PROJECT INFORMATION DOCUMENT (PID) APPRAISAL STAGE Report No.: 82515

Project Name Additional Financing to Financial Sector Rapid Response Project

Public Disclosure Authorized Region SOUTH ASIA Country Sector Payment systems (43%), banking (36%), public administration- financial sector (12%), credit reporting and secured transactions (9%) Project ID P147624 Parent Project ID P119047 Borrower(s) Ministry of Finance, Afghanistan Implementing Agency Environment Category [ ] A [ ] B [X] C [ ] FI [ ] TBD (to be determined) Date PID Prepared October 14, 2013 Date of Appraisal October 10, 2013

Public Disclosure Authorized Authorization Date of Board Approval November 26, 2013

1. Country and Sector Background

Afghanistan will experience a major security and development transition over the next years. At the and Lisbon Conferences in 2010, NATO and the Afghan government agreed that full responsibility for security would be handed over to the Afghan National Security Forces by the end of 2014. The country now faces the drawdown of most international military forces over the coming several years with an expected accompanying decline in civilian aid as international attention shifts elsewhere and aid budgets come under increasing fiscal pressure. The decline in Public Disclosure Authorized external assistance is likely to have widespread ramifications for Afghanistan’s political and economic landscape well beyond 2014. Falling aid flows in Afghanistan will have the most impact on public spending as present levels of expenditure will be fiscally unsustainable for Afghanistan once donor funds decline. The main issue is how to manage this change, mitigate impacts, and put aid and spending on a more sustainable path. At the Tokyo Conference on July 8, 2012, the international community committed to US$16 billion of aid to Afghanistan (annual average of US$4 billion over the next four years) and agreed to the Tokyo Mutual Accountability Framework with the Government of Afghanistan (GOA) that focuses on (i) Representational Democracy and Equitable Elections, (ii) Governance, Rule of Law and Human Rights, (iii) Integrity of Public Finances and Commercial Banking Systems, (iv) Government Revenues, Budget Execution and Sub-National Governance, and (v) Inclusive and Sustained Growth and Public Disclosure Authorized Development.

The financial sector in Afghanistan is still fragile and underdeveloped. The banking sector is composed of 3 state-owned banks (including the newly created bank following the Kabul Bank crisis, New Kabul bank, currently under privatization), 9 private full-fledged banks and 4 branches of foreign commercial banks. The banking sector is still dealing with the aftermath of the Kabul Bank crisis, which threatened the overall stability of the banking sector (as the bank held about one-third of the system’s assets of US$4 billion) and has raised concerns regarding the capacity of the Central Bank to adequately supervise the banking sector. A detailed report of the public inquiry into the Kabul Bank crisis was released in November 2012 by the Independent Joint Anti- Monitoring and Evaluation Committee (MEC). The conclusions are severe and highlight critical weaknesses in governance in the financial sector and more broadly (including the judiciary).

2. Objectives

The revised Project Development Objective is to assist Da Afghanistan Bank (DAB) to develop action plans for improved banking supervision and to establish key building blocks of financial sector infrastructure: payment system, movable collateral registry and public credit registry.

3. Rationale for Bank Involvement

The proposed Additional Financing is fully aligned with Government priorities and is consistent with the World Bank Group’s Interim Strategy Note 2012–2014 (ISN, Report No. 66862-AF). The GOA’s National Priority Programs (NPPs) identify private sector development as the main driver of the diversified growth strategy. However, the underdeveloped financial sector and low rates of financial intermediation are a key hindrance for private sector development. The proposed Additional Financing will therefore consolidate World Bank’s support to the GOA on further strengthening the financial sector after the Kabul Bank crisis, through narrowly defined technical assistance activities relating to DAB. It will in particular ensure the development and implementation of action plans following the audits of commercial banks. The Additional Financing supports the first pillar of the ISN: building legitimacy and capacity of institutions, through technical assistance to DAB, and the third pillar of the ISN: inclusive growth and jobs, through building key financial sector infrastructure.

4. Description

The following changes are proposed in project components and financing:  Component 1. Strengthening of DAB’s capacity (Additional Financing of US$4.5 million): The Component 1 would focus on targeted activities to strengthen DAB’s capacity: (i) stock taking on capacity building efforts on financial supervision over the last ten years and development and implementation of a capacity building plan to sustainably strengthen the Financial Supervision Department, (ii) review of banking regulation framework, and (iii) development and implementation of action plans following the ten audits of commercial banks financed by the Financial Sector Rapid Response Project (FSRRP). These activities will be undertaken by a firm with recognized financial sector expertise, through Quality Based Selection (QBS). Draft Terms of Reference are available and the procurement process will be initiated in October 2013.  Component 2. Development of the financial sector infrastructure (Additional Financing of US$2.2 million): The revised Component 2 would cover broader activities to support the development of financial sector infrastructure, including support to the development of the Collateral Registry (CR) and to the establishment of the Public Credit Registry (PCR), activities initiated under the Financial Sector Strengthening Project (FSSP). The Collateral Registry is now fully operational but further technical assistance is needed to maximize its use by financial institutions. The contract for the establishment of the PCR was signed in February 2013 under FSSP. This contract will therefore be transferred to the Additional Financing of FSSRP. The PCR should be operational by end 2013.  Component 3. Technical assistance and training for project implementation: Within the current project cost (US$3 million), Component 3 will also include support to the establishment of the PCR and CR. In addition, this Component will cover pending payments on a contract for assessment of IT requirement, design, implementation and supervision of IT Installation at DAB, signed under FSSP. The amount of final payments is being finalized between DAB and the firm.

5. Financing

Source: ($m.) BORROWER/RECIPIENT 0 International Development Association (IDA) 6.7 Total 6.7

6. Implementation

Current implementation arrangements will apply to the additional financing. Under these arrangements, the Project Implementation Cell (PIC) at DAB will continue to be responsible for the project implementation. Currently, the PIC at DAB comprises of a Project Director, a Deputy Project Director, two Financial Officers, an International Procurement Specialist and a Procurement Specialist. In addition, a Financial Management Specialist is under recruitment1.

7. Safeguard Policies

1 The Project Director, Deputy Project Director, Finance Officers and Procurement Specialist are DAB staff. The international Procurement Specialist is financed by the Project, as will be the Financial Management Specialist under recruitment. The Environmental category of the Project remains C, given that no significant environmental impacts are foreseen.

8. Contact point

Contact: Guillemette Sidonie Jaffrin Title: Senior Private Sector Development Specialist Tel: +93 (0) 70 11 33 365 Fax: Email: [email protected]

9. For more information contact:

The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-4500 Fax: (202) 522-1500 Email: [email protected] Web: http://www.worldbank.org/infoshop