Report and Recommendation of the President

to the Board of Directors

Project Number: 53090-001 September 2019

Proposed XacBank LLC Micro, Small, and Medium-Sized Enterprises Financing Project ()

This is an abbreviated version of the document approved by ADB’s Board of Directors, which excludes information that is subject to exceptions to disclosure set forth in ADB’s Access to Information Policy.

CURRENCY EQUIVALENTS (as of 8 August 2019)

Currency unit – togrog (MNT)

MNT1.00 = $0.0003751 $1.00 = MNT2,666

ABBREVIATIONS

ADB – Asian Development Bank AQR – asset quality review BOM – Bank of Mongolia CEO – chief executive officer GDP – gross domestic product GAP − gender action plan IFI – international financial institution IMF − International Monetary Fund MSMEs – micro, small, and medium-sized enterprises NPL – nonperforming loan NBFI – nonbank financial institution SEMS – social and environmental management system SMEs – small and medium-sized enterprises US − United States

NOTES

(i) The fiscal year (FY) of XacBank ends on 31 December. (ii) In this report, "$" refers to United States dollars.

Vice-President Diwakar Gupta, Private Sector Operations and Public−Private Partnerships Director General Michael Barrow, Private Sector Operations Department (PSOD) Director Christine Engstrom, Private Sector Financial Institutions Division, PSOD

Team leader Biao Huang, Senior Investment Specialist, PSOD Team members Yidan Chen, Senior Investment Officer, People’s Republic of China Resident Mission, PSOD Nigel Chin, Senior Counsel, Office of the General Counsel Cecilia Alcazar De Castro, Safeguards Officer (Environment), PSOD Enerelt Enkhbold, Senior Investment Officer, Mongolia Resident Mission, EARD Mohsin Monnoo, Senior Investment Specialist (Syndication), PSOD Rhea Branzuela Reburiano-Javier, Social Development Officer, PSOD Grachelle Talicuran, Associate Safeguards Officer (Environment), PSOD Siela B. Teng-Almocera, Social Development Officer, PSOD In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page

PROJECT AT A GLANCE

I. THE PROPOSAL 1 II. THE FINANCIAL INTERMEDIARY 1 A. Investment Identification and Description 1 B. Business Overview and Strategy 3 C. Ownership, Management, and Governance 4 III. THE PROPOSED ADB ASSISTANCE 5 A. The Assistance 5 B. Implementation Arrangements 5 C. Value Added by ADB Assistance 5 IV. DEVELOPMENT IMPACT AND STRATEGIC ALIGNMENT 6 A. Development Impacts, Outcome, and Outputs 6 B. Alignment with ADB Strategy and Operations 6 V. POLICY COMPLIANCE 7 A. Safeguards and Social Dimensions 7 B. Anticorruption Policy 8 C. Assurances 8 VI. RECOMMENDATION 8

APPENDIXES 1. Design and Monitoring Framework 9 2. List of Linked Documents 12

Project Classification Information Status: Complete

PROJECT AT A GLANCE

1. Basic Data Project Number: 53090-001 Project Name Micro, Small, and Medium-Sized Department PSOD/PSFI Enterprises Financing Project /Division Country Mongolia

Borrower XACBANK LLC

qq 2. Sector Subsector(s) ADB Financing ($ million) Finance Small and medium enterprise finance and leasing 30.00 Total 30.00 qq 3. Strategic Agenda Subcomponents Climate Change Information Inclusive economic Pillar 2: Access to economic Climate Change impact on the Project Low growth (IEG) opportunities, including jobs, made more inclusive Qq 4. Drivers of Change Components Gender Equity and Mainstreaming Private sector Promotion of private sector Gender equity (GEN) development (PSD) investment qq 5. Poverty and SDG Targeting Location Impact Geographic Targeting No Nation-wide High Household Targeting No General Intervention on Yes Poverty SDG Targeting Yes SDG Goals SDG5, SDG8 qq 6. Nonsovereign Operation Risk Rating Obligor Name Obligor Risk Rating Facility Risk Rating XACBANK LLC 7. Safeguard Categorization Environment: FI-C Involuntary Resettlement: Indigenous Peoples: FI-C FI-C Qq 8. Financing Modality and Sources Amount ($ million) ADB 30.00 Nonsovereign LIBOR Based Loan (Regular Loan): Ordinary capital resources 30.00 Cofinancing 30.00 Others 30.00 Others a 0.00 Total 60.00

Currency of ADB Financing: USD,MNT

a Derived by deducting ADB financing and Cofinancing from Total Project Cost.

Source: Asian Development Bank This document must only be generated in eOps. 05092019140539075108 Generated Date: 05-Sep-2019 15:32:43 PM

I. THE PROPOSAL

1. I submit for your approval the following report and recommendation on a proposed loan of up to $60,000,000 (or its equivalent in togrog), comprising (i) a senior unsecured A loan of up to $30,000,000 (or its equivalent in togrog), and (ii) a senior unsecured B loan of up to $30,000,000, to XacBank LLC (XacBank) for the Micro, Small, and Medium-Sized Enterprises Financing Project in Mongolia.1

2. The project entails the Asian Development Bank (ADB) providing long-term financing to XacBank to support its lending operations to micro, small, and medium-sized enterprises (MSMEs) in Mongolia. By improving access to finance, the project will support the expansion of MSMEs and diversification of the economy, which will in turn contribute to employment and poverty reduction.

II. THE FINANCIAL INTERMEDIARY

A. Investment Identification and Description

3. Economic overview. After a period of slow growth in 2015−2016, Mongolia’s economy started to recover in 2017 with commodity price increases and higher foreign direct investment in mining as main contributors, as well as rising demand in consumption and increased credit to households. Gross domestic product (GDP) growth further accelerated from 5.3% (2017) to 6.9% (2018), facilitated by expanding manufacturing and services sectors as well as strong investment in mining. For the first time since 2012, the fiscal balance reached a surplus and the public debt to GDP ratio improved from 99.2% (2017) to 86.2% (2018). ADB forecasts GDP growth to be moderate⎯6.7% in 2019 and 6.3% in 2020, with the expectation that a more accommodative fiscal policy will support domestic demand and foreign direct investment in mining will remain important.2 Macroeconomic downside risks include the adverse impact of the ongoing trade tensions between the People’s Republic of China and the United States (US) that may squeeze Mongolia’s mineral exports. In addition, the anticipated 2020 parliamentary elections may trigger fiscal and monetary loosening, which may impact exchange rate stability and foreign exchange reserves. Regional inequality remains significant. The World Bank estimates a poverty rate of 25.9% in Ulaanbaatar versus 32.9% in rural areas in 2018.3 In 2018, the three international rating agencies upgraded the foreign currency sovereign rating for Mongolia by one notch to: B by Standard & Poor’s, B3 by Moody’s Investors Service, and B by Fitch Ratings.

4. Micro, small, and medium-sized enterprises sector. As mining accounts for about one- fifth of GDP and 80% of export earnings, Mongolia is highly dependent on global commodity cycles.4 With mining representing less than 4% of total employment, it is important to support inclusive growth via economic diversification and promote MSMEs as an important sector of employment. The government supports this sector by providing through the SME

1 MSMEs to be financed by the proposed loan include micro-enterprises and retail SMEs (small enterprises and lower medium-sized enterprises) per XacBank’s segmentation, which are defined as enterprises with annual turnover of under MNT3 billion or employees of less than 30. 2 ADB. 2019. Asian Development Outlook 2019: Strengthening Disaster Resilience. Manila. 3 . 2019. Mongolia’s 2018 Poverty Rate Estimated at 28.4 Percent. Ulaanbaatar. https://www.worldbank.org/en/news/press-release/2019/06/21/mongolias-2018-poverty-rate-estimated-at-284- percent (accessed 12th July 2019). 4 ADB. 2017. Mongolia: Country Partnership Strategy 2017-2020. Linked Document 1. Inclusive and Sustainable Growth Assessment: Mongolia, 2017-2020. Manila.

2

Development Fund and technical assistance.5 MSMEs comprise 90.0% of registered businesses and generate about 50.0% of employment.6 MSMEs consistently report access to credit as a major barrier to investment and growth.7 As of March 2019, small and medium-sized enterprises (SMEs) loans accounted for only 19.8% of the banking sector’s outstanding loans.8 MSMEs access to finance, especially for women-owned entities, is constrained by high interest rates, short-tenor loans that do not match the cash flows of investments, and stringent collateral requirements that many MSMEs cannot meet. Low financial literacy is also a problem among smaller entities. Despite comprising 46.2% of the workforce, Mongolian women are less likely than men to own assets that can be accepted as collateral, making banks hesitant to lend them money. This situation persists even though women have higher repayment rates than their male counterparts. Only 19.2% of married women in rural areas own land either individually or jointly with their husbands.9

5. Finance sector overview. The Mongolian finance sector consists of 13 commercial banks of which 12 are privately owned and one is state-owned, 534 nonbank financial institutions (NBFIs), and 207 savings and credit cooperatives. The Bank of Mongolia (BOM) is responsible for supervising the banks, while the Financial Regulatory Commission is responsible for supervising NBFIs including insurance companies, security firms, and savings and credit cooperatives. Commercial banks provided 97.0% of loans in 2018.10 Total assets of the banking sector increased by 14.8% to MNT33.1 trillion in 2018. BOM classified the top five banks⎯Khan Bank, TDB, Golomt Bank, XacBank, and State Bank⎯as systemically important. These banks accounted for 86.0% of the banking system assets. Currently, commercial banks follow the Basel I regulatory framework. Implementation of the Basel II framework is expected by the end of 2019.

6. In February 2018, PricewaterhouseCoopers Česká Republika S.R.O. carried out an asset quality review (AQR) of the banking system as required by the International Monetary Fund (IMF).11 The AQR identified an aggregate capital shortfall representing 3.1% of GDP (2017). BOM required the banks with capital shortfalls to meet additional capital requirements by December 2018. In Moody’s opinion issued in August 2018, all systemically important banks had sufficient capital by June 2018 reflecting full loan loss provisions and asset valuation losses.12 However, the banking sector remains vulnerable with questionable origins of funds used for recapitalization of certain banks and the slow recapitalization of smaller banks. The AQR also led to a reclassification of problem assets resulting in an increase of the banks’ average nonperforming

5 The SME Development Fund provided MNT276.1 billion loans to 1,864 MSMEs during 2013−2016. 6 ADB. 2018. Mongolia Finance Sector Fact Sheet. Manila. 7 European Bank for Reconstruction and Development and World Bank. 2015. Business Environment and Enterprise Performance Survey (BEEPS) V Country Profile: Mongolia. http://ebrd-beeps.com/countries/mongolia/ 8 Bank of Mongolia. Statistical database. Loans https://www.mongolbank.mn/eng/liststatistic.aspx (accessed 31 May 2019) 9 Swiss Agency for Development and Cooperation. 2015. Gender Analysis in Pastoral Livestock Herding in Mongolia. Ulaanbaatar. https://www.eda.admin.ch/dam/countries/countries-content/ mongolia/en/AFS_Gender_Pastoral_2015 _Mongolia.pdf 10 Organisation for Economic Co-operation and Development. 2016. Enhancing access to finance for micro, small and medium-sized enterprises in Mongolia. http://www.oecd.org/eurasia/competitiveness-programme/eastern- partners/Eurasia-Peer-Review-Note-Mongolia-ENG.pdf 11 International Monetary Fund. 2017. Mongolia: 2017 Article IV Consultation and Request for an Extended Arrangement Under the Extended Fund Facility⎯Press Release; Staff Report; and Statement by the Executive Director for Mongolia. Washington, DC. 12 Moody’s Investor Service. 2018. Announcement: Outlook for Mongolia's banking system is stable, supported by economic growth. 29 August. Hong Kong, China.

3 loan (NPL) ratio from 8.5% (December 2017) to 10.0% (March 2019). 13 The Mongolian government’s implementation of the IMF-supported program on bank recapitalization and banking sector reforms is ongoing.

7. Rationale. ADB’s nonsovereign operations in Mongolia’s finance sector have targeted the underserved MSMEs given the vital role that they currently play in overall employment and the potential they have in furthering economic diversification.14 Given its strong positioning as an MSME market leader and its commitment to service women-led MSMEs, ADB selected XacBank as a partner.15 The proposed transaction will constitute the second ADB loan to XacBank;16 however, this is the first time that ADB’s loan may be partially denominated in togrog, funded through ADB local currency bond issuance. The current project also sets more ambitious gender targets as compared with the earlier project. XacBank is owned by reputable shareholders and has sound corporate governance, experienced management, advanced risk management systems, and has displayed solid financial performance and capital adequacy in a challenging operating environment.

8. The design of the proposed transaction builds on the lessons of previous ADB support for MSME financing in Mongolia. XacBank weathered the 2016−2017 economic downturn relatively well compared to other banks but needed to adjust its growth strategy and as a result could not meet the original targets of ADB’s first loan (footnote 16). This resulted in a less than satisfactory rating in ADB’s ex-post evaluation.17 For the proposed project, ADB has considered possible volatility of such resource-based economies and the resulting impacts on the borrower and its target clients when setting out the development targets in the design and monitoring framework. Another important aspect is that ADB has now established effective solutions for offering local currency loans via ADB bond issuances, which will mitigate currency induced risk for ADB’s borrowers and their MSME clients.18

B. Business Overview and Strategy

9. XacBank was established as the result of a merger of the two largest NBFIs in Mongolia, Goviin Ekhlel LLC and X.A.C LLC in 2001. With total assets of MNT3,156 billion at the end of June 2019, XacBank is Mongolia’s fourth-largest , representing about 10% market share. It operates in all 21 provinces and the capital, serving more than 700,000 customers through 87 branches, as well as specialized banking outlets. XacBank has about 1,300 staff (2018).

13 Bank of Mongolia. Key indicators of Banking system consolidated balance sheet 2019 Q1. https://www.mongolbank.mn/eng/liststatistic.aspx (accessed 31 May 2019). 14 ADB. 2007. Report and Recommendation of the President to the Board of Directors: Proposed Loan to Khan Bank in Mongolia. Manila; ADB. 2014. Report and Recommendation of the President to the Board of Directors: Proposed Senior Loan to Khan Bank for Supporting Micro, Small, and Medium-Sized Enterprises in Mongolia. Manila. 15 Women-led enterprise is defined as a business that is (i) at least 51% owned by women; or (ii) at least 20% owned by women and has at least one woman holding key leadership position such as a chief executive officer, president, vice-president or chief operating officer; and (where a board exists) has at least 30% women board directors. 16 ADB. 2013. Report and Recommendation of the President to the Board of Directors: Proposed Senior Loans to XacBank and TenGer Financial Group for Supporting Micro, Small, Medium-Sized Enterprises and Leasing Finance in Mongolia. Manila. 17 Independent Evaluation Department. 2018. Validation Report: Supporting Micro, Small, and Medium-Sized Enterprises in Mongolia. Manila: ADB; ADB. 2017. Extended Annual Review Report: Senior Loan for Supporting Micro, Small, and Medium-Sized Enterprises in Mongolia. Manila. 18 Independent Evaluation Department. 2018. Validation Report: Supporting Micro, Small, and Medium-Sized Enterprises in Mongolia. Manila: ADB; ADB. 2017. Extended Annual Review Report: Senior Loan for Supporting Micro, Small, and Medium-Sized Enterprises in Mongolia. Manila.

4

10. The bank’s MSME clients typically run services and trade businesses, small agri- processing and manufacturing facilities along the supply chain of corporations. Most MSME loans are secured. XacBank will focus on the automation of its main business lines to scale-up its core business. It has invested heavily in digital transformation including expanding its ATM and point of sales networks, loan origination, payments, and establishing mobile and internet banking platforms utilizing suitable FinTech solutions. To expand its cost-effective branchless retail business in rural areas, XacBank has partnered with a mobile telecom company and large gas station operators.

C. Ownership, Management, and Governance

11. Ownership. XacBank is fully owned by the TenGer Financial Group, which is a Mongolian financial services group incorporated in 2001 that provides a range of financial services including banking, leasing, insurance, and asset management and security services. As of 30 June 2019, TenGer Financial Group’s major shareholders were Mongolyn Alt Corporation (20.0%), International Finance Corporation (17.2%), ORIX Corporation (16.8%), European Bank for Reconstruction and Development (12.9%), National Bank of Canada (10.5%), Ronoc (10.2%), Mongolia Opportunities Fund (6.6%), and Triodos Fair Share Fund (3.7%). The remaining small shareholders are the Open Society Forum Mongolia, Rotary Club of Ulaanbaatar, and Mongolian individuals. ADB conducted integrity due diligence and found no significant or potentially significant integrity risks. 19 The identified beneficial owners do not appear to constitute a significant or potentially significant integrity risk, in the absence of any unresolved or substantiated adverse media or other information. Two directors on the board of XacBank and several directors on the boards of shareholder companies are politically exposed persons, however, none are the subject of adverse news. ADB’s review of the entity does not give ADB cause to believe that it is being used for money laundering or terrorism financing. Tax integrity due diligence was not required given that there is no substantial ownership through intermediate jurisdictions or material related-party transactions.

12. Management. An experienced management team, comprised of the chief executive officer (CEO), chief risk officer, chief financial officer, chief credit officer, chief human resources officer, chief operations officer, chief audit, chief investor relations and corporate affairs officer, president of business banking, and the president of retail banking leads XacBank. In May 2019, XacBank’s board appointed Tsevegjav Gumenjav as CEO after having served as the president of retail banking (November 2018−April 2019) and chief retail banking and chief financial officer. Prior to joining XacBank, he served as CEO of XacLeasing, chairman of the board of TenGer Insurance LLC, and treasury manager at a multi-brand company based in San Francisco, California, in the U.S.20

13. Governance structure. XacBank has a well-defined corporate governance structure in line with international best practice. The board of directors provides strategic guidance and leadership of the bank by setting strategy and policy. The board consists of nine members including the chairman, one executive director, five non-executive directors, and two independent directors.21 Sanjay Gupta was elected in March 2019 as the chairman of the board of directors of XacBank and TenGer Financial Group. Previously, he served on the board for 2 years as non- executive director. He has 34 years of banking experience in senior leadership roles in Asia and

19 ADB. 2003. Enhancing the Asian Development Bank's Role in Combating Money Laundering and the Financing of Terrorism. Manila. 20 Ownership, Management, and Governance (accessible from the list of linked documents in Appendix 2). 21 In addition, Maurice Lam has been nominated as independent director, subject to approval by the regulator.

5 the Pacific, Europe, Middle East, and Africa at several financial institutions. The board has three standing committees including the governance, nomination, and compensation committee; risk management committee; and audit committee. The two independent directors serve on the risk management committee and the audit committee.

CONFIDENTIAL INFORMATION DELETED

III. THE PROPOSED ADB ASSISTANCE

A. The Assistance

14. ADB will provide a senior A loan facility to XacBank of up to $30 million (or its togrog equivalent) with a tenor of up to 5 years. ADB expects to syndicate a B loan of up to $30 million among eligible B loan participants. At least a portion of the A loan will be denominated in US dollars as the anchor for the B loan syndication.

B. Implementation Arrangements

15. Use of proceeds. The loan facility will fund XacBank’s lending operations to MSMEs in Mongolia. No less than 33% of the A loan proceeds will be deployed by XacBank for lending to MSMEs that are women-led or are women sole proprietorships. No less than 40% of the A loan proceeds will be provided by XacBank to finance MSMEs located outside of Ulaanbaatar, where economic development lags behind the capital and the poverty rate is 7% higher.

16. Reporting arrangements. ADB will monitor the transaction until the loan is fully repaid. XacBank will report to ADB periodically and on particular requests. These reports will include quarterly unaudited financial statements, annual audited financial statements, compliance certificates on financial covenants, progress reports of XacBank’s MSME lending program in respect of development effectiveness, and the gender action plan (GAP). ADB’s Private Sector Operations Department will prepare the monitoring report regularly, at least annually, and will submit the first monitoring report no later than 12 months after the first disbursement.

C. Value Added by ADB Assistance

17. Providing critically needed long-term finance. Mongolia is a small volatile economy that carries high country risks. Hence, capital markets remain undeveloped and foreign commercial bank funding remains the exception. Most domestic market borrowings are short term with tenor of up to 1 year. Due to challenging market conditions, IFI funding is an important source of funding for XacBank. ADB will provide stable long-term financing, which will help limit XacBank’s funding risk and enable the bank to develop its MSME business on a sustainable basis.

18. Catalyzing private sector funding and support. ADB is expected to mobilize additional private sector funding for this project under a B loan structure, which will help further diversify XacBank’s long-term funding base.

19. Providing local currency finance from international investors. IFIs fund the bank mostly in US dollars that require hedging of the foreign exchange risk. ADB has received regulatory approvals to raise local currency financing through the issuance of an off-shore togrog

6 linker bond.22 Subject to market conditions, the proposed transaction may be partially funded by ADB’s inaugural offshore togrog-linked bond for Mongolia, which will provide long-term fixed-rate local currency funding that is not readily available in the local market.

20. Supporting gender equity. The transaction is classified as gender equity theme and ADB has worked with XacBank to set gender-specific disbursement targets. At least one-third of the A loan proceeds will be used for lending to women-led MSMEs. XacBank will implement a GAP to enhance its outreach to women-led MSMEs, strengthen staff skills, and heighten the awareness to service women borrowers. 23

CONFIDENTIAL INFORMATION DELETED

IV. DEVELOPMENT IMPACT AND STRATEGIC ALIGNMENT

A. Development Impacts, Outcome, and Outputs

21. Impacts. The proposed loan will support the government’s strategy to restore inclusive economic growth to revitalize the economy and improve the well-being of its citizens by improving the resilience of the finance sector and enhancing financial intermediation especially to micro, small, and medium-sized enterprises and other underserved segments.

22. Outcome. The project’s outcome will be improved credit access of Mongolian MSMEs.

23. Outputs. The outputs will be (i) XacBank’s lending capacity to MSMEs, including those led by women and located outside Ulaanbaatar, is increased; and (ii) XacBank’s ability to render services to women is enhanced.

B. Alignment with ADB Strategy and Operations

24. Consistency with ADB strategy and country strategy. The transaction supports two priorities of Strategy 2030: (i) addressing remaining poverty and reducing inequalities, and (ii) accelerating progress in gender equality.24 Strategy 2030 highlights ADB’s supports for SMEs and inclusive businesses to help generate quality jobs and support inclusive growth. It emphasizes ADB’s support to the finance sector by helping to develop financial infrastructure, institutions, and products and services. The project is consistent with ADB’s country partnership strategy, 2017−2020 for Mongolia.25 Under the pillar of promoting economic and social stability, ADB will promote labor-intensive growth outside the mining sector through SME development by improving their access to finance and by establishing credit lines for key financial institutions. The proposed project will improve MSMEs’ access to finance by providing much-needed long-term finance to a local bank. It will also help to tackle the persistent gender gap in the country and is thus aligned with ADB’s Gender Equality and Women’s Empowerment Operational Plan, 2013–

22 In a linker bond structure, the international investor provides and receives foreign currency, most likely US dollars, while retaining the local currency exchange fluctuation risk. XacBank will convert the US dollar payments into togrog and togrog repayments into US dollars at the applicable spot exchange rates. 23 Gender Action Plan (accessible from the list of linked documents in Appendix 2). 24 ADB. 2018. Strategy 2030: Achieving a Prosperous, Inclusive, Resilient, and Sustainable Asia and the Pacific. Manila. 25 ADB. 2017. Country Partnership Strategy: Mongolia, 2017−2020⎯Sustaining Inclusive Growth in a Period of Economic Difficulty. Manila.

7

2020. 26 It is consistent with ADB sovereign operations supporting MSME development in Mongolia, including credit guarantees.27

V. POLICY COMPLIANCE

A. Safeguards and Social Dimensions

25. Category FI (treated as C). ADB has categorized the investment in compliance with ADB’s Safeguard Policy Statement (2009) as FI treated as C for impacts on the environment, involuntary resettlement, and indigenous peoples.28

26. Environmental and social safeguards. The ADB loan facility will fund XacBank’s MSME finance operations in Mongolia, which will specifically exclude sub-loans that are categorized A or B for impacts on environment, involuntary resettlement, and indigenous peoples based on ADB’s Safeguard Policy Statement. XacBank provides sub-loans to MSMEs, which are mostly in the service and trade sectors such as small tourist camp operators, bakery shops, and individual traders. Sub-loans to MSMEs in the manufacturing sector are usually for working capital or purchase of equipment. MSME clients involved in the mining sector are raw material or service suppliers rather than small mining companies. XacBank’s current and likely future MSME portfolio are likely to have minimal or no adverse environmental impacts. Climate change impact from the project is expected to be low due to the nature and scale of MSME sub-loans that may be financed by ADB loan proceeds. No land acquisition, physical, or economic displacement, or impact on indigenous peoples’ communities is foreseen in relation to any activities of the sub-borrowers. XacBank implemented a social and environmental management system (SEMS) in compliance with IFC’s environmental and social performance standards, and further enhanced it to meet ADB’s Safeguard Policy Statement requirement prior to the disbursement of the earlier ADB loan. The SEMS policy document guides XacBank’s environmentally sound and sustainable development principles and ensures that its MSME finance operations comply with national laws and regulations of Mongolia. No MSME activities with adverse impact on environment, involuntary resettlement, and indigenous peoples were financed using the proceeds of the earlier ADB loan, and due diligence confirmed the adequacy of its SEMS to screen and exclude any potential category A or B sub-loans from the proposed ADB finance. Consistent with the earlier arrangements, XacBank will (i) apply its SEMS and exclusion list for finance, which are aligned with ADB’s Safeguard Policy Statement requirements, including ADB's prohibited investment activities list, (ii) exclude all projects that will have adverse environmental and social safeguards impacts, (iii) ensure that investments using ADB funds abide by applicable national laws and regulations, and (iv) comply with the with ADB’s Safeguard Policy Statement.29 XacBank will confirm these in its periodic report to ADB.

27. Labor and social protection. XacBank ensures its and its sub-borrowers compliance with national labor laws and, pursuant to ADB’s Social Protection Strategy, takes measures to comply with internationally recognized core labor standards.30 As part of the loan application process, XacBank evaluates performance of its sub-borrowers on occupational safety, proper

26 ADB. 2013. Gender Equality and Women’s Empowerment Operational Plan, 2013–2020: Moving the Agenda Forward in Asia and the Pacific. Manila. 27 ADB. 2015. Report and Recommendation of the President to the Board of Directors: Proposed Loan and Technical Assistance Grant Mongolia: Supporting the Credit Guarantee System for Economic Diversification and Employment Project. Manila. 28 ADB. Safeguard Categories. https://www.adb.org/site/safeguards/safeguard-categories. 29 Summary Poverty Reduction and Social Strategy (accessible from the list of linked documents in Appendix 2.) 30 ADB. 2003. Social Protection Strategy. Manila (adopted in 2001).

8 working conditions, provision of mandatory compensation and benefits, and protection of worker’s rights. XacBank will report regularly to ADB on (i) its and its sub-borrower’s compliance with such laws, and (ii) the measures taken.

28. Gender Equity Theme. Following ADB’s Policy on Gender and Development (1998), XacBank has incorporated measures to promote gender equality and/or women’s empowerment in its business activities. Through the GAP, XacBank will implement measures to further empower and benefit women-led enterprises and further strengthen its institutional capacity to service women borrowers. XacBank will include its progress on GAP implementation in the annual report to be submitted to ADB.

B. Anticorruption Policy

29. XacBank was advised of ADB’s policy of implementing best international practice relating to combating corruption, money laundering, and the financing of terrorism. ADB will ensure that the investment documentation includes appropriate provisions prohibiting corruption, money laundering, and the financing of terrorism, and remedies for ADB in the event of noncompliance.

CONFIDENTIAL INFORMATION DELETED

C. Assurances

30. Consistent with the Agreement Establishing the Asian Development Bank (the Charter),31 ADB will proceed with the proposed assistance upon establishing that the Government of Mongolia has no objection to the proposed assistance to XacBank. ADB will enter into suitable finance documentation, in form and substance satisfactory to ADB, following approval of the proposed assistance by the ADB Board of Directors.

VI. RECOMMENDATION

31. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Asian Development Bank (ADB) and recommend that the Board approve the loan of up to $60,000,000, comprising (i) an A loan of up to $30,000,000 (or its togrog equivalent) from ADB’s ordinary capital resources, and (ii) a B loan of up to $30,000,000, to XacBank for the Micro, Small, and Medium-Sized Enterprises Financing Project in Mongolia, with such terms and conditions as are substantially in accordance with those set forth in this report, and as may be reported to the Board. Takehiko Nakao President 12 September 2019

31 ADB. 1966. Agreement Establishing the Asian Development Bank. Manila.

Appendix 1 9

DESIGN AND MONITORING FRAMEWORK

Impacts the Project is Aligned with The Action Program of the Government of Mongolia for 2016−2020 where inclusive economic growth to revitalize the economy and improve the well-being of its citizens is anchored to the government’s policy. The government’s policy will improve among others the resilience of the finance sector and enhancing financial intermediation especially to micro, small, and medium-sized enterprises and other underserved segmentsa

Performance Indicators Data Sources and with Targets and Reporting Results Chain Baselines Mechanisms Risks Outcome By 2024:

Credit access of a. Number of MSME a–e. Annual Deterioration of economic Mongolian borrowers increased to XX development conditions reduces MSMEs is b effectiveness XacBank’s lending capacity improved monitoring reports and affects its asset quality b. MSME loans outstanding from XacBank increased to XX

c. Loans outstanding to women-led MSMEs increased to XX c

d. Share of women-led MSMEs borrowers increased to XX% of MSMEs borrowers

e. Share of loans outstanding to women-led MSMEs increased to XX% of MSME loans

Outputs By 2021:

1. XacBank’s 1a. At least XX deployed to 1a–2e. Annual Economic slowdown lending capacity MSME borrowers development reduces demand for credit to MSMEs, effectiveness from women-led MSMEs including those 1b. At least one-third of monitoring reports and MSMEs outside led by women or ADB-funded XX A loan or from XacBank Ulaanbaatar located outside its togrog equivalent is Ulaanbaatar is deployed to women-led increased MSME borrowers

1c. At least XX% of ADB- funded XX A loan or its togrog equivalent is deployed to MSME borrowers located outside Ulaanbaatar

10 Appendix 1

Performance Indicators Data Sources and with Targets and Reporting Results Chain Baselines Mechanisms Risks 2. XacBank’s 2a. Comprehensive ability to render program to support women- services to led MSMEs borrowersd women is established and maintained enhanced 2b. All new loan officers are trained on the specifics of women-owned business loan products with concessional rates

2c. Outreach campaigns targeting XX women-led MSMEs established and completed

2d. All staff are trained on gender sensitization and respectful work environment

2e. At least XX case studies or success stories on women borrowers prepared and disseminated through the company website and/or annual reports

Appendix 1 11

Key Activities with Milestones

Outputs 1−2. XacBank’s lending capacity to underserved segments increased and XacBank’s ability to render services to women enhanced 1. Loan agreement signed by December 2019. 2. ADB loan is fully disbursed to XacBank by December 2020. 3. XacBank disburses proceeds of the ADB loan to MSMEs by 2021. 4. XacBank carries out gender mainstreaming activities by 2021. Inputs

A Loan from ADB: Up to $30,000,000 (in togrog equivalent or United States dollar) B Loan from commercial lenders: Up to $30,000,000 Assumptions for Partner Financing Not applicable. ADB = Asian Development Bank; MSMEs = micro, small, and medium-sized enterprises. a Government of Mongolia. 2016. Action Program of the Government of Mongolia for 2016−2020. Ulaanbaatar. b MSMEs are defined as enterprises with annual turnover of under MNT3 billion or less than 30 employees. c Women-led enterprise is defined as a business that is (i) at least 51% owned by women; or (ii) at least 20% owned by women and has at least one woman holding a key leadership position such as chief executive officer, president, vice-president or chief operating officer; and (where a board exists) has at least 30% women board directors. d The program entails activities to (i) increase capacities of women clients and borrowers and (ii) improve awareness and skills of XacBank staff. Source: Asian Development Bank.

12 Appendix 2

LIST OF LINKED DOCUMENTS http://www.adb.org/Documents/RRPs/?id=53090-001-4

1. Contribution to the ADB Results Framework 2. Country Economic Indicators