Report No. PID8335

Project Name Cote d'Ivoire-Financial Sector (*) Development Project

Region Africa

Sector Financial Sector

Public Disclosure Authorized Project ID CIPE41655

Borrower(s) Government of Cote d'Ivoire

Implementing Agency Ministry of Economy and Finance

Environmental Category C

Date PID Prepared September 2, 1999

Projected Appraisal Date March 25, 2000

Projected Board Date July 31, 2000 Public Disclosure Authorized 1. Country and Sector Background

Performance since the devaluation of 1994. The economy of Cote d'Ivoire has benefited from the competitiveness gains resulting from the January 1994 devaluation of the CFA Franc (CFAF). The Government has pursued economic reforms, supported by an International Monetary Fund Enhanced Structural Adjustment Facility between 1994 and 1997, a second ESAF between 1998 and 2000, several IDA adjustment operations and contributions from other donors. Led by a rise in exports and investment, gross domestic product (GDP) increased in real terms by 2.1 percent in 1994, 7.1 percent in 1995, 6.8 percent in 1996, 6 percent in 1997, and an estimated 5 percent in 1998. The volume of exports rose at annual rate of about 11 percent between 1994 and 1996. Private investment almost doubled as a share of GDP between 1994 and Public Disclosure Authorized 1998.

Medium-term macro framework. The major goals of the 1998-2000 Policy Framework Paper (PFP), distributed to the Board in March 1998, are to sustain growth to reduce poverty and to improve living standards. The next phase of economic reform seeks to: (a) maintain the private sector as the engine of growth; (b) broaden the tax base; (c) reorient Government expenditure to priority social sectors and basic infrastructure; (d) deepen structural reforms to promote private sector development; and (e) further the social agenda, especially in primary education, primary health, basic infrastructure and poverty reduction. New emphasis will be put on good governance through more efficient use of public resources and fighting corruption. The country's financial sector suffered in the late 1980s and early 1990s from structural and solvency problems that endangered its very future. A Financial Sector Adjustment Credit addressed the most immediate issues, Public Disclosure Authorized particularly through the privatization/restructuring of major commercial banks, and the liquidation of insolvent development banks and other institutions. However, the financial sector's capacity to support renewed investment in the economy still remains somewhat hampered by skewed incentives, deficiencies in the legal and regulatory framework, weak capitalization of banks, inadequate technical and managerial capacity, and overall lack of breadth and depth of the system. An efficient financial system is imperative for a stronger private sector. While Ivoirian banks have become more profitable following restructuring in the early 1990s and the devaluation, they suffer from some structural weaknesses. Compliance with regional (UMOA) banking legislation and prudential regulations of the Regional Banking Commission (Commission Bancaire) is sometimes poor; The provision of financial services in rural areas and to small and medium- sized enterprises, as well as the mobilization of long-term savings and the financing of long-term investment, are still deficient; and

The banking system may be subject to excessive risks from coffee and cocoa export financing. The excessive nature of the risk is due, inter alia, to the implicit guarantees provided by the "former CAISTAB's" system of allocating export rights, which is perceived by the industry as a sovereign guarantee for contract enforcement. Liberalization of coffee and cocoa is eliminating some of the risk, and will put pressure on local banks to become more competitive.

The most important current challenges for the financial system are an inadequate regulatory framework, the involvement of the State in financial institutions, problems in financing of agricultural exports, the consequences of these problems on the quality of bank portfolios, and the financial weakness of the Postal Savings network.

Regulatory Framework. Although substantial improvements were made in the early 1990s to the regulatory framework, it remains significantly below international standards. This is most acute in two aspects: prudential norms, and supervision and enforcement of regulations. (a) Prudential norms. The capital adequacy ratio for banks in the West African Monetary Union (UMOA) region is 4 percent. Proposals to raise this standard to the minimum 8 percent recommended by the Basle committee were only recently considered. Loan concentration ratios are also inadequate, currently permitting a bank to have a single exposure equivalent to 100 percent of its capital, instead of the 25 percent maximum recommended by the Basle committee (b) Supervision and enforcement of regulations. A Regional Banking Commission supervises all banks in the UMOA and has full responsibility to undertake on- and off-site supervision. The Commission, headed by the Governor of the BCEAO, can issue seize and desist orders, remove management, and withdraw a bank's operating license. However, actual enforcement of actions such as closure of banks or appointment of new management lies with the national Ministries of Finance.

State involvement in the financial sector. The State substantially reduced its presence in the sector in the early 1990s, but still maintains significant shareholdings. It is the only shareholder in BIAO-CI (100 percent) and the Caisse Autonome d'Amortissement (CAA; 100 percent). It holds 47 percent of the Societe Ivoirienne des Banques (SIB, 47 percent ), 17 percent of the Societe Generale des Banques de la Cote d'Ivoire (SGBCI) and smaller shares in other commercial banks. This role in financial resource mobilization and allocation is in principle incompatible with the Government's economic program, which puts the private sector first. Divestiture of these shareholdings is the logical option to reduce State involvement

-2- Problems in trade finance. Trade finance has been a major share of commercial bank lending. Banks typically lend to exporters, either as lines of credit or secured by stored commodities. Exporters then advance borrowed funds to wholesale buyers in rural areas, who in turn finance farmers' harvests.

The present trade finance system for coffee and cocoa was based on the price stabilization system managed by the "former Caistab". Even under the tight regulation of that system, the trade finance was subject to unusual risks in the past five seasons, given the rapid growth in lending volume. Critical weaknesses became apparent in the warehousing and bonding systems, the solvency of borrowers, and the exposure (relative to their capital) of the banks to exporters.

While the 1998/99 slump in cocoa prices has aggravated the situation, there have been significant structural problems for at least three years. Among them is the fact that the volume of cocoa and coffee exports has grown dramatically since 1994/95 -- due to the devaluation, greater quantities, and the rise in the dollar price of cocoa that began in the last quarter of 1993. Annual exports of cocoa and coffee have reached US$1.8-1.9 billion. In light of the limited size of the Ivorian banking system (particularly in risk- bearing capacity), the concentration of risk in coffee and cocoa financing, and the recent losses by the banks, it is likely that domestic banks will be unable to finance the entire trade in the coming seasons; because of increasing vertical integration of the origin with the international trade, it is expected that financing will be available from international firms to satisfy the credit needs of the economy in these sectors.

Postal Savings System. The postal system and the postal savings and checking institutions were historically joined in the Societe Ivoirienne de Poste et Epargne (SIPE). The SIPE suffered from managerial and financial difficulties and ran a net deficit. The SIPE sometimes used the deposits of the postal savings system to finance its postal operations, plus other parts of the overall deficit. The accumulated deficit of SIPE is a net drain on national savings given that the Government must constantly finance it from tax revenues.

The Government separated SIPE in July, 1998 into a postal checking institution (the Caisse d'Epargne et des Cheques Postaux; CECP) and a postal service. It did so to stop the transfer of losses from the postal service to the financial institution within the old SIPE, and to channel postal savings into the national financial system. There remain two major problems: There is no clear business strategy for the new CECP, and therefore no precise determination of the viability of its products (time deposits, loans, etc.). The risks remain that the postal savings system will lose money on its own, despite having been insulated from the losses of the mail service, and that its depositors will again have to be bailed out by the Government; and The residual deficit of the old SIPE is nearly one percent of GDP and is an important financing item in the budget.

2. Project Objectives

The Project will aim at strengthening Cote d'lvoire's financial sector, deepening and broadening its capacity to support accelerated economic growth and investment. Specifically, the Project will seek to: (a) improve the financial system's capacity to mobilize long-term resources, making them

-3 - available for productive investment; and (b) broaden the system's outreach to economic operators and individuals with no present access to services provided by formal financial institutions.

3. Project Description

To achieve the above objectives, this project would tentatively have four components:

(a) Fine-tuning of banking infrastructure. The Project would seek to address specific regulatory issues in the banking sector, in collaboration with BCEAO, as well as achieve an improved payments system.

(b) Strengthening of microfinance institutions. The Project would finance activities designed to improve access to and quality of financial services in the informal sector. This component would seek to extend the ability of the financial system to reach under-served markets through the following: (i) on the regulatory side, assist the Government in implementing the new "PARMEC" law. Special emphasis would be placed on adequately regulating non-mutualistic microfinance institutions; (ii) on the institutional side, finance the development of support mechanisms aimed at building capacity and networking of microfinance institutions; and (iii) finance new pilot microfinance operations.

(c) Improving the environment for financial transactions. Project activities would include: (i) a legal sub-component to follow up on the implementation of actions launched under the FINSAC, continued under PASCO, and later under the PAGE and the PSD operations. It would focus on collateral realization and on supporting reforms being considered under the OHADA initiative-which seeks to establish a regional legal framework for business activity. The experience of SONARECI (a debt recovery agency) would be analyzed in this context; (ii) a fiscal sub-component in the form of a revision of taxes levied on financial instruments and institutions: taxation of financial instruments does not provide incentives to save, and currently favors debt financing instead of equity financing; (iii) a state-debt monitoring sub-component, to further strengthen the Government's ability to manage its debt in a coherent and transparent way, preventing any future "crowding out" of the private sector in local credit markets.

(d) Broadening the financial system and improving access to term finance. The objectives of this component would be to: (i) provide a better framework for the development of non-bank financial institutions, (ii) promote use of new financial instruments in local capital markets, (iii) assess the impact of the usury law on term finance availability and (iv) study the Ivorian pension system, with a view towards making use of the system's potential for the development of capital markets. Mortgage financing, already addressed in the context of the Bank financed Urban Land Management and Housing Finance Project, would also be subject to support as needed.

4. Project Implementation

Overall responsibility for Project design and implementation is likely to reside with the Chief of Staff Office at the Ministry of Economy and Finance. A Steering Committee has been set up at the initiative of the latter to oversee Project preparation and, later on, its implementation. A smaller

- 4 - Technical Committee will be nominated to deal with specific technical issues, and serve as main interface to the Bank's project team. Concerned parties, including banks and other private sector representatives, will be invited to participate in Steering Committee discussions as needed.

The Project is expected to be implemented over a four-year period 2000-2003. Total costs are estimated at US$ 23 million, of which IDA would finance an estimated US$ 15 million, with possible cofinancing from other donors.

5. Project sustainability

Project sustainability will hinge upon: (a) the ability of the Government's Project Unit to build capacity to monitor and analyze on a permanent basis the financial system's performance and contribution to overall economic development; (b) the ability of financial institutions to operate in the more diversified, competitive environment resulting from Project activities; and (c) the absorption and retention capacity of beneficiary institutions both within Government and the private sector respective to training and other capacity-building activities financed by the Project.

6. Lessons from Past Operations in the Sector

The Project draws extensively from past experience in both Cote d'lvoire and elsewhere. First, the Bank's overall strategy in Africa is to focus as a priority on the establishment of a healthy banking sector, as a prelude to reforms aiming beyond the functioning of that sector and towards greater diversification, efficiency. and outreach of' the system as a whole. Following restructuring of Cote d'lvoire's banking sector in the early 1990s, the country is now poised to take full opportunity of such intervention in the broader financial system. Second, the Project takes full account of weak capacity, both within Government and financial institutions to address problems in the sector: capacity-building is becoming a linchpin of much of the work going on in the sector in the rest of Africa. Third, the Project will focus on a limited number of interventions that offer high potential return in the relatively short-term; experience has shown that wideranging projects aiming at multi-dimensional development of the financial sector often faced implementation problems later on. Fourth, Project timing is intended to take opportunity of current favorable conditions for success, including the existence of keen government interest to promote financial sector development, and interest on the part of banks and other investors in pursuing new opportunities in the sector; experience clearly points to the importance of appropriate timing in the launching of efforts to promote the emergence of new financial institutions in Africa.

7. Poverty Alleviation

The Project will not focus directly on poverty reduction and therefore no poverty category is assigned to the proposed project. However, this Project is expected to contribute to poverty alleviation through the support given to micro-finance institutions. Vulnerable groups are expected to benefit from increased access to small credit which will facilitate their undertaking of economic activities. A more efficient financial sector is also expected to facilitate the development of the private sector and employment in Cote d'Ivoire.

-5- 8. Environmental Aspects

The project is not expected to have any direct adverse environmental impact. The project is envisaged to be classified in Environmental Category C.

9. Program Objective Categories

The Project supports,the achievement of IDA's private sector development and economic management objectives. As mentioned above, it will also address poverty issues via its anticipated impact on growth and employment creation in the informal sector. The program objective category is FS.

10. Contact Points:

The InfoShop The World Bank 1818 H Street, N.W. Washington, D.C. 20433 Telephone: (202)458-5454 Fax: (202) 522-1500

Task Manager Andres D. Jaime The World Bank 1818 H Street, N.W. Washington, D.C. Telephone: (202) 473-9344 Fax: (202) 477-2978

Note: This is information on an evolving project. Certain components may not be necessarily included in the final project.

Processed by the InfoShop week ending November 5, 1999.

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