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Project Number: PPE: LAO 26563 Loan Number: 1458-LAO (SF) February 2006
Lao People’s Democratic Republic: Second Financial Sector Program
Operations Evaluation Department
Asian Development Bank
ASIAN DEVELOPMENT BANK Operations Evaluation Department
PROGRAM PERFORMANCE EVALUATION REPORT
LAO, PEOPLE’S DEMOCRATIC REPUBLIC
In this electronic file, the report is followed by Management’s response.
CURRENCY EQUIVALENTS Currency Unit – kip (KN)
At Appraisal (1 July 1996) KN1,000 = $1.049 $1.00 = KN9,530 ADB APB BCEL BOL BSRP DMC ESAF FSPL I GDP IFI Lao PDR LDB LMB LXB MOF NPL OEM PCR PPER RRP SAC III SCB SOE SSO TA (i) (ii)
At Project Completion (30 April 2001) = $1.179 = KN8,482.5
At Operations Evaluation (31 October 2005) = $0.093 = KN10,800
– – – – – – – – – – – – – – – – – – – – – – – – –
Asian Development Bank Agricultural Promotion Bank Banque pour le Commerce Extérieur Lao Bank of Lao PDR Banking Sector Reform Program developing member country Enhanced Structural Adjustment Facility First Financial Sector Program Loan gross domestic product international financial institution Lao People’s Democratic Republic Lao Development Bank Lao May Bank Ltd. Lane Xang Bank Ltd. Ministry of Finance nonperforming loan operations evaluation mission project completion report program performance evaluation report report and recommendation of the President Third Structural Adjustment Credit state commercial bank state-owned enterprise Social Security Organization technical assistance
NOTES In this report, “$” refers to US dollars. The fiscal year (FY) of the Government ends on 31 December. “FY” before a calendar year denotes the year in which the fiscal year ends.
Director General Director Team leader Team members
B. Murray, Operations Evaluation Department (OED) D. Edwards, Operations Evaluation Division 2, OED H. Feig, Principal Evaluation Specialist, OED J. Dimayuga, Evaluation Officer, OED A. Silverio, Operations Evaluation Assistant, OED Operations Evaluation Department, PE-678
CONTENTS Page BASIC DATA EXECUTIVE SUMMARY I. INTRODUCTION A. Evaluation Purpose and Process B. Program Objectives DESIGN AND IMPLEMENTATION A. Rationale B. Formulation C. Cost, Financing, and Executing Arrangements D. Procurement and Application of Counterpart Funds E. Consultants F. Outputs PERFORMANCE ASSESSMENT A. Overall Assessment B. Relevance C. Effectiveness D. Efficiency E. Sustainability F. Institutional Development G. Impact OTHER ASSESSMENTS A. ADB and Executing Agency Performance B. Technical Assistance ISSUES AND LESSONS A. Issues B. Lessons iii iv 1 1 1 2 2 3 4 4 4 5 7 7 7 12 16 16 17 17 17 17 19 20 20 22
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. The report was prepared by the team leader. Field work was undertaken by the team leader and Kirsten Boe (international consultant/banking specialist) with the assistance of Khamsouk Phommarath (domestic consultant/legal specialist). To the knowledge of the management of OED, there were no conflicts of interest among the persons preparing, reviewing, or approving this report.
APPENDIXES 1. 2. 3. Summary of the Status of Compliance with Program Components and Conditions Macroeconomic, Financial Sector, and Social and Poverty Indicators 1995–2004 and Financial Statements of State Commercial Banks Design and Monitoring Framework 24 30 35
BASIC DATA Loan 1458-LAO(SF): Second Financial Sector Program
PROGRAM IMPLEMENTATION TA Number TA 2642 TA 2643 PersonMonths 27 3 Amount ($’000) 954 130
TA Title Restructuring and Consolidation of the State-Owned Commercial Banks Development of an Interbank Market
Type ADTA ADTA
Approval Date 12 September 1996 12 September 1996
KEY PROGRAM DATA ($ million) Total Program Cost ADB Loan Amount/Utilizationa ADB Loan Amount/Cancellation KEY DATES Expected Fact-Finding Loan Negotiations Board Approval Loan Agreement Loan Effectiveness First Tranche Release Second Tranche Release Program Completion Loan Closing Months (effectiveness to completion) TRANCHE RELEASES First Tranche Release Conditionsb Second Tranche Release Conditionsc c Other Program Conditions d All Conditions BORROWER EXECUTING AGENCY MISSION DATA Type of Mission Pre-Fact-Finding/Fact-Finding Appraisal Review Program Completion Review Operations Evaluation Number of Missions 2 1 14 1 1 Amount ($ million) 12.4 11.2
As per ADB Loan Documents 25.0 25.0 0.0
Actual 23.6 23.6 0.0
13 Nov 1996 6 Dec 1996 31 Oct 1998 31 Oct 1999 6 Jun 2000 36
Actual 23 Jan–5 Feb 1996 14–15 Aug 1996 12 Sep 1996 6 Nov 1996 6 Dec 1996 6 Dec 1996 4 Aug 2000 30 Apr 2001 30 Apr 2001 54
Met 4 12 7 15
Number of Policy Conditions Substantially Met Partially Met Not Met 0 0 0 0 1 0 1 1 1 2 11 1
Lao People’s Democratic Republic Bank of Lao PDR
Number of Person-Days 102 75 146 16 11
ADB = Asian Development Bank, ADTA = advisory technical assistance, TA = technical assistance. a Equivalent to SDR17.15 million. b ADB. 1996. Report and Recommendation of the President to the Board of Directors on a Proposed Loan and Technical Assistance Grant to the Lao People’s Democratic Republic for the Second Financial Sector Program. Manila. (Loan 1458-LAO[SF], for $25 million, approved on 12 September 1996). c Assessment of Board Information Paper on Second Tranche Release (Loan 1458-LAO[SF], for $25 million, approved on 12 September 1996). d Operations evaluation mission assessment.
EXECUTIVE SUMMARY The Asian Development Bank (ADB) has been supporting financial sector development in the Lao People’s Democratic Republic (Lao PDR) since 1988, first through technical assistance, and then through the first Financial Sector Program Loan (FSPL I), to facilitate the establishment of a market-oriented economic system. FSPL I sought to (i) strengthen the overall financial sector policy and legal environment, (ii) enhance its institutional base, and (iii) promote the reform of state-owned enterprises (SOEs) and the development of private enterprise. The recapitalization of the insolvent state commercial banks (SCBs) was a cornerstone of FSPL I. However, as recapitalization was delinked from any meaningful operational restructuring of the SCBs, including improvements of their credit systems, or measures to strengthen corporate governance, improvements in their financial performance proved to be unsustainable. A number of financial-sector related laws promoted under FSPL I still required approval or operationalization through implementing decrees and capacity-building measures to make them effective. To continue its support for policy reforms begun under FSPL I, ADB approved Loan 1458-LAO(SF): Second Financial Sector Program (the Program) for $25 million equivalent on 12 September 1996. The Program was to (i) improve SCB operations through consolidation, corporatization, capacity building, and exploration of joint-venture and other divestment options; (ii) improve banking supervision; and (iii) put in place the required financial infrastructure including the institutional and regulatory framework for an interbank market, a credit information bureau, and a deposit protection fund, and the legal basis for secured transactions, negotiable instruments, leasing, and pension funds. The first tranche was disbursed shortly after the loan took effect on 6 December 1996. The second tranche was released in August 2000, about 21 months later than first planned. The Program is rated partly successful bordering on unsuccessful. It sought to address a number of pertinent structural issues for longer-term financial sector development in the country. However, Program relevance was reduced by design flaws, most notably in the area of SCB restructuring. The findings of ADB-financed reviews of SCB loan portfolios as of 30 June 1995 should have resulted in (i) concrete measures to make the SCBs more profitable, resolve significant nonperforming loan (NPL) problems, and limit the potential for more bad loans. Tranche releases under the Program should have been linked to improvements in bank performance, debt recovery, and meaningful operational restructuring. Instead, the Program pursued a hand-off approach to operational restructuring and sought to improve SCB governance mainly through corporatization, consolidation, and external investment or management without realizing that there was not enough support from senior decision makers at central and provincial government levels for the underlying principle of increased SCB autonomy, as evidenced by continued non-commercially motivated lending. The strong influence of regional governments on SCB branch operations and of line ministries on SCB lending decisions should have warranted more attention. While SOE restructuring was identified as an important condition for SCB restructuring, related conditionality was omitted from the Program, as this and other public sector management issues were to be addressed under parallel programs supported by the International Monetary Fund and the World Bank. These programs were later suspended during the financial crisis, which hit the country in 1998. The country’s crisis was mainly the result of imprudent macro-economic management—fiscal expansion was financed through monetization—and significant reductions in new investments and trade by Thailand in the aftermath of the Asian financial crisis. While the crisis did not have a direct bearing on the achievability of the ADB-supported Program, which mainly comprised medium-term structural measures, it did affect the performance of the banking system and, therefore, the achievement of Program outcomes. The Program should have included specific conditionality related to the discontinuation of non-commercially motivated lending or, at the
v very least, required that such lending be guaranteed by the Government. A number of other sector, macroeconomic, and overall governance problems and conditions were not sufficiently assessed despite ADB’s previous involvement in the sector and the country. For example, the potentially negative impact of dollarization on monetary management and bank restructuring was neither considered nor actively addressed at the program design stage, although the rate of dollarization exceeded 42% in 1995. Although the majority of the policy conditions under the Program were met, many failed to achieve the intended outputs and, ultimately, outcomes. The key objectives of the Program according to the report and recommendation of the President were to (i) mobilize more domestic savings, particularly long-term savings, and allocate them efficiently to promote private sector development; and (ii) strengthen macroeconomic management by developing a sound and market-responsive banking system. While financial depth and savings levels have increased slightly since 1995, banking sector efficiency and soundness have not improved. The growth of credit as a share of gross domestic product (GDP) stagnated, and the share of private sector credit decreased from about 80% of net domestic credit to the economy in 1995 to about 60% in recent years. NPL levels for SCBs, which continue to dominate the country’s banking system, increased from 33% of total SCB loans in mid-1995 to about 52% in 2000, and a reported 64% in 2004. SCB restructuring measures under the Program, in particular the consolidation and formal governance changes, did not lead to any improvements in credit and risk management practices. Because of lack of progress with SOE, fiscal, and overall governance reforms, SCBs continued to be subject to external pressures to lend on a noncommercial basis. Plans to improve the autonomy and commercial orientation of SCBs through joint ventures, divestment, and other arrangements proved to be unrealistic, as foreign investors showed no interest in acquiring or managing any of the state banks. Program efforts to improve banking sector operations through strengthened banking supervision remained ineffective because of the conflicting roles of Bank of Lao PDR (BOL) staff as SCB managers and banking system supervisors. The negative capital positions of SCBs did not trigger an adequate supervisory response from the BOL during the Program period. Despite useful program achievements in establishing an institutional and regulatory framework for interbank market operations, a formal market has not evolved because of weaknesses in the macroeconomic environment and the lack of incentives for banks to improve liquidity management. The establishment of an effective secured transactions regime continued to be constrained by deficiencies in the legislation approved under the Program. Nevertheless, a number of program conditions were effective. Among these were (i) the adoption of a chart of accounts by all banks and the completion of international audits for SCBs, which gave the Government and the international financial institutions (IFIs) a better understanding of the financial position and performance of the banks; (ii) the establishment of a credit information bureau within BOL, which is being used, albeit not as comprehensively as might be desired; (iii) the creation of a legal basis for negotiable instruments; and (iv) the passage of legislation to establish a social security fund/pension scheme for employees of public and private enterprises. Sustainability of program outcomes is less likely. The Program began the consolidation and corporatization of SCBs and thus provided a platform for expanded policy dialogue on these issues under the ongoing ADB-supported 2002 Banking Sector Reform Program (BSRP). As a result of performance-based governance agreements entered into in April 2003 by the Ministry of Finance, BOL, and SCB managements under BSRP, noncommercial lending and associated NPL levels have reportedly been reduced. However, significant efforts will need to be made to (i) reduce pressure for non-commercial lending through further SOE restructuring and strengthened fiscal management, (ii) improve governance in the banking system, and (iii)
vi reinforce the secured transactions regime to ensure the full effectiveness and sustainability of the Program. The Program and its associated technical assistance grants contributed only in a limited way toward building capacity to undertake financial reforms and bank restructuring. Associated TAs 2642-LAO and 2643-LAO are rated as partly successful mainly due to limited effectiveness. The Program did not significantly improve the incentive systems under which the SCBs operate. This situation was worsened by the Program’s unstructured approach to SCB consolidation. Experience with financial sector assistance in the Lao PDR highlights the need for a comprehensive capacity development strategy that is not limited to addressing requirements for training and advisory services, but also covers overall policy, governance, and other incentive structures that have an impact on the effectiveness of such assistance. The OEM confirms international experience gained with policy-based lending and state bank restructuring in similar countries. Lessons identified in conjunction with the Program include the need to (i) carefully assess political economy and overall governance factors that affect banking sector performance determine, particularly credit allocation and recovery decisions; (ii) obtain up-front high-level commitment to a comprehensive reform agenda that addresses all relevant issues; (iii) properly sequence various financial sector reform efforts, and coordinate them with simultaneous reform efforts related to SOE restructuring, and public sector and fiscal management, as well as with legal and judicial reforms that improve the environment for secured transactions and debt recovery, as necessary; (iv) carefully assess the financial position of banks prior to their restructuring, agree on time-bound state bank restructuring plans with meaningful financial and operational performance targets, and link disbursement of program tranches to compliance with targets; (v) adequately consider and mitigate capacity constraints to the identification and implementation of reforms; and (vi) consider the potential impact of the macroeconomic environment on the feasibility of financial sector reforms.
Bruce Murray Director General Operations Evaluation Department
I. A. Evaluation Purpose and Process
1. Loan 1458-LAO(SF): Second Financial Sector Program1 (the Program) was selected for evaluation. As the Asian Development Bank (ADB) has ongoing and planned operations in the financial sector in the Lao People’s Democratic Republic (Lao PDR), the evaluation findings should be useful in helping determine future activities and follow-up policy dialogue to ensure the achievement and sustainability of program outcomes. The assessment was based on the following broad criteria proposed in the ADB Guidelines for the Preparation of Performance Evaluation Reports for Public Sector Operations: (i) relevance, (ii) effectiveness, (iii) efficiency, (iv) sustainability, and (v) institutional development impact. International experience gained in bank restructuring was considered in evaluating the adequacy of the approach. The program performance evaluation report (PPER) also suggests lessons for future ADB assistance for financial sector reforms and bank restructuring. This report was prepared by the operations evaluation mission (OEM) that visited Lao PDR from 24 October to 3 November 2005. The OEM reviewed program-related documentation and other background materials, and met with ADB staff involved in the design and formulation of the Program and with key stakeholders in Lao PDR including representatives of Bank of Lao PDR (BOL), the Ministry of Finance (MOF), state commercial banks (SCBs), the Social Security Organization, private commercial banks, the International Monetary Fund, and the World Bank. 2. A comprehensive and informative program completion report (PCR) prepared by the Governance, Finance, and Trade Division of Mekong Department in January 2002 rated the Program only partly successful because of deficiencies in program design and implementation, and its limited contribution to its broad objectives of deposit mobilization and improved macroeconomic management. Although many policy actions had not yet achieved their intended effects, the PCR nevertheless assessed a number of the reforms promoted under the Program to be sustainable and to have contributed to creating conditions for the further development of a market-driven financial system. The reforms fell into the following categories: (i) institutional (establishment of a credit bureau and of a separate banking supervision department in BOL); (ii) regulatory (adoption of regulations on interbank borrowing and supervision of the interbank foreign exchange market, and of an implementing decree for secured transactions legislation); and (iii) legal (adoption of laws on leasing and social security, and of a decree on bills of exchange and promissory notes). According to the PCR, the Program had underestimated capacity constraints, the complex legislative process, and the level of government ownership and commitment to reform. B. Program Objectives 1. Loan 1458-LAO(SF)
3. The key objectives of the Program were to (i) mobilize more domestic savings, particularly long-term savings, and allocate them efficiently to promote private sector development; and (ii) strengthen macroeconomic management by developing a sound and market-responsive banking system. Program components comprised (i) restructuring and consolidation of the seven SCBs; (ii) strengthening of the autonomy and commercial orientation
ADB. 1996. Report and Recommendation of the President to the Board of Directors on a Proposed Loan and Technical Assistance Grant to the Lao People’s Democratic Republic for the Second Financial Sector Program. Manila. (Loan 1458-LAO[SF], for $25 million, approved on 12 September 1996).
2 of SCBs; (iii) strengthening of the supervisory function of BOL through the adoption and enforcement of prudential regulations; (iv) establishment of market infrastructure; and (v) development of human resources and capacity building in the SCBs and the Agricultural Promotion Bank (APB). 2. TA 2642-LAO: Restructuring and Consolidation of the State-Owned Commercial Banks, and TA 2643-LAO: Development of an Interbank Market
4. The aim of technical assistance (TA) grant 2642 was to “restructure and consolidate SCBs, strengthen their financial and management capabilities, enhance their public image, increase public confidence in their stability and viability, and make them respond efficiently to the banking demands of the private sector.” The TA was to assist the Government and BOL in (i) carrying out the key implementation components of the Program; (ii) consolidating the SCBs and reducing their number from seven to two, to make them efficient and financially sound; (iii) setting up a deposit protection scheme; (iv) paving the way for a joint venture by corporatizing SCBs, valuing the assets, and fixing a selling price; (v) identifying joint-venture partners, management contracts, and ways of reducing government ownership of SCBs; (vi) establishing a credit information bureau; and (vii) developing an effective campaign for mobilizing more deposits. 5. The main objective of TA 2643 was to assist the Lao PDR monetary authorities in promoting the development of an interbank market by (i) identifying the best strategy for market development; (ii) helping to establish the institutional framework, procedures, and guidelines to ensure the normal operation and adequate supervision of the market; and (iii) training bankers involved in the market. II. A. Rationale DESIGN AND IMPLEMENTATION
6. ADB has supported financial sector development in Lao PDR since 1988, first through TA programs, and later through the first Financial Sector Program Loan (FSPL I),2 which was to help create a basic framework for a market-oriented financial system by (i) strengthening the overall financial sector policy environment, (ii) enhancing its institutional base, and (iii) promoting state-owned enterprise (SOE) reform and private enterprise development. The recapitalization of the insolvent SCBs was a cornerstone of FSPL I. However, as recapitalization was delinked from any meaningful operational restructuring of the SCBs or measures to strengthen corporate governance, improvements in their financial performance proved to be unsustainable. A number of laws promoted under FSPL I still required approval or operationalization through implementing decrees and capacity-building measures to make them effective. To continue ADB’s support for policy reforms begun under FSPL I, FSPL II was to (i) improve SCB operations through consolidation, corporatization, capacity building, and exploration of joint-venture and other divestment options; (ii) improve banking supervision; and (iii) put in place the required financial infrastructure including (a) the institutional and regulatory framework for an interbank market, (b) a credit information bureau and a deposit protection fund, and (c) the legal basis for secured transactions, negotiable instruments, leasing, and pension funds. Program content was in line with stated government priorities and ADB country
ADB. 1990. Report and Recommendation of the President to the Board of Directors on a Proposed Loan and Technical Assistance to the Lao People’s Democratic Republic for the Financial Sector Program. Manila. (Loan 1061-LAO[SF], for $25 million, approved on 6 December 1990).
3 strategic objectives at the time, which supported the transition of Lao PDR to a market-based economy. B. Formulation
7. The Program was formulated without the benefit of a project preparatory technical assistance (PPTA) in a relatively short time (about 19 months from the first discussions with the Government to Board consideration). It was felt that ADB’s prior involvement in the sector and the country made a PPTA unnecessary. A large part of the program measures were a continuation of ADB’s earlier policy dialogue on financial sector reforms, and many of the Program’s policy conditions related to legal reforms were indeed carried over from FSPL I. However, other policy conditions, particularly those related to SCB corporatization, the establishment of a deposit protection scheme, and the establishment of a legal framework for leasing, were apparently derived from ADB-supported sector programs in other developing member countries (DMCs), notably Viet Nam,3 rather than being reform priorities appropriate for Lao PDR. In addition, several conditions, namely those related to the establishment of an interbank market and the strengthening of BOL’s banking supervision function, followed from parallel efforts by the International Monetary Fund under the Enhanced Structural Adjustment Facility (ESAF) and the World Bank under the third Structural Adjustment Credit (SAC III), with which the Program was coordinated. Structural ESAF benchmarks included the (i) implementation of a foreign exchange auction system, (ii) implementation of a reserve money program, (iii) adoption of prudential regulation on foreign currency exposure in commercial banks, (iv) adoption of a plan to enhance banking supervision, (v) adoption of a plan to restructure SCBs, (vi) removal of minimum interest guidelines on deposits, (vii) completion of a review of agricultural lending policies, and (ix) passage of legislation on negotiable instruments. Besides public sector management and SOE reforms, SAC III supported the (i) introduction of prudential banking regulations for capital exposure, exposure limits, asset classification standards, enforcement powers, and treatment of failed banks; (ii) adoption of a uniform chart of accounts for SCBs; (iii) enforcement of loan loss provisions for SCBs; and (iv) independent audits of the 1995 SCB accounts. However, as the Government could not meet its macroeconomic targets during the Asian financial crisis, the ESAF was suspended in May 1997, and the second tranche of SAC III canceled in December 1998. 8. A review of project files and interviews with ADB staff and government officials did not indicate that different policy options had been considered in the design stage, or that the proposed policy actions and their underlying objectives and principles had in fact been discussed in detail. Various issues and their possible solutions were to be analyzed in detail under the associated TA after the Program was approved. This explained in part the lack of discussion at the design stage but also made it difficult to gauge and obtain up-front government commitment to the full reform Program. BOL nevertheless affirmed that government ownership of the program reform agenda was high. ADB does not appear to have imposed any policy conditions against the Government’s wishes. If there were objections to the program reform agenda, they were not raised formally during processing. Implicit objectives presumably played a role in the Government’s support for the Program. The current account deficit had widened to 15% of gross domestic product (GDP) by the end of 1994, causing inflation to accelerate to more than 20% in 1995–1996. The overall fiscal deficit on a commitment basis was 9.7% of GDP in fiscal year 1994–1995, and was funded mainly through foreign financing.
ADB. 1996. Report and Recommendation of the President to the Board of Directors on a Proposed Loan and Technical Assistance Grant to the Socialist Republic of Viet Nam for the Financial Sector Program. Manila. (Loan 1485-VIE[SF], for $90 million, approved on 19 November 1996).
Cost, Financing, and Executing Arrangements
9. The Program was approved on 12 September 1996 and comprised (i) a policy loan of $25 million equivalent (SDR17,151,000) to be disbursed in two equal tranches, and (ii) two TA grants to (a) support the restructuring and consolidation of SCBs, and (b) develop an interbank market. The costs associated with the Program were estimated at between $28 million and $38 million, mainly for SCB recapitalization needs, market infrastructure, and capacity-building expenses. The first tranche was disbursed shortly after the loan took effect on 6 December 1996. The second tranche was released in August 2000, more than 22 months later than planned. The Program was originally scheduled to end in December 1999 but actually closed in April 2001. BOL was the Executing Agency for the Program with responsibility for overall program implementation, and coordination with MOF and other relevant authorities. D. Procurement and Application of Counterpart Funds
10. Program loan proceeds were withdrawn according to ADB’s standard disbursement procedures and used to finance imports of goods and services produced in and procured from ADB member countries. Most of the imported foods came from Thailand (48%), Singapore (38%), and Viet Nam (14%). E. Consultants
11. Under TA 2642, consulting firm was hired to provide 30.5 person-months of advisory services. The consulting team comprised seven experts, who delivered services of generally acceptable, but varying, quality. The project department considered the firm’s performance as satisfactory bordering on marginal because of non-delivery of the SCB restructuring plans, lack of efforts in identifying external management options, and non-performance of the legal and regulatory specialist, who had to be replaced, which delayed the implementation of related conditionality. However, failure to produce the restructuring plans was due to a range of factors including lack of relevant focus under ADB’s policy dialogue, delayed availability of financial information, the SCB consolidation process. In the first phase, the consultants reviewed banking and other relevant legislation, and produced plans for SCB corporatization and consolidation, a strategy for deposit mobilization, and blueprints for a deposit protection scheme and the credit information bureau. With respect to the deposit mobilization strategy and the deposit protection scheme, consultant performance was considered as average. Consultant recommendations were appropriate, although the task at hand was less relevant. In the second phase of the TA, the team leader assisted BOL in program implementation, coordination, and reporting. No training was provided under the TA. With the savings from the TA, individual consultants were recruited in the latter part of 1999 to review the credit portfolios of the SCBs and assist them in developing loan recovery strategies, and to draft an implementing decree for secured transactions. Under TA 2643, consultants were contracted through another consulting firm for a total of 3 person-months to produce (i) a strategy outlining recommended policy and institutional actions for the establishment of an interbank market, (ii) related regulations including a clearinghouse agreement, and (iii) a manual for interbank trading. These consultants’ performance was rated good. They developed an appropriate framework for interbank market operations, mentored relevant BOL staff on technical issues, and conducted a 1-day training seminar on interbank trading for bankers.
5 F. Outputs
12. According to the Board information paper for the release of the second tranche, 20 of the 23 policy conditions under the Program that were not related to the release of the first tranche had been fully complied with. The PCR, in contrast, declared full compliance with only 19 of these conditions; it said that there was only partial rather than full compliance with the conditionality related to the review of subsidized lending for agriculture. Both documents found (i) no compliance with the requirement to increase the SCBs’ autonomy by introducing external ownership or management, (ii) partial compliance with the required enforcement of prudential regulations for SCBs, and (iii) substantial compliance with the requirement to facilitate Treasury bill (T-bill) auctions. Using a narrower definition of compliance, which also considers the effect of the policy measures taken on program output and outcome, the OEM found full compliance with only 13 of the 23 policy measures that were not related to the release of the first tranche (see Appendix 1 for a detailed analysis). Two conditions were substantially complied with, according to the OEM, seven were partially complied with, and one was not complied with. With regard to the four conditions related to the release of the first tranche, OEM determined that only three were fully complied with before tranche release. With regard to conditionality requiring BOL to confirm actual SCB compliance with reporting requirements related to prudential regulations, ADB accepted written confirmation from the SCBs themselves as evidence of compliance. 13. The key outputs achieved by the Program were as follows.
14. Restructuring and Consolidating the State-Owned Commercial Banks. In 1998– 1999, six of the seven SCBs were consolidated into a southern and a northern bank, named after the dominant constituent banks in the respective groupings, i.e., Lane Xang and Lao May Bank. The other state bank, Banque pour le Commerce Extérieur Lao (BCEL), remained intact. The three banks were incorporated in April 1999. The consolidation of the SCBs did not result in any other significant bank restructuring. In 2003, continued lack of performance led to the merger of Lane Xang and Lao May Bank into Lao Development Bank (LDB) under the follow-up Banking Sector Reform Program (BSRP) supported by ADB.4 15. Strengthening the Autonomy and Commercial Orientation of SCBs. Amendments made in 1997 to the Decree on the Management of Commercial Banks stipulated that (i) the SCB board of directors would determine SCB polices, and (ii) MOF would appoint the chairman and other SCB board members. MOF appointed to the boards MOF and retired government officials with no commercial banking or finance experience. In 2000, the law was amended again to make MOF, rather than BOL, responsible for appointing and removing the managing director and other SCB senior managers. However, despite the change, MOF has not fully exercised its right to appoint management, and has instead continued to rely on BOL in this regard. As a condition for loan negotiations, BOL issued an instruction to the SCBs and the APB requiring all lending to be based on “technical, financial and economic” considerations. However, non–commercially motivated credit decisions by SCBs were uncovered in subsequent audits. Compulsory lending to the agriculture sector by the SCBs was discontinued under the Program, although agricultural loans are still being subsidized. APB continues to act as a policy bank.
ADB. 2002. Report and Recommendation of the President to the Board of Directors on a Proposed Loan and Technical Assistance Grant to the Lao People’s Democratic Republic for the Banking Sector Reform Program. Manila. (Loan 1946-LAO[SF], for $15 million, approved on 28 November 2002).
6 16. The Program helped implement other operational restructuring measures for SCBs. In December 1998 BCEL formally adopted “operations manuals” establishing procedures for credit management and other operations, and business plans, which also included deposit mobilization measures. In June 1999, the merged SCBs did the same. To increase transparency and boost incentives to improve performance, the financial statements of the SCBs have been subjected to external independent audits. However, there is little evidence of improved SCB performance as a result of these actions. In fact, SCB performance, including levels of capitalization, capital adequacy, profitability, and portfolio quality, continued to deteriorate after 1996, according to the results of independent audits (Appendix 2). Also, while the expansion in branch operations resulted at first in an increase in deposit volumes, the 1997– 1998 financial crisis led to negative real interest rates, which thwarted further deposit mobilization efforts. 17. Strengthening BOL’s Supervisory Function. The Program helped establish a separate banking supervision function within BOL. It also supported the adoption and implementation of a unified chart of accounts for all banks. BOL has conducted on-site (since 1998) and off-site supervision to help enforce strengthened prudential regulations, which are largely in line with international standards. During the program period, BOL implemented mostly appropriate enforcement actions for private commercial and foreign banks, but exercised regulatory forbearance for SCBs that failed to comply with BOL loan classification/provisioning and capital adequacy standards. Meaningful remedial action plans were formalized only in 2003 under BSRP. 18. Building Market Infrastructure. The Program laid the foundations for the establishment of an interbank market by supporting (i) the issuance of relevant BOL regulations and procedures, (ii) the sale of T-bills through auctions, and (iii) the circulation of higherdenomination kip notes in the market. To help banks screen potential borrowers, BOL established a credit information bureau under the Program. To help mobilize bank deposits, a depositor protection fund was set up within BOL to safeguard small depositors. The Program also helped establish the legal basis for the use of bills of exchange and promissory notes, and for the establishment of a social security system including a pension fund for private sector employees. 19. Upgrading Commercial Banking Skills. A training needs assessment was conducted under TA 2642. The ADB-financed TA 31465 later used the findings in designing a credit training program for SCB and BOL staff that comprised training of trainers, workshops, and onthe-job training. Comprehensive training programs for BOL and SCB staff on all aspects of commercial banking operations have been conducted since 2003 by BOL’s Bank Training Center with support from a bank training project funded by the European Union. The World Bank financed the training of BOL staff in 1998 on the implementation of the new prudential regulations. Under TAs 2642, 3146, and 3466,6 SCBs received further assistance in the implementation of the BOL regulations, as well as in loan classification and provisioning.
ADB. 1998. Technical Assistance to the Lao People’s Democratic Republic for Commercial Banking Capacity for Efficiency Enhancement. Manila. (TA 3146, approved on 24 December 1998, for $500,000). ADB. 1998. Technical Assistance to the Lao People’s Democratic Republic for Strengthening Corporate Governance and Management of State-Owned Commercial Banks. Manila. (TA 3466, approved on 7 July 2000, for $900,000).
7 III. A. 20. Overall Assessment The PPER rates the Program partly successful bordering on unsuccessful. Table 1: Overall Performance Assessment Weight (%) 20 25 25 30 PERFORMANCE ASSESSMENT
Criterion 1. Relevance 2. Effectiveness 3. Efficiency 4. Sustainability Total Ratinga
Rating Value 1 1 1 1
Rating 0.20 0.25 0.25 0.30 1.00
Highly successful > 2.7; successful 2.7 < S < 1.6; partly successful 1.6 < PS < 0.8; unsuccessful < 0.8. Source: OEM Mission
21. The Program was partly relevant. A sound and efficient financial sector is a condition for sustainable economic growth. The development of a functioning market-based banking system is a key reform area for transitional economies like Lao PDR. The scope and focus of the Program were in line with stated country development priorities and ADB country and sector strategies at the time of appraisal. The Program sought to address issues pertinent to financial sector development in Lao PDR, including state bank restructuring, interbank market development, and strengthened banking supervision. However, individual program measures within these broad output areas were not always identified, formulated, and sequenced in a way that was appropriate and suitable for the country, as explained below. 1. Adequacy of Problem Analysis and Design Assumptions
22. Lack of Design and Monitoring Framework to Guide Program Formulation. No such framework was prepared during program formulation. The reconstituted program framework (Appendix 3) shows that a significant number of program conditions, if implemented more effectively, could have contributed to the achievement of program outputs. Most envisaged program outputs were consistent with intended program outcomes, although more careful problem analysis at the outset could have resulted in the inclusion of additional reform measures, particularly in the areas of banking competition, secured transactions and debt recovery, and policy lending. 23. Inadequate Problem Analysis. A number of program actions, particularly the introduction of a deposit insurance system and the hands-off approach to bank restructuring pursued under the Program, would have been more suitable for an essentially stable (or at least sufficiently capitalized) banking system with scope for further strengthening.
8 24. The findings of ADB-financed reviews of SCB loan portfolios as of 30 June 1995 could have alerted program designers to the high probability of a further deterioration in the SCBs’ loan portfolio quality and financial performance in the years to come, which should have resulted in concrete measures to remedy the situation and limit the potential for more bad loans. The portfolio reviews, which were conducted by ADB during program processing, showed average nonperforming loan (NPL) levels (i.e., substandard, doubtful, and lossclassified loans) of about 33% for the six regional SCBs and BCEL, with a range of 19–100%. As a result, two of the regional SCBs needed additional recapitalization just 6 months after they had been recapitalized and their NPLs transferred to a central debt recovery unit. In fact, the international audits of the 1996 accounts under the Program, which were completed only in June 1998, showed significant portfolio and capital problems for the SCBs. By the end of 1997, NPL levels in the various SCBs ranged from 25% to 70%, and all SCBs had negative capital. 25. Further analysis of the nature and causes of the NPL problem would have revealed not only capacity problems, which were recognized at the design stage, but also continued non– commercially motivated lending stemming from unresolved issues in the SOE restructuring, fiscal, and governance areas. Although directed credit programs had been officially discontinued, the SCBs were still under pressure to make loans based on noncommercial considerations. SOE-related NPLs actually account for the majority of SCB NPLs,7 as even unrestructured SOEs continue to be funded through the banking system rather than the budget. Another issue in this regard that warranted more attention at the program design stage is the strong influence that regional governments exert over SCB branch operations. While the consolidation of the SCBs under the Program somewhat diminished the scope for provincial governments to influence banking decisions, local government interference with branch lending decisions continued, as reflected in the use of SCBs to fund local government construction projects.8 26. Inadequate Institutional Analysis. Such an analysis would have revealed the need for BOL to be more independent to ensure adequate checks and balances, and for incentives for banking sector supervision and restructuring. The Program sought to improve framework conditions for SCB operations by strengthening banking supervision through (i) the establishment of a separate banking supervision department, (ii) the adoption of a chart of accounts for all banks, and (iii) the enforcement of strengthened prudential regulations. However, BOL continued to be part of the government structure. Moreover, as BOL effectively retained control over the appointment of SCB management, and often seconded staff to assume these functions, its effectiveness as supervisor was reduced. 27. Insufficient Consideration of Macroeconomic Environment. Other sector and macroeconomic problems and conditions were not sufficiently assessed despite ADB’s previous involvement in the sector and the country. For example, the potential effects of dollarization on monetary management and bank restructuring were neither considered nor actively addressed at the program design stage,9 although the rate of dollarization exceeded 42% in 1995. When
According to estimates by consultants financed under TA 3146, SOE loans accounted for 45% of all SCB loans at the end of 1999, but NPLs associated with SOE loans accounted for 53% of all NPLs. Eighty percent of SCB loans to SOEs were nonperforming at that time. SCBs actually made loans to private construction companies contracted by local governments to build infrastructure projects. When contractors did not get paid for their services, they defaulted on their loans to state banks. The fact that foreign currencies account for the largest component of domestic money supply encourages financial intermediation in a country with poorly developed financial institutions. However, high levels of dollarization also increase the risk of banking crises as commercial banks are induced to become exposed in foreign currencies, while the central bank loses its ability to act as lender of last resort.
9 expansionary fiscal policies, coupled with a decrease in foreign investments in the aftermath of the Asian financial crisis, resulted in a depreciation of the kip by 300%, many unhedged borrowers defaulted on their loans, further increasing already high NPL levels. Banks also suffered revaluation losses associated with unhedged balance sheets. The Program should have recognized the possibility of an increased dollarization of the economy—the rate of dollarization actually went up from about 40%, at the time of loan approval, to more than 90% in 1999—and its impact on the banking system. At the very least, the Program should have included explicit measures to reduce the net open positions of banks and foreign currency lending to unhedged borrowers. 2. Adequacy of Program Design
28. Lack of Coherent Strategy for SCB Restructuring. Given the poor financial situation of most SCBs during the program design phase, the conditionality under the Program should have specifically required the preparation and enforcement of remedial action plans for the banks with time-bound restructuring and performance targets from the outset to avoid a further deterioration of SCB’s financial performance. The situation was further complicated by the fact that improved loan classification standards were approved only in 1998. Proper sequencing of the bank restructuring process would have involved (i) the adoption of adequate prudential regulations and loan classification and provisioning standards, (ii) the completion of international audits of the SCBs, (iii) the preparation of an analysis of the causes of portfolio and other bank performance problems, (iv) the design of a bank restructuring program, (v) highlevel support for the program and other suitable measures to stop the flow of NPLs, and (vi) continued enforcement of the restructuring program. SCB consolidation should have been part of overall operational bank restructuring efforts. 29. The underlying rationale for the consolidation of seven regional SCBs into less than four SCBs, a key condition under the Program, was designed to make the resulting banks more competitive by increasing their efficiency and the size of their capital and asset bases. However, without a bank restructuring strategy, these objectives were not achieved. During program implementation, it was decided to merge the six regional SCBs into two groups: (i) Lao May Bank Limited (comprising Lao May Bank, Phak Tai Bank, and Nakhoneluang Bank), and (ii) Lane Xang Bank Limited (comprising Lane Xang Bank, Aroun May Bank, and Sethathirath Bank). TA consultants had recommended a different grouping to maximize the strengths of the three southern banks (i.e., Lao May Bank, Phak Tai Bank, and Sethathirath Bank), given their branch networks and the anticipated increase in commercial activity in the southern part of the country due to improved road linkages with Thailand and Viet Nam. The Government and BOL, however, insisted on having regional banking groups of equal size. Although much time and energy was spent on allocating banks to the regional groupings, project files and interviews with government, SCB, and ADB staff did not indicate why two regional banking groups were contemplated at all. Lane Xang Bank and Lao May Bank were later merged under BSRP to form the new LDB. The interim solution of two regional SCB groups added operational complexities and costs, and delayed the unification of policies, systems, and procedures throughout the branch network. More importantly, as the rationale for this consolidation was not made explicit, no meaningful actions were taken to benefit from the consolidation in terms of (i) branch rationalization, (ii) the adoption of a unified corporate culture, and (iii) the establishment of better systems. The only tangible effect seems to have been an upscaling of lending operations, i.e., the extension of larger loans. Presumably, banking consolidation was also motivated by the desire to delink banks from regional government influence and to increase economies of scale. In this case, a direct consolidation of the six SCBs into one SCB would have made more sense. If the rationale and principles for bank consolidation had been made explicit and had been
10 agreed upon during program formulation, and the costs and benefits associated with various merger options assessed during program preparation, a more rational approach, i.e., consolidation into one SCB, might have been pursued. It would have facilitated the timely introduction of common policies, systems, and procedures, as well as the supervision and oversight of the bank by BOL and MOF. Instead, time and money were spent on developing business plans and strategies for entities that existed for less than 3 years. A completely different approach to decreasing the number of banks in the system that should have at least warranted consideration would have been to close down the worst-performing SCBs and build the remaining banks into strong regional players. However, this option might have had its own set of problems, and probably would not have been politically feasible. 30. Despite significant NPL levels at the time of program approval, the Program did not include any measures or performance targets to encourage debt recovery by SCBs or stop the flow of new NPLs. Concerted efforts by the Program to strengthen the capacity and incentives of banks for NPL resolution might have improved its outcome. 31. Insufficient Consideration of Other Economic and Governance Reform Needs. Although lack of progress with real sector reforms, in particular with regard to the commercialization and privatization of SOEs, was identified as a potential risk, ADB decided not to address these issues directly under the Program, and instead rely on the Government to advance structural reforms in these areas in conjunction with the International Monetary Fund’s ESAF and the World Bank’s SAC III. Despite the continued privatization of SOEs after 1995 and the increasingly dominant role of private investment, credit to the private sector as a share of total credit decreased from about 75% in 1995 to 63% in 2004. Large utilities and other strategic industries were not included in the privatization program and continue to be state-owned, like a number of other nonstrategic enterprises.10 While a division of responsibilities for policy dialogue among international financial institutions (IFIs) was a reasonable strategy for designing a focused policy program, the Program should have included a specific conditionality discontinuing non–commercially motivated lending or requiring that such lending be guaranteed by the Government.11 A suitable policy response with regard to the prevention of lending for construction projects by local authorities would have been to require banks to verify the existence of special budgetary allocations before lending to private construction companies undertaking public investment projects, and to ask that such lending be backed up with appropriate government guarantees. 32. Overall, banking sector restructuring under the Program might have been more effective if macroeconomic and fiscal management issues had also been proactively addressed in tandem. As a matter of principle, any subsidies for public sector projects and state enterprises should be paid from the budget. Timely efforts to enhance public expenditure management through improvements in expenditure planning and budgeting, budget execution, accounting, and reporting both at the central and provincial level, as later envisaged under the new Public Expenditure Management Strengthening Program, could have helped reduce NPLs associated with government investments. 33. Program attempts to strengthen SCB governance through corporatization, in an environment that did not provide the right incentives and conditions for commercial decision
There are currently 140 SOEs operating in the country. The issuance of a BOL instruction to state banks requiring them to lend only on the basis of “technical, financial, and economic considerations” that were not further defined was a condition for loan negotiations. However, compliance with this instruction was not subsequently monitored or enforced.
11 making, were doomed to fail. Support from senior decision makers at central and provincial government levels for more SCB autonomy should have been evidenced by formal commitments to abstain from influencing lending and other bank management decisions. 34. The Program did not continue ADB’s support for private sector development started under FSPL I, which promoted the establishment of a legal framework for private business and a central company registry. A number of constraints related to enterprise registration and licensing, property rights, taxation, business development services, and foreign investment continue to hamper enterprise development, and thus limit banks’ range of viable borrowers. In addition, debt recovery problems and lack of non-collateral-based credit skills have affected the ability of banks to lend to small and medium enterprises. 35. Suitability of Program Measures for the Country. Efforts to increase SCB autonomy through divestment to and joint ventures with foreign banks did not succeed. While TA 2642 assessed divestment options, there was little interest on the part of potential foreign strategic investors to acquire a stake in any of the SCBs. A review at the program design stage of the factors driving strategic bank investments would probably have determined this option to be nonviable in the short term.12 36. Generally, international commercial banks setting up operations in foreign countries would rather build up these operations from scratch than buy existing banks. The Program did not contemplate any measures to increase competition from private domestic and foreign banks, and thus provide SCBs with incentives to improve their performance, nor did it actively pursue other external management options such as twinning arrangements or the placement of international bank advisers. 37. Inadequate Sequencing of Financial Sector Reforms. Successful bank restructuring is a condition for interbank market development and the introduction of a deposit insurance scheme, as is a certain degree of macroeconomic stability. Deposit protection schemes are usually introduced only when banking systems are stable and the likelihood of a banking crisis is remote. This has not been the situation in Lao PDR, given the negative capital position of the largest banks and the inability of the central bank to act as lender of last resort. Assuming current deposit levels, it will take many years before the deposit protection fund will have enough resources to provide the envisaged coverage of up to KN15 million per kip account. In the meantime, the Government would have to make up any shortfalls in the fund in case of bank failures. It is not clear whether the inherent capping of implicit government guarantees for SCB depositors would be politically acceptable should an SCB fail. The stated objective for such a deposit protection fund at the time of program formulation was to help mobilize deposits by strengthening depositor confidence in the banking system. Overall deposit volumes as a share of GDP did not increase significantly after the scheme was introduced in January 2000. From 14.2% as of year-end 1999 their share rose to only 16.9% in 2003, although the share of deposits held in non-state banks grew from 21.6% to 26.4% over the same period. The tradeoffs between building up a dedicated depositor protection fund over time and having to deal with the financial burden this poses on undercapitalized banks need to be carefully assessed.
Only a very few international banks have been actively looking to invest in banks in ADB’s DMCs. Their interest has been usually limited to well-established midsize banks in the larger and more developed banking markets in the region. Exceptions to this situation have been investments in smaller markets with viable project finance potential, in which case commercial banking activities are usually only pursued on a limited scale.
12 C. Effectiveness
38. The Program was less effective. The key objectives of the Program, according to the report and recommendation of the President (RRP), were to (i) mobilize more domestic savings, particularly long-term savings, and allocate them efficiently to promote private sector development; and (ii) strengthen macroeconomic management by developing a sound andresponsive banking system. As no program framework was prepared at the time of Program processing, this evaluation considered increased financial intermediation levels as the intended program impact, and improved soundness and efficiency of the financial system as the intended program outcomes. While financial depth (M2/GDP) and savings levels (deposits/GDP) increased, the banking system has not become more sound and efficient. The share of credit to the private sector in net domestic credit to the economy decreased during that period, while domestic credit as a share of GDP grew only marginally, from 9.8% to 10%. The NPL levels of the SCBs increased substantially from 1995 to 2004 (also see Appendix 2). Table 2: Program Effectiveness
1995 During Program Processing (%) 13.6 10.6 82.2 6.0 33.0 a 2000 At Program End (%) 16.5 15.9 60.0 10.0 52.0 b 2004 At Program Evaluation (%) 20.9 18.2 62.7 9.0 64.0 c
Item Financial Depth Efficiency
Indicators • M2 to GDP ratio • Deposits to GDP ratio • Credit to private sector to Net domestic credit to the economy • Interest rate margin • NPLs to Total SCB loans ratio
GDP = gross domestic product, NPL = nonperforming loan, SCB = state commercial bank. As of 30 June 1995, according to estimates of ADB consultants. b As estimated by ADB consultants. c As reported by SCBs. Source: IMF. 2004 and 2005. International Financial Statistics. Washington, DC.
39. Financial intermediation might have increased more significantly without the 1997–1998 Asian financial crisis. The crisis, particularly the overshooting of the exchange rate (inflation increased by 150% while the exchange rate depreciated by 300%), contributed to temporarily reduced intermediation levels and an increase in NPL levels. Unaddressed deficiencies in the financial system—particularly continued unsound lending practices—and their role in the dollarization of the economy made the country more vulnerable to macroeconomic instability. 40. While most Program conditions were technically met, many of them failed to produce the outputs needed to achieve intended outcomes. In some cases (e.g., SCB restructuring and consolidation), this was the result of inadequate identification and selection of Program measures due to deficiencies in problem analysis and design. In other cases (e.g., legal reforms, enforcement of prudential regulations by SCB), measures were not properly implemented which could be indicative of inadequate assessment and consultation at the program formulation stage. Other factors responsible for shortfalls in the intended program outcomes include (i) the focus during Program design and implementation on policy conditions rather than outcomes; (ii) the opaque wording of Program actions, which did not include a
13 description of underlying principles and intent of the conditionality, making it difficult to reach a common understanding on what constitutes compliance and to monitor achievements (but making it easier to justify tranche releases even without meaningful reform efforts); and (iii) poor follow-up of continued compliance. 1. Ineffective Program Measures
41. Areas in which little progress was made include (i) SCB restructuring, (ii) the development of a formal interbank market, (iii) the development of a leasing market, and (iv) the establishment of an effective secured transactions regime. 42. SCB Restructuring. SCB consolidation and formal governance changes did not lead to any meaningful operational restructuring or improvements in credit and risk management practices of SCBs, which are necessary for banking sector soundness. Capacity-building efforts related to the preparation and adoption of operations manuals and business plans provided in conjunction with the Program were just as ineffective. While the Program required SCBs to adopt operations manuals and business plans, the principles underlying the use of these documents were not specified. The business plans developed by the banks under the Program in 1998 and 1999 were not suitable for guiding the necessary changes in the operations of the banks. Performance indicators were not based on audited financial information and meaningful analysis, focusing on growth-oriented deposit and lending targets instead of profitability. Operations manuals were not conducive to assisting staff in making sound credit decisions, as they consisted mainly of BOL policy instructions rather than operating procedures. TA 3466 (footnote 6) in 2000 aimed, among other things, to make the operational manuals more useful for credit management with the help of operational guidelines and work aids. In 2003, the international bank advisers in the SCBs produced yet another set of credit manuals. Despite the corporatization of the SCBs under the Program, the overall corporate governance framework and continued external interference in lending decisions at the time did not encourage bank management to improve credit and risk management practices, as evidenced by the persistently poor financial results of the banks and the high NPL levels after 1996. To facilitate better enforcement of prudential regulations for SCBs and justify the release of the second tranche under the Program, ADB, in 2000, required BOL and the SCBs to submit an enforcement plan to bring SCBs in line with required standards and achieve sustainable operations by 2002. The plan comprised actions related to (i) debt recovery (the organization of an internal debt recovery unit and the recruitment of workout specialists); (ii) governance (improved loan loss provisioning, reporting, adequate recognition of off-balance-sheet items and loan losses, the establishment of an MOF unit to exercise MOF’s ownership rights in SCBs, the approval of corporate governance policies, and the requirement that all directed lending would need prior MOF approval); and (iii) operational restructuring measures to enhance the banks’ efficiency. TA 3466-LAO was designed to assist BOL and the state banks in implementing the plan. However, as there were few incentives to comply with the plan after the second tranche of the Program was released in August 2000, the plan was not fully implemented. As a result, the financial performance and capital position of the SCBs continued to deteriorate between April 2000 and early 2003, with NPL levels for loans approved during that period exceeding 50%. The Government continued to use SCBs for financing not only local but also central government investment projects that did not have the necessary budget provisions.13 These loans are estimated to account for about half of the “flow NPLs,” i.e., NPLs that were approved after 31 December 1999.
The Government eventually started to issue bonds to banks in exchange for these loans, albeit with significant time lags and below-market pricing, at the inflation rate plus 1%.
43. Banks report that NPL levels for loans made since performance-based governance agreements between SCB managements, the MOF, and BOL took effect on 1 April 2003 have fallen significantly compared with NPL levels associated with earlier loans. This will have to be verified through the ongoing independent audits of the 2004 SCB accounts. Significant improvements in lending performance would indicate that FSPL II could have been more effective if the Program had promoted the more hands-on approach to state bank restructuring taken under BSRP, i.e., (i) the use of performance-based governance agreements between bank managements, BOL, and MOF; (ii) the strengthening of SCB management through international advisers who are consulted in lending decisions; and (iii) the linking of tranche releases to actual performance improvements. If, on the other hand, BSRP turns out to be equally ineffective and noncommercial lending continues, it can probably be concluded that (i) the Government is not prepared to accept the establishment of a truly market-based banking system free of government intervention; and (ii) policy conditionality does not address the more fundamental issues related to the political economy of the country. 44. Interbank Market Development. There has not been any significant formal interbank market activity, although there are informal arrangements among the state banks to help one another out by using excess liquidity at one bank for lending by another bank. Most of these deals do not involve payment of interest, and therefore do not contribute to the development of a pricing mechanism for money market funds. Other factors also explain the lack of development of a formal interbank market. The macroeconomic and fiscal situation has not been conducive to the development of the market, which requires a stable macro environment, and the regular issuance of treasury paper that can be held by banks and used for repurchase transactions. T-bills have been issued only from time to time, at low volumes, according to fiscal requirements. For example, no T-bills were issued between October 1996 and January 1999. The only maturity for T-bills is 12 months. There is no secondary market in government paper, and the high levels of dollarization do not leave much scope for monetary management by BOL. Also, banks with excess liquidity do not provide these funds to other banks, with the exceptions noted above. Given the lack of readily available and reliable information on the financial condition of banks, this is hardly surprising. There are some interbank foreign exchange transactions. However, expectations of a further depreciation of the kip and future inflation cause banks to hold on to foreign currency. There also has been a general lack of commercial awareness within banks of the opportunities afforded by interbank markets within an overall asset-liability management framework. 45. Leasing Development. The approval of leasing legislation under the Program did not result in any significant leasing activity. Apart from some limited motorcycle and car leasing by vendors, no leasing has developed, although a number of banks would be interested in establishing leasing operations, if the registration issue can be resolved. At this moment, the registration of movable property does not appear to be reliable, making the repossession of a leased asset difficult should the lessee be in breach of terms of the lease. It will also have to be assessed whether existing tax and accounting rules need to be changed to encourage leasing. 46. Debt Recovery Framework. The Program had only limited impact on improving the environment for debt recovery, mainly because of deficiencies in the relevant legislation and the overall enforcement framework. The 1994 Secured Transactions Law and the related 1999 Implementing Decree adopted under the Program did not provide for direct repossession and disposition of collateral by the creditor without recourse through the court system. This made enforcement of collateral difficult in view of a largely inefficient and unpredictable court process. The 2000 implementing decree adopted under the Program did not help operationalize existing
15 bankruptcy legislation. No bankruptcy case has been decided under the 1994 Bankruptcy Law. Bankruptcy legislation is not suitable for larger, more complex company bankruptcies and effectively suspends the rights of secured creditors over pledged collateral during the bankruptcy process. 2. More Effective Program Measures
47. A number of program conditions were largely effective. These include (i) the adoption of a chart of accounts by all banks and completion of international audits of SCBs, (ii) the adoption of a legal basis for negotiable instruments, (iii) the establishment of a credit information bureau within BOL, and (iv) the passage of legislation to establish a social security fund/pension scheme for employees of public and private enterprises. 48. Increased Financial Transparency. The adoption of a chart of accounts for commercial banks and the requirement of international audits of SCB accounts under the Program, and later in conjunction with the monitoring of governance agreements under BSRP, are major achievements. They have given the BOL and IFIs a better understanding of the financial position and performance of the banks. This served as a basis for continued policy dialogue on SCB restructuring. 49. A credit information bureau was established within BOL under the Program. It is still operating and is reportedly being used (no related data could be provided by BOL), albeit not as comprehensively as envisaged. Although not all loans are reported, banks use the service to check on the creditworthiness of their borrowers. However, they also draw on other sources of information to determine the payment behavior of potential clients. 50. Establishment of a Legal Basis for Negotiable Instruments. The creation of a legal basis for promissory notes and bills of exchange has been somewhat effective, as banks are actively using bills of exchange for import finance. However, foreign banks would use bills only if there is additional collateral to secure their exposure. Promissory notes are not widely used. 51. Establishment of a Legal Basis for Pension Funds. The adoption of the Decree on the Social Security System for Enterprise Employees under the Program provided the necessary legal basis for the introduction of a social security system including a pension scheme for nongovernment employees, which is being administered by the newly established Social Security Organization (SSO). There has been a steady increase in the number of participants since the mandatory scheme began operating in June 2001. Currently, 25% of all nongovernment employees in Vientiane are covered under the various schemes, and the fund has assets of about $3 million equivalent. One of the challenges of the fund will be to find suitable investment opportunities in Lao PDR, as T-bills are not readily available, and the interest paid on SSO funds in savings accounts and term deposits has been slightly below the inflation rate, resulting in a negative return on investments. The legal framework for the investment of these funds needs to support the SSO in having access to viable investment alternatives, to protect the value of its reserves.
16 D. Efficiency
52. The Program was less efficient. Had the Program been more effective, the loan amount of $25 million equivalent would have been appropriate in view of the envisaged policy content and costs associated with SCB restructuring and the development of financial infrastructure. As the Program failed to improve economic allocation mechanisms, the provision of budgetary support might have actually lessened incentives to undertake reform. With regard to efficiency of process, while the Program was prepared with comparatively little staff and staff consultancy inputs, program implementation required a high level of ADB resources and 14 review missions. Ten out of 14 review missions were fielded after the original program completion date. By that date, only two out of 13 conditions for the release of the second tranche had been met. The second tranche was eventually disbursed with 19 months’ delay caused by a combination of factors. The approval of several decrees took longer than expected because of (i) internal coordination problems, (ii) the complexity of the subject matter, (iii) delays in related consulting outputs, and (iv) lack of understanding and buy-in at all relevant levels for the proposed legislation. Also, BOL did not take timely action to enforce prudential regulations for SCBs, partly because BOL management was preoccupied with the management of the 1998 crisis and did not have the experience, and initially assistance,14 to develop effective remedial measures for the insolvent banks. A major constraint on program monitoring was the lack of timelines for the implementation of each program condition. E. Sustainability
53. Program sustainability is less likely. As explained, the Program failed to achieve many of its intended outputs and, therefore, outcomes. However, it sought to put in place basic conditions for further banking sector development by initiating the corporatization and consolidation of SCBs and promoting measures to strengthen banking supervision. It therefore provided a platform for expanded policy dialogue under subsequent ADB sector interventions in the country including the ongoing BSRP and the planned microfinance program loan. Continued noncommercial lending, implying a certain lack of commitment to SCB autonomy, indicates that significant additional efforts are needed to ensure the Program’s full effectiveness and sustainability. This is to be expected, considering that the implementation of banking sector reforms in transitional economies usually entails a lengthy process involving significant institutional and cultural change. The process should be even lengthier and more complex in the case of Lao PDR, which has comparatively large capacity and governance problems to begin with15. If the overall governance environment can be enhanced, program measures related to market infrastructure development will bear fruit. For example, the creation of the necessary regulatory framework for interbank market operations is likely to be sustainable and will assist market development, once conditions improve.
ADB. 1998. Technical Assistance to the Lao People’s Democratic Republic for Human Resource Development in Banks. Manila. (TA 2160, approved on 21 September 1994, for $350,000). 15 Transparency International ranks Lao PDR 77th out of 159 countries in its 2005 Corruption Perception Index with a score of 3.3. The score, however, has a significant error of estimate as it is based on only three surveys. World Bank. 2003. Country Policy and Institutional Assessment. Washington, DC, by comparison, found that Lao PDR was perceived to have larger problems with governance and corruption issues than its neighboring countries in the Greater Mekong Subregion. There is anecdotal evidence that corruption might be partly responsible for the high level of NPLs. The upcoming country assistance program evaluation for Lao PDR includes a more in-depth review of governance and corruption issues.
54. The contribution of the Program and its associated TAs to institutional development and capacity building for financial reforms and bank restructuring was moderate. A number of program conditions—including (i) measures to improve operational autonomy, (ii) the adoption of operations manuals and business plans, and (iii) improvements in accounting requirements— were intended to strengthen the capacity of SCBs. However, these measures were not implemented effectively because of a combination of factors including lack of political support and stakeholder buy-in,and limited institutional capacity. The institutional development impact was limited to (i) the establishment of a separate banking supervision department, a credit information bureau, and a deposit protection fund; (ii) BOL and SCB management exposure to restructuring concepts; (iii) familiarization with interbank market development concepts and the establishment of the related regulatory framework; and (iv) the introduction of new corporate governance structures for the SCBs. Most inputs under TAs associated with the Program were related to sector assessments, the identification of policy measures, and the preparation of draft legislation or financial reviews by consultants, rather than training or other forms of capacity building. The capacity-development measures under the Program were not part of a coherent and comprehensive plan for strengthening BOL and SCB capacity. There was no prior in-depth review of the framework conditions under which banks operate, including (i) their inherent governance and incentive structures; (ii) their ability to take independent decisions; (iii) the adequacy of their policies, systems, and procedures; (iii) the human and financial resources needed to fulfill their mandate; and (iv) skill levels and gaps. Such a review could have formed the basis for a longer-term capacity development strategy to guide the design and implementation of individual interventions. G. Impact
55. Program impact across other sectors of the economy and on the society at large was moderate to negligible. As most measures to improve financial infrastructure have not been effective and SCB restructuring under the Program did not result in significantly improved credit allocation mechanisms, it is unlikely that allocative efficiencies improved or credit to the private enterprise sector increased as a result of the Program. There is therefore also no evidence that the Program accelerated reforms in other sectors. On the contrary, the Program was probably not as effective as it could have been because reforms of the state enterprise sector and fiscal reforms were not actively pursued at the time. The introduction of the social security system for private sector employees could help reduce the risk of falling into poverty due to ill health, incapacity, or old age. It is unlikely that the Program had any negative impact on the economy, the environment, or poverty reduction efforts. Indicators for poverty and economic growth have been showing positive developments (Appendix 2). The OEM did not assess the impact of budgetary support associated with program lending at Asian Development Fund terms on the economy of the country, as this would have been beyond the scope of a PPER. IV. A. OTHER ASSESSMENTS
ADB and Executing Agency Performance
56. ADB’s performance was less than satisfactory. Program performance was significantly affected by the poor quality of the design. Despite ADB’s experience and knowledge gained with the sector in Lao PDR under one prior program loan and numerous TAs, ADB did not
18 adequately assess the extent of sector and macroeconomic problems. The insufficient institutional, sector, and economic analyses and resulting deficiencies in problem identification, and policy selection and sequencing have been described in preceding sections. The findings of ADB-financed reviews of SCB portfolios were not properly interpreted and used as inputs in strategizing effective bank restructuring and consolidation measures. Many policy measures were not fully formulated during processing, but instead were to be detailed during program implementation with the help of TA. Meaningful compliance with and ownership of policy conditionality was adversely affected by the fact that underlying principles were apparently not sufficiently discussed and agreed with the Government and other stakeholders at the time of program processing. This situation was further complicated by the fact that there were frequent changes in ADB dealing officers (staff movements necessitated the assignment of two different mission leaders during program processing and four ADB professional staff tasked with program implementation), raising questions about ADB’s accountability for the Program and suggesting loss of institutional knowledge. It might have been helpful if a suitably qualified resident mission staff had been assigned to at least monitor sector and other relevant developments throughout program implementation. Substantial efforts by ADB in the supervision of the Program, particularly in 1999–2000, did not overcome these problems. Most of the earlier program review missions focused entirely on output achievements (i.e., compliance with program conditionality). ADB relied substantially on consultants to shape and conduct policy dialogue during the program implementation phase. The ADB staff’s lack of understanding of the relevant policy and legal issues and inability to control and guide the legal consultants resulted in ADB’s acceptance of a draft implementing decree on secured transactions that was not conducive to achieving the intended program outcomes. Another problem was that ADB intensified its supervision efforts only after the date originally set for the release of the second tranche. As a result, the deteriorating financial performance of the SCBs did not trigger any significant response by ADB until 1999–2000, when ADB insisted on formulating an enforcement plan for prudential regulation, in an effort to facilitate the release of the second tranche. 57. Government and BOL performance was less than satisfactory. During program processing, the Government appeared to be embarking on a new phase of reforms to shift the country to a market-based economy. However, in the run-up to and immediate aftermath of the 1998 financial crisis, economic reforms stalled, as Lao PDR struggled with serious macroeconomic problems. The economy stabilized in 2000 and a number of structural reforms were continued in 2001. Given continued non–commercially motivated lending in SCBs and problems in recovering associated NPLs, the full commitment of all government entities to banking reform and its objectives has been questionable. Also, as mentioned, BOL continued to exert a strong influence on the management of SCBs, which was not in line with the stated program intention to enhance the autonomy of SCBs. While the Government and BOL did make efforts to comply with the conditionality as they understood it, meaningful reforms did not ensue. In hindsight, it is difficult to determine whether this was due to a change in the level of commitment or to a lack of understanding of the meaning and potential ramifications of conditions. The fact that BOL questioned the need for MOF to appoint SCB boards, for independent external SCB audits to be carried out, and for subsidized credit for agriculture to be discontinued within 1 year of program approval indicates that commitment was an issue. ADB’s decision to waive four conditions for the release of the second tranche for FSPL I probably led the Government to expect that program conditionality could be negotiated at any time. The lack of continuity of senior BOL management—there were three different governors during program implementation—contributed to implementation delays and shortcomings, although direct BOL counterpart staff for the Program did not change. The approval of required legal documents took fairly long, indicating perhaps a lack of up-front consultation and agreement on the reform agenda with other government entities and levels, such as the Prime Minister’s Office and the
19 Ministry of Justice. In a number of cases, the originating or sponsoring government entity responsible for producing the first draft of new legislation was difficult to determine. Also, it took time to establish at what level legislation should be prepared or amended. In general, the decision-making process in Lao PDR is not clearly defined and is therefore perceived to be opaque by outsiders, who often have difficulties determining which government entities and levels to approach. Overall, however, the Government and BOL staff made sincere efforts to implement program conditions, but were constrained by country conditions and capacity problems. B. 58. Technical Assistance The OEM confirms the PCR ratings of TAs 2642 and 2643 as partly successful.
59. Both TAs contributed significantly toward achieving compliance with Program conditionality. However, Program conditionality did not necessarily translate into the achievement of the envisaged program outputs and outcomes. The design of TA 2642 was deficient, as it assumed a banking system and SCB sector capable of being further developed and changed than was actually the case, given the lack of skills and management autonomy of SCBs. For example, the TA helped organize a small workshop on the development of business plans, but did not assist managements in preparing the plans. Bank business plans produced under the TA were inadequate and thus ineffective. Also, the TA assisted in the corporatization and consolidation of SCBs, but provided comparatively little assistance in the actual operational restructuring of the SCBs. Although the TA was to prepare time-bound restructuring plans for the SCBs, this output was not achieved. There are a number of reasons for this: (i) SCB restructuring was not directly supported under ADB’s policy dialogue; (ii) the consolidation and corporatization process took considerable time, and delayed consultant work on restructuring issues; (iii) audited financial information, which provides a basis for the preparation of meaningful restructuring actions, became available only toward the end of TA implementation; and (iv) substantial levels of TA inputs would have been required to assist in the implementation of restructuring measures. Skewed incentives of SCB managements and government decision makers also affected the full implementation of the few TA recommendations on bank restructuring. For example, the TA consultants provided useful recommendations for improving record keeping and other procedures for the international banking function of BCEL. These could have been implemented with some effort by the bank, but were not accepted by BCEL management. In comparison, TA recommendations for less-sensitive policy areas, including the establishment of a credit information bureau and deposit protection fund, were largely implemented. Overall, TA implementation was less than efficient mainly because of the consultants’ lack of access to required information, translation problems, and the lack of full-time counterpart to work with the consultants, which slowed down implementation. Because of the nonperformance of the first legal adviser recruited under the TA, the implementing decree on secured transactions had to be redrafted by other consultants, causing delays and confusion. Consultants under TA 2643 (i) prepared a useful strategy for the development of an interbank market, (ii) drafted the necessary regulations, and (iii) prepared a manual and conducted training for market participants. However, the absence of an appropriate macroeconomic and sector policy environment prevented the development of any market activity during the program period. The TA was nevertheless useful in identifying constraints on market development and in establishing a sustainable regulatory framework for market operations. Related capacitybuilding efforts are likely to be less effective and sustainable because of the considerable lag between TA outputs and their potential application by market participants. The TA was highly efficient in terms of input/output ratio and timeliness of completion.
20 Table 3: TA Performance Assessment
TA 2642 Criterion 1. Relevance 2. Effectiveness 3. Efficiency 4. Sustainability Total Ratinga Weight (%) 20 25 25 30 Rating Value 1 1 1 1 Rating 0.20 0.25 0.25 0.30 1.00 TA 2643 Rating Value 1 1 3 1 Rating 0.20 0.25 0.75 0.30 1.50
TA = technical assistance. a Highly successful > 2.7; successful 2.7 < S < 1.6; partly successful 1.6 < PS < 0.8; unsuccessful < 0.8. Source: Operations Evaluation Mission.
V. A. Issues
ISSUES AND LESSONS
60. The SCBs are deeply insolvent and need to be restructured. The planned recapitalization of LDB and BCEL over a period of 4 years—although forcing the Government to recognize losses associated with noncommercial lending by SCBs—will only partially address this problem. Despite comparatively high interest rate margins, profitability remains affected by (i) substantial overall NPL levels, (ii) low loan-to-deposit ratios, (iii) a lack of alternative investment opportunities in the form of risk-free government securities, (iv) high reserve requirements, (v) a comparatively high-cost funding base, and (vi) increasing operating costs. If deposit growth stops, this situation will manifest itself in liquidity problems that might be difficult to solve throughout the system while maintaining macroeconomic stability. There is need to ensure that all new lending is prudent and properly priced to reflect inherent risks. The high demand for foreign currency–denominated loans by kip-earning entities─about 80% of all outstanding bank loans are made in foreign currency─not only reflects a lack of understanding of associated foreign exchange risk on the part of borrowers, but also indicates submarket pricing of foreign currency loans, which may need to be adjusted to motivate more kipdenominated financing. Although improvements have been made in SCB staff skills and operating procedures and SCBs are reporting a much improved performance for loans made during the past 2 years, there is scope for further institutional development, particularly in the areas of (i) new business products, (ii) human resources management, (iii) treasury management, and (iv) the implementation of management information systems than can assist in financial reporting, adequate pricing, and the identification of product, customer, and branch profitability, as a basis for determining business strategy and cost reduction measures. The adoption of a commercial business culture at all levels will be a condition for future success. Most importantly, the SCBs’ corporate governance structure needs to be strengthened to (i) provide the necessary checks and balances, (ii) further encourage the implementation of adequate credit and risk management practices, and (iii) allow for independent supervision. MOF has stated that it intends to play a more active role in the oversight of the SCBs. The Government must refrain from interfering in the banks’ credit allocation process. Draft amendments to the banking law include provisions that transfer responsibility for the appointment of deputy SCB managing directors, division chiefs, and branch managers from MOF to the SCB boards of directors. The transfer should help improve SCB autonomy. SCBs
21 should also be subjected to more competition from private domestic and foreign banks through the creation of a level playing field.16 Draft banking legislation will allow foreign banks to establish fully owned subsidiaries in Lao PDR with a minimum capital requirement of $10 million. This is in line with minimum capital requirements for private domestic banks, but is unlikely to generate much interest. Foreign-owned subsidiaries should be able to open branches throughout the country and operate on the same footing as domestic banks. 61. A national effort is required to rectify the problems of the state bank sector. Buy-in for far-reaching reforms can be achieved only if decision makers at all levels of government have access to the necessary information that will allow them to assess the extent of the problem and determine what measures are required for its resolution. There also has to be some recognition of bank losses to help the Government understand the ramifications of policy lending.17 Government authorities at central and local levels must stop using the banking system to finance expenditures and subsidies that should be funded from the budget, if considered necessary, or removed altogether. Improved fiscal management and SOE restructuring will be crucial in this regard. This process might have to be supported through more donor funding to facilitate the financing of noncommercial, but economically viable, projects or long-term investments outside the banking system. Moreover, lending to politically favored private sector projects on noncommercial terms will also have to be discontinued.18 62. Problems in the overall framework for secured transactions and debt recovery remain a major obstacle to instilling proper credit discipline and management. A centralized secured transactions registry must be put in place to effectively establish secured interest. Banks have refrained from using the court system for debt recovery and have instead relied on negotiations with defaulting clients, with suboptimal results. For example, it continues to be difficult to foreclose on real estate, which is still the most common form of collateral, if the defaulter is living on the property or is using it for commercial purposes. A number of ADB-supported initiatives are planned or under way to build the capacity of the court system and strengthen the legal and institutional basis for secured transactions. The new commercial court that was set up in Vientiane with ADB assistance in September 2004 is reported by banks to be working more effectively. To further improve the efficiency and predictability of the debt recovery process, it will be important to operationalize amended secured transaction legislation from May 2005. There should be an implementing decree that provides a clear legal basis for banks to repossess and sell collateral pledged by defaulting borrowers outside the court system, and improves the registration of collateral. Debt recovery legislation must be enforced regardless of the nature of the defaulter. 63. The following actions would enhance the effectiveness of the effectiveness of the Program. A number of these measures are being pursued under ongoing and planned ADB assistance. Others, such as a review of SCB pricing of foreign currency–denominated loans and interbank loans, and the establishment of an effective centralized registry for secured transactions should be incorporated in ADB’s ongoing policy dialogue.
The number of foreign bank branches stagnated at six between 1995 and 2005; the number of private domestic banks increased from two to three during that period. This is due in part to limited market opportunities. Private banks accounted for 43% of all banking sector assets of about KN5,000 billion in 2003, an increase from 31% at the end of 1995. 17 The Government otherwise has little incentive for SCB reform. Even the financial crisis of 1998 did not cause bank runs, as depositors maintained their faith in the banking system. A run might have prompted a more proactive approach to SCB restructuring. The crisis resulted, however, in better macroeconomic and fiscal management practices. 18 Recent bank lending for a Government-supported private cement factory was in breach of prudential bank exposure limits.
Table 4: Actions required to enhance Program Effectiveness
1. Credit Allocation and Pricing. Noncommercial lending and lending violating prudential regulations should be discontinued for SCBs in accordance with the SCB governance agreements, and for APB. SCB pricing of foreign currency–denominated loans and interbank loans should be reviewed.
Enforcement of governance agreements and commercialization of APB including discontinuation of noncommercial lending are being addressed under BSRP and planned ADB policybased assistance for microfinance. See above. The issuance of recapitalization bonds was authorized by MOF in September 2005, but actual allocation to the two SCBs has been pending. Measures to strengthen the legal and institutional framework for secured transactions are to be addressed through planned ADB TA and under policydialogue in conjunction with planned policy-based lending for the small- and mediumsized enterprise sector.
SCB Restructuring. Governance agreements for SCBs should be enforced and APB should be commercialized. The Government needs to recognize the losses of SCBs through the issuance of recapitalization bonds. Efforts should be made to privatize at least one SCB. If no suitable investors can be found, foreign management should be considered. Debt Recovery. The secured transactions regime should be strengthened through the (i) issuance of an implementing decree for the 2005 secured transactions legislation to enable direct foreclosure and sale of security pledged by defaulting borrowers without recourse to the court system, and (ii) establishment of an effective centralized registry for secured transactions. Legislation should be amended to effectively enable corporate bankruptcies and the legislation should be enforced.
ADB = Asian Development Bank, APB = Agricultural Promotion Bank, BSRP = Banking Sector Reform Program, SCB = state commercial bank, TA = technical assistance. Source: OEM Mission
64. Lessons identified for future ADB financial sector assistance in Lao PDR and other DMCs include the need to (i) carefully assess the political economy factors that determine credit allocation and recovery decisions in the banking system, and obtain up-front high-level commitment to a comprehensive reform agenda that addresses all issues significantly affecting sector performance; (ii) adequately assess the extent and nature of sector, macroeconomic, and overall governance and capacity problems before formulating banking sector restructuring programs; and (iii) properly sequence reform efforts. Proper sequencing of reform efforts would include, among other things, coordinating banking sector reforms with SOE and public sector management, as well as fiscal reforms, and with legal and judicial reforms to improve the environment for secured transactions and debt recovery. An analysis of the factors that drive bank credit decisions, based on in-depth portfolio reviews and interviews with bank management and credit officers, is key to identifying appropriate bank reform measures, as is an assessment of how public expenditures and public and private enterprises are financed. Government ownership of policy reforms should be evidenced through (i) meaningful policy actions before the approval of program loans, (ii) agreement to meet performance targets that are conducive to achieving meaningful outcomes, and (iii) the thrust and pace of the overall economic reform agenda.
65. The evaluation results for this Program confirm international experience, which indicates that state bank restructuring without privatization is difficult to achieve. In the few cases where restructuring without ownership changes has worked, factors and conditions associated with success included (i) strong government commitment to banking reform; (ii) an adequate banking regulatory and supervisory framework that does not distinguish between state and private commercial banks; (iii) financial restructuring and recapitalization assistance that is linked to significant performance improvements; (iv) strong incentives for proper governance and management including operational autonomy and performance-based management contracts and remuneration; (v) a focus on improving credit management including the active resolution of nonperforming loans; and (vi) encouragement of competition in the sector. Most importantly, state bank restructuring cannot be undertaken in isolation. As long as state banks are under pressure to provide loans for government programs, projects, and enterprises that would not merit financing on purely commercial considerations, they will be difficult to reform. 66. A number of general lessons identified by IFIs with regard to policy-based lending are being reconfirmed by the evaluation of this Program: (i) country ownership is a precondition for policy reform, but difficult to assess; (ii) the conditionality can be successful only if there is commitment and capacity to reform; (iii) TA and staff resources at Headquarters and the resident missions have to be sufficient to ensure adequate program preparation, implementation, and related capacity building; (iv) policy conditions have to be conducive to achieving program outcomes; and (v) a medium-term framework that links policy actions, progress indicators, and envisaged outputs and outcomes should facilitate up-front agreement among all stakeholders on effort and purpose and assist in the monitoring of policy reforms. With regard to the latter point, the use of a well-designed cluster loan facility19, which was not available during the processing of the Program, would have required more in-depth analysis and discussions with the Government about strategy and long-term reform outcomes, and might have been more effective in responding to capacity constraints and in achieving a results orientation and adequate phasing of policy measures. The cluster program loan modality also provides ADB with regular opportunities to assess and reward policy commitment. 67. Capacity constraints need to be adequately considered and mitigated. Relying on TA consultants to formulate policies and laws in lieu of government officials does not always facilitate ownership. In an environment with low indigenous capacity for identifying and implementing reforms, it needs to be carefully assessed whether policy lending is an appropriate lending modality. ADB’s experience in other DMCs similar to Lao PDR has shown that policy lending can be successful, even under difficult circumstances. There is a clear need to formulate a comprehensive capacity-development strategy that is not limited to addressing the need for training and advisory services, but also covers overall policy, governance, and other incentive structures that have an impact on the effectiveness of such assistance.
Operations Manual Section D4 on program lending allow the use of this modality.
SUMMARY OF THE STATUS OF COMPLIANCE WITH PROGRAM COMPONENTS AND CONDITIONS
Program Components and Conditions A. • Status of Compliance at Operations Evaluation Mission
Strengthen State-Owned Commercial Banks’ (SCB) Autonomy and Commercial Orientation Each SCB board of directors to approve the operations manual covering such matters as credit evaluation and management, lending criteria and procedures, disbursement of funds and debt recovery, and show evidence of implementation. Partially complied with (deemed to be complied with at second tranche release). The board of directors of Banque pour le Commerce Extérieur Lao (BCEL) formally adopted their operations manual in December 1998. The boards of the newly formed Lane Xang Bank Ltd. (LXB) and Lao May Bank Ltd. (LMB) also adopted in June 1999 a uniform manual for their operations, which was based on manuals that were used by the constituent six regional SCBs. The operations manual covered all aspects of bank operations including, among other things, human resources management and staff benefit policies. However, the manuals did not provide a meaningful policy and procedural framework for credit and risk management–related activities and were first supplemented by operational guides and work aids that were later replaced by more meaningful credit policy manuals in 2003. High levels of nonperforming loans (NPLs) in these banks, particularly for loans made before April 2003, indicate that the earlier manuals were ineffective or not implemented. Complied with. Relevant BOL instruction no. 302/BOL was issued on 31 October 1996.
Bank of Lao PDR (BOL) to issue an instruction to SCBs to prepare business plans, which include target financial ratios and performance indicators.* SCB boards of directors to approve business plans including target financial ratios and performance indicators acceptable to the Asian Development Bank (ADB) and show evidence of effective implementation.
Partially complied with (deemed to be complied with at second tranche release). The business planning workshop in August 1998 under TA 2642 assisted senior SCB staff in the preparation of business plans. BCEL’s board adopted its business plan in December 1998, while LMB and LXB adopted theirs in June 1999. The quality of the business plans could not be judged, as no translations were available (nor were translations available during program implementation). However, further deterioration of SCBs’ financial performance after 1998 indicates that the plans were ineffective in guiding the restructuring of the SCBs or were not fully implemented. Complied with. Decree Law No.1 of 1997 with the required provisions, amending and replacing Decree Law No. 3 of 1992, was adopted by the National Assembly in March 1997. Further amendments to Decree Law No. 1 were made at the instigation of ADB to remove the authority of Bank of Lao PDR to appoint the deputy managing director and other senior management of SCB, down to branch manager level. To further enhance SCBs’ autonomy, new draft amendments to the banking law are proposing to transfer responsibility for appointing senior SCB management from MOF to the bank boards. But there is little evidence that the new SCB boards have really acted
Amend Decree No. 3 of 1992 on the Management of Commercial Banks and Other Financial Institutions to be consistent with the Business Law and the Law on the BOL, including that the board of directors will be the policy-making body of each SCB and the chairman and other members of the board will be appointed by Ministry of Finance.
Program Components and Conditions
Status of Compliance at Operations Evaluation Mission as policy-making bodies, partly because board members lack background and experience in finance.
SCBs to undertake a nationwide public campaign to increase deposit mobilization with priority on attracting longer-term deposits and savings from rural areas.
Complied with. The business plans of the SCBs include a savings mobilization and marketing plan to attract deposits of longer maturity. In the rural areas, some SCBs adopted mobile banking targeted at specific depositor groups. The SCBs joined efforts in publicizing and selling retail savings bonds worth KN5.225 billion issued by the Government through BOL. However deposit mobilization efforts were affected by the financial crisis, which resulted in deposit rates that were negative in real terms. Although banks have started to collect more time deposits with 12-month maturities, they sometimes allow earlier withdrawals without penalties. Complied with. Relevant BOL instruction no. 301/BOL was issued on 31 October 1996.
BOL to issue an instruction to SCBs to prepare for public disclosure, annual reports commencing with the 1997 financial year, and such reports shall include audited financial statements prepared in accordance with International Audit Standards (IAS) 30 and summaries of their business plans.* Each SCB to prepare a 1997 annual report to include audited financial statements prepared in accordance with International Accounting Standard 30, and a summary of the business plan. These will be approved by the SCB boards and publicly disclosed. BOL to increase SCBs’ autonomy through join ventures, management contracts, reduced government ownership and control or other arrangements acceptable to ADB. BOL to establish policy review of subsidized lending and the impact of compulsory sector lending of 10% bank deposits to agriculture.
Substantially complied with (deemed to be complied with at second tranche release). External audits of the 1997 accounts for the seven SCBs were completed on 18 December 1998. The management of the former SCBs signed the audited financial statements. Annual reports of the seven SCBs included the 1997 audited accounts. However, the reports have been distributed only on special request through BOL. Not Complied with. Remains a medium- to long-term objective. There is little interest among foreign banks in investing in the Lao PDR banking sector given the small size of the market and its undeveloped stage. Twinning arrangements and other forms of external management were not actively pursued. Partially complied with (deemed to be complied with at second tranche release, although PCR determined only partial compliance). BOL conducted a policy review on subsidized lending. While compulsory sector lending allocations for the SCBs have been discontinued, SCBs, particularly the Agricultural Promotion Bank (APB), still charge considerably lower interest rates for agricultural lending than for loans to other sectors, regardless of risks involved. APB has continued to be a policy bank providing subsidized loans for government agricultural development programs. ADB has been engaging in a policy dialogue with the Government on the commercialization of APB in
Program Components and Conditions
Status of Compliance at Operations Evaluation Mission conjunction with a planned lending operation for a microfinance program .
Strengthen BOL’s Supervisory Function BOL to divide the Control Department into two separate departments for banking supervision and internal audit functions. BOL to require: o Adoption and implementation of chart of accounts by all banks; and Complied with. Separate supervision and examination and internal audit departments were established on 15 May 1998.
Partially complied with (deemed to be complied with at second tranche release). The chart of accounts was generally adopted. Implementation by SCBs is affected by limited accounting skills and the decentralized nature of their branch-based accounting systems. For the SCBs that have been subject to independent audit, there have been substantial discrepancies between the banks’ presentation of their accounts and the external auditors’ findings. Complied with. Reports of the 1996 independent audits of the seven SCBs, funded by the World Bank, were signed on 22 May 1998. Substantially complied with. BOL established a system of penalties for noncompliance, and compliance with prudential regulations has been one of the regular BOL reporting requirements for banks analyzed as part of BOL’s off-site surveillance function. It is unclear, however, whether SCBs have actually complied with the reporting requirements on time and comprehensively.
BOL to require 1996 independent audits of commercial bank accounts
BOL shall, with respect to the prudential regulations agreed to between BOL and the Bank and governing all banks, including APB, have (i) established a system of penalties for noncompliance by the banks; (ii) established a system to record and verify the information that banks are required to report pursuant to such regulations; and (iii) confirmed that SCBs have complied with the reporting requirements under such regulations.* BOL to show evidence of enforcement of prudential regulations in all banks including APB and imposition of penalties for noncompliance.
Partially complied with. BOL has been actively enforcing prudential regulations for foreign bank branches and the private commercial banks. However, APB and the SCBs have not been in compliance with capital adequacy requirements since at least 1997, and in some cases also with other prudential regulations, particularly limits on foreign currency and large exposures. Only in 2000 did BOL issue remedial action plans for LMB, LXB, and BCEL, which were not fully implemented. In April 2003, BOL, MOF, and SCB management signed governance agreements with restructuring and performance targets to restore the SCBs to financial health and bring them into compliance with prudential regulations. Implementation of these governance agreements has been subject to external review.
Program Components and Conditions C. • Restructure and Consolidate SCBs SCBs to be consolidated and their number reduced from seven to no more than four.
Status of Compliance at Operations Evaluation Mission
Substantially complied with (deemed to be complied with at second tranche release). The governor of the BOL and the MOF signed a policy statement on 15 May 1998 confirming the consolidation plan for the six regional SCBs involving the merger of Lao May Bank, Phak Tai Bank, and Nakhouneluang Bank into LMB, and of Lane Xang Bank, Aroun May Bank, and Sethathirath Bank into LXB. Plan implementation started in December 1998. The consolidation of the six regional SCBs into two SCBs did not involve any merger of systems, policies, staff resources, or branch networks, and therefore did not result in any operational synergies. BCEL, the largest of the original seven SCBs, was kept essentially intact. In April 1999, LXB, LMB, and BCEL were incorporated as separate legal entities with their own corporate structure and the Government as the sole shareholder. To enhance their performance, LXB and LMB were subsequently merged into the new Lao Development Bank. Complied with. The new notes were announced to the public on 22 May 1998 and introduced on 8 June 1998. The benefits of the new notes were offset largely by the substantial devaluation of the kip and high inflation over the past 3 years. BOL is preparing the issuance of kip notes in a denomination of 50,000 in the near future. Partially complied with (deemed to be substantially complied with at second tranche release). BOL has been issuing T-bills for the Government at a discount in certificate units of KN10 million. After the first auction of T-bills in 1994, bimonthly auctions were held first with only commercial banks as participants, and since 1995 also with nonbank financial institutions participating. Yields on T-bills were capped at 20% from October 1997 until April 1998, when the auctions were stopped for lack of bids from the commercial banks. Until the end of 1998, T-bills were then sold through commercial banks at a fixed rate of 24%. The rate was increased to 30% in January 1999, and to 60% in April 1999. From April 1998 to May 2001, when BOL resumed the auctions, limited amounts of T-bills were also occasionally sold by MOF directly to the public. Total T-bill volumes sold through auctions between 2001 and 2004 amounted to KN204 billion, compared with the KN 115 billion issued between 1996 and 1998.The maturity of T-bills was increased from 6 months to 12 months in December 1997. No bills with other maturities have been issued since. Complied with. CIB formally began operations on 1 February 1999 under the Credit Department of BOL. CIB was transferred to the accounting department of BOL in 2001 and became fully operational in November 2001, covering loans for all types of banks using a semiautomated system. Its effectiveness has been reduced by the fact that not
Build Market Infrastructure BOL to circulate higher denomination 2000 and 5000 kip notes in the market.
BOL to facilitate T-bill auction operations through auctions and increase the range of maturities.
BOL to establish a credit information bureau (CIB), acceptable to ADB, which will maintain a database on the performance of the loan accounts of the banks and other financial
Program Components and Conditions institutions to enable these institutions to identify delinquent borrowers. • BOL to issue regulations and formulate procedures for the development of an interbank market, acceptable to ADB.
Status of Compliance at Operations Evaluation Mission all loans are reported. Complied with. BOL approved clearinghouse rules on 30 August 1999 and issued regulations on interbank market activities and a related code of conduct for market participants on 29 November 1999. BOL issued regulations for the supervision of the interbank foreign exchange market on 30 November 1999. Complied with. BOL approved regulations for the DPS on 30 August 1999. On 20 January 2000, the deposit protection company was established under the Business Law as a corporate entity fully owned by the Government. MOF provided the company’s registered capital of KN100 million, while BOL shoulders its operating expenses. Membership is limited to the SCBs, APB, two joint-venture banks, and one private domestic bank. Extending the membership to foreign bank branches is being contemplated. Insurance coverage is limited to kip deposits up to a maximum of KN15 million per depositor. With a premium rate of 0.1% of average kip deposits, it will take some time before the fund is able to fully pay all claims. Partially complied with (deemed to be complied with at second tranche release). The Prime Minister signed the decree to implement the Law on Secured Transactions on 21 September 1999 and the Law on Bankruptcy on 20 June 2000. However, as the decree does not allow direct foreclosure and sale of security pledged by defaulting debtors without recourse to the court system, it has not facilitated debt recovery efforts by banks. The Law on Secured Transactions was amended in May 2005. Complied with. A decree governing bills of exchange and promissory notes was issued on 12 December 1998. Complied with. A decree on leasing was signed on 18 February 1999. Complied with. The decree establishing a social security system for all workers in state-owned enterprises and private sector companies with 10 or more workers was signed by the President on 23 December 1999. Complied with. The Decree on Cheques was issued by the Prime Minister on 22 October 1996.
Government to establish a depositor protection scheme (DPS), including a separate and independent insurance fund targeted to protect small investors.
Government to issue implementing regulations for debt recovery and enforcement of security in connection with the Law on Bankruptcy and the Law on Secured Transactions.
Government to issue a decree establishing the legal basis and regime governing bills of exchange and promissory notes. The Borrower to issue a decree on leasing. The Borrower to issue a decree on pension funds by the end of the program period (31 October 1999). The Government shall have issued the Decree on Cheques.*
Program Components and Conditions E. • Upgrade Staff Commercial Banking Skills BOL and SCBs to establish a regular system of commercial bank training.
Status of Compliance at Operations Evaluation Mission Complied with. A training needs assessment was conducted under TA 2642. TA 3146 later used the assessment in designing a credit training program for SCB and BOL staff that comprised training of trainers, workshops, and on-the-job training. Comprehensive training programs for BOL and SCB staff on all aspects of commercial banking operations have been conducted since 2003 by BOL’s Bank Training Center with support from a bank training project funded by the European Union. Complied with. The World Bank financed training of BOL staff in 1998 on the implementation of the new prudential regulations. Under TAs 2642, 3146, and 3466, SCBs received further assistance on the implementation of the BOL regulations, as well as on loan classification and provisioning.
BOL and SCBs to complete the training program for implementing and enforcing commercial bank prudential regulations.
ADB = Asian Development Bank, APB = Agricultural Promotion Bank, BCEL= Banque pour le Commerce Extérieur Lao, BOL = Bank of Lao PDR, CIB= Credit Information Bureau, DPS= Deposit Protection Scheme, MOF= Ministry of Finance, LMB= Lao May Bank, LXB= Lane Xang Bank, SCB = state commercial bank, TA = technical assistance.
Note: Tranche release conditions are in boldface type. Conditions for the release of the first tranche are additionally marked with an asterisk. Source: OEM Mission
MACROECONOMIC, FINANCIAL SECTOR, AND SOCIAL AND POVERTY INDICATORS 1995–2004 AND FINANCIAL STATEMENTS OF STATE COMMERCIAL BANKS Table A2.1: Macroeconomic Indicators, 1995–2004
Indicator 1995 A. Income and Growth 1. GDP per Capita ($, 308.0 current) 2. GDP Growth (%, constant) 7.0 a. Agriculture 3.1 b. Industry 13.1 c. Services 10.2 B. Saving and Investment (% of GDP) 1. Gross Domestic — Investment 2. Gross National Saving — C. Money and Inflation (% change) 1. Consumer Price Index 19.6 2. Total Liquidity (M2) 16.4 D. Government Finance (% of GDP) 1. Revenue 11.4 2. Expenditure 20.4 3. 1996 366.0 6.9 2.8 17.3 8.5 — — 13.0 26.7 12.6 21.7 1997 364.0 6.9 7.0 8.1 7.5 26.2 10.0 19.3 65.8 11.0 19.8 1998 259.5 3.9 3.1 9.2 5.5 24.9 14.8 90.5 113.3 15.2 22.7 1999 285.4 7.3 8.2 8.0 6.7 22.7 13.8 134.3 78.3 16.5 19.4 2000 335.1 5.8 4.9 8.5 4.9 20.5 12.2 8.4 45.8 12.4 18.4 2001 333.3 5.8 3.8 10.1 5.7 21.0 14.1 7.8 20.1 12.6 20.2 2002 325.5 5.9 4.0 10.1 5.7 21.2 15.6 10.7 27.0 13.4 21.7 2003 350.5 5.9 2.2 11.5 7.5 21.2 18.7 15.8 19.2 11.0 18.8 2004 402.0 6.5 3.5 11.4 7.3 22.0 — 10.6 21.3 11.9 16.7
Overall Fiscal Surplus (3.9) (5.7) (8.8) (7.5) (2.9) (6.0) (7.6) (8.3) (7.8) (4.8) (deficit) E. Balance of Payments 1. Merchandise Trade (15.9 (19.9) (18.9) (13.2) (9.9) (11.8) (11.2) (8.0) (6.3) (6.2) Balance (% of GDP) ) 2. Current Account Balance (7.5) (12.3) (16.2) (3.4) (5.2) (7.3) (4.6) (2.3) (0.3) (0.5) (% of GDP) 3. Merchandise Export (% 2.4 3.1 (1.4) 24.0 (11.0) 9.6 (3.3) (5.9) 11.6 7.6 change) 4. Merchandise Import (% 4.4 17.1 (6.0) (6.0) (5.0) (3.4) (4.7) (12.4) 3.4 9.5 change) F. External Payments 1. Gross Official Reserves 92.7 170.1 110.7 112.8 106.2 141.0 133.0 196.0 216.0 225.0 (including gold, $ million) 2. External Debt Service (% 6.3 6.7 8.8 4.6 6.3 5.7 7.8 8.9 6.8 9.4 of exports of goods and services) 3. Total External Debt (% of 123.2 121.3 132.9 101.3 73.4 83.2 82.7 88.8 104.0 93.9 GDP) G. Memorandum Items 1. GDP (current prices, KN 1,419 1,726 2,201 4,240 10,329 13,671 15,670 17,698 20,307 24,621 billion) 2. Exchange Rate (KN/$, 805 921 1,259 3,296 7,106 7,888 8,955 10,056 10,652 10,380 average) 3. Population (million) 4.6 4.7 4.8 5.0 5.1 5.2 5.3 5.4 5.7 5.8 — = not available, GDP = gross domestic product. Sources: National Statistical Center, Bank of Lao PDR, Ministry of Finance, International Monetary Fund, and Asian Development Bank estimates. Quoted in ADB. 2002. Country Strategy and Program Updates (2003-2005): Lao People’s Democratic Republic. Manila; ADB. 2003. Country Strategy and Program Updates (2004-2006): Lao People’s Democratic Republic. Manila; and ADB. 2005. Country Strategy and Program Updates (2006-2008): Lao People’s Democratic Republic. Manila.
Table A2.2: Selected Financial Sector Indicators, 1995–2004
A. Financial Depth 1. Domestic Deposits (% of GDP) 2. Domestic Credit (% of GDP) 3. Money and quasi money M2 (% of GDP) B. Soundness 1. Gross Foreign Liabilities of the Banking Sector as % of Total Liabilities, EOP 2. Foreign Currency Deposits on Broad Money (rate of a dollarization) 3. Loans-to-Deposits (%) 4. NPLs/Total Outstanding b SCB Loans (%) 5. Real Bank Credit Growth Rate 6. Real Bank Credit Index (1996=100) 7. Ratio of Gross Foreign Liabilities of the Banking Sector to Gross Foreign Assets, EOP C. Efficiency 1. Credit to the Private Sector (% of total credit to economic entities) 2. Interest Rate Margins in Local Currency (local banks) D. Market Share of SCBs (in % of) 1.Credit to the Economy 2. Credit to SOEs 3.Total Deposits
10.6 9.8 13.6
11.7 9.7 14.1
16.6 14.0 18.5
18.9 13.4 20.4
14.2 9.2 15.0
15.9 10.0 16.5
15.6 12.0 16.4
17.9 10.3 19.3
16.9 8.9 18.2
18.2 10.0 20.9
85.5 33 2.4 89.7 0.4
97.8 — 11.5 100.0 0.4
94.5 — 25.5 125.5 0.4
76.4 39 -23.0 96.6 0.4
60.4 64 -16.5 80.7 0.2
55.9 52 33.4 107.6 0.3
68.2 72 17.2 126.1 0.4
62.3 80 -14.8 107.4 0.5
53.6 75 -11.9 94.7 0.4
50.2 64 6.6 100.9 0.4
73.5 93.4 69.6
63.9 85.5 70.0
55.8 — 86.4
54.0 90.1 74.2
58.5 88.7 77.6
64.5 85.2 78.4
68.1 78.6 77.3
64.6 79.3 75.1
53.5 74.1 73.6
53.1 65.5 64.7
— = not available, GDP = gross domestic product, NPL = nonperforming loans, SCB = state commercial banks, SOE = state-owned enterprise. a IMF estimates based on data provided by the Lao PDR authorities. b ADB consultants’ estimates and external audits for 1995 to 2003 data, 2004 data as reported by SCBs. Sources: IMF. 2004 and 2005. International Financial Statistics, Washington, DC; ADB. 2004. Key Indicators. Manila; IMF. 2002 and 2005. Lao PDR Selected Issues and Statistical Appendix, Washington DC; Bank of Lao PDR; and ADB Asian Regional Information Center (ARIC), compiled from IMF International Financial Statistics database.
Table A2.3: Social and Poverty Indicators, 1995–2004
Indicator Poverty, Income, and Human Development 1. Income Per Capita Index (1996=100) 2. Poverty Incidence, % of Total Population below $1-a-day poverty line 3. Poverty Incidence, % of Total Population below $2-a-day poverty line 4. HDI Value 5. HDI Rank 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
— = not available, HDI = human development index. Sources: ADB Asian Regional Information Center (ARIC) and UNDP Human Development Report, various issues.
Table A2.4: Financial Performance of State-Owned Commercial Banks Combined Balance Sheets, 1995–2000 (KN million)
Item A. Assets Cash, Deposits and Interbank Accounts Net Loans (after provisions) Other Receivables Investment (at cost) Net Fixed Assets Other Assets B. Total Assets Liabilities, and Capital Deposits Borrowings and Interbank Accounts Other Liabilities Capital Paid-Up Capital Reserves Accumulated Deficit Total Capital C. Total Liabilities and Capital 1995 1997 1998 1999 2000
78,380 81,292 17,254 15,204 3,085 15,257 210,472 119,960 63,012 5,828
201,354 45,178 30,769 17,667 6,427 2,752 304,147 304,686 57,888 49,975 4,000 (112,402) (108,402) 304,147
547,392 220,890 56,525 12,620 16,637 7,700 861,764 845,511 36,083 37,348 4,000 7,630 (68,808) (57,178) 861,764
1,182,803 235,892 180,885 48,541 34,348 10,303 1,692,772 1,804,651 78,267 86,805 4,000 9,733 (290,684) (276,951) 1,692,772
1,286,877 486,769 301,832 48,116 45,544 13,057 2,182,195 2,343,054 85,612 106,960 4,000 15,286 (372,717) (353,431) 2,182,195
Performance Indicators NPL Ratio (before 33 — provisions) (%) Ratio of Liquid Assets to 65 66 Deposits (%) Ratio of Loans to Deposits 68 15 NPL = nonperforming loan, — = not available Sources: ADB consultants’ estimates and 1997 external audits.
39 65 26
64 66 13
52 55 21
Table A2.5: Financial Performance of State-Owned Commercial Banks Combined Profit and Loss Statements, 1998–2000 (KN million)
Item Interest Income Deposits with Other Banks Net Loans and Related Assets Other Total Interest Income Interest and Related Expenses Net Interest Income Gain (Loss) on Foreign Exchange Operations Income on Foreign Exchange Transactions Loss on Foreign Exchange Transactions Loss from Revaluation of Loans and Off Balance Sheet Items Net Gain (Loss) on Foreign Exchange Operations Commissions and Service Fees Other Operating Income Reversal of impairment losses Net Operating Income Less: General and Administrative Expenses Other Expenses Provisions for Loan Losses Net Taxable Income (Loss) Less: Income Tax Net Income (Loss) After Tax 1998 11,443 26,829 38,272 35,643 2,629 27,379 15,573 6,601 5,205 7,770 1,187 16,791 6,958 1,911 4,009 3,913 2,755 1,158 1999 18,860 48,812 67,672 66,072 1,600 77,732 48,052 23,788 5,892 25,384 1,630 34,506 18,697 (1,017) 235,585 (218,759) 0 (218,759) 2000 29,712 52,953 82,665 68,802 13,863 29,371 2,747 21,840 4,784 28,981 2,742 50,370 28,056 10 97,038 (74,734) 0 (74,734)
Performance Indicators Ratio of Non-interest Expense to Interest Income and Fees (%) General and Administrative Expenses + Recurring Nonbanking Expenses/Beginning Assets (%) Return on Assets (%) — = not available Source: ADB consultants’ estimates.
17.6 — 0.1
27.0 2.1 (12.9)
32.8 1.7 (3.4)
DESIGN AND MONITORING FRAMEWORK
Design Summary Impact Increased financial intermediation supporting economic growth Performance Targets/Indicators Increase in M2/gross domestic product (GDP) Increase in savings rate from Actual Results Increase in M2/GDP from 13.6% in 1995 to 18.2% in 2003. Increase in deposits/GDP from 10.6% in 1995 to 16.9% in 2003 Assumptions and Risks Assumption Improved public confidence in banking system Risk Macroeconomic instability (actually occurred in 1997– 1998) Assumptions • Macroeconomic stability • Effective SCB restructuring • Sufficient effective credit demand • Market-based pricing
Outcome Sound banking system
Improved financial performance and capitalization levels in line with prudential regulations Declining nonperforming loan (NPL) levels
Worsening financial position of state commercial banks (SCBs) resulted in negative capital since 1997. NPL levels for SCBs increased from 33% in 1995 to 64% in 2004. Share of private sector credit in total net domestic credit to the economy decreased from about 82% in 1995 to 63% in 2004. Interest rate margins increased from 6% in 1995 to 9% in 2004.
Efficient financial system that allocates resources to best economic use
Increase in private sector credit
Reduced interest rate margins Outputs 1. Strengthened SCB autonomy and commercial orientation Reduced levels of noncommercial lending
SCB NPLs increased during program period with most of them related to lending to state-owned enterprise (SOEs) and public investment projects of local governments. No remedial action programs implemented for insolvent SCBs between 1996–1997 and 2000.
2. Strengthened supervisory function of BOL
Enforcement of prudential regulations through regular on-site inspections, charging of fines, and remedial action programs Reduction in number of SCBs Improved financial performance of SCBs including reduced operating costs Effective legal basis for debt recovery
Assumptions • Continuing SOE, fiscal, and governance reforms • Political commitment to BOL independence • Policy conditions conducive to achieving outputs • Policy measures are effectively implemented
3. Institutional Strengthening through: • Restructuring and consolidation of SCBs
Number of SCBs reduced from seven to three in 1998 and from three to two in 2003. SCB profitability deteriorated during program period, while the ratio of noninterest expenses to interest income and fees increased to 33% in 2000. Debt recovery is mainly based on direct negotiation between creditors and debtors.
Establishment of market infrastructure
Performance Targets/Indicators Reduced credit and market risks through operation of credit information bureau and increased financial transparency
Actual Results Bureau is being used, but information is supplemented with information from other sources. Introduction of uniform chart of accounts for banks and independent audit of SCB accounts improved financial transparency. No functioning interbank market in place.
Assumptions and Risks
Improved price finding and liquidity management through interbank market development Increased deposit volumes through deposit protection scheme Leasing market established through provision of legal basis for leasing Development of institutional investor base through establishment of legal basis for pension funds 4.Upgrading of commercial banking skills Increase in number of bank and Bank of Lao PDR (BOL) staff trained in commercial banking principles and practices
No significant leasing activity, which is limited to operational leases Creation of legal basis for Social Security Organization resulted in establishment of pension scheme for nongovernment employees Most BOL and SCB employees have received formal training in commercial banking principles and practices under a wide range of training programs funded by various official development assistance sources. However, scope for application of acquired knowledge is limited. Inputs • Asian Development Bank (ADB) loan of $25 million at Asian Development Fund terms • TA 2642 ($954,000 by ADB and $10,000 by Government) • TA 2643 ($130,000 by ADB and $10,000 by Government)
Activities with Milestones See Appendix 1, “Program Components and Conditions” column
MANAGEMENT RESPONSE TO THE PROGRAM PERFORMANCE EVALUATION REPORT FOR THE SECOND FINANCIAL SECTOR PROGRAM LOAN IN THE LAO PEOPLE’S DEMOCRATIC REPUBLIC (Loan 1458-LAO)
On 29 March 2006, the Director General, Operations Evaluation Department, received the following response from the Managing Director General on behalf of Management:
1. Management finds OED’s Program Performance Evaluation Report (PPER) well prepared. The PPER’s analysis and conclusions are substantially in agreement with the program completion report (PCR), which was prepared in January 2002. The PCR found the Second Financial Sector Program Loan (FSPL II) to be deficient in design, implementation, and effectiveness. These findings are underscored by the PPER, and we therefore concur with the latter’s overall findings and assessment. 2. Like other transition economies, Lao PDR, at the time it initiated the transition to a market-based financial system, faced the twin challenges of building up governance institutions and resolving the insolvency of the state banks. Significant progress was made in the first round of reforms in the 1980s through the establishment of a two-tiered banking system and the containment of bank losses to a relatively small proportion of GDP. The Government’s reform agenda in the 1990s was more ambitious. Effective bad debt resolutions, a sound and safe banking system with increased lending to the private sector, and strong supervisory capabilities were the outcomes that the government sought, with the support of ADB and other development partners. However, these envisaged outcomes were not achieved. The attempt to strengthen governance by building up institutions that are insulated from political influence did not prove feasible. The incentives supported by the FSPL II did not change the behavior of banks. Nor did it contribute to adequate strengthening of supervisory and oversight capacities. In particular, neither banks nor regulators engaged in sufficient investments to improve their capacities. B. Lessons Learned
3. The PPER’s findings help to clarify the weaknesses of the program design and implementation that explain the limited outcomes emerging from FSPL II. The PPER’s analysis of current issues is an exemplary guide towards the principles for reengagement with Lao PDR on further reform of the financial sector. We note, in particular, the importance of the PPER’s findings on the need for sequenced and synchronized reforms. This has two major implications for the program design. First, to link progress in the banking sector to improved fiscal management, attainment of macroeconomic stability, and the strengthening of the legal framework including the capacity of the court system. Second, the need to address the problems of banks and enterprises together, rather than in isolation.
4. As noted in the PPER, macroeconomic instability arising from the Asian economic crisis of 1997 adversely affected the policy climate and made it more difficult for Lao PDR to pursue reforms under FSPL II. However, by 2000, with the return of macroeconomic stability a basis emerged for renewed attention to reforms. At about this time, Lao PDR began to develop a comprehensive framework for macro economic stability, poverty reduction, financial and fiscal reforms, and judicial strengthening in conjunction with policy dialogue and support from the ADB, International Monetary Fund, and the World Bank. 5. Reflecting the importance ADB attached to the issues of political commitment raised in the PPER, a sustained process of consultations with highlevel officials was initiated and this laid the basis for the policy reform agenda that was subsequently developed. This was underpinned by a very difficult—and necessary—joint exercise in which the staff of the state- owned commercial banks (SCBs), the Bank of Lao PDR, and ADB carried out a detailed examination of the balance sheets and portfolio of the SCBs. The high level policy dialogue, in combination with the portfolio examination, led to a reformulation of the reform agenda stressing upfront reforms, conditional recapitalization, stricter lending criteria, and greater transparency and disclosure to aid monitoring. 6. Thus, the key lessons emerging from the PCR, and those which could be said to have been anticipated in the PPER, helped shape the international community’s support of further banking and financial sector reforms in Lao PDR during 2000–2003. In particular, they helped shape the design of the ongoing Loan 1946-LAO (SF): Banking Sector Reform Program and in structuring the Rural Finance Sector Development Program in the pipeline for 2006. 7. The overall context for reform remains difficult however, in part because of weak capacities in terms of human resources and institutions, and in part because of the political economy context in which reforms are required to be understood, supported, and reconfirmed with a range of domestic actors and agencies. Two specific aspects of ongoing difficulties are noteworthy. First, to resolve of bad debts the Banking Sector Reform Program makes the recapitalization conditional on the progress made in the resolution of nonperforming loans (NPLs). We see encouraging progress in the reduction of NPL ratios of flow loans. However, the ultimate test of progress made will lie in the attainment of hard budget constraints on the state enterprise sector. There is not yet conclusive evidence that budgets have hardened, although the issuance of debt clearance bonds—admittedly at below market interest rates—is a step in this direction. 8. Second, the need for stricter lending requirements and market-based credit risk management in the SCBs. This is highlighted by the PPER as a key issue and was anticipated in the design of the Banking Sector Reform Program. In addition to other measures, this objective was addressed by the introduction of resident advisors who were to certify that SCB’s were meeting the new criteria. The initial results are encouraging with a sharp reduction in SCB credit growth in 2003-2004 in line with the recommendations of the advisors. However, since then SCB credit growth has grown substantially. It will be important to determine the basis of some recent credit decisions and whether they conformed to the new
lending criteria. The issue here is not only the independence of credit decisions made by the management of the SCBs; it is whether a definitive shift has taken place from the centralized bank decision-making culture. C. Conclusion
9. In conclusion, Management appreciates the PPER’s comprehensive analysis of FSPL II and its implementation. In implementing the Banking Sector Reform Program and preparing the Rural Finance Sector Development Program, ADB will be proactive in taking actions proposed in the PPER to enhance program effectiveness.