found that, based on the survey sample, 73% of all household loans were from informal sources, with moneylenders accounting for 33% of the loans supplied (RRP, para. 29). While no similar survey has been conducted since then, the Project Completion Report prepared in September 2002 estimated that AB had 8 million clients, accounting for 67% of the 12 million rural households in the country. In 2004, ABs clients exceeded 9 million.2 According to a recent ADB study, 3 as of December 2003, AB had provided total lending of 117.87 trillion (equivalent to $7.6 billion) in rural Viet Nam, accounting for 92% of the formal financial market, while VBSP and PCFs accounted for 6% and 2%, respectively, of the market share. 5. In the areas of the Northern Uplands visited, rural credit is now easily available to most rural households, including low-income families as well as poor households. Easy access to credit has enabled poor and near-poor families to raise one or two livestock, such as cows and buffaloes, which made a significant difference in their cash income, because they previously depended on subsistence farming with a small amount of land and limited access to nonfarm employment. However, in the Central Highlands and some southern areas visited, shortage of credit remains a major concern (para. 22). 6. Improvements in Credit Services. In addition to substantially increased lending, the quality of rural credit has been improved. In the villages visited in Phu Yen, borrowers enjoy flexibility in loan repaymentthey can repay any amount of both principal and interest at any time on or before the due date. In some branches visited, farmers can borrow loans without collateral of up to 30 million (equivalent to $1,898), while government policy encourages lending without collateral up to 10 million (equivalent to $633). Due to their small size, private (member) ownership, and closeness to borrowers, PCFs can usually provide more varied loan products, albeit at higher interest rates compared with AB. Some PCFs visited provide lending for education (short-term) and emergency purposes; such services effectively reduce farmers reliance on moneylenders in times of urgency. In one village, the OEM was told that moneylenders disappeared after the PCF started to provide loans quickly (within 1 day in the best case). In other cases, the OEM was told by interviewees that interest rates charged by moneylenders declined sharply after AB or PCF began operating in their villages. In Phu Yen Province, an AB district branch has financed 11 small-scale rural infrastructure projects; such loans were issued to individuals (usually commune leaders), who borrowed on behalf of a large number of beneficiaries to invest in small-scale infrastructure (rural roads or irrigation systems), while grants from government entities financed 4060% of the total investment cost. Due to a lack of long-term funds, however, loans for infrastructure are limited to a maturity of 3 years. 7. Efficiency in Loan Provision. Mass organizations (mostly farmers associations and womens associations) actively participate in rural lending programs run by AB and VBSP. In Phu Yen, an AB branch offered a commission (3% of interest payments collected) to such mass organizations, which selected borrowers for AB; facilitated loan applications (helping farmers fill in forms); encouraged borrowers to repay their amounts due on time; and provided
2 3

Data provided to the OEM by the Headquarters of AB in September 2005. ADB. 2003. Making Markets Work Better for the Poor in Viet Nam. Hanoi.

Appendix 1

17

recommendations of borrower creditworthiness to loan officers when it became necessary to extend loans, such as when borrowers encountered unanticipated misfortune. In this way, mass organizations reduced ABs administrative cost and credit risk, and enabled the AB branch concerned to achieve a ratio of 3,0004,000 clients per loan officer. 8. Lending through groups is commonly used for poverty lending or lending in remote areas. Groups are generally used to facilitate loan processing and encourage repayment. Loans are made to members of the group primarily through individual loan contracts rather than to the group as a whole, though there is joint liability for loan repayment among group members. Loan officers and some borrowers appreciate such lending, because it reduces their time and cost. In some remote villages, however, the OEM noted complaints about the difficulty of group lending, because loan officers required all group members to borrow and repay at the same time. While this reduces the administrative cost of AB, it increases the transaction cost of borrowers. Further, some borrowers had to forgo potential business opportunities due to the long period (up to 2 months) required to process loans through group lending. Others have concerns over their creditworthiness being adversely affected by being a member of a group in which certain members are unable to meet debt-service payments. 9. Revolving Credit. An urban branch of AB in Dong Nai Province provides a credit limit facility to non-agricultural enterprises. This resembles a revolving credit or overdraft that establishes an annual credit limit for the customer but allows him or her to make multiple withdrawals and deposits to the account, subject to the agreed upon facility ceiling, with interest being paid only on the balance outstanding. This gives the borrower greater flexibility in the use of credit than is possible with a fixed-term loan in which the principal amount is repaid and cannot be increased, should the borrower find it necessary during the loan term. It also enables a borrower to withdraw funds only when they are actually required, as opposed to the current practice with fixed-term loans by which the whole loan amount is disbursed in a single payment, apparently without reference to actual financing needs at the time of the disbursement, thereby causing some borrowers to incur unnecessary interest cost. Such facilities are not available to agricultural borrowers in spite of the fact that several borrowers interviewed indicated that such a facility would be beneficial, a view that was supported by a number of loan officers interviewed in both AB and PCFs. 10. The OEM identified a number of weaknesses in the design of the Project as well as additional constraints, which are discussed in detail in the following sections, including an indepth analysis of the underlying causes and suggestions for improvement. C. Issues, Underlying Causes, and Recommendations 1. Restrictions on Lending

11. Due probably to ABs general lending policy and an established practice in ADB that assumed that repayment capacity comes only from the invested subproject per se, the Project restricted the use of its credit line to only productive investment in agriculture and agroprocessing. The OEM noted that many rural households need loans for consumption as well, including in particular loans for high school education for their children and for emergencies such as medical bills. The lack of access to such loans forces some households to borrow from moneylenders at high cost in times of urgency, resulting in large debts and/or distressed sale of animals and farmland. This has caused many such households to slip back further into poverty.

18

Appendix 1

12. Furthermore, given the need to develop infrastructure in rural areas, there is a demand for long-term loans for investment in small-scale rural infrastructure when grant funds from the Government are limited. The OEM observed cases of households contributing cash to upgrade small roads and bridges. In many cases, however, rural households cannot themselves raise sufficient funds to finance such investment. The provision of long-term loans to finance such investment, recovered from repayments by beneficiaries, will accelerate rural development by alleviating the constraint of insufficient funds for rural infrastructure development. However, lending for rural infrastructure has so far been limited. While some AB branches visited expressed their interest in such lending, the shortage of long-term funds is a major constraint. 13. There are other constraints on rural lending as well: First, due to the fairly egalitarian distribution of farmland in Viet Nam and the issuance of land use right certificates (red books), most rural households use red books as collateral for borrowing from formal financial institutions. The OEM noted, however, that many households have only one red book, which covers all pieces of their farmland as well as their houses. When a farmer sells some but not all pieces of his or her farmland, separation of the red book becomes necessary. Such a process reportedly takes a long time. The OEM observed cases where farmers who had bought land use rights 57 years ago were still waiting for red books to be issued to them. Many young couples visited had no access to formal credit because they had received land from their parents without red books, due primarily to the slow process of separation. 14. Second, the OEM was told by senior officials in the central and provincial offices of SBV, AB, and CCF that the previous restriction on the number of loan extensions had been removed, and there were now no restrictions on loan size, term, and extension. However, many loan officers interviewed at the field level continued to apply the former restrictions, apparently unaware of the change in policy. These officers shared the OEMs observation that the previous policy, by restricting all loan extensions to a maximum of half of the original loan term, forced some borrowers to borrow from moneylenders to repay their loans in order to borrow a new loan to continue their business. Nevertheless, the loan officers continued to deny borrowers requests for loan extension, arguing that it is an SBV regulation. It appears that a change of policy alone is not sufficient and that active dissemination of new policies to all loan officers and borrowers is needed. 15. Finally, in some remote villages where individual lending was not permitted by loan officers who reduced their administrative effort and cost by imposing group lending, the slow process of lending through groups discouraged borrowing from formal financial institutions (para. 8). 16. To alleviate the above constraints, the following suggestions may be considered: (i) Remove the restriction on lending for productive investment only. Provide loans for consumption, education, and emergency purposes based on borrowers repayment capacity. Disseminate widely new policies, for instance the removal of restrictions on loan size, term, and extension. Instruct local branches and loan officers to provide loans based on borrowers demand, repayment capacity, and the availability of funds.

(ii)

Appendix 1

19

(iii)

Provide borrowers with a choice of borrowing as an individual or through a group on the understanding that individual loans may carry different terms reflecting the different costs and risks of the two types of lending. Review the entire process of changing or separating red books, with the aim of simplifying procedures and accelerating the process. Simple procedures may be developed to divide a family's property among several red books so as to make it easy to secure loans with an appropriate amount of collateral. Design future ADB credit projects to provide long-term loans for (a) lending to private entities, individuals, or beneficiary representatives for investment in small-scale infrastructure, with interest rates subsidized by the Government to encourage investment in public or semipublic goods; and (b) lending to parents for high school education for children, with interest rates not subsidized but lending risk covered by some form of guarantee fund; such a fund could be financed from the spread between the cost of ADB loans and the onlending rates to financial institutions minus the cost of administration and foreign exchange risk borne by the Government. Remaining Policy Distortions

(iv)

(v)

2.

17. The removal of government restrictions on interest rates in May 2002 enabled AB to operate on a more commercial basis and increased its profitability in recent years. In 2003, AB earned a small profit even according to international accounting standards (IAS). However, two policies continue to restrict the commercial operations of formal financial institutions: First, institutions providing loans to households living in remote areas are required to do so at subsidized interest rates.4 While the subsidies are funded by the Government, reimbursement is reportedly delayed (sometimes by 12 years). This may have reduced ABs incentive to expand lending in remote areas. Second, loans provided by VBSP are capped by the Government at highly subsidized interest rates (0.450.50% per month compared with 1.031.15% per month by AB and 1.35% by PCFs). This has negatively affected VBSPs incentive to mobilize deposits, as interest rates for deposits are higher than their lending rates. The OEM feels and international experience indicates that interest subsidies are unnecessary and have negative impacts on both the sustainability of financial institutions and, therefore, on borrowers in the long run. International experience also shows that poor people can and are willing to pay commercial interest rates, their priority being easy and rapid access to credit, especially in times of urgency, rather than low interest rates. Subsidized interest rates can therefore have the opposite effect of that intended by government policy by reducing the incentive and capacity of financial institutions to expand the supply of credit to the poor, and therefore forcing the poor to borrow from moneylenders at interest rates significantly higher than prevailing commercial rates. 5 Finally, subsidized loans are frequently captured by the nonpoor or borrowers from outside the intended target group.

Areas in Viet Nam are divided into three zones. The current policy requires 15% interest subsidy for borrowers living in Zone 2 and 30% subsidy for those in Zone 3. In one poor household visited, the borrower received a subsidized loan of 1 million ($63) for 12 months at a monthly interest rate of 0.5%. Because access to subsidized loans was rationed due to higher demand than supply, the borrower was forced to obtain additional funding from a moneylender in times of urgency, at an interest rate of 3% per month, much higher than the commercial rates of 1.031.18%.

20

Appendix 1

18. In the long run, both AB and VBSP have to rely primarily on mobilizing deposits instead of borrowing from aid projects and government funds to sustain their operations on a commercial basis. To encourage savings mobilization and provide strong incentives to expand and sustain poverty lending, it may be better if the Government allows AB and VBSP to lend to poor borrowers on a commercial basis, charging interest rates high enough to cover their operational costs and lending risk associated with poverty lending. If there is any need to subsidize poor borrowers, interest coupons could be issued by the Government and distributed directly to those to whom interest subsidy may be justified.6 The poor may borrow commercial loans and pay the interest charges by the interest coupons; banks may issue commercial loans to the poor and collect the coupons, which will be reimbursed by the Government. 19. As compared to the current practice of providing cheap loans to the poor using government funds, interest coupons may have the following advantages: First, since AB and VBSP will use their own funds for lending to the poor and receive interest coupons as payments for their interest charges, scarce government funds will be used for interest payments instead of for provision of loans. A small amount of government funds will therefore leverage a large amount of banking resources for poverty lending. Second, since banks will use their own funds for poverty lending, they will be more careful in loan appraisal and more vigorous in repayment collection as compared with current poverty lending by using government funds, where all losses are covered by the Government. Similarly, when facing difficulties in repayment, borrowers may give priority to repaying commercial loans with high charges instead of cheap loans from governments. By providing appropriate incentives to both financial institutions and borrowers, this policy may significantly reduce the risk of lending to the poor. More importantly, allowing banks to lend to the poor on a commercial basis may sustain poor peoples access to formal credit on a long-term basis. The OEM highlights the need for careful design and pilot testing of such a policy, to be followed by rigorous evaluation before its actual implementation. 3. Capital Adequacy

20. The rapid growth in ABs portfolio (para. 4) raises concerns over the sustainability of this institution, given that its capital has not kept pace with the resulting growth in assets. Based on the OEMs estimates of the value of risk-weighted assets and total capital, ABs capital adequacy ratio (CAR) stood at 5.72% at the end of 2004 according to Vietnamese accounting standards, but at only 0.18% according to IAS. The Basel Committee on Banking Supervision recommends a minimum CAR for total capital of 8%. While under Vietnamese accounting standards, ABs capital adequacy is below this internationally accepted minimum, it is not yet critical: it implies a recapitalization requirement of 2,869 billion to meet the 8% minimum. However, under IAS, the CAR is well below the minimum and implies a capital shortfall of 8,259 billion (over $500 million). While it may be argued that, as a state-owned bank, there is no immediate threat to ABs existence, continued confidence in the banking sector, particularly among international finance institutions, may be adversely affected if such a large bank is allowed to remain undercapitalized for a long period. 21. Substantial policy dialogue on the CAR issue was conducted between ADB missions and concerned government agencies during the project design and implementation periods.
6

For some poor who never borrow and therefore do not yet understand the potential benefits of investment, including in particular some poorest who are sensitive to high interest rates, interest subsidies for the first loan may have certain positive effects.

Appendix 1

21

While the Government has strongly committed to increasing ABs capital adequacy, its financial capacity for injecting sufficient funds into AB within a short period may be limited. The OEM noted discussions on capital injections for AB through appropriate government financial instruments such as treasury bonds as in the recent past. Meanwhile, the Government may borrow large amounts of long-term loans from ADB, and inject the funds into AB and CCF as their equity so as to substantially improve their capital adequacy. The significantly improved CAR may enable AB and CCF to continue their expansion in loan portfolio, outreach, and assets, strengthening their financial capacity to sustain operations in rural areas. Since ABs profitability has improved significantly after the removal of government control on interest rates in May 2002,7 it is likely that AB will have sufficient financial capacity to repay ADB loans within the loan term of 40 years. 4. Shortage of Credit Supply and Non-optimal Use of ADB Funds

22. In spite of ABs rapid growth in lending, a shortage of credit supply seems to be widespread in the central and southern areas visited, where the demand for larger and longer term loans is high due to a high level of commercial agriculture including tree crops such as coffee, rubber, and fruits, and cash crops such as sugarcane. The reported problems include (i) lack of long-term loans, for instance for more than 3 years; (ii) small loan size (insufficient for borrowers needssome of whom have to borrow from other sources, including moneylenders at high cost, to meet remaining needs); and (iii) insufficient access to short- and medium-term loans. In all areas visited, long-term loans (for more than 3 years) are not available, except from VBSP, which uses government funds and provides subsidized loans for up to 5 years. VBSP lending, however, is rather limited as it accounts for only 6% of the formal financial market in rural Viet Nam. The shortage of credit ranged from 20% to 80% of estimated demand in the branches visited, with the provision of medium-term loans (23 years) suffering the most severe shortage. Due to the non-availability of medium- and long-term loans, some households borrowed short-term loans for long-term investments (such as coffee, fruit trees, or livestock) and then requested an extension at the end of the loan term, or borrowed from moneylenders to repay the loan in order to get a second loan to continue their business. In many cases, where extended loans were treated as rescheduled, the recorded level of overdue loans might not reflect a lack of credit discipline but a restrictive loan term that did not adequately reflect a borrowers cash flow. 23. The primary cause of the above problem is a severe shortage of long-term funding in AB, CCF, and PCFs, which are unable to mobilize sufficient long-term deposits (or borrowing) most of which have maturities of less than 12 months.8 While the Projects credit line was longterm (40 years to the Government and onlent for 20 years to AB and CCF), onlending of project funds to AB branches was for only 5 years, and for only 1 year from CCF to PCFs). Furthermore, the funding under the Project accounted for only a small portion of funding sources in AB and CCF.9 To promote sound risk management and to limit asset-liability maturity gaps, new SBV regulations issued in 2005 limit the proportion of short-term funds that may be used to finance medium- and long-term lending to 30% for both AB and PCFs. SBV also limits the proportion of medium- and long-term loans to 45% of the total loan portfolio.

7 8

AB, for the first time, recorded a profit by IAS in 2003 and again in 2004. The OEM noted that many rural households preferred to keep savings at home, using it for animal raising or lending to others instead of depositing in financial institutions. The shortage of credit supply seems to have reinforced such a tendency. For instance, in 1997, the Projects credit line of $32 million to AB accounted for less than 2% of its total funding resources.

22

Appendix 1

24. Given the lack of long-term funds and the high demand for long-term loans, it was intended that ADB funds with a term of 40 years to the Government should be used exclusively for medium- and long-term lending. However, the OEM noted that some ADB funds (including funds from this Project and from a follow-up one) were used for short-term lending.10 The low interest rates attached to the ADB funds (0.77% per month from CCF to PCF compared with 0.80.9% per month paid by PCF on deposits) may have negatively affected deposit mobilization11 and provided a strong incentive for financial institutions to borrow from the ADB lines of credit. The limited supply of the cheap ADB funds appears to have led to an equal allocation of the funds to all participating AB branches and PCFs. In the view of the OEM, a more commercially oriented and competitive allocation could have been achieved if long-term ADB funds had been auctioned among AB branches and PCFs, with those offering higher interest rates receiving greater shares. This approach could have ensured the allocation of the long-term funds from ADB to branches with the highest demand for long-term lending. To address the concern about equity, profits earned from the auction of ADB funds could have been redistributed to branches located in remote or poor regions to support their lending for the poor. The OEM observed a concern that auction of ADB funds might lead to adverse selection of PFIs, which might bid high prices to obtain funds for high risk loans. While the concern is valid, the risk could be overcome by proper design of the auction system, such as requiring specification of a portfolio of loans to be financed by the ADB funds. In any case, this new idea needs to be pilot tested followed by vigorous evaluation before actual application. Finally, the Projects credit line might have been used more effectively, and in line with ADBs objective of providing medium- and long-term lending, if it had been allocated to AB branches and PCFs for 10 or more years rather than a maximum of 5 years.12 25. To alleviate the constraint of insufficient credit supply, the following suggestions may deserve consideration: First, funds from future ADB projects could be auctioned so that the limited amount of the long-term funds would be used by financial institutions that have determined a strong and effective demand for long-term loans, instead of by those that are interested merely in the low cost of those funds. 26. Second, as a solution in the short run, more flexible lending facilities such as revolving credit or overdrafts (which have been used by some AB branches for non-agricultural enterprises; see para. 9) might be introduced for agricultural lending. Such facilities would enable the use of short-term funds to finance long-term investments. While borrowers might face uncertainty, as there would be no guarantee that financial institutions would have sufficient funds next year to extend their loans, it is likely that borrowers would accept the risk, because they do not have better alternatives when they have no access to medium- and long-term loans but need such loans for their businesses. Concerns over liquidity and risk management in financial institutions (including the need to maintain higher levels of liquid funds to meet borrowers variable needs) could be mitigated by appropriate facility design and pricing. Such facilities might be introduced on a pilot basis in selected branches, to be followed by vigorous evaluation before scaled replication.
10

In one extreme case, the OEM visited a PCF where ADB funds provided for 5 years, had financed 2.8 billion of its 9.4 billion loan portfolio. However, only 1% of this funding had been used for medium-term loans (23 years). 11 At the national level, the ADB funds accounted for only a small portion of the total resources of AB and CCF, and the negative impact of the cheap ADB funds might not be significant. At the local level, however, the ADB credit was very important to some PCFs and AB branches, as observed by the OEM. Under such cases, the low cost of the ADB credit might have reduced PFIs incentive to mobilize deposits from clients. 12 The 5-year term was consistent with the implementation period of the Project. Since revolving funds from repayments of subloans continued to be onlent to endborrowers, however, the ADB funds could have been allocated to PFI branches for 10 or more years.

Appendix 1

23

27. Third, long-term loans from future ADB projects might be used to (i) increase the capital adequacy of AB and PCFs to enable their continued expansion of rural lending; (ii) provide longterm loans to parents for investment in high school education for children; and (iii) provide longterm loans to private entities, individuals, or beneficiary representatives for investment in smallscale rural infrastructure. 28. Fourth, to meet rural households demand for emergency loans, it might be appropriate and necessary to legalize moneylenders. The OEM noted that moneylenders provide quick and flexible lending services needed by households but not yet supplied by formal financial institutions, such as providing loans on the spot without collateral, albeit at very high charges to borrowers. Outlawing moneylenders will not lead to their disappearance as long as demand for such services is not met by formal financial institutions. In contrast, making moneylenders illegal would increase the costs of their operation, resulting in higher interest charges. If there is any concern about the negative impacts of moneylenders, specific policies and measures should be developed to address the specific concerns instead of simply banning all moneylenders. 29. Finally, as a solution in the long run, the current policy of subsidized interest rates for the poor and for borrowers living in remote areas (Zones 2 and 3) should be gradually phased out. AB and VBSP should be allowed to lend to the poor on a commercial basis and charge marketbased interest rates high enough to fully cover operating costs and lending risks, and to earn a commercial return. Whenever necessary, interest coupons could be issued to poor households to enable them to pay commercial interest rates. This policy, by enabling poverty lending as a long-term business run by financial institutions instead of short-term welfare programs by government agencies, might provide sufficient incentive for financial institutions to expand lending to the poor, and sufficient incentives to mobilize savings so as to sustain poverty lending without relying on external funds from the Government and aid agencies. 5. Potential Risk of AB Leaving Agriculture

30. AB is now allowed to operate in non-agriculture sectors. In one district with a fast growing industry sector, the OEM noted a potential risk of this AB branch gradually shifting its operations to non-agriculture sectors. In the view of the OEM, the purpose of allowing AB to diversify its operations into non-agriculture sectors is to enhance its financial strength so that it can sustain its operations in rural areas without government subsidies. However, if the result of a financially strong AB is its gradual withdrawal from agriculture, leaving rural households to be served by moneylenders and VBSP (which serves only 6% of the formal rural market), government and ADB support for rural development through the provision of funds to AB will be meaningless. 31. In the view of the OEM, AB should be allowed to operate on a commercial basis, charging interest rates high enough to cover all costs and lending risks. However, AB should not be encouraged to maximize profit, which may lead it to exit from agriculture, undermining the original purpose of making AB financially strong so as to sustain its services for the rural population without relying on government funds. Considering the current reality where a perfect market system cannot be quickly developed over a short period, certain government intervention is justified by the need to support rural and agricultural development for social stability and, consequently, economic efficiency in the long run.

24

Appendix 2

APPRAISAL AND ACTUAL PROJECT COSTS Planned ($'000) Actual ($'000) Comparison (%) (Underrun)/Overrun

Costs

A. Investment Costs 1 Credit AgriBank CCF 2 Vehicles SBV AgriBank CCF 3 Equipment SBV AgriBank CCF 4 Training SBV AgriBank CCF 5 Consulting Services SBV AgriBank CCF B. Recurrent Costs SBV AgriBank CCF C. Project Management Costs SBV AgriBank CCF D. Auditing Costs SBV AgriBank CCF E. Service Charge Total Project Costs

72,000

305

505

1,415

70,739 47,852 22,887 107 57 28 22 186 24 27 135 269 242 27 65 0 65 0 24 24 0 0 63 63 0 0 26 4 0 22 793 72,272

(1.8)

(64.9)

(63.2)

(81.0)

335 335 340

(80.6) (80.6) (92.9)

850 75,750

(6.7) (4.6)

ADB = Asian Development Bank, CCF = Central Credit Fund, SBV = State Bank of Viet Nam. Source: ADB. 2003. Project Completion Report on the Rural Credit Project in Viet Nam. Manila.

SUMMARY DESIGN AND MONITORING FRAMEWORK Design Summary 1. Goal 1.1 Rural economic growth Rural economic growth is improved from current level. No assessment Agricultural gross domestic product (GDP) increased by 29% from 1997 to 2002. Share of food crops in agricultural GDP declined by 1.6% from 1997 to 2002, while that of cash crops increased by 1.5%. Nationwide purchasing power parity poverty rate of one-dollar-a-day was reduced from 23.6% in 1996 to 13.6% in 2002 and 10.6% in 2004. Appraisal Targets PCR Assessment OEM Assessment

1.2 Diversification of rural economy

Growth in rural nonfarm activities is enhanced.

No assessment

1.3 Reduction of rural poverty

Rural poverty is reduced.

2. Purpose 2.1 Improve incomes of rural people. Agricultural productivity and incomes are raised. No assessment From 1997 to 2002, rice production increased at an annual rate of 4.4%, while annual growth rates of cash crops were higher: 31.5% for black pepper, 12.2% for both soybean and rubber, 10.4% for coffee, and 8% for sugarcane. Since there was little open land in Viet Nam for cultivation expansion, the achievements in production increase were primarily by higher crop yields. At project appraisal in 1995, AgriBank (AB) served fewer than 3 million rural households, and informal credit accounted for 73% of

Appendix 3

2.2 Expand productive employment in the rural sector.

Access to formal credit in rural sector is improved.

No assessment

25

26

Design Summary

Appraisal Targets

PCR Assessment

OEM Assessment
Appendix 3

rural lending. ABs clients increased to 8 million at project completion in 2002, and to more than 9 million in 2004. 2.3 Strengthen rural financial system. Number of participating people's credit funds (PCFs) will reach 1,000. No assessment There were 905 PCFs working in 53 provinces as of 31 December 2004. With total assets of 5.8 billion, the PCFs provided 7.8 billion of loans in 2004.

3. Output 3.1 Subproject investments 3.1.1 Resources for AB AB resources to increase by about $32 million Medium-term subloans totaling $30 million were disbursed to around 80,000 households. Average loan size was $400. AB resources increased by $30 million due to the Projects support. Medium-term subloans disbursed since project start to end of first quarter 2005 totaled 160,678 for a cumulative amount of $83 million. Average subloan size disbursed in first quarter 2005 was $816.

Allocation represents full utilization as of November 2001. Short-term subloans totaling $14.7 million were disbursed for around 46,000 subprojects. Average loan size was $450. Allocation represents full utilization as of October 2001. Central Peoples Credit Fund (CCF) and PCF resources increased by $14.7 million due to the Projects support.

3.1.2

Resources for PCFs

PCF resources to increase by about $15 million

Design Summary 3.2 Strengthening of financial system 3.2.1 AB staff trained

Appraisal Targets

PCR Assessment

OEM Assessment

About 210 AB staff members to be trained

5,576 AB staff received local training using funds from the Project, the World Bank Rural Finance Project, and ABs own resources. 1,838 PCF staff received local training from other external agencies, State Bank of Viet Nam (SBV) and PCFs themselves. Project funds for this subcomponent were totally reallocated. CCF staff received training from other funding agencies. Project funds for this subcomponent were totally reallocated. PCFs did not agree to borrow the necessary funds as required by the Project. Also, PCFs are prohibited from spending more than 40% of their capital on equipment. CCF computerized its head office and branches, and procured office equipment for its Project Implementation Unit (PIU). Unused funds were reallocated. Environmental unit was

Project Completion Report (PCR) assessment confirmed

3.2.2

PCF staff trained

About 4,000 PCF staff to be trained

PCR assessment confirmed

3.2.3

CCF staff trained

About 30 CCF staff to be trained

PCR assessment confirmed

3.2.4

Computer software adapted and installed on a pilot basis and staff trained

New computer software to be installed and used; staff trained at CCF and PCFs

PCR assessment confirmed

PCR assessment confirmed

Appendix 3

3.2.5

Environmental unit

An environment unit at AB to

PCR assessment confirmed

27

28

Design Summary established at AB and staff trained in environmental issues

Appraisal Targets begin operations and staff to be trained in environmental issues

PCR Assessment established in AB. Workshops were undertaken and environmental impact guidelines issued by both AB and CCF. 27 head office staff were trained overseas and 94 staff attended local workshops.

OEM Assessment
Appendix 3

3.2.6

SBV staff trained in supervision of PCFs

About 46 SBV staff members to be trained in supervising PCFs

PCR assessment confirmed

3.3 Project management 3.3.1 Banking Projects Management Unit Equipment to be procured for International Credit Projects Management Unit (ICPMU) Project management system to be established at SBV Computer and office equipment and a vehicle procured for ICPMU. ICPMU managed the Project. No project benefit monitoring and evaluation unit was established in ICPMU. Implementing Agencies received only limited capacitybuilding support under the Project. PIUs were established in both AB and CCF. ABs PIU procured computer and office equipment and vehicles. CCFs PIU procured office equipment. PCR assessment confirmed

3.3.2

Project management system

PCR assessment confirmed

3.3.3

PIUs

A PIU to be established and staffed at both AB and CCF Equipment to be procured for the PIUs

PCR assessment confirmed

PCR assessment confirmed

= Vietnamese dong. AB = AgriBank, CCF = Central Peoples Credit Fund, GDP = gross domestic product, ICPMU = International Credit Projects Management Unit, OEM = Operations Evaluation Mission, PCF = peoples credit fund, PCR = Project Completion Report, PIU -= Project Implementation Unit, SBV = State Bank of Viet Nam. Source: Asian Development Bank.

Appendix 4

29

GROWTH IN OVERALL ECONOMY AND THE AGRICULTURE SECTOR

Table 4.1: Growth in Gross Domestic Product (constant 1994 prices) 1997 ( billion) 231,264 95,638 135,626 2002 ( billion) 313,135 128,068 185,067 Overall Growth (%) 35.4 33.9 36.5 Annual Growth (%) 6.2 6.0 6.4

Item Gross Domestic Product State Non-State

= Vietnamese dong. Sources: Joint Donor Report to the Vietnam Consultative Group Meeting. 2003; Vietnam Development Report 2004 . Hanoi.

Table 4.2: Agricultural Growth (constant 1994 prices) 1997 ( billion) 93,783 75,746 46,953 15,804 15,465 2,572 2002 ( billion) 121,011 96,921 58,687 22,234 21,200 2,890 Overall Growth (%) 29.0 28.0 25.0 40.7 37.1 12.4 Annual Growth (%) 5.2 5.1 4.6 7.1 6.5 2.4

Item Gross output Crop cultivation Food crops Industrial crops Livestock Services

= Vietnamese Dong. Source: Vietnam Development Report 2004. Hanoi.

Table 4.3: Growth in Crop Production 1997 ('000 metric tons) 13 113 187 421 11,428 27,524 353 1,318 2002 ('000 metric tons) 51 201 331 689 16,824 34,064 397 838 Overall Growth (%) 293.1 77.9 77.7 63.8 47.2 23.8 12.5 (36.4) Annual Growth (%) 31.5 12.2 12.2 10.4 8.0 4.4 2.4 (8.7)

Crop Black pepper Soybean Rubber Coffee Sugarcane Rice Peanut Coconut

Source: Vietnam Development Report 2004. Hanoi.

30

Appendix 4

Table 4.4: Share of Gross Output in Agriculture Sector (%) Item Gross output Crop cultivation Food crops Cash crops Livestock Services 1997 100.0 80.8 50.1 16.9 16.5 2.7 2002 100.0 80.1 48.5 18.4 17.5 2.4 Changes 0.0 (0.7) (1.6) 1.5 1.0 (0.4)

Sources: Joint Donor Report to the Vietnam Consultative Group Meeting. 2003; Vietnam Development Report 2004 . Hanoi.

Appendix 5

31

FINANCIAL PERFORMANCE OF AGRIBANK A. Comparison of Performance under Different Accounting Standards

1. Financial statements of the AgriBank (AB), formerly the Viet Nam Bank for Agriculture and Rural Development, presented in both the Report and Recommendation to the President (RRP) of the Rural Credit Project (the Project)1 and its Project Completion Report (PCR)2 were prepared under international accounting standards (IAS). Accounts for comparable years prepared under Vietnamese accounting standards (VAS) were not available to the Operations Evaluation Mission (OEM). An analysis of the differences between VAS and IAS that existed at the time of the RRP and PCR is, therefore, neither possible nor considered to be meaningful for the purpose of this Project Performance Evaluation Report. 2. After the preparation of the financial statements presented in both the RRP and the PCR, the State Bank of Viet Nam (SBV) introduced a number of changes in prudential regulations designed to achieve convergence between VAS and IAS. The Ministry of Finance also introduced a new chart of accounts for credit institutions with effect from January 1 2005, though this does not affect the financial statements for 2004 and earlier, which were used for the following analysis. 3. The principal areas in which SBV strengthened regulations relate to capital adequacy, liquidity, maturity risk management (Decision 457), and loan loss provisions (Decision 493). The new regulations issued in April 2005 define Tier 1 (core) and Tier 2 (supplementary) capital and establish a minimum capital adequacy ratio (CAR) of 8%.3 Under the regulation, SBV allows financial institutions a period of 5 years to reach the required minimum level of capital on a phased basis, with the requirement that there should at least be annual increases in the ratio. Liquidity requirements, defined as the ratio between the value of cash and other short-term liquid assets and short-term liabilities falling due, are set at 25% for assets and liabilities with maturities of up to 1 month, and 100% for maturities of up to 1 week. The maximum amount of short-term liabilities (deposits and borrowing with a maturity of less than 12 months) that may be used to fund medium- and long-term loans is set at 30% for state-owned commercial banks compared with 40% for other commercial banks, 25% for other state-owned credit institutions such as the Central Peoples Credit Fund, and 30% for other nonstate-owned credit institutions such as individual peoples credit funds. The regulation allows for SBV discretion in this respect, provided that a financial institution can show that it satisfactorily meets other prudential regulations, has a ratio of overdue to total loans of less than 3%, and has in place sound assetliability management procedures. 4. Decision 493, relating to loan loss provisions, brings the valuation of financial institutions portfolio at risk currently applied through VAS more in line with IAS by increasing the number of classes for assessing loan quality to five and adjusting the percentage provision to be made under each to follow international practice. It also introduces a general loan provision (made

1 2 3

Proposed Loan Rural Credit Project (Viet Nam), R172-96, 22 August 1996. Project Completion Report Rural Credit Project, Viet Nam (Loan 1457-VIE[SF]), IN.225-03, 25 September 2003. This follows the accord of the Basel Committee on Banking Supervision of the Bank for International Settlements. However, there is no requirement in Decision 457 that Tier 1 capital should be a minimum of 4% of risk-weighted assets, which is stipulated by the Basel Accord. Also, the amount of Tier 2 capital that may be counted in the calculation of the CAR differs in that the SBV regulation stipulates that Tier 2 capital may be included to a maximum of 50% of Tier 1 capital, while the Basel Accord allows 100%.

32

Appendix 5

against performing, or pass, loans). This is set at 0.75%, though financial institutions are allowed a period of 5 years in which to phase in this provision. 5. As these and future regulations take effect, VAS and IAS will converge, and the practice of preparing accounts according to both standards, as for instance in the case of AB, will be unnecessary. It will also, initially, have a negative impact on the reported profitability and financial status of financial institutions, as the following analysis of ABs performance according to financial statements prepared under both accounting standards indicates. 6. AB annual reports for 2001 and 2002 present financial statements prepared according to VAS only. The annual report for 2003, however, presents statements prepared according to both standards for 2002 and 2003. AB provided draft statements for 2004 prepared according to both standards. As drafts, these were regarded as confidential, and not all supporting documentation was provided to the OEM. 1. Profitability

7. Although there are marginal differences in reported interest income and interest expenses between the VAS- and IAS-based accounts, net income varies by a maximum of 3% in 2002 to 2004. Reported other income and expenses similarly vary little between the two accounting systems. However, significant differences appear in respect of loan loss provisions. In 2002, provisions for the year amounted to 2,793 billion under IAS compared with 1,021 billion under VAS, equivalent to only 37% of provisions under IAS. For 2003 and 2004, provisions recorded under VAS were relatively higher but still represented only 46% of provisions recorded under IAS. The provision in 2004 amounted to 2,766 billion under IAS and 1,273 billion under VAS. 8. This underprovisioning led to a significant exaggeration of net income in both 2002 and 2003. In 2002, under VAS, AB recorded a net profit after tax of 467 billion compared with a net loss of 1,420 billion recorded under IAS. In 2003, under VAS, the net profit after tax increased to 699 billion, while under IAS the net loss decreased as profitability improved, but it remained at 1,113 billion. According to VAS, profit after tax grew in both 2003 and 2004 by 50% and 90%, respectively, reaching 1,329 billion in 2004. While the positive trend is also reflected under IAS, the level of profitability is significantly lower. AB reported losses in each year from 2000 to 2004, with a significant increase in the loss in 2002. Though the level of loss fell in both 2003 and 2004, the reported post-tax loss in 2004 amounted to 528 billion, a difference of some 1,850 billion from the profit reported under VAS. The more liberal treatment of bad and doubtful debts under VAS and the resulting overstatement of profits in recent years have led to a significant exaggeration of the value of both ABs assets, notably its loan portfolio, and capital. 2. Assets

9. The most significant impact of VAS in respect of ABs assets is the exaggeration of the value of its loan portfolio. The value of all other assets is very similar under both IAS and VAS. A comparison of the components of the loan portfolio under IAS and VAS is presented in Table A5.1.

Appendix 5

33

Table A5.1: Comparison of AB Loan Portfolio under VAS and IAS, 20022004 ( billion)
Item Gross portfolio Loan loss reserve Net portfolio Loan loss reserve/gross portfolio (%) Overvaluation of net portfolio under VAS to IAS (%) 2004 VAS IAS 142,251 138,468 1,188 10,178 141,063 129,204 0.8 7.4 2003 VAS IAS 115,284 105,014 1,184 7,693 114,100 99,205 1.0 7.3 2002 VAS IAS n/a 72,706 n/a 6,371 76,395 70,019 n/a 8.8

9.2

15.0

9.1

= Vietnamese Dong. AB = AgriBank, IAS = international accounting standards, n/a = not applicable, VAS = Vietnamese accounting standards. Source: Asian Development Bank staff estimates.

10. It is clear that under VAS the level of the loan loss reserve is significantly lower than under IAS, indicating exaggeration in the value and, therefore, in the quality of the loan portfolio. While as a percentage of the gross portfolio the loan loss reserve under IAS has improved since 2002, the rapid growth in the gross portfolio (35%, 44%, and 32% in 2002, 2003, and 2004, respectively) and the more conservative provisioning requirements under IAS resulted in diverging values of the net portfolio between 2002 and 2003. The trend was, however, reversed in 2004, when the over valuation of the net portfolio fell back to 9.2%. Further declines in the overvaluation of the portfolio under VAS may be expected as a result of the introduction of more stringent provisioning policies by SBV (para. 4). 11. The overstatement of the net loan portfolio contributes to the overvaluation of total assets under VAS. Under IAS, the value of total assets was reported as 161,757 billion in 2004. By comparison, under VAS, the value of total assets stood at 171,964 billion (6% higher than under IAS). 3. Capital

12. The overstatement of profitability has a significant impact on ABs capital. Although there are small differences in the value of share (or legal) capital (6,298 billion in 2004 under VAS and 6,114 billion under IAS), there are significant differences in the level of reserves between VAS and IAS. The value of reserves under VAS has been increasing in recent years (by 65% between 2002 and 2003, and by 75% between 2003 and 2004), due largely to the growth in retained earnings, reflecting the reporting of post-tax profits under VAS.4 As a result, under VAS, ABs total funds employed were reported at 7,193 billion in 2003 and 9,078 billion in 2004, an increase of 26%. By contrast, reserves under IAS have been negative and declining in recent years, amounting to negative 5,860 billion in 2004. However, capital injections by the Government in 2003 and 2004 resulted in AB reporting positive equity of 126 billion in 2003 and 254 billion in 2004.

A breakdown of the composition of capital and reserves under VAS and IAS was not provided to the OEM, other than the listing of capital sources provided in the notes to the financial statements in the Annual Report 2003. It was not possible, therefore, to determine the impact of the provisioning system of the two standards on, for instance, retained earnings.

34

Appendix 5

13. The differences in the value of AB capital are also reflected in the banks capital adequacy. Based on OEM estimates of the value of risk-weighted assets and total capital under each accounting standard, ABs CAR stood at 5.7% at the end of 2004 (compared with 5.8 in 2003) according to VAS, but at only 0.18% (compared with 0.12% in 2003) according to IAS. While under VAS, ABs capital adequacy is below the internationally accepted minimum of 8% (also introduced by SBV in 2005), this is not critical. It implies a recapitalization requirement of 2,869 billion to meet the 8% minimum. However, under IAS, the CAR is well below the minimum and implies a capital shortfall of 11,218 billion. B. Financial Analysis of AB under IAS5 1. Capital Adequacy

14. The assessment of ABs capital adequacy is based on mission estimates for risk weighting of the banks assets and capital.6 Equally, because ABs capital is not broken down into its Tier 1 and Tier 2 constituents, it has been possible to analyze ABs capital adequacy only in relation to total capital. 15. ABs capital adequacy is well below the international and new SBV minimum of 8%. The CAR of only 0.18% implies a capital shortfall of 11,218 billion. This is a significant increase over the estimated shortfall in 2003 of 8,259 billion and implies a worsening position with respect to ABs solvency. This reflects the increasing gap between risk-weighted assets and capital resulting from very high growth rates in the loan portfolio in recent years, with which the growth in capital has not kept pace. 16. The extent to which the low level of capital adequacy represents a serious risk to AB itself and more broadly to the whole financial sector, given ABs size and outreach, is open to debate. Given the significance of AB to the financial sector and rural finance in particular, the possibility of SBV actually revoking the banks license at any time in the foreseeable future for failing to comply with capital adequacy requirements appears remote. Support from the Government to keep the bank operating is likely to be forthcoming until adequate competition to supply the rural finance market arises, but this appears to be likely only in the long term. Meanwhile, it is probable that the Government will continue to provide the necessary finance or guarantees to ensure ABs future, irrespective of its level of capital adequacy. In this context, international experience suggests that capital adequacy requirements have an important influence on bank behavior. Increasing capital in the first instance reduces profitability and so induces banks to acquire more risky assets (loans). In addition, enforcement of CARs on a banking system short of capital is found to reduce the supply of finance. The implication is that higher CARs, or the enforcement of CARs on capital-deficient banking systems, should be phased in (as SBV proposes). But other research suggests that a bank with low capital has little to lose, and will reap a disproportionate return from successful risk taking, implying a tendency to take excessive risks.7

The following analysis of ABs financial performance is based on accounts prepared under IAS and reported according to international financial reporting standards. It follows ADBs Guidelines for the Financial Governance and Management of Investment Projects Financed by the Asian Development Bank, ADB, 2001. A detailed breakdown of ABs assts to allow an accurate allocation of risk weights was not available to the OEM. However, given that the majority (88%) of the assets attract a risk-weighting of 100% and a further 11% a riskweighting of zero, any discrepancy in the estimation of total risk-weighted assets is minimal. Brown, K. and Skully, M. 2003, International Studies in Comparative Banking: A Survey of Recent Developments, Monash University, 29 January 2003.

Appendix 5

35

2.

Asset Quality and Portfolio Structure

17. A variety of indicators may be used to assess the quality of ABs assets, particularly its loan portfolio and risks associated with it. At the institutional level, there is little evidence of loan concentration risk. Risks with respect to economic sector, geographic area, borrower type, and loan maturity are minimal. A breakdown of outstanding loans financed under the Project at the end of the second quarter of 2005 indicates that the portfolio is also relatively evenly spread among rural income-earning activities. Crop production and livestock husbandry accounted for 32% and 40%, respectively, though within those categories there were varied activities. Trading and other loans each accounted for 10% of the project portfolio. 18. At the individual branch level, the OEM did observe an example of a high degree of sectoral concentration with an associated high level of contagion risk. Almost the entire portfolio of one AB branch visited in Dak Lak Province was used to finance coffee production in 2001. A significant decline in the price of coffee adversely affected the income of many subborrowers and, as a result, their debt-service capacity. They were able to continue operating only as a result of a Government-backed rescue package involving a moratorium on principal and interest payments for a period of 3 years. This had obvious negative implications for the profitability of the branch and for the expansion and sustainability of its services. Since that time, although almost all amounts outstanding on the affected loans were repaid by the end of 2004 following a rise in coffee prices to above break-even levels, the branch has diversified its portfolio such that loans for coffee production accounted for only 50% of the portfolio at the time of the OEM. 19. The quality of ABs portfolio is reflected in the relationships between its loan loss reserve and arrears and the loan portfolio. The loan loss reserve has for some years been a high percentage of the value of the gross portfolio and, although it fell from 8.8% to 7.3% in 2003, preliminary figures suggest that it rose again to 7.4% by the end of 2004. With respect to arrears, Table A5.2 indicates the repayment status of ABs portfolio at the end of 2004. Table A5.2: Structure of AB Loan Portfolio by Repayment Status, 2003 and 2004
2004 billion 137,021 983 297 166 830 84 139,382 (10,178) 129,204 2,360 1.7 2003 billion 103,844 791 180 199 1,173 712 106,899 (7,693) 99,205 3,055 2.9

Item Performing loans Arrears less than 180 days Arrears 181 to 360 days Arrears more than 360 days Loans in debt recovery Frozen loans Gross portfolio Provision Net portfolio Total arrears Arrears percentage

% 98.3 0.7 0.2 0.1 0.6 0.1 100.0

% 97.1 0.7 0.2 0.2 1.1 0.7 100.0

= Vietnamese dong. Source: Viet Nam Bank for Agriculture and Rural Development, Consolidated Financial Statements, 31 December 2004 (Draft).

20. The value of arrears declined in 2004 to 1.7% of the gross portfolio, due largely to the writing off of loans in debt recovery and frozen loans. Loans in debt recovery and frozen loans are predominantly loans disbursed under government programs. Frozen loans are subject to a

36

Appendix 5

repayment moratorium approved by the Government, which also cancelled all interest charges payable by AB on the funding of such loans. AB applied to the Government to write off a portion of loans in debt recovery in January 2002 and was authorized to do so in December 2004. The improvement in the balance of loans in debt recovery also includes 218 billion collected during the year. ABs management is confident that the remaining debts associated with these loans will be covered by the Government. If these are omitted from the estimate of arrears, the arrears percentage falls to 1.1%, though realistically there may be little chance of collecting on any of the loans overdue for more than 360 days. 21. Since 2001, there has been significant growth in the loan portfolio, which has been largely responsible for the growth in ABs total assets. The portfolio grew at an average annual rate of 27% from 2001 to 2004. The portfolio has become less concentrated in state-owned enterprises, with their share in the total portfolio falling from 27% in 2001 to 18% in 2004. The share of farmers and traders also fell from 41% to 37%, though they still account for the largest proportion of the total portfolio. The most significant change in the structure of the portfolio with respect to borrowers has been in the growth of lending to private enterprises and cooperatives, whose share in the total portfolio grew from 6% in 2001 to 23% in 2004. Moreover, while farmers and traders account for the largest share of the total portfolio and of short-term loans, the share of private enterprises and cooperatives share in medium- and long-term loans increased relatively, in 2004 accounting for 21% compared with 24% for farmers and traders. 22. A positive development in the structure of the portfolio is that much of the growth has been accounted for by growth in normal commercial loans, at an average annual rate of 33%. Their share in the total portfolio increased from 72% in 2001 to 88% in 2004. While concessionary loans have also grown (at an annual average rate of 21%), their share in the total portfolio has fallen from 7% to less than 6%. Both state planning and state-directed loans have fallen steadily since 2001, and as of the end of 2004 together accounted for a little over 1% of the portfolio, compared with more than 14% in 2001. 23. With respect to loan maturity, there has been little change since 2001, with short-term loans accounting for 55% and medium- and long-term loans for 45% of the portfolio each year. This does not reflect the lengthening funding maturity, which has seen a shift toward mediumand long-term rather than short-term borrowing and deposits (para. 28). 3. Management Quality

24. Management quality is considered from the point of view of ABs efficiency and cost effectiveness in the management of its loan portfolio. In this respect, ABs performance has improved steadily since 2001. Operating costs as a proportion of average gross portfolio have fallen each year, from 4.3% in 2001 to 2.9% in 2004. Similarly, in the cost per unit of money lent, indicating the efficiency of loan disbursement, AB has recorded a steady improvement since 2001. The average cost of disbursing 1 million had fallen from 37,000 in 2001 to 25,000 in 2004. 4. Earnings Performance

25. ABs return on assets has been negative since 2001, reflecting the fact that it has incurred post-tax losses in each of the last four years. Since 2002, however, the size of the loss fe;; from 1,420 billion to 528 billion, resulting in an improvement in the return on assets from

Appendix 5

37

minus 1.80% in 2002 to minus 0.37% in 2004.8 This improvement in earnings is also reflected in ABs operational sustainability, which rose from 81% in 2001 to 93% in 2004, based on financial income alone. Based on total income, operational sustainability in 2004 stood at 99%, indicating that AB is virtually able to cover all its operating costs from income. Financial income (interest, fees, commissions, etc.) has also been increasing as a proportion of total income and reached 94% in 2004. 26. Of concern, however, is the decline in ABs interest spread. Interest income as a percentage of the average loan portfolio increased from 9.96% in 2001 to 10.17% in 2003 but only marginally in 2004 to 10.18%. This represents an annual increase of less than 1%. By contrast, interest expenses as a percentage of average deposits and borrowing increased over the same period by an average of over 7% per year, from 3.80% in 2001 to 5.04% in 2004. This resulted in a declining interest spread from 6.16% in 2001 to 5.14% in 2004. Total earnings spread followed the same trend. It was positive in 2001 at 0.45% but declined to minus 0.53% in 2004. 5. Financial Structure

27. As a result of the rapid growth in loan disbursement (para. 21), AB increased the proportion of total assets that is accounted for by the loan portfolio, from 81% in 2001 to 86% in 2004. Other earning assetsincluding balances with other financial institutions, government securities, and investmentsraised the total proportion of ABs total assets in income-earning assets to 96% in 2004, the balance of non-earning assets being in fixed, current, and intangible assets. 28. There has been a significant change in the structure of ABs funding since 2001. Customer deposits grew at an average annual rate of 35% and in 2004 accounted for almost 60% of total funding compared with less than 45% in 2001. There has also been a rise in deposits and borrowing from other banks, which accounted for 7% in 2001 and 16% in 2004, having increased at an average rate of 48% per year. There has been a corresponding decline in both the volume and importance of funding from SBV and the Treasury, reflecting ABs declining dependence upon state funding. There has also been a shift in the maturity structure of funding. Short-term borrowing and deposits accounted for 31% of total funding in 2001 but for only 18% in 2004. Within medium- and long-term borrowing and deposits, there has also been a shift towards deposits rather than borrowing, with the share of medium- and long-term borrowing in total funding declining from 16% in 2001 to 11% in 2004. By contrast, the share of medium- and long-term deposits in total funding increased from 54% in 2001 to 72% in 2004. While this shift toward longer maturities and less dependence on government funding has been positive, it has been at the expense of an increasing cost of funds, which has had a negative impact on ABs interest spread (para. 26). The growth in deposits is also reflected in the banks loan-deposit ratio, which fell from 1.93 in 2001 to 1.46 in 2003 before rising again to 1.50 in 2004. This reflects the high rate of growth in deposits between 2001 and 2004 compared with the average annual growth in the loan portfolio of 27% (para. 21). 29. Data available at the time of the OEM were insufficiently disaggregated by maturity to allow a detailed analysis of liquidity or a maturity gap analysis. Also, given the very low level of capital, ABs gearing (leverage), defined as the relationship between total liabilities and equity,

Ratios relating to ABs return on equity are of little value, as both the annual post-tax losses and, until 2003, ABs equity was negative, and in 2004 remained extremely low, making the return on equity very high.

38

Appendix 5

is extremely high and does not allow for a meaningful analysis other than that the relative size of ABs capital to total liabilities has improved annually since 2001.

Appendix 6

39

FINANCIAL PERFORMANCE OF CENTRAL PEOPLES CREDIT FUND A. Comparison of Performance under Different Accounting Standards

1. Financial statements of the Central Peoples Credit Fund (CCF) are prepared only according to Vietnamese accounting standards. With the support of the World Bank Rural Finance 2 Project, which began in 2005, CCF is in the process of converting to international accounting standards. A requirement of the project is that CCF must be fully convergent by 2007 and audit its 2006 accounts according to international accounting standards. There is no such requirement for individual peoples credit funds (PCFs). 2. The financial analysis of CCF is therefore based only on financial statements prepared according to Vietnamese accounting standards. It is also restricted to an analysis of CCF itself and not the PCF system as a whole. CCF acts as a wholesale financial institution for the PCF system (as well as offering retail financial services), absorbing surplus liquidity from and relending to individual PCFs. However, it does not maintain any consolidated data on the PCF system, nor, in fact, on the rating of individual PCFs according to State Bank of Viet Nam (SBV) criteria. Consolidated financial data and PCF ratings are maintained by the Cooperative Credit Institute within SBV. The Cooperative Credit Institute did not make such data available to the Operations Evaluation Mission (OEM). B. Financial Analysis of CCF 1. Capital Adequacy

3. CCFs capital adequacy is estimated to be 9.2%, which is above the internationally accepted minimum and the level set by SBV but below the Asian Development Banks (ADB) recommended level of 12%.1 This is based on OEM estimates of the risk weighting of CCFs assets. A weighting of 100% has been applied to CCFs loans to other credit institutions whereas a lower weighting of 50% may normally be applied. Such credit institutions are predominantly PCFs. In the absence of the SBV rating of PCFs and, therefore, an indication of their financial status and risk profile, a more conservative weighting was applied for the purpose of the analysis. In reality, a lower weighting may be applied to some PCFs, which would increase the capital adequacy ratio above the estimated 9.2%. 4. Although the capital adequacy ratio remains above the minimum level of 8%, there has been a disturbing, steady decline in the ratio since 2001 when it stood at 20.1%. This reflects the fact that CCFs capital has grown only slowly since 2001, at an annual average rate of 2.3% to reach 196 billion in 2004, while assets have grown at an annual average rate of 37% and stood at 2,330 billion in 2004. 2. Asset Quality and Portfolio Structure

5. CCF provides loans to other financial institutions, predominantly wholesale loans to PCFs (including loans funded by ADBs Rural Credit Project [the Project]) and retail loans to enterprises and individuals. Table A6 presents the structure of the total CCF portfolio according to repayment status for 2003 and 2004.

ADB. Guidelines for the Financial Governance and Management of Investment Projects Financed by the Asian Development Bank. Manila. 2001.

40

Appendix 6

Table A6: Structure of CCF Loan Portfolio by Repayment Status, 2003 and 2004
2004 million 1,995,404 9,770 845 15,478 2,021,497 (10,015) 2,011,483 26,093 1.3 2003 million 1,506,705 2,893 1,955 14,414 1,525,966 (3,932) 1,522,035 19,262 1.3

Item Performing loans Arrears less than 180 days Arrears 181 to 360 days Bad debts Gross portfolio Provision Net portfolio Total arrears Arrears percentage

% 98.7 0.5 0.0 0.8 100.0

% 98.7 0.2 0.1 1.0 100.0

= Vietnamese dong. Source: Central Peoples Credit Fund, Audited Financial Statements, for the Year Ended 31 December 2004.

6. Although there has been an absolute increase in the level of arrears, as a proportion of the total portfolio they remained constant at 1.3% from 2003 to 2004. There has, however, been a small increase in the loan loss reserve as a proportion of the gross portfolio, from 0.3% in 2003 to 0.5% in 2004, reflecting the substantial increase in the reserve in absolute terms between 2003 and 2004 as a result of changes in loan loss provisioning regulations introduced by SBV. Within the individual components of the CCF portfolio, for loans to enterprises and individuals, arrears increased almost four times between 2003 and 2004. As a proportion of the portfolio, they rose from 0.5% to 1.2%. By contrast, within loans outstanding to credit institutions, the level of arrears fell in spite of an increase in the portfolio of 25%. As a proportion of the portfolio, arrears fell from 2.0% in 2003 to 1.4% in 2004. 7. The Project-financed portion of the portfolio, which falls only under loans to other credit institutions, namely PCFs, accounts for 11% of performing loans. Overdue loans of 430 million were reported in 2003 but had been collected by the end of 2004. Within bad debts, the Projectfinanced loans accounted for 21% at the end of 2004 compared with 23% in 2003, reflecting a decrease in the balance of bad debts.2 8. The distribution of the CCF portfolio shifted in 2004 towards lending to enterprises and individuals. In 2004, loans to enterprises and individuals stood at 1,020 billion, equivalent to 50.5% compared with 47.2% in 2003, and exceeded loans to credit institutions, which amounted to 1,002 billion. The distribution of the portfolio between enterprises and individuals and credit institutions is not reported in the financial statements for 2002 and previous years. It is not possible, therefore, to determine whether the shift in 2004 towards retail lending to enterprises and individuals is part of a longer term trend. 9. Within performing loans to credit institutions, loans to PCFs account for 99.8%. Of these, 34% are medium-term loans, of which 99.5% are funded by ADB (Rural Enterprise Finance Project Loan 1802). Of other loans to PCFs, those funded by the Project account for 16%, with the balance being funded from domestic sources.

It is not clear from the financial statements or accompanying notes whether any of these Project-financed bad debts were included in bad debts written off in 2004.

Appendix 6

41

10. Of performing loans to enterprises and individuals outstanding at the end of 2004, loans to individuals accounted for 87.5% at the end of 2004, a marginal increase over 2003. In volume terms, they grew by 43% in 2004. Loans to enterprises also grew, by 87%, taking their share in this component of the CCF portfolio to 10%. The growth in loans to individuals and enterprises was at the expense of loans to state-owned enterprises, which fell in 2004 both in absolute terms and in respect of their share in the portfolio. At the end of 2003, loans to state-owned enterprises represented 6% of the portfolio compared with a little under 3% in 2004. 11. CCF did not provide the OEM with any further data to allow an analysis of the concentration of the portfolio according to economic sector, geographic area, etc. 12. In terms of portfolio growth, loans to enterprises and individuals grew at an average annual rate of 12% from 2001 to 2004, while loans to other credit institutions grew at 112%, though from a low base in 2001. The combined portfolio grew at an average annual rate of 34%. 3. Management Quality

13. CCFs operating cost ratio stood at 2.9% in 2004. It has increased slightly in each of the last three years from 2.6% in 2002 (and 2001). Although the upward trend is of concern, the ratio is on a par with that of AgriBank. It is not possible to determine the operating cost ratio for the separate components of the portfolio, as costs are not disaggregated. It is also not possible to estimate the cost per unit of money lent, since CCF did not provide disbursement data to the OEM. 4. Earnings Performance

14. The return on assets has also shown a downward trend, from 1.34% in 2001 to 0.51% in 2004. Return on equity similarly declined from 2001 to 2003, from 6.6% to 4.3%, but recovered in 2004 to 5.4%. However, both the interest spread and earnings spread have increased since 2001. Interest income as a percentage of average gross portfolio rose from 7.93% in 2001 to 14.34% in 2004, while interest expenses as a percentage of average borrowing grew from 6.45% to 10.99%. As a result, CCFs interest spread increased from 1.48% in 2001 to 3.35% in 2004. Total earnings spread increased from minus 0.78% in 2001 to 5.36% in 2004, following an increase in total income as a percentage of the average gross portfolio from 9.49% to 15.29% and a decline in interest and financial costs as a percentage of average total resources from 10.27% to 9.93%. 15. The decline in profitability, indicated by the decline in the return on assets and return on equity, is also reflected in CCFs operational sustainability which, though remaining above 100%, fell from 112% in 2001 to 104% in 2004 based on financial income alone, and from 118% to 106% in respect of total income. 5. Financial Structure

16. The growth in the total portfolio of 34% (para. 12) was exceeded by the rate of growth of total deposits, which grew at an average annual rate of 63% from 2001 to 2004. This resulted in CCFs loan-deposit ratio falling from 2.7 in 2001 to 1.5 in 2004. This increase in deposits added to the growth in CCFs total liabilities, which grew at 43% per year from 2001 to 2004. By comparison, CCFs equity grew at only a little over 2% per annum. This resulted in a significant increase in the level of CCFs gearing or leverage (the ratio of total liabilities to equity) from 396 in 2001 to 1,087 in 2004.

42

Appendix 6

17. Although the loan portfolio has grown significantly, its share in CCFs total assets has actually fell from 93% in 2001 to 87% in 2004. At the same time, investments in Treasury bonds and other securities grew by an average annual rate of 85%, largely as a result of a large increase in (unspecified) medium- and long-term securities of 50 billion. In addition, nonearning assets, such as cash, fixed assets, and intangible and other assets, increased and accounted for a larger share of total assets in 2004 (11%) than in 2003 (6%).

Appendix 7

43

INDICATIVE SUBPROJECTS FINANCED BY THE ADB LOAN Subproject 1 Livestock (Calf and Goat Rearing) Province Location Borrower name AgriBank (AB) branch/ peoples credit fund (PCF) Subproject purpose Subproject investment cost million $ Loan amount million $ Loan term (months) Interest rate (% per month) Repayment schedule Dak Lak Village No 3, Hoa Khanh Commune, Buon Ma Thuot City Le Van Tinh Hoa Khanh PCF

Livestock (calf and goat rearing) 49.3 3,120 35.0 2,215 36 1.26 Principal 10 million after 12 and 24 months, 15 million after 36 months Interest semiannually Red book (59.3)

Collateral (value in million) Subproject description and performance (income, expenditure, net income, other sources of income)

Income: 81.3 million over 3 years Expenditure: 49.3 million over 3 years Net income: 32.0 million (10.7 million per year) Other sources of income: rice crop, 3.4 million per year; sugarcane, 7.7 million per year; coffee, 9.5 million per year) Le Van Tinh has been a member of the PCF for 5 years and has received a loan each year. All previous loans were short-term (less than 12 months) and all were repaid in full in advance of the due date. Two loans were for emergency purposes (following the death of each of his parents). These were each for 5 million and were disbursed within a day. Tinh does not have a deposit account with the PCF. Any cash income is used for consumption purposes, with very little saved. The loan was taken out in January 2005 to partly finance investment in four cows and two goats. A further three cows were financed from Tinhs own funds at a cost of 25 million. The estimated net income from the subproject is barely sufficient to cover debt service but Tinh has sufficient additional sources to cover repayment. He also has a daughter working away who sends money home on a

44

Appendix 7

regular basis. Tinh was pleased with the speed of processing the loan, which was 6 days. However, although this loan is longer than previous loans, he would prefer a loan term of 57 years, as 3 years is insufficient time to raise animals to their optimum market weight. Larger loans would also be preferable. Tinh has never tried to obtain loans from other financial institutions such as AB. A moneylender used to operate in the village but subsequently ceased operations leaving the PCF as the only source of finance.

Subproject 2 Livestock (Dairy Calf Rearing) Province Location Borrower name AB branch/PCF Subproject purpose Subproject investment cost million $ Loan amount million $ Loan term (months) Interest rate (%) Repayment schedule Collateral (value in million) Subproject description and performance (income, expenditure, net income, other sources of income) Phu Yen Phu Vang Village, Binh Tien Commune, Tuy Hoa City Luong Tan Tuy Hoa AB Branch Livestock (dairy calf rearing) 50 3,165 20 1,265 36 0.95 Principal after 12, 24, and 36 months Interest: quarterly Red book (not applicable [n/a])

Income: 44 million over 3 years Expenditure: 18 million over 3 years Net income: 26 million (8.7 million per year) Other sources of income: n/a Loung Tan used the loan to diversify his existing dairy calf rearing enterprise into rearing imported breeds rather than local breeds. Imported breeds sell at a premium because of both their greater size and higher milk yields. He expects to sell one calf per year at the age of 1218 months. Cows are reported to be productive for 10 years. He does not sell milk himself. A local state-owned enterprise previously agreed to purchase calves but failed to do so, leaving Tan to sell on the local market, where the price is slightly lower. Annual cash costs are limited to feed and veterinary

Appendix 7

45

services. Tan produces his own fodder, and labor comes from his own household. Income from the investment is sufficient to cover debt service, though it is not necessarily available at the time payments are due. Other sources of income, from poultry and wage labor, are used to cover debt service. Tan proposes to expand his enterprise by buying a further seven cows and will borrow again once the present loan is repaid. He would prefer to borrow again before then or take out a second loan, and for such loans to be for larger amounts and for a longer term.

Subproject 3 Ornamental Tree Cultivation Province Location Borrower name AB branch/PCF Subproject purpose Subproject investment cost million $ Loan amount million $ Loan term (months) Interest rate (%) Repayment schedule Collateral (value in million) Subproject description and performance (income, expenditure, net income, other sources of income) Phu Yen Lien Tri Village, Commune No. 9, Tuy Hoa City Tran Thi No (spouse of borrower Dang Phim) Tuy Hoa AB Branch Ornamental tree cultivation 25 1,580 10 630 24 1 Principal after 24 months Interest quarterly Red book (n/a)

Income: 30 million over 2 years Expenditure: 16 million over 2 years Net income: 14 million (7 million per year) Other sources of income: n/a Dang Phim has been engaged in ornamental tree production for some years but took a loan to expand the business. A total investment of 25 million was required to purchase seedlings, pots, growing compound, soil, and fertilizer. Annual costs for fertilizers, pesticides, watering amount to 8 million. Income of 15 million is derived from selling trees at various stages of maturity. Depending on variety and size, 12 year-old trees sell for 50,000100,000, while larger trees may fetch over 200,000. Sales are made

46

Appendix 7

through traders, who collect trees directly from Phims garden and sell either locally or to traders in other provinces. Loan repayment is made both from income from the sale of trees and from animal husbandry which generates a net income of 5 million per year. The livestock enterprise was also financed by a loan from AB. The current loan is the second loan Phim has taken from AB. He would prefer a larger loan with a term of 710 years to more closely reflect the cash flow derived from trees, which take up to 10 years to mature to a more marketable (and profitable) size.

Subproject 4 - Transport Province Location Borrower name AB branch/PCF Subproject purpose Subproject investment cost million $ Loan amount million $ Dong Nai Bien Hoa City Vu Minh Khiem AB Dong Nai Industrial Zones Branch Transport 140 8,860 70 4,430 (maximum allowed by Rural Credit Project [the Project] terms and conditions) 36 0.9 Principal and interest monthly (principal 1.9 million per month) Lien over vehicle notarized registration book retained by AB Income: 536 million over 3 years Expenditure: 140 million over 3 years Net income: 396 million (132 million per year) Other sources of income: n/a Khiem started the business in 1990, producing bamboo and rattan furniture (chairs, settees, cupboards, storage units, etc.) for domestic and export markets. Current export markets include Europe, Japan, and the United States. Most finished products for export are collected from the enterprise by container. Domestic sales are made to local wholesalers and retailers using the enterprises own transport facilities.

Loan term (months) Interest rate (%) Repayment schedule Collateral (value in million) Subproject description and performance (income, expenditure, net income, other sources of income)

Appendix 7

47

As well as producing on-site, the enterprise contracts local households to produce smaller items by delivering the necessary materials to the household and collecting finished goods. Prior to receiving the loan, the enterprise employed 300 people working on a part-time basis to supplement household income. The loan was used to purchase a new 750-kilograms capacity truck to expand production through household producers. The truck enables the enterprise both to expand production and to save on the cost of hiring a truck for delivering materials and collecting finished goods from households. Production capacity is estimated to have increased by 40%, and monthly cost savings amount to around 11 million.

Subproject 5 Quail Farming Province Location Borrower name AB branch/PCF Subproject purpose Subproject investment cost million $ Loan amount million $ Loan term (months) Interest rate (%) Repayment schedule Collateral (value in million) Subproject description and performance (income, expenditure, net income, other sources of income) Dong Nai Thong Nhat Village, Phu Cuong Commune, Dinh Quan District Mrs. Tran Thi Bich Thuy PCF Dinh Quan Branch Quail farming 45 2,850 20 1,265 6 1.35 Principal after 6 months Interest monthly Red book (70) Income: 65 million over 6 months Expenditure: 35 million over 6 months Net income: 30 million (60 million per year) Other sources of income: n/a This commercial enterprise does not sell quail eggs but uses its own hatchery to produce chicks. It sells approximately 5,000 birds per day, each bird weighing approximately 200 grams and selling for around 3,000. It also sells day old chicks at 400 per bird. Most birds are sold to wholesalers who collect the birds from the enterprise and sell in local

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Appendix 7

markets and in other provinces. The current loan and previous loans were used to expand production within the existing level of capacity, incremental net income being used to cover loan repayment. Mrs. Tran would like to expand production further through additional, longer term loans to increase capacity.

Subproject 6 Brick Production Province Location Borrower name AB branch/PCF Subproject purpose Subproject investment cost million $ Loan amount million $ Loan term (months) Interest rate (%) Repayment schedule Collateral (value in million) Subproject description and performance (income, expenditure, net income, other sources of income) Dong Nai Thong Nhat Village, Phu Cuong Commune, Dinh Quan District Le Van Doan PCF Dinh Quan Branch Brick production 70 4,430 20 1,265 6 1.35 Principal after 6 months Interest monthly Red Book (150)

Income: 85 million over 6 months Expenditure: 70 million over 6 months Net income: 15 million (30 million per year) Other sources of income: n/a Lee Van Doan started the business 30 years ago using his own funds and by borrowing from friends and relatives. He first borrowed from AB in 1998 and has borrowed every year since. Because of the limit on funding on AB loans under the Project, he also borrows from the PCF, of which he is a member, at a higher rate of interest than that of AB. All loans are for working capital (fuel, clay, etc.) and for a term of 6 months. They are frequently repaid in advance of the due date. Doan has on occasion reborrowed within a week of repaying a previous loan. The enterprise has a capacity of 540,000 bricks per year; the project loan being used to increase production by

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100,000 bricks per year. It employs 40 people, largely from the local ethnic minority community. Bricks are sold both to wholesalers and directly to local householders. Doan would prefer a larger loan that would avoid borrowing from the PCF at higher rates, and a longer loan term, which would allow for capacity expansion.