Document of

The World Bank

Report No: 23817-VN

PROJECT APPRAISAL DOCUMENT

ON A

PROPOSED CREDIT

IN THE AMOUNT OF SDR 160.2 MILLION (US$200 MILLION EQUIVALENT)

TO THE

SOCIALIST REPUBLIC OF VIETNAM

FOR A

SECOND RURAL FINANCE PROJECT

May 2, 2002

Rural Development and Natural Resources Sector UnitEast Asia and Pacific Region

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CURRENCY EQUIVALENTS

(Exchange Rate Effective April 26, 2002)

Currency Unit = DONG

1,OOODONG = US$0.066

US$1 = DONG15,225

FISCAL YEARJanuary 1 -- December 31

ABBREVIATIONS AND ACRONYMS

ADB Asian Development BankAMC Asset Management CompanyBIDV Bank for Investment and Development of VietnamCAS Country Assistance StrategyCCF Central Credit FundDOSTE Department of Science, Technology, and EnvironmentFRP Fund for the Rural PoorLAS Intemational Accounting StandardICPMU Intemational Credit Project Management UnitIDP Institutional Development PlanJSB Joint-Stock BankLWU Loan Workout UnitMFI Micro-Finance InstitutionMLF Micro-finance Loan FundMPDF Mekong Project Development FacilityMOF Ministry of FinanceMOSTE Ministry of Science Technology and EnvironmentNGO Non-Govemmental OrganizationNPL Non-Performing LoansPCF People's Credit FundPFI Participating Financial InstitutionPRSC Poverty Reduction Support CreditRDF Rural Development FundSBV State Bank of VietnamSOCB State Owned Commercial BankSOE State Owned EnterpriseVAS Vietnam Accounting StandardVBARD Vietnam Bank for Agriculture and Rural DevelopmentWBO Wholesale Banking Operation

Vice President: Jemal-ud-din Kassum, EAPVPCountry Manager/Director: Andrew Steer, EACVQ

Sector Manager/Director: Mark Wilson, EASRD)Task Team Leader/Task Manager: Arie Chupak, EASRD

VIETNAMSECOND RURAL FINANCE PROJECT

CONTENTS

A. Project Development Objective Page

1. Project development objective 22. Key performance indicators 2

B. Strategic Context

1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 32. Main sector issues and Government strategy 33. Sector issues to be addressed by the project and strategic choices 4

C. Project Description Summary

1. Project components 52. Key policy and institutional reforms supported by the project 63. Benefits and target population 64. Institutional and implementation arrangements 6

D. Project Rationale

1. Project altematives considered and reasons for rejection 122. Major related projects financed by the Bank and other development agencies 143. Lessons learned and reflected in the project design 144. Indications of borrower commitment and ownership 165. Value added of Bank support in this project 17

E. Summary Project Analysis

1. Economic 182. Financial 193. Technical 204. Institutional 205. Environmental 226. Social 247. Safeguard Policies 26

F. Sustainability and Risks

1. Sustainability 27

2. Critical risks 283. Possible controversial aspects 29

G. Main Credit Conditions

1. Effectiveness Condition 292. Other 30

H. Readiness for Implementation 33

I. Compliance with Bank Policies 33

Annexes

Annex 1: Project Design Summary 34Annex 2: Detailed Project Description 37Annex 3: Estimated Project Costs 42Annex 4: Cost Benefit Analysis Summary, or Cost-Effectiveness Analysis Summary 50Annex 5: Financial Summary for Revenue-Earning Project Entities, or Financial Summary 52Annex 6: Procurement and Disbursement Arrangements 55Annex 7: Project Processing Schedule 70Annex 8: Documents in the Project File 71Annex 9: Statement of Loans and Credits 72Annex 10: Country at a Glance 74Annex 11: Key Performance Indicators 76Annex 12: Credit Operations Arrangements 82Annex 13: BIDV's Operations, Financial Performance, and Projections 91Annex 14: VBARD's Operations, Financial Performance, and Projections 103Annex 15: Potential Project's PFIs 117Annex 16: Environmental Protection Arrangement 122Annex 17: Structure and Staffing of the Project Management Unit (PMU) 130

MAP(S)IBRD 29370

VIETNAMSecond Rural Finance Project

Project Appraisal Document

East Asia and Pacific RegionEASRD

Date: May 2, 2002 Team Leader: Arie ChupakCountry Manager/Director: Andrew D. Steer Sector Manager/Director: Mark D. WilsonProject ID: P072601 Sector(s): AC - Agricultural CreditLending Instrument: Financial Intermediary Loan (FIL) Theme(s): Private Sector

Poverty Targeted Intervention: Y

Project Financing Data] Loan [X] Credit [] Grant [ ] Guarantee [ ] Other:

For Loans/Credits/Others:Amount (US$m): 200 equivalent: SDR160.2 million

Proposed Terms (IDA): Standard CreditGrace period (years): 10 Years to maturity: 40Commitment fee: 0.5% Service charge: 0.75%Financing Plan (US$m): Source Local Foreign TotalBORROWER 0.00 0.00 0.00IDA 78.20 121.80 200.00BORROWING AGENCY 10.70 15.10 25.80BORROWING COUNTRY'S FIN. INTERMEDIARY/IES 12.10 17.20 29.30SUB-BORROWER(S) 17.80 25.30 43.10Total: 118.80 179.40 298.20

Borrower: THE SOCIALIST REPUBLIC OF VIETNAMResponsible agency: BIDVBank for Investment and Development of Vietnam (BIDV)Address: 194 Tran Quang Khai Street, Hoan Kiem District, Hanoi, VietnamContact Person: Ms. Pham Thi Ngoc AnhTel: 844 8253448 Fax: 844 9321975 Email: anhptn@bidv.com.vn

Estimated Disbursements ( Bank FY/US$m):FY 2003 2004 2005 2006 2007 2008 2009

Annual 10.00 35.00 35.00 40.00 40.00 30.00 10.00Cumulative 10.00 45.00 80.00 120.00 160.00 190.00 200.00

Project implementation period: 5 yearsExpected effectiveness date: 09/30/2002 Expected closing date: 09/30/2008

CCS PAD Fm RFt Md0 0

A. Project Development Objective

1. Project development objective: (see Annex I)

Building on the achievements of, and the experience gained under, the First Rural Finance Project (RF I),Credit 2855-VN, the proposed project would assist the Government in its efforts to develop the ruraleconomy and improve the living conditions in the rural areas through: (a) encouraging investments of farmhouseholds and private rural entrepreneurs; (b) strengthening the banking system's capacity to better servethe rural economy; and (c) increasing access of the rural poor to financial services. These would beachieved through the provision of: (a) further assistance to the Rural Development Fund (RDF) byextending additional medium and long term financial resources, through the banking system, for thefinancing of private viable investments in the rural areas; (b) further support to the government in its effortsto alleviate rural poverty through the extension of financial and institutional support to the Micro-financeLoan Fund (MLF) and its implementation agencies (Micro-finance Institutions, MFIs); (c) institutionalsupport to strengthen the Bank for Investment and Development of Vietnamn (BIDV, the project ApexBank) as a wholesale financial institution serving the rural areas; and (d) help to enforce financial disciplineon the project's Participating Financial Institutions (PFIs). These goals are in line with those of theGovernment (GOV) and coincide with the banking sector reforms undertaken by GOV and supported byIDA through the Poverty Reduction Support Credit (PRSC). The project would support these initiativesover a period of five years.

Through the RDF, the project would assist private sector enterprises and individuals, particularly farmhouseholds and rural entrepreneurs, to help implement their expansion and modernization plans, toundertake new sub-projects, and to finance working capital requirements. These private enterprises wouldthus be able to expand their production capacity, provide employment opportunities, and contribute to ruraleconomic growth and poverty alleviation. Through the MLF, the project would provide additional lendingresources and technical support to Micro-finance Institutions (MFIs) serving the poor. This would improveMFIs' ability to accommodate the saving needs of the poor and directly provide credit facilities to financeviable economic activities of rural poor households and micro-enterprises (those employ at least threepersons outside the immediate family members).

The project would also assist BIDV and PFIs/MFIs in strengthening their institutions and increasing theircapacity to provide financial services to the rural areas, and the rural poor in a sustainable manner. Underthe project, BIDV as well as PFIs/MFIs would be required to apply higher financial standards with regardto solvency, liquidity, profitability, and best management practices. BIDV and the PFIs/MFIs would eachprepare an institutional development plan (IDP) to be agreed and implemented during the projectimplementation period.

2. Key performance indicators: (see Annex 1)

To assist the Government, the management of BIDV, and IDA in monitoring and evaluating projectimplementation performance, a set of Key Performance Indicators (KPIs) related to project objectives wasagreed at negotiations. The KPIs include: (i) supporting rural development through financing of viableinvestments (number of sub-loans, total sub-project investments, and estimated incremental jobs created);(ii) strengthening BIDV's capacity to manage wholesale banking operations and finance private sectorinvestments (real increase in equity, private deposits mobilization, upgrading lending quality, and improvedinformation and control systems); and (iii) upgrading the operational capacity of MFIs to provide financialservices to the rural poor (number of participating MFIs, cumulative amount lent through them to the ruralpoor, and cumulative numbers of rural poor borrowers); and (iv) accomplishment of their Institutional

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Development Plans (IDPs) by the PFIs and MFIs, including tracking sets of financial ratios which reflectprogress with regard to solvency, liquidity, resource mobilization, profitability, and management. A set ofKPIs regarding the IDPs and the Credit components is presented in Annex 11.

B. Strategic Context

1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex I)Document number: IDAIR2001-0160 Date of latest CAS discussion: October 25, 2001

The project would support and contribute to several goals of the CAS. It would (i) contribute directly topoverty alleviation and equitable growth through the financing of the rural poor and rural micro enterprises,and indirectly through the provision of term lending for viable private investments in the rural areas; (ii)accelerate rural development through financing of rural small and medium private investments; (iii)increase competitiveness among banks that operate in the rural areas through its wholesale lines of credit;(iv) create off-farm employment to absorb agricultural labor and contribute to the agriculturalindustrialization; (v) promote agricultural export and improve rural productivity through lending to exportoriented and large farming activities in the rural area; (vi) contribute to the strengthening of the financialsector through: (a) the enforcement of financial discipline on project's PFIs and the implementation of theirIDPs; (b) enhance the implementation of the restructuring plans of BIDV as the project's Apex Bank andthe Vietnam Bank for Agriculture and Rural Development (VBARD) as the project's main credit retailer.By financing private investments, the project would also support the CAS' twin imperatives targets, i.e.restoring the momentum and deepening the quality/sustainability of development.

2. Main sector issues and Government strategy:

While progress achieved over the past decade has been substantial by all standards, Vietnam remains apoor country with great development potential that needs to be realized. While the share of population inpoverty has been substantially reduced over the past decade, some 28 million people (about 35% of thepopulation) are estimated to live in poverty. About 85% of the poor live in rural areas and about 40% ofthe rural population live in poverty. About 75% of the population of Vietnam live in the rural areas andagriculture remains their main source of living. Raising living standards in rural areas is perhaps the mostcritical challenge for Vietnam in the next decade. However, the small farm sizes (on average less than onehectare) provide only part time work for most farm families. Consequently, sustained sectoral growth,combined with increased employment opportunities outside the agriculture sector will be indispensable toreduce rural poverty in the years to come. Raising rural incomes will have to come from increaseddiversification, intensification, and the development of non and off farm opportunities. This new approach,which would result in substantial changes in cropping pattem and increased commerce in agricultural andnon agricultural products, will require substantial sectoral investments by the private sector, pointing upthe need for adequate term financing.

Government's strategy places the agriculture and the rural sector soundly at the core of their developmentplans. Prioritizing agriculture and particularly rural development is crucial to poverty reduction and asubstantial factor in the country's economic growth. Output from the agriculture sector accounted, in1999, for nearly 25% of GDP, 66% of total employment and about 30% of export revenue. These sharesare likely to decline over the coming years as they have done slowly over the past decade. Farm familiesare increasingly turning to non-farm and off-farm activities as source of income and employment. Theacceleration of this trend is curbed by several constraints such as lack of market information, outmodedequipment and technology, limited availability of saving services and inadequate credit facilities.

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Financial services in Vietnam are provided by a network of banks, non-bank financial institutions, and to alarge extent by the informal financial sector (moneylenders, relatives, and individuals). The Vietnameserural financial sector is comprised of five State Owned Commercial Banks (SOCBs), about 20 ruralshareholding banks (RBs) about 970 People's Credit Funds (PCFs), and about 70 Credit Cooperatives(CCs). In 1999, total formal lending to rural households was estimated at US$2.9 billion equivalent,serving some 6 million households or about 50% of rural population. The bulk of these banking activities(about 80% or US$2.3 billion equivalent) has been undertaken by VBARD. Most of these loans, however,were short-term and financed mainly agricultural production. The rural financial sector is currently notproviding adequate term financing for rural investments, and its services to non-farm rural entrepreneursare alnost non existent.

Banking competition is very limited. Except for the SOCBs all other rural financial institutions (RBs,PCFs and CCs) are quite small and serve only small parts of their related communities. Basically, the ruralfinancial institutions suffer from the samne weaknesses as the entire banking system in Vietnam. Thissystem is currently quite weak, and banks are characterized by low level of equity, relatively largenon-performing loans, inadequate provisions for possible loan losses, low profitability, and insufficientknowledge and experience in banking operations among banks' management and staff. Govemment'spolicy toward strengthening the banking system is focussed on the following reform programs: (i)improving legal, regulatory and supervisory framework; (ii) restructuring and commercializing of SOCBs;(iii) restructuring of Joint Stock Banks (JSBs); (iv) improving the financial performance of the bankingsystem in general, and the quality of their loan portfolio, in particular; (v) leveling the playing field for allbanks; (vi) improving transparency and financial information flow; and (vii) training management and staffin commercial banking and in central bank supervision. The implementation of these key reforms wouldpositively affect the perforrmance of the rural financial sector as well.

3. Sector issues to be addressed by the project and strategic choices:

The project would address most, if not all of the main sector issues. These include (i) provision ofadditional term financial resources for the financing of viable rural investments, and economic activities ofthe rural poor, thus contributing to diversification of rural economy, increasing employment opportunities,and reducing rural poverty (RDF II and MLF, components a and b); (ii) enhancing access to financialservices of small farmers, entrepreneurs, and the poor in remote areas through support of mobile bankingoperations, (components b and d); (iii) promoting banking competition in the rural areas through theoperation of wholesale banking programs, for the poor and general rural investments (components a andb); (iv) assisting in the restructuring of BIDV and VBARD , two out of five SOCBs (components c andd); (v) helping to enforce financial discipline on PFIs and MFIs and strengthening their operations throughthe implementation of their agreed IDPs (component d); and (vi) promoting training of management andstaff of BIDV, PFIs', MFIs, through financing of training programs and the provision of technicalassistance (component d).

1/ The project would assist the restructuring of more SOCBs (Vietcombank and INCOM bank) if they become project's PFIs.The Restructuring Plans (RPs) of SOCBs isfocusing on: (i) improving governance and management structure; (i) introductionof risk management systems to cover credit, assets, foreign exchange, liquidity, etc.; and (iii) dealing with their bad debts andrecapitalization.

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C. Project Description Summary

1. Project components (see Annex 2 for a detailed description and Annex 3 for a detailed costbreakdown):

Indicative Bank- % ofComponent Sector Costs °/e of financing Bank-

._________________________ _ .(US$M) Total (US$M) financinga. RDF II. A fund, at market interest 257.20 86.3 167.40 83.7rates, available through the BIDV toaccredited PFIs on a short, medium orlong-term basis to finance ruralinvestments of farm households andprivate rural entrepreneurs that areeconomically and technically viable.b. A fund lent by BIDV to MFIs at 36.20 12.1 28.00 14.0market rates would form the MLF,which would provide finance forworking capital and small capitalinvestment of micro-enterprises andindividual poor people.c. Strengthening of BIDV. An agreed 2.20 0.7 2.00 1.0IDP would be implemented by BIDV.This would focus on strengtheningBIDV's financial performanceincluding: (i) increasing the quality ofits loan portfolio; (ii) diversifyingincome sources, widening interest ratespreads and improving operationaleffectiveness to increase profitability;(iii) mobilization of medium and longterm VND resources; (iv) equity buildup to reach and maintain an acceptableCAR; (v) staff training; and (vi)improving MIS and internal controlsystems.d. Strengthening PFIs and MFIs. 2.60 0.9 2.60 1.3Under this component, PFIs/MFIswould also implement their ownrespective IDPs. This would includebuild up capital base, improve solvencyposition, profitability, depositmobilization, and training. Under thiscomponent, a mobile banking operationwould be financed.

Total Project Costs 298.20 100.0 200.00 100.0

Total Financing Required 298.20 100.0 200.00 100.0

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Project Scope. The project would finance eligible sub-projects all over Vietnam except in the urban areasof Hanoi, Ho Chi Minh City, Hai-Phong, and Da Nang. The need for rural commercial medium andlong-term resources is currently estimated, by the task team, to exceed US$1 billion per year over a periodof five years. However, the likely risks for credit delivery in the country in general, and in the rural areasin particular, are: (i) the number of financial institutions that would meet the project's accreditation criteria;and (ii) the borrowing capacity of those accredited PFIs and MFIs. It is currently estimated that theborrowing capacity of about 24 potential PFIs, under RDF I and II, would be sufficient to borrow theadditional US$200 million equivalent that proposed under the Project. More specifically, the borrowingcapacity of the 24 potential PFIs/MFIs would be sufficient to borrow some US$260 million equivalent orabout 85% of RF I and RF II available funds (the equivalent of about US$295 million in total, US$105million of RF I and US$190 million of RF II) over a period of five years (more details are presented inAnnex 15). The balance of about US$30 million would be left for: (i) other PFIs or MFIs that will bewilling to join, and accredited by, the project during its five year implementation period; and (ii) thoseaccredited PFIs that will be willing to increase their lines of credit provided that their respectiveperformance indicators would justify such an increase.

2. Key policy and institutional reforms supported by the project:

The project would seek: (i) to ensure that all PFIs/MFIs whether SOCBs or non-state owned financialinstitutions would be treated equally, under the project; (ii) the institutional development of BIDV andPFIs/MFIs; and (iii) the introduction and approval, by SBV, of a legal framework and prudentrequirements for the operation, as financial intermediaries, of non-bank MFIs. Also, the project would seeka further liberalization and rationalization of interest rate policy to: (i) encourage more term lending; (ii)sustain micro-finance operations; (iii) encourage more banks to actively operate in the rural areas; and (iv)improve banks' profitability.

3. Benefits and target population:

The RDF II would provide credit to assist individual and privately owned enterprises includingfarm households and small and medium scale entrepreneurs in Vietnam's rural areas. It isestimated that about 90,000 economic entities would benefit from this component through theestablishment and expansion of existing viable operations. The Micro Finance component wouldprovide credit to assist individual poor households and micro-enterprises in the rural areas. It isestimated that about 75,000 households and 10,000 micro-enterprises would benefit from thiscomponent. The institutional strengthening component would assist: (i) BIDV to become astronger institution capable of effectively wholesaling investment finance, so that better financialservices can be delivered to the rural areas, resulting in job creation and increased incomes amongthe poor; (ii) the PFIs to upgrade their performance and provide better services to their clientele inthe rural areas; and (iii) farm households, entrepreneurs, and the poor to have better access tofinancial services and benefit from a more competitive market (mobile banking).

4. Institutional and implementation arrangements:

The Credit would be made to the Socialist Republic of Vietnam for on-lending to BIDV. BIDV wouldassume overall responsibility for project implementation. It would do this through a Project ManagementUnit (PMU) that would handle day-to-day implementation of the funds. The project would make nodemand on government financial resources and be independent of the administrative capacity of govemmentline agencies.

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The Credit Component

The credit component consists of two lines of credit, the RDF II and the MLF (the FUNDS). Each of thetwo FUNDS would function as a wholesale banking operation. The two lines of credit would each beoperated on the basis of an agreed Policy Manual, prepared2' by BIDV, that would incorporate the basicexperience gained and lessons learned under the first Rural Development Fund (RDF I) and the Fund forthe Rural Poor (FRP). The main elements of these policy manuals would include details on: eligibilitycriteria of sub-projects; accreditation criteria for Participating Financial Institutions (PFIs/MFIs); amechanism for setting market based interest rates; arrangements for foreign exchange risk coverage;subsidiary and sub-loan maturities, appraisal, disbursement and supervision of sub-projects; environmentalprotection; and monitoring the financial performance of PFIs/MFIs. These are detailed in Annex 12. Theoperation of the FUNDS would be determrined by market forces, with no earmarked allocation by crop ortype of investment; it would be a demand driven operation, and would bear a market deternined interestrate.

The two lines of credit would finance private viable investments anywhere in the country except in majorurban areas (Hanoi, Ho Chi Minh City, Hai-Phong, and Da Nang). The RDF HI sub-component wouldfinance rural investment in general (mainly medium and long term financing). It would be used to makeshort, medium, and long term credit available through competing PFIs to finance investments of farmhouseholds and privately owned small and medium enterprises in agriculture and other viable ruraloperations (both fixed assets - excluding land - and working capital). The proceeds of IDA credit would beused to finance eligible sub-loans made by PFIs for farm production, small scale manufacturing,processing, trade, services, and other viable investments of farm households and rural entrepreneurs. Thefunds would be on-lent to accredited PFIs who have signed a Subsidiary Loan Agreement with BIDVacceptable to IDA. Proceeds which accrue from the repayment of the principal of the subsidiary loans byPFIs would be used to establish and maintain a revolving fund for on-lending for the same purposes andunder the same terms and conditions as those for on-lending the IDA Credit initially. The proceeds of IDACredit and the associated revolving fund would be known as RDF II. Total investment costs of 'firstround' sub-projects supported under RDF II are estimated at the equivalent of US$255.0 million. Totalcost of this component including goods, training, TA, and contingencies is estimated at US$257.2 million.

The MLF sub-component would be restricted to financing economic activities of the rural poor and microenterprises. The MLF would be used to provide mainly short term financing, through competing MFIs tofinance economic activities of the rural poor (individuals and micro-enterprises). Medium term loans, ifgranted, would not exceed three year maturity. The funds would be on-lent to accredited MFIs who havesigned a Subsidiary Loan Agreement with BIDV acceptable to IDA. Proceeds accrued from the repaymentof the principal of the subsidiary loans by MFIs would be used to establish and maintain a revolving fundfor on-lending for the same purposes and under the same terms and conditions as those for on-lending underthe proposed IDA Credit. To ensure that the funds, under this Category, reach the poor, it is proposed thata cap on sub-loan amount would be set initially at the equivalent of US$400 for individual borrowers and aUS$1,000 equivalent for household based businesses (micro-enterprises) employing at least three personsoutside the immediate family. The sum of the proceeds of IDA Credit and the revolving fund would beknown as the MLF. Sub-projects' investment costs under the MLF are estimated at the equivalent ofUS$32 million. Total cost of this component including goods, vehicles for mobile banking, training, TA,and contingencies is estimated at US$36.2 million.

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On-lending Arrangements

The Socialist Republic of Vietnam would be the Borrower of IDA Credit. The proceeds of the Creditwould be made available to BIDV under an On-lending Loan Agreement (OA), satisfactory to IDA, to beentered between MOF and BIDV. Under this OA, which form part of the RDF II and MLF PolicyManuals, funds would be lent to BIDV for a period of 25 years with a grace period of 8 years on theprincipal. The interest rate charged by MOF to BIDV would be such as to give BIDV at least 2% spreadto cover its operating costs and risks. This should be adequate to make the project attractive to BIDV andto encourage it to promote the flow of resources into the two funds. Finance for the RDF and the MLFcredit lines would be made available to the PFIs and MFIs, respectively, under subsidiary loan agreements(SLAs) between them and BIDV.

The on-lending rates from BIDV to the PFIs and MFIs, under these SLAs, would be adjustable periodicallybased upon criteria that fully reflect market interest rates. BIDV would manage the two funds and wouldbear the credit risk at the level of the PFIs/MFIs. Funds would normally be on-lent to PFIs/MFIs in localcurrency, in line with their clients needs. They would bear a variable rate of interest adjusted monthly andintended to be equal to the adjusted cost of medium term deposits. This rate would be calculated based onthe prevailing prime rate minus a 'margin'. The 'margin' would be fixed for three months, and would bedetermined by subtracting from the prevailing prime rate3' the Weighted Average Interest Rate (WAIR) for3, 6 and 12 months deposits in the banking system in Vietnam, adjusted for the reserve requirementimposed by the SBV. While the on-lending rate would reflect prime rate changes monthly, variations inthe 'margin', which are likely to be small, would be adjusted on a quarterly basis.

For local currency sub-loans, GOV would bear the foreign exchange risk against a 'fee' - the differencebetween the on-lending rate to BIDV and the cost of IDA funds. This is because: (i) the smallsub-borrowers would not be in a position to bear the foreign exchange risk, and therefore, BIDV would notbe able to pass on this risk to the PFIs; and (ii) the US$ of IDA proceeds would actually remain with theGovernment who in return would provide BIDV with the equivalent local currency for on-lending to thePFIs and MFIs. However, a few larger borrowers, primarily export-oriented clients, may be in propercondition to borrow foreign exchange sub-loans, thus, under the proposed project, BIDV may include suchan option . But most, if not all the sub-loans are likely to be in local currency. Based on currentconditions, the on-lending rate from BIDV to the PFIs would be about 6.5% p.a., giving a pass on ratefrom MOF to BIDV of 4.5% p.a. This would leave MOF with an adequate margin to cover the foreignexchange and the credit risk of BIDV 3.8% p.a. (the difference between the cost of IDA's funds (0.7%) andthe pass-on rate (4.5%). To limit MOF's exposure, a floor rate of 3% p.a. would be set for MOF's pass onrate to BIDV, consequently BIDV's pass on rate would have a floor of 5% p.a.

The PFIs and the MFTs would be free to set their spreads, so as to fully reflect market forces and associatedrisk. To ensure the sustainability and the financial viability of MFIs without a Government subsidy, anadequate lending rate must be in place. On-lenders under MLF would need to be pernitted to chargeinterest rates that are sufficient to fully cover related operating costs, including cost of funds, provisions forpossible loan losses, and adequate profits to allow for further lending expansion to the poor, withoutundermining the MFIs prudent equity to risk asset ratio. To meet these needs, higher ceiling rates wouldneed to be allowed for this specific sector.

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The Institutional Strengthening Component

This would consist of two sub-components, (a) the strengthening of BIDV; and (b) strengthening of PFIs/MFIs with special focus on VBARD performance as a potential key retailer of both the RDF and the MLF.

Strengthenini BIDV's Institutional Capability: BIDV's Institutional Development Plan (IDP) which is tobe agreed with IDA " and adopted by BIDV (condition of effectiveness) would be geared to ensuring thesustainability of BIDV's operation and improving its financial performance. The IDP would focus on (i)increasing the quality of its loan portfolio through: (a) cleaning the balance sheet of those bad directedloans which have already been identified, using procedures outlined in its Restructuring Plan 6' , mainlyinvolving write offs to be financed by GOV funds 7/; and (b) reducing the level of its other NPLs throughbetter loan collection (using Asset Management Company, AMC) together with associated write-offsagainst existing provisions, and by ensuring that future provisions made for possible loan losses arerealistic, and are in accordance with the newly issued Resolution 1627 for loan classification andprovisioning; (ii) raising spreads and diversifying sources of income leading to improved profitability; (iii)using market interest rates; (iv) improving accounting (IAS to be gradually applied) and internal controlsystems; (v) upgrading BIDV staff and management through appropriate training and technical assistance,particularly in cases where staff responsibilities have changed as a result of the implementation of theagreed restructuring program; (vi) mobilization of medium and long term financial resources; (vii) makingadequate arrangements for capital build up, so as to ensure BIDV's ability to expand its lending whilemaintaining acceptable solvency ratios; and (viii) advancing further its automation systems andmanagement information flow (see Annexes 2 and 11).

BIDV's IDP would be annually reviewed and if warranted, adjustments to the respective strategy, actions,and targets would be made. In addition, a semi-annual report on the outstanding issues and implementationof the IDP would be prepared by BIDV with contributions from the various departments involved in itsimplementation. Part of the IDP would involve preparation and implementation of the project training andTechnical Assistance (TA) programs. These programs would then be updated annually and details for theimmediately succeeding year would be submitted by BIDV for IDA review by November 30, each year,starting in 2002. In carrying out the training program, BIDV would employ consultants whosequalifications, experience, and terms and conditions are satisfactory to IDA. Details on the principles,targets, and timetable regarding the implementation of the IDP are provided in Annex 2. A review ofBIDV's financial performance in the last five years and projection for the next five years are presented inAnnex 13.

Strenatheninz PFIs and MFIs. As part of the accreditation process, each of the accredited PFIs and MFIswould be responsible for preparing and implementing its own IDP. These would be reviewed annually andupdated as necessary. Progress reports would be submitted to IDA every six months. Each of the IDPswould be prepared for a three year period by the respective institution, approved by its own board ofdirectors and be satisfactory to IDA. The main objective of the IDPs would be to improve the financialperformance of the PFIs/MLFIs so as to meet the project's long term prudent accreditation criteria. TheIDPs would normally cover building up the capital base, improving solvency and profitability, andstrengthening the institutional capability and skills of staff in implementing various types of rural-financeactivities. Under this sub-component an expanded mobile banking operation would be financed . Detailson PFIs performance under RF I and a list of potential PFIs/MFIs with an estimation of their lines of creditis presented in Annex 15.

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VBARD would update its IDP, focusing on (i) implementing the recommendations outlined in the 2000IAS audit report; (ii) improving solvency and liquidity; (iii) meeting the NPL resolution targets forre-capitalization; (iv) increasing profitability and sustainability; (v) improving the quality of its loanportfolio; (vi) strengthening its risk management; (vii) becoming more commercial; (viii) increasingdomestic resource mobilization; (ix) improving prudence and transparency; (x) improving accounting (IASto be gradually applied) and internal control systems; and (xi) strengthening institutional capacity andhuman resources. A review of VBARD's financial performance over the last five years and projection forthe next five years is presented in Annex 14.

Technical assistance (TA) and Training are part of the Institutional Strengthening Component of theproject would be provided both to BIDV and to PFIs/MFIs to develop their capacity in banking operations.This would include, but not be limited to, (i) evaluation of financial institutions' performance; (ii)preparation and appraisal of sub-project proposals including cash-flow analysis, business plandevelopment, and credit applications for SMIEs; (iii) credit risk, lending to households, and rural SMEs;(iv) risk management; (v) managing problem loans and debt recovery; (vi) accounting and internal controlsystems; and (vii) environmental safeguards. While most of the cost of the TA and training would be borneby the project, the PFIs/MFIs would be required to shoulder some of the related costs. The program wouldinclude training of trainers, training of staff, and/or on-the-job coaching by qualified experts. To ensure thequality of the training, it is proposed that a well qualified institution, such as the MPDF-supportedBusiness Training Center (BTC) be subcontracted to carry out the training of trainers. Later on, thePF1/MFI staff training could be conducted by those financial institutions themselves or by specializedtraining institutions, such as the BTC, SBV's Banking Institute, or the SOCB's training centers, under thequality supervision of the PMU. Training and/or provision of information to SMEs, and other potentialsub-borrowers on the preparation of business plans, and credit applications would be undertaken by thePFIs.

Implementing Institutions

The Bank for Investment and Development of Vietnam (BIDV) (for more details see Annexes 11 and 13)

BIDV would be the project's Apex Bank, handling both of the funds (RDF II and MLF) under this credit,and also the RDF I and Fund for the Rural Poor (FRP), established under the first Rural Finance Project(Credit 2855-VN).

BIDV was established in 1957 and is one of the four large commercial State-owned banks in Vietnam.Originally, it was used to provide investment and development finance to State-owned enterprises (SOEs).BIDV is a full service bank which, operates throughout Vietnam, through a network of about 140branches/sub-branches. Over the past five years, it has grown rapidly (total assets have increased at 29%p.a.), so that at the end of December 2001, BIDV had a staff of over 6,000 and total assets of about $4billion equivalent. Its paid up share capital, which all belongs to the state, is about US$70 million. BIDVis rapidly changing, from being a state conduit for resources to becoming a fully commercial operation.Since 1999, it has not committed any new lending to SOEs as 'directed loans' under Governmentinstruction and credit guarantee; all its new lending commitments, whether to SOEs or the private sectorare now commercial, with BIDV taking the credit risk.

Accounting Systems and Audit. BIDV is supervised by the State Bank of Vietnam (SBV) and thereforehas had to follow the system of accounting prescribed by SBV - Vietnamese Accounting Standards (VAS).In company with various other Vietnamese banks however, BIDV has appointed international auditors andhas had their accounts for the last five years (1996 to 2000) audited under International Accounting

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Standards (IAS) as well as using VAS for reporting to SBV and for tax purposes. In line with agreementsunder PRSC, BIDV is continuing to have international audits, and work on the 2001 audit has alreadystarted. VAS has been changing over time and becoming closer to IAS; under decision 1627 of 2002,banks are required to classify the whole of past due loans as non performing, rather than just the overdueinstallments. As a result, provisions for bad and doubtful debts will need to increase sharply.

Profitability. BIDV has been profitable over the past five years, based on its VAS accounts, making anaverage of about $11 million per year, after tax or about 0.5% on earning assets. However under IAS, andapplying tough provisioning requirements, BIDV showed a profit in 1997, 2000 and 2001 (initial draftfigures) but a loss in 1998 and a smaller loss in 1999. Future projections indicate that BIDV is likely to beprofitable under IAS. But the magnitude of future profitability will depend heavily upon: (i)re-capitalization by Government, as agreed under its restructuring plan; (ii) a concerted effort to diversifyits income sources (non interest income is only 12% of gross margin); and (iii) raise its spreads betweenlending and borrowing rates (currently only about 2%). Operating costs (excluding provisions) are alreadywell controlled at less than 1%, and so there is little room for cost cutting there. The first re-capitalizationtranche is planned for July 31, 2002, and the second one by July 31, 2003.

Resources and Assets. By international standards, BIDV is undercapitalized, based on its IAS balancesheet. Because of the losses, and the fact that BIDV has paid substantial business income tax (more thanUS$40 million over the past five years), its net worth, measured under IAS, has been eroded and isestimated at about US$37 million as of December 31, 2001, or only 1.3% of its risk assets, well below theBIS minimnum of 8%. However, with the phased infusion of new capital as agreed under the IMF andPRSC supported Restructuring Plan, BIDV is projected to meet the BIS requirement by 2006. Given thatachievement is largely depends on re-capitalization by government, financial covenants in the IDA Creditare proposed which would require prudent criteria to be met over a predetermnined time frame.

Loan Portfolio qualitv and Adequacy of Provisions. BIDV bears the credit risk on about VND 31.8 trillionout of its total loan portfolio of VND45 trillion. Accrued provisions for bad and doubtful debts within theloan portfolio, as indicated by the draft accounts, at the end of 2001 were VND 2.39 trillion under IAS andVND 1.03 trillion under VAS. The system of loan classification and provisioning which had been appliedby the auditors under IAS for 2000 was quite strict, and resulted in higher provision levels than would berequired by other South East Asian countries. Based on this, while the provisioning under VAS willcertainly increase substantially in 2002, to take account of decision 1627 , the IAS levels are probablyconservative. Analysis of BIDV's data on credit quality, using VAS indicates that between December 2000and December 2001, the absolute level of commercial NPLs, on which BIDV bears the risk, decreased in2001 by VND8 billion, and the proportion of NPL to BIDV's loan portfolio reduced from 1.3% to 0.9%.At the same time, the absolute value of provisions increased by VND242 billion. Taken together, theseindicate an improved net loan portfolio quality over the past year.

Overview of BIDV's Financial Situation. Initial accounts for 2001 indicate that BIDV is now a strongerinstitution financially than it was at December 1998. Over the past two years (2000 and 2001), BIDV hasbeen profitable after making substantial provisions for loan losses. In that its returns, based on VAS,further provisioning will be necessary following the adoption of decision 1627 in 2002. This will almostcertainly mean that under VAS BIDV, in company with other SOCBs, will show a heavy loss for 2002 intheir VAS accounts (and hence have to pay no income tax). In reality, the additional provisions required in2002, will be mainly to correct an old imbalance, rather than to reduce estimates of eamings 1999 - 2001.

Institutional Development Plan (IDP). To enhance its ability to develop into a sound commercial institution,BIDV is finalizing a five-year Institutional Development Plan (IDP) which would be fully consistent withthe restructuring plan which is already under implementation of the SOCB's restructuring program,

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supported by the PRSC and the IMF. The IDP would be fnancially supported under the project, throughmaking available IDA funds for training, technical assistance and possibly hardware. Key elementsinclude: (a) the use of IAS for management purposes', and maintaining an external international auditor;(b) clearing bad debts from the balance sheet and in consequence being ready for re-capitalizing quicklywith a minimum of VNDI.2 trillion new equity to be provided in July 2002 (condition of effectiveness); (c)meeting IAS/BIS standards for its Capital Assets Ratios by end 2006; (d) improving asset quality includingloan classification, risk analysis and strengthened internal controls; (e) aligning business plan targets onprofitability and rate of expansion to maintain prudent solvency ratios; (f) improving Governance; (g)mobilizing more longer term resources; (h) continuing to modernize banking technology; (i) raising averagestaff qualifications, through staff development and recruitment, to allow for both growth anddiversification, and (1) continuing to increase business with the private sector, including wholesaling underthis project. An agreed time-bound IDP with specific monitoring indicators, would be adopted by BIDVboard by effectiveness. This would also include projections of Profit and Loss accounts as well as BalanceSheet through 2006, and the first year's proposals for training, technical assistance and hardware to befunded under the project.

2/ Drafts have been reviewed by the mission andfound to be satisfactory.

3/ Or such other representative rate which may be readily determined and tracked.

4/ In that case, the first roundforeign exchange risk would be borne by the initial sub-borrowers who would be required tohave foreign exchange income or have income that is linked to foreign exchange.

5 A draft IDP has been reviewed by the mission andfound to be satisfactory..

6/ According to the Restructuring Plan, BIDV wouldfocus on the resolution of its NPLs according to the classification andtime table for re-capitalization agreed with SBV. The classification of NPLs would be done as follows: (i) collateralized NPLs;(ii) non-collateralized NPLs; and (iii) NPLs derivedfrom directed lending to SOEs. Banks have to resolve 20% of their NPLby June 2002, and an additional 20% by December 2002 to qualify for re-capitalization. Re-capitalization is planned in twotranches, i.e. July 2002 and July 2003.

7/ In many cases, this will not involve cash transfer, as the funds for these loans were provided in the first place by GOV.

D. Project Rationale

1. Project alternatives considered and reasons for rejection:

Options for Project Design. Generally, there are four main options for the design of a credit project: (a) aWholesale Banking Operation (WBO) to be carried out by an Apex Bank (AB); (b) several pre-determinedparticipating banks of which each would receive a line of credit for on-lending to its respective clients; (c) apre-selected Government bank to retail the credit to its clients and/or to the targeted group(s); and (d) acombination of the first and the third of the above, i.e. a basic wholesale banking operation with a relativelylarge line of credit to be extended directly (outside the WBO) to a pre-selected PFI. Out of the fouroptions, the wholesale banking operation has been selected as it is likely to be the most effective inachieving project's objectives. It provides equal opportunities to all banks that meet the accreditationcriteria, except the apex bank, to retail project funds to their clients. Moreover, this option has alreadybeen found to be suitable to the local conditions in Vietnam. It was successfully operated under theongoing Rural Finance Project - Credit 2855-VN. The advantages and disadvantages of the four optionsare summarized below.

Wholesale Banking Operation

There are some clear advantages in selecting this option: (i) it allows more banks to participate in theproject, thus increasing banking competition in the rural areas (one of project objectives); (ii) this option

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would allow the project to diversify project's beneficiaries as each PFI will accommodate its own clientele;(iii) this option would better fit the basic concept of a demand driven operation, as it allows potential PFIsto join the project at their suitable timing; (iv) except of appraising the Apex Bank, there is no need, at theproject preparation stage, to fully appraise other financial institutions; (v) the system is already known inVietnam and the major banks are already familiar with its operation and procedures; and (vi) social andeconomic impact of the project is spread, through the wholesale operation, throughout the country.

There are, however, several weaknesses in the Vietnamese banking system that were taken into account informulating project's components (training and TA). These are: (i) inadequate capacity to evaluate banksperformance including their loan portfolio; (ii) poor local auditing capacity (for banks and their borrowers)which exacerbate the banking evaluation problems; (iii) an accounting system that does not force adequatetransparency, thus making PFIs accreditation a more complicated and difficult exercise; and (iv) weakmonitoring and supervision capability.

Pre-determined PFIs

This option would be the most expensive one in terms of project preparation and supervision as it wouldinvolve the appraisal of several banks and later on routine supervision of the performance of each of theselected financial institutions and the way they were implementing the project. The main disadvantage isthat such a design is inflexible, specifically it would: (i) prevent other financial institutions from joining theproject in a later stage; and (ii) limit the number of PFIs that are able to participate under the project, thuslimiting project impact on enhancing banking competition in the rural areas and diversification of itsbeneficiaries. Experience in other countries has indicated that there are often problems in making desirablere-allocations of committed funds from institutions which are unable to disburse funds quickly to thosewhich could use them. This 'predetermined' option, if selected, would reduce the likelihood that the projectwould fully meet all its objectives.

Single Pre-selected Bank

Another option is to use one bank, e.g. VBARD in the case of Vietnam, to finance viable rural economicactivities. The advantages of using this option are: (i) the operation is simple; (ii) only one bank needs tobe appraised and later on supervised; (iii) VBARD has quite large number of branches that are scattered allover the country; and (iv) its operation is quite efficient in terms of credit delivery and loan collection. Themain disadvantages, however, are that: (i) VBARD is quite weak in terms of its exposure to privatenon-farm activities, thus reducing project capacity to further support diversification of the rural economy;(ii) banking competition will not be enhanced, thus the project would indirectly support VBARD's nearmonopoly power in the rural areas; and (iii) the project would have no impact on strengthening other ruralfinancial institutions. This option, if selected, would defeat project objectives that are associated withdiversification of rural investment and enhancing banking competition.

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A combination of a WBO and a Pre-selected Bank/PFI

This option tries to combine the benefits of the first and the third options. The apparent advantage is thatwhile maintaining the WBO concept with all its benefits, it would save the pre-selected bank the need toapply for renewal of its RDF line of credit and it would save one operational stage of re-lending from theAB to this pre-selected bank. There are, however, several disadvantages to this option. It would force thepre-selected bank to operate within its initial allocation of funds, unable to increase it over the life of the

RDF (up to 30 years). If in future, the pre-selected bank were to decide, for its own reasons to reduce theuse of RDF resources, these funds would be unavailable to the rural economy. Finally, this option wouldreduce flexibility in allocating project funds to the various PFIs, and also lead to a reduction in bankingcompetition in the rural areas, which is contrary to one of the project's main objectives.

2. Major related projects financed by the Bank and/or other development agencies (completed,ongoing and planned).

Latest SupervisionSector Issue Project (PSR) Ratings

._(Bank-financed projects only)Implementation Development

Bank-financed Progress (IP) Objective (DO)

Rural Finance Project (Credit S S2855-VN)

Other development agenciesADB-Rural Credit (approved9/96; effective date: 4/97;closing date: 12/01.

ADB-Rural Enterprise FinanceProject (approved 12/00 butstill not effective)

IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory)

3. Lessons learned and reflected in the project design:

The broad lessons that emerge from the review of the previous first Rural Finance projects andincorporated in the design and the arrangement of RF II, are: (i) there is a need to undertakepre-accreditation activities with PFIs/MFIs, including listing of potential PFIs/MFIs, and dissemination ofthe project concept (marketing) in order to generate credit demand from these intermediaries; (ii) a levelplaying field for all PFIs, whether they are SOCBs or non-state banks, is required for successful projectimplementation; (iii) a professional team is necessary for accreditation and supervision of PFIsperformance, if not available, technical assistance is essential; (iv) a management unit, independent ofpolitical influence, that is well equipped and staffed is essential for the effectiveness of the wholesalebanking operation; (v) variable interest rate must react quickly to changes in market conditions - wheninterest rates declined fast, as happened in 1999, and ceiling rates were reduced four times, it becarnenecessary to shorten the period in which the RDF's lending rates were calculated and announced; (vi) PFIsneed more assistance in the preparation and implementation of their respective IDPs; and (vii) too smallspread to banks and a single ceiling lending rate for short, medium and long-term loans, as had been thecase in Vietnam between mid 1998 and August 2000, had motivated banks to: (a) lend to larger and lessrisky borrowers, thus avoiding or miniiizing lending to small and medium scale investments, particularlyrural ones; and (b) favor short term lending rather than medium and long term investments. These

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undesirable results rn contrary to Vietnam national goals of promoting economic growth and ruraldevelopment.

Experience and lessons from the implementation of credit projects in other countries were also taken intoaccount and incorporated in the project. These include: (i) directed credit by crop or type of investments, atsubsidized interest rates, have not sustained economic growth, improved credit delivery mechanisms inrural areas, or increased access of rural borrowers to formal credit facilities; (ii) heavy arrears and poorfinancial conditions within the apex financial institution or the selected PFIs has severely constrainedprojects' sustainability; (iii) private financial resource mobilization is extremely important for institutionalsustainability; (iv) strong financial institutions along with qualified and experienced management and staffat headquarters, branches and field offices, are crucial to project success; and (v) when interest rates eitherfell significantly below or move well above prevailing market rates, serious implementation problems haveemerged; above market-rates have resulted in slow disbursement, while below-market rates have led toconcentration of credit to relatively wealthy and large clients. These lessons are being incorporated in thedesign of the proposed project.

The first Rural Finance Project (Credit 2855-VN) that fully utilized its Credit by December 31, 2001, isprogressing well in almost all components. As of the end of September 2001, RDF disbursement hasreached about US$205 million equivalent (US$100 million IDA's proceeds, US$60 million RDF secondgeneration funds, and US$45 million PFIs' participation), financing some 565,000 sub-projects with totalinvestments of about VND6,000 billion (about US$400 million). Short-term loans accounted for about70% and the balance was used to finance medium term investments. Average sub-project and sub-loan sizewere about US$710 and US$445, respectively.

The reported composition of sub-projects' financing (as of the end of September 2001) were:sub-borrowers' equity investment about 40% of total sub-projects cost or about VND2,265 billion (aboutUS$150 million); PFIs participation about 11% or VND670 billion (US$45 million); and RDF lendingabout 50% or VND3,000 billion (about US$200 million). Collection rates under the project are quitegood. No overdue amounts from PFIs to ICPMU was recorded (end of September 2001), and collectionrates from sub-borrowers to their respective PFIs was reported to be about 98% on average.

Sectoral and geographical distribution are as follows: agricultural cultivation (44% of total lending), animalhusbandry 30%; food processing and aquaculture 10%; and services and others about 16%. Upland andmidland regions received about 25% of RDF resources; Mekong Delta 20%; Red River Delta 13%; CentralHighland 19%; and other regions 23%. The Socio-Economic Impact Assessment conducted by a localindependent consultant team, indicates that 30% of sub-borrowers, under the first Rural Finance Projectare women and in another 35% of sub-borrowers women actively participated in the decision to borrow andits purposes.

Neither the Socio-economic Impacts Assessment of RF I, nor any of RF I supervision mission, nor thepre-appraisal mission of RF II, found any negative impact, as a result of RF I project's activities, onIndigenous People (IP). However, VBARD was able to substantially expand its outreach and providefinancial services to remote areas, including to IP communities through it's mobile banking operation (seebelow details of this operation), that was financed and supported under RF I.

Almost all KPI targets for project completion have been met. The main lesson to be leamed from thisProject and incorporated in the proposed new project are as follows: (i) due to the volatility of interest ratesit is necessary to shorten the period in which the market reference rate is being calculated from once perquarter to a monthly or even bi-weekly basis, this would reflect better the market rates and its trend; (ii)

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PFIs accreditation criteria, particularly the cut off points need to be periodically reviewed and adjusted tomarket conditions; (iii) more attention should be given to diversification of the RDF lending, i.e. lending tonon-farm and labor intensive operations; (iv) IDP targets should be reviewed and updated more often toreflect better the new challenges and issues that the PFIs need to cope with; (v) mobile banking appears tobe an effective way to improve access of rural people in remote areas to formal banking services; and (vi)although this project is a demand driven operation, the gender disaggregated data need to be collected andbe integral part of the project's M&E process.

A study on the Socio-economic impact of RF I was undertaken by a consultant. The study indicatespositive impact in terms of: (i) outreach to a large number of household borrowers; (ii) income of householdborrowers has been increased remarkably; (iii) Small and Medium Enterprises (SMEs), although onlyrelatively small amount (about 10%) of project funds supported this group, have benefited from the projectand were able to expand their business operation and helped create about 3,000 new jobs; and (iv) theparticipating banks who were able to expand their lending operations, particularly for financing mediumand long term investments, improve the capacity of their staff through project's training program, andimprove their financial performance through the implementation of their IDP, initiated under the project.

The Study also highlights some of the weak points of RF I implementation and made recommendations forimprovement. The main points are that: (i) PFIs should focus more on financing of medium and long terminvestments; (ii) more training and TA support should be given to SMEs on the preparation of loanapplications and carrying out projects' feasibility studies, and to PFIs on sub-projects' appraisal and creditrisk evaluation; (iii) PFIs should fully undertake to implement their respective IDPs, and the Apex Bankshould provide more resources for close supervision of PFIs performance; (iv) saving should have a higherpriority in project activities and PFIs operation; (v) most of the training should be carried out at the veryearlier stage of project implementation; and (vi) more resources should be allocated for training of projectrelated staff in the apex bank and the PFIs. All these recommendations are incorporated in the design andarrangement under RF II.

Mobile Banking Operation. Under RF I, 159 vehicles for mobile banking were financed. Mobile bankingis generally a unit of 3 persons which are providing financial services in areas where no bank branchesexist, mainly remote and mountainous areas. Experience so far, indicate that, on monthly average, onemobile banking unit, mobilized about 2,000 deposit accounts with total amount of VND 19 billion (aboutUS$1.2 million equivalent), released about 1,900 loans with total amount of about VNS 15 billion (US$1million equivalent), collect about 1,400 loan repayments with total amount of about VND 10 billion orUS$650,000 equivalent. The operation is profitable generating net income before taxes (after provisions,car maintenance, cost of funds, and operating costs) of about US$ 1,000 a month (the price of one vehiclewas US$22,000 equivalent).

4. Indications of borrower commitment and ownership:

The ICPMU/SBV has a good record of project implementation. The ICPMU has developed andmaintained a good operational relationship with all the PFIs. The borrower has requested the project. Allproject preparation activities including the drafting of the related policy manuals were prepared by theborrower and its implementing agencies (the ICPMU/SBV and BIDV). BIDV, the proposed apex bank,has confirmed its strong interest in implementing the project and has agreed in principle, to ensurecontinuity in project implementation, to appoint the entire ICPMU team to manage the project.

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5. Value added of Bank support in this project:

The expansion of term lending, through the RDF, by commercial banks to finance investments of farmhouseholds and rural entrepreneurs addresses the constrained availability of term credit for private sectorinvestments. The micro finance component aims to provide a sustainable mechanism, based on bestpractice and experience, for micro-finance development in the country. Therefore, these two lines of credit(the RDF II and the MLF) would help the Government in its efforts to reduce rural poverty both (i) throughan expansion and diversification of rural investments that would provide employment opportunities, and (ii)by directly assisting individual poor people and micro-enterprises in financing their own viable initiatives.

By providing long term finance for these Funds (RDF II and MLF), which would not be available fromelsewhere, the IDA is able to directly support private sector investment in the rural areas in a way that willhelp to alleviate poverty while at the same time assisting in enhancing the rural financial sector. There is aclear need in Vietnam for banking sector reform, and IDA is pushing for that as part of the PovertyReduction Support Credit (PRSC). This project would support PRSC, and importantly would providedirect benefits in terms of improved profits and some technical support to both BIDV and the PFIs. Itwould thereby provide a strong incentive to these institutions for making the changes necessary to be aproject participant. Because it is able, within the framework of this project, to ensure the provision of longterm funds at market rates to the PFIs, on an even handed basis, IDA is perceived as an honest broker bythe financial sector. This, together with its access to technical skills means that IDA is ideally positioned toassist in the provision of informed support and advice to BIDV, the PFIs and MFIs with respect to thedesign and content of their IDPs.

Specifically, IDA's involvement in the project would: (i) ensure the implementation of the restructuringplans of BIDV, VBARD, and any other SOCB that would participate in the project; (ii) provide strongprofessional support to PFIs/MFIs in the design of their respective IDPs; (iii) enhance banking competitionfor the benefits of the rural economy; (iv) provide the rural poor with better access to financial services,particularly in remote areas (mobile banking units financed with project resources); and (v) ensure a betterlevel playing field for PFIs/MFIs whether they are SOCBs or non-SOCBs, thereby creating a frameworkwithin which there can be substantial private development within the financial sector.

The likely timing and design of the project would strongly complement the proposed banking sector reformsand it is in line with the policy of development of agriculture and rural economy. It would fit well with fourcomponents of the banking reform program which include (i) restructuring of joint-stock-banks (JSBs)through closure, merger and rehabilitation to around half their current number; (ii) restructuringstate-owned-commercial banks (SOCBs) to make them operate on a commercial basis; (iii) improving andstrengthening the legal, regulatory and supervisory framework under which banks operate; and (iv) levelingthe "playing-field" for all banks.

Through the process of project identification, preparation, and implementation, BIDV and any otherparticipating SOCBs (as retailers of project funds) would be likely, as part of their agreed IDPs, to take onboard the following key elements of the banking reform program: (i) non-commercial and policy lending

would be phased out , (ii) annual independent audits would be carried out, using intemational standardsfor loan-classification and loan-loss provisioning, thereby improving the quality of information available tobank management decision making; (iii) reforms to improve credit-risk assessment, intemal audits andcontrol processes, as well as accounting, would be implemented; (iv) debt workout for recovery ofnon-collateralized NPLs will be carried out; (v) agreeing targets so that bank-management would knowclearly at the outset the specific reform actions to be implemented and the levels of NPL-recovery andoperational performance to be achieved for each year; and (vi) re-capitalization to be phased in over a 3-4

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year period. The re-capitalization will be conditional on SOCBs annual performance, i.e. key actions takenand key operational targets met, in line with their respective restructuring plan.

Likely positive impacts of the project to the economy:

With per capita GDP of about $370 in 1999, Vietnam remains one of the poorest countries in East Asia.Although the share of the people living below the poverty line fell from 58% in 1993 to 37% in 1998(GSO's VLSS 1993/1994 and 1997/1998), the achievement in poverty reduction remains quite fragile.With 40% of rural population getting an income lower than poverty line in 1998, poverty is a commonphenomenon in Vietnam and is amplified by rural unemployment and underemployment, and thevulnerability of the rural poor to intemal and external shocks, as well as the widening gap between urbanand rural incomes. Because the project would contribute to rural economic growth, increase in ruralincome and employment, it would contribute to poverty reduction. Financing viable initiatives of the ruralpoor and providing them with better access to financial services would increase their chances of getting outof the poverty trap.

As part of its growth strategy, Vietnam is targeting investment at levels of about 30% of GDP. While thisfigure will vary between sectors, a reasonable guess is that agriculture and the rural business sector, whichin 1999 together probably comprised about 30% of GDP (output of VND 120,000 billion or US$9 billion)would need to invest perhaps US$1 to US$3 billion per annum - 11 - 33% of rural GDP per annum, sayUS$10 billion over the five year project period. The project would be able to contribute a small part ofthis, perhaps 2% to 3% of this gross amount over a five year period. Because the project would supplylong term resources , it would contribute mainly in those areas where investment is needed by private ruralbusinesses. In particular, this is likely to include agro-processing and other non farm investments anddiversification of agricultural production, particularly for the fast growing agricultural export crops andin association with the development of larger private commercial farms. As a result it would generatemore employment opportunities both on and off farm, and support more productive high output fanmingsystems.

8/ This may happen either, if the Selected Bank decides to switch its lending strategy away from rural lending or if it becomesless successful over time and is unable to identify creditworthy rural clients to lend to.9/ During the transition phase, banks would be able to make policy or non-commercial loans provided MOF would explicitlyguarantee them.10/ The rural sector is an important source of export growth. In 2000 exports of agricultural products in total grew fasterthan those of all other sectors except for oil; with specific increases of 95%forfruit and vegetables, 52% for seafood, 29% forpeanuts and 18% for cashews. In addition, rural handicraft exports grew by 40%.

E. Summary Project Analysis (Detailed assessments are in the project file, see Annex 8)

1. Economic (see Annex 4):O Cost benefit NPV=US$ million; ERR = over 15 % (see Annex 4)O Cost effectiveness* Other (specify)

Economic evaluation methodology:[ ] Cost benefit [ ] Cost effectiveness [x] Other [specify] Economic Analysis Summary

Because this is a credit project, with no advanced knowledge of the precise investments to be made, or eventhe sub sectors likely to be involved, it is only possible to estimate the project's economic impact in a very

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general way. There are a number of key factors that indicate that the project would be likely to have asound economic impact. First, there is a strong demand for long term credit resources in a growingeconomy with planned annual investment of close to 30% of GDP. The project would contribute to theeffective provision of these resources and in particular long-term resources, which at present are not easilymobilized in the banking system. Second, the project is designed such, that larger sub-projects haveex-ante financial rates of return of over 15%. Within the rural sector, there are not many distortionsbetween financial and economic rates of return, and the general distortion (shadow price of labor beingbelow the wage rate) means that economic rates of return would normally be higher than the financial rates.This indicates that economic rates of return are likely to be well in excess of 15%. Third, the socioeconomic study on the first Rural Finance Project, which is similar to this, has shown that there wasgenerally a very positive impact on the household incomes of small scale borrowers and on employmentcreation, indicating a positive contribution to poverty alleviation. Fourth, by helping to improve the strengthand viability of the SOCBs and the removal from them the implicit subsidy of being able to expandregardless of capital adequacy, the financial market will become more competitive. Other banks, if they aremore efficient than the SOCBs, will be able to compete profitably and expand their market share.Accordingly, the quality and cost effectiveness of financial services delivery would be improved.

2. Financial (see Annex 4 and Annex 5):NPV=US$ million; FRR = % (see Annex 4)

Fiscal Impact:

Results from the socio- economic study under RFP I, have shown improvement in household incomes. Thisfinding is supported by the high repayment rates from household sub-borrowers (average 98%).Furthermore, the continued availability and use of more expensive informal borrowings indicates strongdemand for credit. Arrangements for lending to households under RFP II would be very similar to those forRFP I, consequently similar sound financial benefits to households would be expected. For largersub-borrowers, sub-project appraisals would approve loans only to investments with projected FRRs ofover 15%. With this floor level, yet an economy that is growing fast, average returns, well in excess of15% are expected. Participating in the project would improve the liabilities side of PFIs/MFIs balancesheets, in that it would increase the average maturity of their resources. While the price of resources toPFIs/MFIs would be determined by a market-related formula, they would determine their own on-lendingrates, which would be expected to be profitable to them.

As a result of being the Project's Apex Bank, BIDV would develop a US$300 million wholesale lendingportfolio (RFP I and RFP II). This would contribute about US$6 million annually to its profit at fulldevelopment. Additionally its equity would be increased by about US$24 million under an agreement byGovermment to ensure that undertaking of this wholesale operation does not weaken its capital position.Furthermore, by participating in the project and effectively implementing its IDP under IDA supervision,BIDV would ensure that its Restructuring Plan targets are met and necessary re-capitalization takes place.

As the project would be implemented by Government corporations (BIDV and VBARD), PFIs/MFIs andthe private sector, it would not directly require any Government counterpart funding. The actual cash flowto the Govermnent depends on future inflation (stability of exchange rate) and domestic interest rates.However, based on current parameters, GOV would earn a real income from RFP I and II of about US$4million p.a. initially, rising to US$12 million by 2008, before falling back as the IDA Credit is repaid. Thisshould be more than adequate to cover the real foreign exchange risks, the BIDV credit risk, and the need toprovide for the agreed increased equity investment in BIDV. The gross figure does not include the indirect

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income to Government that would stem from increases in taxes on employment and incomes of projectbeneficiaries, including sub-borrowers, PFIs/MFIs and BIDV or the potential dividend income from theincremental equity invested in BIDV.

3. Technical:

Main operational principles and project's concept are already known in Vietnam. BIDV, the PFIs and thesub-borrowers would all be operating in areas which technology is known. The new area, which involvesabout 11% of total project cost, is the wholesale micro-finance component. This is a new operation inVietnam, and the project would be breaking new ground in this regard.

4. Institutional:

4.1 Executing agencies:

The project would be implemented by BIDV, the PFIs/MFIs, and the sub-borrowers. The wholesalebanking operation would be managed by BIDV which would handle the project as part of its normalbusiness. Loans made under the project would be reflected in its balance sheet and the benefits and costsassociated with the project would be included within its profit and loss account. By preparing and agreeingto an IDP as part of the appraisal process and implementing it under the project with IDA supervision, andsupporting TA, BIDV would increase its chances of becoming a sound financial institution. Due to theagreements under the PRSC, reinforced by covenants under this project, its susceptibility to being used byGovernment for non commercial operations would be substantially reduced.

The retail operation of the project would be on a normal commercial basis of the PFIs and MFIs.PFIs/MFIs would borrow project funds from BIDV, at a market linked rate, and lending to eligiblesub-borrowers under their own normal terms and conditions. Eligibility of sub-borrowers and activities tobe financed under the project would follow the guidelines provided by the project implementation manuals.The requirement that PFIs/MFIs prepare, implement and monitor an agreed IDP would also assist them inbecoming financially sounder than they would have been without the project and give them access to TAand staff training.

4.2 Project management:

BIDV, on behalf of the Government, would be the owner, the manager, and the executive administrator ofthe project. Oversight responsibility for the project would rest with the senior management of BIDV.BIDV would be responsible for project implementation and would undertake fully the credit risk associatedwith lending to the PFIs and the MFIs. A Project Management Unit (PMU) to be established andmaintained within BIDV would handle day-to-day matters related to the implementation of the project. ThePMU would have a Project Director unit, and the following six divisions: (i) PFIs and MFIs accreditationand follow-up on IDPs implementation Division; (ii) Sub-projects appraisal Division; (iii) M&E Division;(iv) Accounting and Disbursement Division; (v) Environmental Division; and (vi) Administrative Division.

During the first stage of project implementation and to ensure a smooth transfer from SBV to BIDV, thePMU's operations and policies would be monitored by a Steering Committee that would be chaired by theSBV's Deputy Governor, currently in charge of the implementation of RFP I. In addition, other committeemembers would comprise the Chairperson and the General Director of BIDV, representatives of MPI, andMOF. The Steering Committee and later on BIDV's management would be responsible for the governanceof the project in accordance with the Development Credit Agreement (DCA), the RDF and MLF PolicyManuals, and the agreed institutional development plans. The detailed composition and the structure of the

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PM-U and its responsibilities is being presented in Annex 17.

To ensure continuity, consistency, and to enjoy the benefits of the knowledgeable and experienced team, thestaff and management of the ICPMU/SBV who have been running the first Rural Finance Project (Credit2855-VN) would be transferred to BIDV to play a major role in managing the project, the RDF II, theMLF, and the FUNDS. As an integral part of its responsibilities, the PMU would be responsible formonitoring and evaluation of project performance. The findings of the M&E system would be presented inthe project's quarterly and semi-annual progress reports. The format of these progress reports wouldfollow the ones that already applied under the First Rural Finance Project with some modifications toexpand and deepen the project's M&E system.

Based on the appraisal of BIDV, and a review of its procedures, quality of management and staff, that wasundertaken by the mission, it is clear that BIDV's strength and its delivery capacity would ensure asuccessfully implementation of the project. Provided, however, that the agreed Restructuring Plan is fullyimplemented, and a strong Institutional Development Plan (IDP) will be in place. The adoption of BIDV'sagreed IDP by its Board of Directors would be a condition of Credit effectiveness. The adoption andcompliance of an agreed IDP by each of the PFIs/MFIs Board of Directors would be a condition foraccreditation of each of these financial institutions.

4.3 Procurement issues:

There are no major issues facing this project. Details of procurement arrangements under the project arepresented in Annex 6.

The two institutions BIDV and VBARD, which will be carrying out all project's procurement activities, arewell versed in IDA procedures and the use of IDA standard bidding documents and requests for proposals.Some refresher procurement training may be required and this would be provided under the project by theVietnam Country Office.

There is an existing conflict between local NCB procurement procedures and those mandated by IDA.This conflict will be addressed by including an Annex to Schedule 3 of the DCA. NCB documentsproduced by Country Office would be used in place of local bidding documents.

All contracts for goods and services would be procured using IDA competitive procedures. Only one smallconsultant contract for audit services would be procured on the basis of single-source selection.

The bulk of the Credit funds (about 95%) would be used for on-lending to private sub-borrowers for theirprocurement of works, goods, and services, which will be procured through procedures customary forindustrial development finance operations. Large contracts for works and goods exceeding $2,000,000 and$1,000,000 respectively, which would be procured through ICB procedures, are not expected, because theloan to sub-borrowers will be generally small, averaging about $2,500 equivalent.

The issue of State Owned Enterprises (SOEs) participating in the procurement of goods and services wouldbe closely monitored for compliance with IDA rules pertaining at the time. These rules will change to amore strict version on January 1, 2003.

4.4 Financial management issues:

The Bank issued Country Financial Accountability Assessment for Vietnam on October 15, 2001.

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During the project preparation mission, the Financial Management Analyst conducted an assessment of thefinancial management system proposed for the project which was endorsed by the accredited FinancialManagement Specialist. The review concluded that this project meets the minimum requirement of theBank's OP/BPI0.02. The Project will adopt the transactional-based disbursement system and will producequarterly financial management reports. The project is ready to implement in terms of the project financialmanagement aspect provided the borrower successfully carry out the action plan.

The accounts of the on-going Rural Finance Project and the two major retailing Banks VBARD and BIDVhave been audited by the intemational auditing firm Price Waterhouse Coopers (PWC). The audits wereconducted in accordance with intemational auditing standards and in compliance with the independentauditing regulations of Vietnam. The Auditor's Opinion for the ongoing Rural Finance I project isunqualified. However, the Management Letter identifies several weakness regarding the project'sdisbursement system. In particular, sub-loan initiation and monitoring procedures need to be improved.Therefore, an action plan has been agreed with BIDV to address these issues under this project.

BIDV will be responsible for the project's overall financial management system. However, other projectimplementing institutions including PFIs and MFIs will be responsible for the financial management of theproject resources to which they will have access under the respective project components. All projectimplementing institutions will have adequate financial management and accounting systems in place beforethey can use the proceeds of IDA Credit.

5. Environmental: Environmental Category: F (Financial Intermediary Assessment)5.1 Summarize the steps undertaken for environmental assessment and EMP preparation (includingconsultation and disclosure) and the significant issues and their treatment emerging from this analysis.

The key stakeholders in environmental protection under the project are BIDV, the PFIs/MFIs, thesub-borrowers, the Ministry of Science, Technology, and Environment (MOSTE) and the provincialDepartments of Science Technology and Environment (DOSTE). There are no major environmental issuesanticipated under the project. Most of the project's sub-borrowers would be rural poor people with anaverage loan size of below US$400. Micro-enterprises sub-loans would not exceed the equivalent ofUS$1,000 and other project entrepreneurs (under RDF) sub-loans are estimated to average at aboutUS$2,500. It is also very likely that most of these sub-projects would be exempted from environmentalassessment either because they are too small or because they are operating in areas or sectors that under theVietnamese laws and regulations are exempted. Nevertheless, steps have been taken to anticipate and dealwith any environmental issue that may arise. The Project task team reviewed if any negative environmentalimpacts were experienced under the first Rural Finance Project (Credit 2855-VN) and also reviewedexisting national laws and regulations to determine the current criteria for EA exemptions. Findings andrecommendations of these reviews are presented in Annex 16.

The main issue concems the mechanism and procedures that should be introduced to ensure thatsub-projects financed by the project would be environmentally sound. Prior to sub-loans disbursement,sub-project approval documents would include environmental permits (if not exempted) for the constructionof sub-projects and their operations, in accordance with guidelines that will be reflected in the RDF IIPolicy Manual. That requires that all these sub-projects will have to be first screened, and those that arenot exempted must be assessed and cleared for financing before project funds can be disbursed.MOSTE/DOSTE capacity to provide these services is hampered by understaffing. Therefore, the EMP

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includes administrative measures and responsibilities that would be within the purview of BIDV and thePFIs, and that would ensure appropriate pre-loan screening of sub-projects by the lending institutions fortheir anticipated environmental impacts.

5.2 What are the main features of the EMP and are they adequate?

The RDF H Policy Manual includes (Section K. Environmental Protection) Environmental Guidelines thatwill guide the BIDV and the PFIs in complying with the Government's environmental clearancerequirement, undertaking environmental analysis of sub-projects and adopting mitigation measures toaddress any adverse environmental impacts. These guidelines include a pro-forma checklist per types ofsub-projects that BIDV/PFIs can use to secure Environmental Clearance Certificate (ECC). In order toassist the rural credit officers in executing the decision whether a potential sub-project should be exempted

or not, they would be provided with field guidelines . In addition, the loan officers will be givenappropriate environmental training to provide them with tools to perform their sub-project screening.

The arrangement and procedures of the EMP are incorporated in the RDF II Policy Manual. To assistMOSTE/DOSTE in this operation and to ensure smooth project implementation, an EnvironmentalDivision (ED) will be established within the PMU (see Annex 17) to provide BIDV, PFIs, and relatedsub-projects with environmental technical assistance and coordination services. The ED would be staffedby a core of professionals and administrative assistants. The ED would concentrate on: (i) planning andimplementing environmental training, both domestically (train the trainers) and overseas; and (ii) assistedby BIDV liaisons and DOSTE's staff in the provinces, monitor sub-projects' adherence to EnvironmentalGuidelines and project approval screening criteria by auditing a sample of sub-projects on a periodic basis.In addition to the details of the Policy Manual, the project team prepared a brief environmental Annex tothe PAD (Annex 16) which describes experience under previous projects; outlines the proposed screeningprocedures; and defines the institutional arrangements for environmental review.

5.3 For Category A and B projects, timeline and status of EA:Date of receipt of final draft: July 24, 2001 (submitted)

5.4 How have stakeholders been consulted at the stage of (a) environmental screening and (b) draft EAreport on the environmental impacts and proposed environment management plan? Describe mechanismsof consultation that were used and which groups were consulted?

Environmental consultation entails two stages. The first one (completed), took place during projectpreparation and included meetings with BIDV/SBV, leading PFIs, MOSTE/DOSTE officials, and seniorstaff of environmental research and teaching institutes in Hanoi and HCMC, and the project preparationteam. The main objectives of these meetings were to design and work out a proposal for furtherdiscussions with other stakeholders. The second stage (pending), will be carried out in the form ofworkshops. Participants of these workshops will be mainly representatives of potential PFIs/MFIs andpotential rural sub-borrowers, MOSTE/DOSTE officials, and related staff of BIDV. The purpose of theseworkshops will be to present the proposed EMP and related procedures and get feedback to this proposal.The outcomes of these workshops will be incorporated in the credit policy manual. This part of the PolicyManual, like other parts, will be subject to periodical review and adjustment, if warranted. Once theproject is under implementation, there will be opportunity for periodic reviews, involving key stakeholders,of the operational procedures to determine their effectiveness and to identify changes that may be requiredas the project progresses.

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5.5 What mechanisms have been established to monitor and evaluate the impact of the project on theenvironment? Do the indicators reflect the objectives and results of the EMP?

Several arrangement will be made to ensure that MOSTE/DOSTE together with the project's ED will beable to effectively monitor compliance with the country's environmental rules and regulations. Assisted byBIDV liaisons and DOSTE's staff in the provinces, the ED will monitor the sub-projects' adherence to theEnvironmental Guidelines and project approval screening criteria by auditing a sample of sub-project on aperiodic basis. A formal accountability mechanism (e.g., environmental score cards) will be put in place.To ensure that a meaningful integration of environmental considerations into sub-projects approvalbecomes a metric for the PFI's performance, the PFI's sub-loan approval authorization would beconditioned, among others, on their environmental score. Also, MOSTE would instruct DOSTE in aprovince yet to be selected, to embark on a cooperative effort with an appropriate GoV agency (e.g., theDevelopment Strategic Institute within the Ministry of Planning and Investment, MPI) or selectedenvironmental research institutions, as appropriate, to jointly prepare a provincial land use map employingGeographic Information System (GIS). This land use map would incorporate environmental baselineparameters (e.g., water and air quality; sensitive ecological areas, areas susceptible to flooding and soilerosion, and areas deployed or designated for waste disposal, sewerage treatment, and industrial zonedevelopment). Available soil, water and air pollution information would be computerized and updatedperiodically. Made accessible to all stakeholders down to the POs and sub-borrower level, this, andsubsequently similar graphic databases in other provinces would streamline DOSTE's environmentalpermitting process, facilitate effective sub-project screening by the PFIs, and provide a current tool formonitoring environmental quality and controlled development.

6. Social:6.1 Sumimarize key social issues relevant to the project objectives, and specify the project's socialdevelopment outcomes.

No key social issues are expected to arise from project initiatives nor pure social development outcomes areplanned, except the increase in employment opportunities. The project would contribute directly to theimprovement of the socio-economic state of project beneficiaries and indirectly by creating moreemployment opportunities and better access to financial services to the rural poor and those living in remoteareas.

Sub-borrowers whether individuals or corporations, PFIs, and the BIDV are all expected to benefit fromproject initiatives. The project is expected to have a positive impact on employment. The project, with itsmicro-finance component is expected to accommodate about 90,000 economic entities, 75,000 of individualrural poor, and about 10,000 micro-enterprises. This is a demand driven project and as such is "a bottomup" operation. The wholesale operation would not exist if there were no demand for its products. At thesame time and to ensure adequate repayment discipline, the nature of a wholesale operation comprises "topdown" rules and regulations.

Experiences have confirmed that a social collateral (group guarantee) system is a feasible way to reachsmall farmers and rural entrepreneurs in Vietnam. The capital requirement for production and business hassignificantly increased and a large number of people are willing to join credit groups. Under themicro-finance component, efforts will be made to reach a broad spectrum of possible borrowers efficientlyand effectively by making credit information available in the rural areas; providing training and support togroup members; and helping the MFIs improve the processing and evaluation procedures.

Based on the Social and economic Impacts study on RF I project, and on RF I supervision visits, as well asa review that carried out under the pre-appraisal of RF II, there has not been any adverse findings on

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Indigenous People (IP). Nevertheless, under this RF II project, a pro-active approach will be taken toensure that the rights and the benefits of IP will not be adversely affected as a result of project activities. Inparticular, an assessment of this matter will be conducted in any supervision mission and in the projectmid-term review.

Gender Matters. OED's Beneficiary Assessment and survey confirm that women benefited equitablyfrom the first Rural Finance Project (Credit 2855-VN). This is further corroborated by particulars of theloan application process which both husband and wife have to sign the contract. Moreover, a commonscenario is that both husband and wife discuss the borrowing and jointly make decisions. Overall theassessment concludes that women's access to credit has improved greatly during the last few years. Theproject preparation team with this proposed project met with the Vietnam Women's Union through theproject design stage and was pleased to learn that Women's Union had signed the contract with VBARD,which is likely to be the main retailer of project's funds, to target the women's borrowers in the rural area.The project team encourages continuous coordination between the Women's Union with VBARD duringthe future project implementation to strengthen the outreach to the women and increase their credit accesscapability and payment management. The PFIs and MFIs will be required to keep the record of theinformation of the women borrowers, to obtain gender disaggregated data for project monitoring andevaluation.

As project beneficiaries would all be private rural entrepreneurs, the project will not be associated withresettlement activities and will not finance any land purchasing transaction.

6.2 Participatory Approach: How are key stakeholders participating in the project?

Project key stakeholders would be the sub-borrowers, the PFIs, MFIs, and the BIDV. The project couldnot be implemented, as designed, if even one of these stakeholders were not actively participating.

Discussions with representatives of PFIs, MFIs, and sub-borrowers, as well as with ICPMU/SBV andBIDV have already taken place during several supervision missions to get feedback on arrangement andimplementation matters concerning the first Rural Finance Project. This feedback has been incorporated inthe design and formulation of the proposed project's various components. During project preparation andits pre-appraisal a further consultation with representatives of all stakeholders including PFIs, MFIs,Vietnam Women Union, Vietnam Fanner's Association and sub-borrowers took place. The outcome ofthese consultations incorporated in the project design, and its implementation arrangements.

6.3 How does the project involve consultations or collaboration with NGOs or other civil societyorganizations?

Consultation with NGOs has been focused on the formulation of the micro-finance component.Their participation may involve either in community support to sub-borrowers among the ruralpoor, and/or in operating as financial intermediaries for credit delivery to the rural poor (providedthey meet the related accreditation criteria). A workshop on the micro finance in Vietnam washosted by the British Department for Intemational Development (DFID) in Vietnam, and all themain NGOs who have been involved in this area were invited. There was a session on thisproposed project to seek the participants' feedback and generate their interest. The projectpreparation team also met with several international NGOs to discuss their micro finance activitiesin Vietnam and to explore their interest in participating in this project. The project team encouragesthe Government to expedite the development of an appropriate regulatory framework and legalstatus for non-bank financial institutions that are interested in providing financial services to thepoor, such as local and international NGOs. The final mode of NGOs' participation need to be

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worked out between the NGOs themselves, the BIDV, SBV, and GOV.

6.4 What institutional arrangements have been provided to ensure the project achieves its socialdevelopment outcomes?

Through the project's participatory approach, and by the benefits to the project's main stakeholders thatwould be generated from its activities.

6.5 How will the project monitor performance in terms of social development outcomes?

This will be monitored through the project's regular progress reports, review of its KPIs implementation,and supervision missions.

7. Safeguard Policies:7.1 Do any of the following safeguard policies apply to the project?

'Policy. ApplicabilityEnvironmental Assessment (OP 4.01, BP 4.01, GP 4.01) * Yes 0 NoNatural Habitats (OP 4.04, BP 4.04, GP 4.04) 0 Yes * NoForestry (OP 4.36, GP 4.36) 0 Yes * NoPest Management (OP 4.09) 0 Yes * NoCultural Property (OPN 11.03) 0 Yes 0 NoIndigenous Peoples (OD 4.20) 0 Yes * NoInvoluntary Resettlement (OP/BP 4.12) 0 Yes * NoSafety of Dams (OP 4.37, BP 4.37) 0 Yes 0 NoProjects in International Waters (OP 7.50, BP 7.50, GP 7.50) 0 Yes * NoProjects in Disputed Areas (OP 7.60, BP 7.60, GP 7.60)* 0 Yes 0 No

7.2 Describe provisions made by the project to ensure compliance with applicable safeguard policies.

The project will take the necessary measure to ensure compliance. Enviromnental protection measures arealready discussed under Section 5 (Environment) and Annex 16.

II/ Environmental assessment ofRural Credit Loans in Vietnam, Field Guidelines, November 2000, prepared by JacquesWhitford, Environment Ltd., in cooperation with SB V andfunding by the CIDA.

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F. Sustainability and Risks

1. Sustainability:

Sustainability of this operation depends on the profitability of the program to the sub-borrowers, PFIs,MFIs, and BIDV. The good results from the First Rural Finance Project (RFP 1) confirm that such aprogram is likely to benefit all of the participants. The proposed Restructuring and the InstitutionalDevelopment Plan (IDP) which BIDV will be implementing should ensure that it becomes a much strongerinstitution. In parallel, the development of a US$300 million wholesale lending portfolio (RFP I and II), onwhich a reasonable spread would be earned would be reflected directly into its profitability, while theconversion of part of the long term debt associated with the program into equity would ensure that itsCapital Adequacy Ratio does not suffer as a result of the project. BIDV, is already in the process offurther commercialization of its operations and has the capacity to successfully manage the project.Together with the qualified management and staff of the ICPMU/SBV that is being transferred to it, andwith adequate TA support, and provided that the re-capitalization agreed under its Restructuring Plan, is inplace, BIDV would be able to effectively implement the wholesale lines of credit (the RDF and the MLF).

There is little risk that the Project will not improve the financial position and profitability of BIDV,compared to the likely 'without program' situation. The main potential risk is not really associated withproject activities as such; it is related mainly to GOV's performance regarding the SOCBs RestructuringPlan (RP). The RP may go slower than expected, and GOV may not fully deliver on its support forBIDV's restructuring, in terms of: (a) assisting in the resolution of the whole amount of non performing'state directed' loans; (b) providing the whole resources needed to counterbalance the writing off of frozenloans; and (c) re-capitalizing BIDV as agreed under the RP. Given that there are adequate MOF and SBVresources within BIDV's balance sheet to cover these requirements, unlike in some other SOCBs, it isexpected that Restructuring of BIDV could go ahead as planned, even if the process had to be slower forsome of the other SOCBs.

PFIs are already familiar with such operations and, reflected in their performance under RFP I, are quiteconservative in their lending decisions. As they will fully bear the credit risk associated with theirsub-borrowers, they are likely to finance only viable and creditworthy sub-projects.

Possible risks associated with macroeconomic instability

Following GOV policy to stimulate demand through expansionary monetary policy, credit growth increasedby 19 % in 1999 to 39% in 2000 and over 20% in 2001. This policy may lead to promote inflationarypressure. Although the project will provide additional financial liquidity, this is very small compared withoverall liquidity and liquidity growth. Incremental liquidity generated by the project would be about US$40million per year, or about 4% of the annual investment needs for Vietnam. The project would providelong term financial resources, which are scarce, and it is not likely to be a significant contributor toeconomic instability. Policy actions needed to limit inflationary pressure would be supported throughmeasures to be undertaken under the PRSC, and in dialogue between GOV and the IMF. Also, toencourage the banks to provide more credit to the rural areas, the Government issued new creditregulations, allowing lending up to a maximum amount of VND 10 million (US$650) to rural householdwithout collateral. This may increase banks' NPLs. The NPLs issue would be addressed at the levels ofBIDV and the PFIs. BIDV would take steps (reflected in its agreed IDP) to fully control the level of itsNPLs. Also, in selecting PFIs as conduits for project funds, BIDV would apply prudent financial criteriaand/or ensure PFIs' solvency through measures to be incorporated in their respective IDPs.

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2. Critical Risks (reflecting the failure of critical assumptions found in the fourth column of Annex 1):

Risk Risk Rating Risk Mitigation MeasureFrom Outputs to Objective(a) Sub-projects financed under the N -The project would restrict its financing toproject failed due to: private initiatives that are likely to be quite*Poor investments careful and selective in their investments.

* PFIs that would bear the credit risk wouldcarefully evaluate the associated risk and therelated sub-loan securities.* A prudent financial analysis would be requiredfor every sub-loan that exceed US$50,000equivalent, and an ex-ante economic analysiswould be required for every sub-loan that

Change in conditions of trade exceed US$200,000 equivalent.*Change in Government Policy

The risks of change in the country's conditionsof trade and change in Government policy wouldbe minimized through: (i) exchange rate ofwhich its movement is basically determine bymarket forces; (ii) a set of initiatives to becarried out under the PRSC program; and (iii) acontinuous dialogue with the Government.

(b) The number of new jobs created by M Diversification of sub-projects, in terms of theirsub-projects is insignificant due to industry and size, would mitigate this risk and itsub-projects financed under the project are would be achieved through the increase in thenot being labor intensive number of accredited PFIs.

From Components to Outputs(a) Low demand for project funds due to: M

-Slow down of the economy -Improvements in macro policy, which issupported by the Bank (PRSC), and in theregional economy would minimize this risk.

*GOV/Donor(s) subsidized interest rates *This risk would be treated in the context ofdonors' partnership.

-Inadequate number of accredited -An acceptable IDP would allow banks toPFIs/MFIs. participate even if the entire set of accreditation

criteria is not met.(b) BIDV fails to fully implement its own M -Close supervision by SBV and the Bank wouldrestructuring plan ensure that implementation issues would be

addressed in timely manners.(c) GOV/SBV fail to improve the legal M *TA and supervisory support under the PRSCframework, related regulations and would help SBV to implement its part of thesupervisory capacity which are program.indispensable for the overall success of -Re-capitalization of BIDV would beSOCBs restructuring plan. encouraged by GOV swapping its loans to

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BIDV into equity and so avoiding the need touse budgetary resources.

Overall Risk Rating M Policy actions as stated above plus closefollow-up on project's implementationperformance.

Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N(Negligible or Low Risk)

3. Possible Controversial Aspects:

None

12/ Based on Vietnam's rural economic development plan.

G. Main Loan Conditions

1. Effectiveness Condition

(a) The Financial Management Manual has been adopted by the Borrower, through the StateBank of Vietnam, and BIDV in a manner and substance satisfactory to IDA [Section 6.01 (a)and 3.01(c) of the DCA];

(b) The MLF Policy Manual and the RDF II Policy Manual have been adopted by the Borrower,through the State Bank of Vietnam, and BIDV [Section 6.01(b) and Section 3.02(a) of theDCA];

(c) The Project Management Unit has been established, including the appointment of anaccountant, acceptable to IDA, with sub-units for (a) accreditation of MFIs and PFIs; (b)accounting and disbursement; (c) review of applications for Sub-loans; (d) monitoring andevaluation; and (e) environment and social standards and practices [Section 6.01(c)of theDCA, and paragraph I of Schedule 4 to the DCA];

(d) BIDV has adopted its Institutional Development Plan in a manner and substance satisfactoryto IDA [Section 6.01(d) of the DCA, and paragraph 3 of Schedule 4 to the DCA];

(e) The Restructuring Plan of BIDV is being implemented in a manner and substance satisfactoryto IDA, including the increases in BIDV's equity by the Borrower through its Ministry ofFinance in an amount of not less than VND 1.2 Trillion [Section 6.01(e) of the DCA];

(f) A Project Senior Advisor has been employed by BIDV with qualifications and experienceacceptable to IDA [Section 6.01(f) of the DCA, and paragraph 2 of Schedule 4 tothe DCA];'

(g) The On-lending Loan Agreement has been entered into between the Borrower and BIDVunder terns and conditions satisfactory to IDA [Section 6.01(g) and Section 3.04 of theDCA];

(h) The operation and maintenance of the Fund for the Rural Poor and the Rural DevelopmentFund, including all assets and liabilities have been transferred to BIDV, and BIDV has

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adopted the FRP Policy Manual [Section 6.01(h) and Section 3.03 of the DCA].

2. Other [classify according to covenant types used in the Legal Agreements.]

(a) BIDV, PFIs, and MFIs would establish adequate and separate project accounts and internalcontrol and maintain them according to sound accounting practices [Sections 4.01 and 4.02 ofthe DCA; paragraph 10 (b) of Schedule 4 to the DCA; paragraph l(b)(x) of Section I ofSchedule 5 to the DCA; paragraph 1 (b)(ix) of Part A of Section II of Schedule 5 to the DCA;and paragraph l(b)(ix) of Part B of Section II of Schedule 5 to the DCA];

(b) The RDF II and the MLF (the Funds) would be managed on a commercial basis and netprofits generated from these operations which would be reflected in BIDV's financialstatements, would remain within the Funds as BIDV's investment [paragraph 10(b) ofSchedule 4 to the DCA, and paragraph l(b)(xvi) of Section I of Schedule 5 to the DCA];

(c) BIDV would exclude itself from retailing the RDF II and the MLF [paragraph 10(c) ofSchedule 4 to the DCA];

(d) The project annual training program would be submitted for IDA review by November 30 ofeach year of project implementation, starting from November 30, 2002 [paragraph 11 ofSchedule 4 to the DCA];

(e) Proceeds accrued from the repayment of the principal of sub-loans to PFIs and MIFIs would beused to establish and maintain revolving funds for on-lending for the same purposes and underthe same terms and conditions as those for on-lending under the "On Lending Agreement"(OA) between MOF and BIDV [paragraph 10 of Schedule 4 to the DCA, and paragraphl(b)(xvi) of Section I of Schedule 5 to the DCA];

(f) The RDF II and the MLF would be operated on the basis of agreed Policy Manuals. TheFunds would be on-lent according to procedures described in the agreed Policy Manuals.Changes in these manuals would not be made without IDA's prior concurrence [Section 3.02of the DCA];

The manuals would incorporate agreements with IDA on the following:

(1) eligibility criteria for RDF and MLF sub-projects, sub-loans, and beneficiaries includingminimum funding requirements and equity contributions of PFIs/MFIs andsub-borrowers, respectively;

(2) interest rate structure and principles for the determination of lending rates underthe project;

(3) terms and conditions of subsidiary and sub-loans including additional financing of BIDV,PFIs, and MFIs;

(4) PFIs/MFIs accreditation criteria and principles for setting PFIs/MFIs lines of credit;

(5) methods of appraisal and analysis of viability of sub-projects;

(6) financial management system for BIDV and for each of the PFIs/MFIs including systemof review of sub-projects' documents and disbursement;

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(7) Operation and management of RDF I, RDF II, and MLF;

(8) audit, supervision, and reporting of PFIs and MFIs; and

(9) means of ensuring sub-projects' conformity with environmental laws and regulations.

(g) BIDV would carry out by June 30, 2003, (i) an audit of its internal control procedures toreview BIDV's compliance with the provision of the Financial Management Manual; (ii)furnish to IDA, for its comments, the auditor's recommendations of the said audit; and (iii)promptly implement these recommendations taking into account IDA's comments [paragraph15 of Schedule 4 to the DCA];

(h) The Borrower through BIDV/SBV would submit the following:

(1) quarterly progress reports with regard to the RDF H, MLF, and training activities nolater than two months after the end of each quarter, i.e. by February 28, May 31, August31, and November 31 of each year commencing with May 31, 2003 [paragraph 13 ofSchedule 4 to the DCA];

(2) by September 30 and March 31 of each year, semi-annual reports of the performance ofBIDV, VBARD and each PFI and MFI and on the implementation of their respectiveIDPs commencing on September 15, 2003 [paragraph 14 of Schedule 4 to the DCA];

(3) a mid-term review on project implementation and operational issues on November 30,2005 [paragraph 12 of Schedule 4 to the DCA];

(4) audited accounts including auditor's reports on BIDV, RDF II, MLF, PFIs/MFIs, theSpecial Account, and the Statement of Expenditures for activities under the projectwithin six months after the end of each accounting year [Section 4.01(b) of the DCA];

(5) as of the second year of project implementation (CY 2004), an intemational audit basedon IAS procedures would be required from all PFIs that would receive a line of credit ofat least US$1 million equivalent [Section II paragraph 1 (b)(ix)(B) of Schedule 5 to theDCA];

Condition of Disbursement

(a) BIDV certifies to IDA that each of the PFI and MFI is in compliance the project's accreditationcriteria. In case a PFI or a MFI does not meet all the accreditation criteria, an acceptable InstitutionalDevelopment Plan (IDP), along with adequate training program, and detailed time table for itsimplementation would be prepared and submitted by the PFI/MFI to, and found to be acceptable by, BIDVand IDA [paragraph 3(b) (ii) and (c)(ii) of Schedule 1 to the DCA];

(b) For each PFI/MFI, a Subsidiary Loan Agreement (SLA) acceptable to IDA will have to be enteredinto with BIDV [paragraph 3(b)(i) and 3(c)(i) of Schedule I to the DCA];

(c) For the MLF sub-component, confirmation from SBV that the on-lenders under MLF would bepermitted to charge rates that are sufficient to fully cover related operating costs including cost of funds,provisions for possible loan losses, and some profits to allow for further lending expansion to the poor[paragraph 3(e) of Schedule 1 to the DCA].

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(d) A Sub-loan under the RDF II and MLF (Category (1), unless the Sub-loan has been made inaccordance with the procedures and on the terms and conditions of the respective sub-loan [paragraph 3(d)of Schedule 1 to the DCA].

Financial Covenants for BIEV

(a) Set aside fifty percent (50%) from the principal amount repaid to BIDV for Subsidiary Loans byeach MFI and PFI up to an aggregate amount of $24,000,000 equivalent in an escrow account in the nameof the Borrower [paragraph 4(a) of Schedule 4 to the DCA];

(b) Convert into BIDV's Equity, in the name of the Borrower, an amount equivalent to $24,000,000 asset aside in accordance with (a) to achieve a capital adequacy ratio of 8% of the aggregate principalamount of the Sub-loans made under this Project and those under the Rural Finance Project [paragraph4(b) of Schedule 4 to the DCA];

(c) By June 30 of each calendar year, commencing June 30, 2003, the Borrower shall exchange viewswith BIDV and IDA on the level of interest rates charged on Subsidiary Loans and Sub-loans, and review,said rates as approved by IDA [paragraph 5 of Schedule 4 to the DCA];

(d) Except as IDA shall otherwise agree, the Borrower shall cause BIDV to achieve the followingfinancial ratios: (a) ratio of equity to risk assets of not less than 5% by December 31, 2002; 6% byDecember 31,2003; 6.5% by December 31, 2004; 7% by December 31, 2005; and by December 31, 2006,achieve and thereafter maintain 8%; (b) ratio of net past due loans to equity of not more than 25% in fiscalyear 2002, and not more than 15% in fiscal year 2003 and thereafter, all established in accordance withinternational accounting standards acceptable to IDA [paragraph 6 of Schedule 4 to the DCA];

(e) The Borrower shall, and shall cause BIDV to, limit retail of State Directed Loans as a percentageof total loans, to 15% by December 31, 2003, and to 10% by December 31, 2005, or to VND 8 trillion byDecember 31, 2003, and to VND 6.2 trillion by December 31, 2005, whichever is lower [paragraph 7 ofSchedule 4 to the DCA];

(f) Cash dividend on its common shares will be paid only after: (1) Capital Adequacy Ratio (CAR), asreflected in equity/risk assets ratio, will not less than 8%; and (2) adequate provision have been made inaccordance with BIDV's IDP for: (i) taxes; (ii) dividend on preferred shares; (iii) possible loan losses,determine on the basis of its accounts audited in accordance with international audited accounts acceptableto IDA; (iv) adjustment to its equity caused by within year inflation (to ensure that dividend will be paidonly on profit in real terms); and (v) retain earnings in the amount equal to at least one seventh of thegrowth in its net RDF II, MLF, and private sector loan portfolio [paragraph 8 of Schedule 4 to the DCA];

(g) By July 31, 2003, or such later date as IDA may so agree, the Borrower shall through its Ministryof Finance, increase BIDV's equity in an amount of not less than VND1.35 trillion [paragraph 9 ofSchedule 4 to the DCA].

13/ The senior project advisor would have adequate knowledge in accreditation offinancial institutions, the preparation offinancial institution development plans, and in sub-projects' appraisal.

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H. Readiness for Implementation

0 1. a) The engineering design documents for the first year's activities are complete and ready for the startof project implementation.

Z 1. b) Not applicable.

D 2. The procurement documents for the first year's activities are complete and ready for the start ofproject implementation.

Z 3. The Project Implementation Plan has been appraised and found to be realistic and of satisfactoryquality.

D 4. The following items are lacking and are discussed under loan conditions (Section G):

1. Compliance with Bank Policies

1 1. This project complies with all applicable Bank policies.O 2. The following exceptions to Bank policies are reconmmended for approval. The project complies with

all other applicable Bank policies.

Arie Cl a Mark D. Wilson / iw D. SrTeam Leader Sector Manager/Director CountrY ManagerDirector

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Annex 1: Project Design Summary

VIETNAM: Second Rural Finance Project

Key Performance, Data-Collection StrategyHierarchy of Objectives, Indicators - Critical Assumptions

Sector-related CAS Goal: Sector Indicators: Sector/ country reports: (from Goal to Bank Mission)(a) Alleviate poverty; and (a) Poverty incidence has been a) Progress reports on poverty. (a) GOV initiatives to

reduced. alleviate rural povertytogether with donor's supportincluding the availability ofmicro-finance resourceswould reduce povertyincidence.

(b) improve private business (b) Policy, regulatory, and (b) GOV laws, regulations, (b) private sector willenvironment including institutional framework and procedures. positively respond to the newavailability of medium and becomes more conducive for framework.long term financing. private sector activities and

banks' sound development.

Project Development Outcome / Impact Project reports: (from Objective to Goal)Objective: Indicators:(a) provide financial support (a) BIDV and PFIs increase (a) BIDV's quarterly and semi a) & (b) Rural enterprises andto the rural economy and term lending to private annual reports as well as SBV households including microaugment the RDF to finance enterprises in the rural areas; statistic; finance beneficiaries would beviable investments in the rural able to increase ruralareas; investments, obtain financing

for their operations, and meettheir working capital needs;and

(b) assist the government in (b) MFIs to increase lending (b) MLF quarterly Progressits efforts to alleviate rural and providing financial Report and MFI's semi-annualpoverty through the provision services to individual working reports on IDP'sof financial and institutional poor and micro-enterprises; implementation; andsupport to the country's andmicro-finance system; and

(c) BIDV and PFIs/MFls (c) BIDV, PFIs and MFIs incl. (c) Progress reports on the (c) Projecfs FIs wouldwould become stronger FIs VBARD to submit their IDP implementation of the vigorously implement theirand would provide better and related training program. respective IDP of each of the respective IDP.financial services to the rural financial institutionareas. participating in the project.

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. Key Performance Data Collection StrategyHierarchy of Objectives Indicators - Critical Assumptions

Output from each Output Indicators: Project reports: (from Outputs to Objective)Component:(a) Lending to viable rural For (a) & (b) components: M&E would be regularly (a) Financial institutions willeconomic entities would Total investments of undertaken by the BIDV and be interested in using the RDFimprove their economy, sub-projects. would be reviewed by IDA and MLF to finance theirincrease employment -Number of sub-projects Supervision Missions. clients' initiatives;opportunities, and thus financed. (b) RDF's and MLF's lendingindirectly contribute to -Increase in employment. would finance a wide range ofpoverty alleviation. Number of micro enterprises viable economic activities;

and individual poor financed (c) RDF and MLF wouldunder the project and their attract large number oftotal investments. PFIs/MFIs.For component (c):Real increase in equity.-Decrease in proportion ofretail directed loans in theportfolio.Increase of the proportion ofprivate VND deposits andborrowings.-Improvement in operatingmargins as a percentage ofearning assets.-Reduction in Net past due toequity ratio under IAS.

(b) Micro-finance would Number of sub-borrowers. Project's quarterly progress Strong MFIs anddirectly contribute to poverty Volume of loans provided. reports. sub-borrowers demand forreduction by financing micro Collection rates. micro-finance services.enterprises and individual Volume of savingpoor people to finance their mobilization.viable economic activities. Number of saving accounts.

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Hiera Key Performance 1 Data Collection StrategyHierarchy of Objectives | Indicators T Critical Assumptions

Project Components / Inputs: (budget for each Project reports: (from Components toSub-components: component) Outputs)(a) General Line of credit (a) RDF US$253.9 million; Quarterly Progress Report on (a) PFIs would finance labor(RDF); lending and training; semi intensive operations;

annual reports on institutionalperformnance; mid-term reviewreport, and ICR

(b) Micro-finance (MLF); (b) FRP US$38.0 million; (b) IDPs would be rigorouslyimplemented by thePFIs/MFIs.

(c) Strengthening the BIDV; (c) BIDV StrengtheningUS$2.0 million;

(d) Strengthening PFIs/MFIs (d) Strengthening PFIs/MFIsUS$2.6 million.

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Annex 2: Detailed Project DescriptionVIETNAM: Second Rural Finance Project

1. The project would be implemented over a period of five years and includes two major components:the credit component and the institutional strengthening component.

By Component:

Project Component I - US$293.40 million

2. The credit component would include two sub-components, the Rural Development Fund II (RDFII), and the Micro-Finance Loan Fund (MLF). The estimated costs of the two funds are US$257.2million equivalent for the RDF II, and US$36.2 million equivalent for the MLF (these costs includesub-projects' investments, TA, training, and goods to be procured under these two sub-components). Thetwo funds would be wholesale operations. While under the RDF II, the project would provide lines ofcredit for the financing of rural investment in general (mainly medium and long term financing), the lines ofcredit, under the MLF, would be restricted to finance economic initiatives of the rural poor (mainlyshort-term financing).

3. RDF II financial resources would be used to make short, medium, and long term credit available,through competing PFIs, to finance household and private enterprise investments in agriculture and otherviable rural operations (both fixed assets and incremental working capital), in accordance with a PolicyManual satisfactory to IDA.

4. The Policy Manual would be prepared by the ICPMU/BIDV, based upon the experience gainedand lessons learned under the first RDF. The Policy Manual would include the following main sections: (i)the management of the Funds; (ii) eligible sub-projects; (iii) type of financial institution to be eligible toparticipate in the project; (iv) qualifying (accreditation) criteria for PFIs/MFIs; (v) terms and conditions ofsubsidiary loans (currency, lending rate, maturity, sub-project financing, collateral, default, andprepayment); (vi) terns and conditions of sub-loans; (vii) environmental protection, audit, supervision andreporting.

5. The operation of the general line of credit would be determined by market forces, with noearmarked allocation by crop or type of investment, would be a demand driven operation, and would bear amarket determined interest rate. The proceeds of IDA credit would be used to finance eligible sub-loansmade by PFIs with respect to production, processing, trade, services, on-farm development, and otherviable investments in areas outside the urban areas of Hanoi, Ho Chi Minh City, Hai-Phong, and Da Nang.All provinces would be eligible. It is estimated that about 90,000 sub-borrowers would benefit from thissub-component.

6. The funds would be on-lent to accredited PFIs who have signed a Subsidiary Loan Agreement withthe BIDV acceptable to IDA. Proceeds accrued from the repayment of the principal of the subsidiary loansby PFIs would be used to establish and maintain a revolving fund for on-lending for the same purposes andunder the same terms and conditions as those for on-lending under the IDA Credit. The sum of theproceeds of IDA Credit and the revolving fund would be known as RDF II. Investment under thissub-component is estimated to be, at least. US$255.0 million of which IDA may finance about US$165.7million or up to 65%. In practice, it is likely that the sub-borrowers would finance more than the minimumnecessary (15% of sub-projects' costs) as has occurred under RDF I (about 40% of sub-projects' costs),consequently, while the IDA contribution remain the same, the total investment supported is likely to bemuch larger.

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7. The Micro-Finance Sub-Component: BIDV would manage and implement this sub-componentin accordance with a Policy Manual satisfactory to IDA. MLF financial resources would be channeledthrough accredited Micro-Finance Institutions (MFIs) comprised of commercial banks, ruralsharing-holding banks, credit funds, credit cooperatives and credit-granting non-governmentalorganizations who meet the MLF accreditation criteria. This sub-component would provide (i) short-termloans to individual households and micro-enterprises to finance working capital for their viable initiativesincluding production, non-farm and off-farm activities; and (ii) medium terms loans (up to three years) tofinance small capital investment of individual households and micro-enterprises which would boostproductivity, generate employment and increase rural income. Sub-loans under this component would notexceed the equivalent of US$400 for individual farmer and US$ 1,000 for micro-enterprises (employed atleast two persons outside the immediate family members). Under the MLF financing of any singlesub-project would not exceed in any case 75% of sub-project costs. The MFIs and sub-borrowers wouldbe required to provide for each sub-project at least 25% of the financing package from their own funds.The share in equity contribution by the sub-borrower would be determined by the MWI concerned, as itbears fully the credit risk.

8. The on-lending interest rate from MFIs to sub-borrowers would be market-determiined based on thecost of loan able funds in Vietnam plus adequate spread to cover operating cost including provision forpossible loan losses and profit.

9. To assist the project's final beneficiaries in gaining access to the micro-finance credit, MFIs willraise awareness among their sub-borrowers of the availability of the fund. The project would encouragethe accredited MFIs to promote the participation of small farmers and entrepreneurs by working with themass organizations such as Vietnam Women's Union, Vietnam Farmner's Association, who would providesupport to create and strengthen credit groups that can obtain loans through social collateral. The MFIswould simplify procedures, documentation and loan requirements to reduce transaction costs and improvingaccess by delivering services at the village level via mobile banking. It is estimated that at least 85,000individual and micro-enterprises would benefit from this sub-component.

10. The total estimated investment under this sub-component is US$32 million, and IDA will financeup to 75% of the total cost which will be US$24 million.

Project Component 2 - US$4.80 million

11. The institutional strengthening component would include two sub-components, the strengtheningof BIDV (the Project's Apex Bank), and the strengthening of PFIs/MFIs, including VBARD. Theestimated costs of the two sub-components are US$2.2 million equivalent for strengthening BIDV, andUS$2.6 million equivalent for strengthening PFIs and MFIs.

The Bank for Investment and Development of Vietnam (BIDV)

12. BIDV is the project's apex bank and would be restructured, under the SOCB's restructuringprogram, supported by the PRSC and the IMF. The Restructuring Plan is already under implementation.Key elements of this are (a) clearly distinguishing between Government guaranteed 'state directed loans'and commercial loans, identifying all loans with problems and cleaning the balance sheet of those debtswhich were bad at 31/12/2000, (b) the provision of additional equity by Government, to bring BIDV'scapital adequacy ratio to an acceptable international standard, (c) maintaining international accountingstandards (IAS) and audit, (d) restructuring BIDV's organization and management, specifically to (i) cover

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a broader range of activities, (ii) enhance effectiveness of supervision, (iii) improve risk management, (iv)enhance human resources management and training and (v) upgrade BIDV's IT and banking technology.Implementation of this plan is an important element in the effective development of BIDV.

13. Carrying out this restructuring will provide a basis from which BIDV can develop and become aneffective Apex Bank. Even with the restructuring plan in place, however, it will still need furtherstrengthening in a number of key areas. BIDV prepared a five-year Institutional Development Plan (IDP)which would be financially supported under the project, through making available IDA funds for training,technical assistance and possibly hardware. Key elements include:

* Continuing with the use of IAS" for management purposes', and having accounts externallyaudited by an international auditor even though some parallel use of VAS may continue to berequired for purposes of tax and reporting to SBV.

* Cleaning bad debts from the balance sheet as indicated under the Restructuring Plan and inconsequence being ready for re-capitalizing with a minimum of VND1.2 trillion new equity to beprovided by credit effectiveness and a further VND 1.35 trillion by July 31, 2003.

* Striving to ensure that equity increases to be provided under the Restructuring Plan are timely andthat they result in BIDV meeting IAS/BIS standards for its Capital Assets Ratios by end 2006.

* Enhancing asset quality by operating on a purely commercial basis, and not undertaking moreretail 'directed lending' and by classifying debts in line with decision 1627, analyzing risks,formalizing lending limits on a branch by branch basis, and strengthening internal audit andsupervision.

* Setting business plan targets on margins and other earnings to allow BIDV, provided it is wellmanaged, to earn sufficient profits to prudently self-finance its expansion, once the restructuringprogram is finished. Based on its initial medium term growth projections of over 20% p.a., BIDVwould need to achieve an after tax profit of at least 1.4% of earning assets to maintain a plannedCapital Adequacy ratio of 8%. This would appear unrealistically high under the presentenvironment. The relationship between growth plans, loan pricing and realistic earningsprojections needs to be consistent, therefore BIDV2 needs to carefully review its expansion plan inthe light of this.

* Improving Governance by clearly delineating the functions of the BIDV board and its management.* Mobilize more longer-term resources through a flexible range of financial instruments so as to

more closely match the term of resources to the term of loans.* Implement a phased program of modernizing bank technology.* Implement a training and staff development and recruitment program, which will raise the average

qualifications of BIDV staff, and provide for a growth in staff numbers sufficient to cope with theexpanded and more diverse future operation of BIDV.

* Continuing to increase activities with the private sector, including lending to SMEs, and expandingactivities with foreign partners, including taking on the wholesaling role under this project.

14. A time-bound IDP, approved by BIDV Board, with specific monitoring indicators would be agreedwith IDA and adopted by BIDV by effectiveness. The IDP would also include the first year's proposalsfor training, technical assistance and hardware to be funded under the project, and also Projections of Profitand Loss Accounts, Balance Sheets and Cash Flows through 2006.

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Strengthening PFIs and MFIs

15. To ensure the funds be used efficiently, BIDV will employ screening criteria in accrediting PFIsand MFIs. As part of the accreditation process, those PFIs which do not meet BIDV's requirements forscreening requirements for financial strength and experience, as set out in the operations manual and allpotential MFIs would be required to prepare an Institutional Development Plan (IDP). This would addressthe main issues identified including, (a) building up their capital base, (b) improving their solvency positionand profitability, (c) extending market outreach, and (d) strengthening the staff capacity to implement itsvarious types of rural-finance operations. The IDP would include a time-bound action plan to achieve itstargets. To support this, the project would finance relevant training programs and provide technicalassistance to help the accredited MFIs prepare and implement their IDPs. For MFIs, technical assistanceand training would also be provided to the joint-liability credit group and to the sponsoring agency assistingin group formation and promotion of basic financial literacy.

16. VBARD has been the main retailer of funds under RDF I and has achieved a wide outreach. Overthe past five years, it has grown very rapidly in terms of total assets but has not expanded its capital base.In consequence, it remains a weak bank both financially and institutionally. Its portfolio, in company withthose of the other SOCBs, is severely burdened by bad and risky debts. At the end of 2000, totalproblematic loans amounted to 8 trillion, or 18 percent of total loan portfolio. It is understood that most ofthese loans (87 percent) are either "directed loans" or loans guaranteed by the government. They included:(i) frozen loans (VND1.4 trillion, or 18% of total problematic loans); loans to sugar enterprises (VND2.3trillions, 29%); loans under natural calamities program (VND3.3 trillions, 41%); and bad debts (VND1trillion, 12%). In addition, VBARD was also required to make loans with subsidized interest rates toVND3.3 trillions (about US$235 million).

17. Institutionally, as with other SOCBs, VBARD's weaknesses have been identified with regard to itsplanning, corporate governance, accounting transparency, risk management, internal controls andprofessional/technical skills.

18. To support VBARD's development as a viable institution which can continue to lead the nationaleffort in extending financial services to rural households and enterprises, VBARD finalized its revised IDPto cover the next five years so as to address its weaknesses. The IDP is consistent with the framework ofthe on-going PRSC and IMF supported Restructuring Plan with respect to transparency, debt resolutionand re-capitalization. In the area of govemance, it would follow the guidelines recommended by the ADB'sgovernance improvement assistance program.

19. The most important elements of VBARD's IDP would therefore be as follows:

* VBARD moving to operating on a purely commercial basis, trying to recover all debts and ceasingto make non-commercial loans, such as risky loans to sugar SOEs;

* Introduction and use of IAS for management purposes, especially in the area of treatment of itsloan portfolio and non-performring loans and having accounts externally audited by an intemationalauditor even though some parallel use of VAS may continue to be required for purposes of tax andreporting to SBV;

* Increasing equity such that VBARD will meet the 8% capital adequacy ratio as soon as possible(and at least by end 2005), and maintaining at least that ratio in future;

* Increasing the lending spread and diversifying its income sources with the aim of having after taxeamings of a minimum of 1% on eaming assets. This may require actions to change the bankingregulations as well as for VBARD to do what it can within the existing framework;

* Ensuring that VBARD's planned rate of growth is consistent with the its ability to increase equity,

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either through retained profits, or by increased shareholder contribution;* Improving govemance by clearly delineating the functions of the Board and its management;* Reviewing the performance of its credit officers and the average number of borrowers assigned to

each of them, with the aim of optimizing the officer/borrower ratio. From several field visits it wasfound that there are sometimes up to 800 borrowers per officer, which by all standards is tooexcessive. A reasonable target would be about 400;

* Introducing and improving the management information system to strengthen VBARD's intemalcontrols and allow the performance of individual branches to be centrally evaluated;

* Improving assets quality and setting up a Credit Committee to review risk concentration and setguidelines for risk exposures by sector and monitor the level of provisions made against IASstandards;

* Increasing mobilization of rural savings and linking it with term lending.

20. A time-bound IDP, approved by the VBARD board, with specific monitoring indicators would beagreed with BIDV and IDA before RDF/MLF disbursement.

1/ Because BIDVhas Joint Venture enterprises in which its senior management and chairwoman are directly involved whichuse IAS, this type of accounting isfamiliar to BIDV and its introduction should therefore be straightforward.2/ This issue would apply to all SOCBs and so needs to be addressed by SBV.

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Annex 3: Estimated Project Costs

VIETNAM: Second Rural Finance Project

Local Foreign TotalProject Cost By Component US $million US $million US $million

a. Rural Development Fund 102.58 154.34 256.92b. Micro Finance Loan Fund 19.76 16.35 36.11c. Strengthen BIDV 0.30 1.76 2.06d. Strengthen PFIs and MFIs 1.52 0.62 2.14Total Baseline Cost 124.16 173.07 297.23

Physical Contingencies 0.23 0.24 0.47Price Contingencies 0.30 0.17 0.47

Total Project Costs' 124.69 173.48 298.17

Total Financing Required 124.69 173.48 298.17

. - ; ; ';.. 'Local 'Foreign TotalProject Cost By Category US $million US $million US $million

Sub-projects under Rural Development Fund 102.00 153.00 255.00Sub-projects under Micro-Finance Loan Fund 19.20 12.80 32.00Goods (for component a, b, and c) 0.76 5.47 6.23Training & TA (for component c and d) 2.14 1.66 3.80Incremental Operating Cost (for component c) 0.06 0.14 0.20Physical Contingencies 0.23 0.24 0.47Price Contingencies 0.30 0.17 0.47

Total Project Costs 124.69 173.48 298.17

Total Financing Required 124.69 173.48 298.17

Identifiable taxes and duties are 0.8 (US$m) and the totalproject cost, net of taxes, is 297.4 (US$m).Therefore, the project cost sharing ratio is 67.25% of total project cost net of taxes.

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Financing Plan Sub-borrowers PFIs/MFIS BIDV IDA Totalby Component US$ million US$ million US$ million US$ million US$ Million

Incl.Contingencies

a. RDF 38.3 26.0 25.5 167.4 257.2

b. MLF 4.8 3.4 - 28.0 36.2c. Streg. BIDV - - 0.2 2.0 2.2d. Streng. - 2.6 2.6PFIs/MFIsTotal 43.1 29.4 25.7 200.0 298.2

Financing Plan Sub-borrowers PFIs/MFIs BIDV IDA Totalby Categories US$ million US$ million US$ million US$ million

Inc.Contingencies

RDF 38.3 25.5 25.5 165.70 255.0(sub-projects)

MLF 4.8 3.2 - 24.0 32.0(sub-projects)

Goods - 0.7 0.1 5.6 6.4Training - - - 3.8 3.8

TA - 0.8 0.8

Increm. Op. - - 0.1 0.1 0.2CostsTotal 43.1 29.4 25.7 200.0 298.2

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Socialists Republic of VietnamRural Finance II

Table 1. Rural Development FundDeted CostS

(US$ VoO)

Qumabtes Unit Totls hcuding Conringencies3-Feb MM4 GM5 0YO6 06(7 Total CoSt 02103 3O4 04W05 W06 06107 Total

. nv nt CostsA Fund CWitl

Rual Develpmerf Fund -Mecdum Term 35,714 35,714 35,714 35,714 35,714 178,571Rual Develo ent FUrid -Shot Term 15,286 15,286 15,286 15,286 15,286 76,429

Suboal Fund Capitl 51,000 51,000 51,000 51,000 51,000 255,D0OB. Project Mangeent Unit

1.kMS lnstalation 334 - - - 334Worlati Computrs and Prntes 10 5 - - - 15 1.5 17 9 - - 25

LaPlop Cnuters 2 2 - - 4 3 7 7 - - - 14Poo 1 1 - - 2 10 11 11 - - - 23Oeter Offi EquipyXer 56 - - - 5SMIS Upgrat and Exns - - - - 123 123

Subto EquIPnient 424 27 - - 123 5742 VehIc sfr Fund SuPelVBOn 2 1 - - - 3 55 123 63 - - - 185

Subtoal Prject Managenent Unit 547 90 - - 123 760C. Institutional Buiding

1. TrainingRDFLadchVWakshops 3 - - - - 3 10 34 - - - - 34Worcshops onBankAoedttan,IDPs 2 2 2 2 2 10 5 11 12 13 13 14 63Wohos Pro AjeAppFsal 2 2 2 2 2 10 5 11 12 13 13 14 63LoaTraTrninWo desaleBBankin9andPRjedAPPcapsa 3 2 2 2 2 11 10 34 24 25 26 28 137LocalTra,inhgonEnvvboiment 2 2 2 2 2 10 10 23 24 25 26 28 126OVarseeS Traniing on Vlesale Bankdng 1 1 1 1 1 5 40 45 46 47 48 49 234

Subtotal Trining 158 118 123 127 132 6582 Advsoy Se es

Advsay Servicss fWr Wholesale Banldng Opeaton andAppal PRoedure 6 6 3 3 18 16 107 110 56 58 - 331Advisay Servcs for Envmnnir ent 3 3 3 3 12 16 53 55 56 58 - 223Loal AdvsOry Sevcs for EIA 3 1 1 1 1 7 1 3 1 1 1 1 8

SUbtl Adviry SAVIces 164 166 114 117 1 562Subtal- Institutional BuIlding 322 284 237 244 134 1,220

TOtal InVestent Coss 51,869 51,373 51,237 51,244 51,257 258,980H.cuwent Costa

A b Cwnena Opera"ng CostProjectALjdt 24 25 26 26 27 128Prject Marketng 103 - - - - 103

Total Recunnet Costs 127 25 26 26 27 230Total 51,996 51,398 51,262 51,270 51,283 257,210

-44 -

Socialist's Republic of VietnamRural Finance II

Table la. Rural Development FundDetailed Costs

(USS '000)

Unit Base CostUnit Cost 02103 03104 04105 05106 06107 Total

I. Investment CostsA. Fund Capital

Rural Development Fund -Medium Term amount 35,714 35,714 35,714 35,714 35,714 178,571Rural Development Fund -Short Term amount 15,286 15,286 15,286 15,286 15,286 76,429

Subtotal Fund Capital 51,000 51,000 51,000 51,000 51.000 255.000B. Project Management Unit

1. EquipmentMIS Installation amount 300 - - - - 300Workstation Computers and Printers Set 1.5 15 8 23Laptop Computers Unit 3 6 6 - - - 12Photocopier Unit 10 10 10 - - - 20Other Office Equipment amount 50 - - - - 50MIS Upgrading and Expansion amount - - - - 100 100

Subtotal Equlpment 381 24 - - 100 5052. Vehides for Fund Supervision Unit 55 110 55 - 165

Subtotal Project Management Unit 491 79 - - 100 670C. Institutional Building

1. TraIningRDF Launch Workshops amount 10 30 - - - - 30WorkshopsonBankAccreditatlon,IDPs Courses 5 10 10 10 10 10 50WorkshopsonProject Appraisal Courses 5 10 10 10 10 10 50Local Training on Wholesale Banking and Project Appraisal Courses 10 30 20 20 20 20 110Local Training on Environment Courses 10 20 20 20 20 20 100Oversees Training on Wholesale Banking Courses 40 40 40 40 40 40 200

Subtotal Training 140 100 100 100 100 5402. Advisory Services

Advisory Services for Wholesale Banking Operatbon andAppraisal Procedure Consultant Month 16 96 96 48 48 - 288Advisory Services for Environment Consultant Month 16 48 48 48 48 192Local Advisory Services for EIA Consultant Month 1 3 1 1 1 1 7

Subtotal Advisory Services 147 145 97 97 1 487Subtotal InstItutional Building 287 245 197 197 101 1,027

Total Investment Costs 51,778 51,324 51,197 51,197 51,201 256,697II. Recurrent Costs

A. Incremental Operating CostProject Audit amount 24 24 24 24 24 120Project Marketing amount 100 - - - - 100

Total Recurrent Costs 124 24 24 24 24 220TOWal 51,902 51,348 51,221 51,221 51.225 256,917

-45 -

SodgsIs RepI cofVenamRPu Frinoe 11

Tabe 2. NMkro Fhm Lan ELnd

es Uht TT tl g C aniesa3m 0304 045 055 0007 Tm Cd OZ03 m c04 0485 OS0 OW Tom

I~COWARrdaM

ma9oRwFLrntr Ft,d-eirnTunm 1E 1,2B0 1;0 1 1,8 6,4WM4VGrQDhLcnRnJ-SotTen, 5,12 5,120 5,120 5,120 5,12D 25,6D

Su1 FundOU 6i4D 6,4W 6,4W 6,4D 0 6,4W 32p03EL aksna*i g

1.TmkftChnrum T 4 4 4 4 4 20 10 45 48 51 53 56 22M.FL&rdih Wup 3 - - - - 3 5 17 - - - - 17

SLfT d *akf0 62 48 51 53 55 269ZTedv4wAs_

AivySs;vim b 6 3 - - - 9 16 107 55 - - - 1625 huI BaiiS 163 103 51 53 55 431

Vhs O15 - - - 150 25 3,797 - - - 3a797Taw 1QE 6,503 6,451 64M5 6,415 36,

SocialisVs Repubic of VietnamRural Finance 11

Table 2a. Micro Finance Loan FundDa Cost

(uss I)

UnH Base CostUnH Cost oo3 03104 0415 006 06107 Tolal

L wsT CosA ffid CqI

Mm FRrice Loan Frid -Medurn Term arT 1,280 1 80 1,280 1,280 1,280 6,400vrot>FLnan Furo d --SultTerm arort 5,120_ 5,120 5,12D 5120 5,12 25,600

Suhb Fuid Cwrf 6,400 6,400 6,400 6,400 6,400 3Z000EL hbihtlorul Buddn

1. Tm*fgCo fnn yTr&*lgWaNohqp CQses 10 40 40 40 40 40 2W0

Wvt Lau \k rIhops Cases 5 15 - - - 15SuItoflTA*ft 55 40 40 40 40 2152 Tecvi,d Assitmnoe

AdviySexsvisn Uniarnce conultantMor1h 16 96 48 - - - 144SI*iaw kitosal BtSig 151 88 40 40 40 359C Oueac md Rld tiAble Badng Pmui forVRD

Vehides Untb 25 3,750 - - - - 3,750Trlai 10,301 6,488 6,440 6,440 6,440 36,19

-46 -

: - *pi l il * j - - 1-1- 1- | I' ''' 1¶1 10> ' ^ _ N B 8 O ~ . . . c =

I.~~~~~~~~~~~b9

tWi a I O p°108 9N 8 8 ^ 8

I~~~~I ID 0i 0t~ 11 0IJ ;m te 8

.~~~~~' .I J

$1~ 1-T '511r B -1'18 ' ir1C| Iq11z3 81820 8151a 2 I I 1E '~ ,ilg ' ('1s a ClE2lE9 g ' I'll, 'N'I ' 1

N I NL r'N N) ULU )

N U N I N m I IU1~~~~~~~~~M '' ..

gW3xaliX3!M!cmamscoIn ai313Li Lo N=<~~~~~~~~I eq cq m §L n

Socialist's Republic of VietnamRural Finance 11

Table 4a. Strengthen PFls/MFlsDetailed Costs

(US$ '000)

Unit Base CostUnit Cost 02V03 03104 04105 05106 06/07 Total

I. Investment CostsA. Institutional Development of VBARD

1. Outreach and Rural Saving Mobilization Programa. Training In Outreach and Rural Mobilization Program

Workshops/Seminars Units 5 10 10 - - - 20Oversees Study Tours and Courses Person 2 - 20 20 20 20 80

Subtotal Training In Outreach and Rural Mobilization Program 10 30 20 20 20 1002. Managing Rural Development Fund

Workshops for Branch Officers on ROF Units 18 72 36 - * 108Training on Project Appraisal Courses is 36 54 54 54 36 234

Subtotal Managing Rural Development Fund 108 90 54 54 38 3423. Managing Micro Finance Loan Fund

Workshops for Branch Of ficers in MLF Units 18 72 36 - - - 108Training in Credit/Savings Group Formation Courses 18 36 54 54 54 36 234Training on Microfinance Management Courses 18 38 54 54 54 36 234

Subtotal Managing Micro Finance Loan Fund 144 144 108 108 72 576Subtotal lnsUtutional Development of VBARD 262 264 182 182 128 1,018B. Institutional Development of Other PFIs

1. Project Preparation and Appraisal Units 15 45 75 75 45 30 2702. Training

Improving Rural Banking Operation Courses 15 75 75 - - - 150Outreach to Remote Areas Courses 20 100 100 - - - 200Overseas Training in Improving Banking Operation Courses 30 150 - - - ISO

Subtotal Training 325 175 - - - 500Subtotal Institutional Development of Other PFIs 370 250 75 45 30 770C. Institutional Development for Other MFis

1. TrainingMicrofinanceActivities Courses 20 100 100 - - - 200Study Tours to Leam Successful Experiences from Other Countries Courses 30 30 60 60 - - 150

Subtotal Training 130 160 60 - - 350Total 762 674 317 227 158 2,138

- 49 -

Annex 4: Economic Analysis SummaryVIETNAM: Second Rural Finance Project

1. Because this is a credit project, with no advanced deternination of the precise investments to bemade, or even the sub-sectors likely to be involved, it is only possible to estimate the project's economicimpact in a very general way. There are a number of key factors that indicate that the project would belikely to have a sound economic impact which are set out below.

2. Contribution to Poverty Reduction. With per capita GDP of about $375 in 1999, Vietnam remainsone of the poorest countries in East Asia. Although the share of the people living below the poverty linefell from 58% in 1993 to 37% in 1998 (GSO's VLSS 1993/1994 and 1997/1998), the achievement inpoverty reduction remains quite fragile. With 40% of rural population getting an income lower thanpoverty line in 1998, poverty is a common phenomenon in Vietnam and is amplified by ruralunemployment and underemployment, and the vulnerability of the rural poor to internal and externalshocks, as well as the widening gap between urban and rural incomes. The project would be financing bothindividual households, which would use the resources to enhance their own productivity and incomes, andrural entrepreneurs who would expand their operations and increase the numbers of people they employ. Itsbalanced approach to supporting rural finance would thus be expected to contribute to rural economicgrowth, at the household, micro-enterprise, and private small business levels. The impact of this would bemanifested by increases in both rural incomes and levels of employment. As a result, it would contribute topoverty reduction. Financing viable initiatives of the rural poor and providing them with better access tofinancial services would increase their chances of getting out of the poverty trap. The likelihood that thiswould be achieved is supported by the findings of the Socio Economic Study of RF I project, whichindicated that most households borrowing under the project (93% of a sample of 1883 borrowing familiessurveyed in 2001) had experienced 'family economic benefits' as a result of borrowing under the project.

3. Contribution to Necessary Long Term Investment Finance. As part of its growth strategy,Vietnam is targeting investment at levels of about 30% of GDP overall. This figure will vary betweensectors, and both investment and growth in agriculture are likely to be below that of the economy as awhole. It is estimated that agriculture (growing at about 4%) and the rural business sector (growing atabout 10% - 12%), would together comprise about 30% of GDP and have a Gross Value Added (GVA) ofabout US$10 billion in 2002. Even if the investment requirement of this sector were only 10% of GVA, orone third of the overall figure, investments of US$1 billion per annum or US$5 billion over the five yearproject period would be required for agriculture and rural business. The project would be able tocontribute to this to a limited extent; about 4% of the conservatively estimated gross amount needed over afive-year period. Because it would supply long-term resources, while the banks can readily accessshorter-term resources through deposits, project funds under the RDF would be likely to be channeledtowards longer-term investments in the sector. This is likely to include agro-processing and other non farminvestments and diversification of agricultural production, particularly for fast growing agriculturalexport" crops and the development of larger private commercial 2' farms. As a result the RDF componentof the project would generate employment opportunities both on and off farm, and support productive highoutput famning systems.

4. Acceptable Rates of Return. The RDF and the MLF components would finance economically andfinancially viable investments in rural areas, including both agricultural and other types of viable economicactivities. There would be no ex-ante allocation by crop, or type of industry. This is a demand drivencredit operation, with no predetermnination of investment, and since investment composition would not beknown, no quantitative assessment of the likely economic rate of return has been calculated for the project.

- 50 -

However, the eligibility criteria for project funding would be set so that projects with likely EconomicRates of Return (ERRs) below 15% would not be financed. Therefore the ERR for the whole projectshould be well in excess of 15%. Sub-loan processing would include a financial analysis of sub-projects'viability for projects involving sub-loans greater than US$50,000 equivalent. For a sub-project to beacceptable, the ex ante real Financial Rate of Return (FRR) should be greater than 15%. For sub-projectswith sub-loans greater than US$0.2 million an ex-ante economic analysis with a minimum ERR of 15%would also be required.

5. Market interventions in Vietnam have generally been dismantled and policy induced divergencebetween economic and financial values are not presently substantive when considering most agriculturaland types of investment likely to be made by farrm households. Because the shadow wage rate is below thefinancial wage rate in rural areas for much of the year, it is likely that ERRs would on average be higherthan FRRs. Thus sub-projects with ERRs of less than 15% would generally be excluded as a result of thefinancial cut off. There still remain, however, one or two sectors where there is considerable pricedistortion e.g. sugar. To avoid financing of uneconomic projects in those sectors, a negative list, to befinalized at negotiations, would be drawn up and those sectors would be excluded from the project. Basedon this, the economic rate of return of the project's overall investment is likely to be well in excess of 15%.

6. Promotion of Competition and More Cost Effective Financial Services. By helping to improve thestrength and viability of the SOCBs and the removing from them the implicit subsidy of being able toexpand regardless of capital adequacy, the financial market will become more competitive. Specifically, ifVBARD adopts a sound IDP, to be monitored under the project and raises its interest rate spreads, as itneeds to do to be viable in the long run, other banks, if they are equally or more cost effective thanVBARD, will be able to compete profitably and so expand their market share. Accordingly, the qualityand cost effectiveness of financial services delivery in the rural areas would be improved.

1/ The rural sector is an important source of export growth. In 2000 exports of agricultural products in total grewfaster thanthose of all other sectors exceptfor oil. Specific increases over the previous year were 95%forfruit and vegetables, 52%forseafood, 29%for peanuts and 18%for cashews. In addition, rural handicraft exports grew by 40%.2/ Recently, land consolidation and larger scale agricultural production have successfully piloted. This new developmentwhich allows private ownership of largerfarms requires considerable on-farm investment and results in more intensiveproduction as well as economies of scale. It thus increases agricultural productivity and creates more rural employment.Lending to such businesses through the project's RDFfacility would provide important support to these new kinds ofenterprises.

- 51 -

Annex 5: Financial SummaryVIETNAM: Second Rural Finance Project

1. The project will impact upon sub-borrowers, MFIs and PFIs, BIDV and the Government asindicated below.

2. Sub-borrowers. Results from RFP I indicate strong demand and good repayment rates fromsub-borrowers (average 99% from households and 98% from SMEs). This indicates that borrowers havebeen investing in sub-projects with sound financial rates of return, ex post. It is expected that this willcontinue under RFP II, although inevitably, as the prices of commodities change and the profitability ofdifferent rural activities changes, the sub-project mix would also be expected to change. Ex ante, subproject appraisals limit loans of more than US$50,000 to those sub-projects with an expected FRR of over15%. Training and support for the appraisal staff within PFIs should help to ensure sound sub-projectselection, and professional application of these criteria. A priority, FRRs from smaller loans are likely tobe higher, particularly because (i) the vast majority of borrowers under RFP I indicated that they gainedbenefits from borrowing under the project, and (ii) part of the lending would be to replace informal finance,typically being lent at more than double the likely rate from PFIs/MFIs. As a result of this, sound financialreturns to sub-borrowers, well in excess of 15% on average can be expected.

3. PFIs/MFIs. The project would have a positive impact on the profitability of PFIs/MFIs becausethey are free to set their own spread, and therefore, they would only participate in the project if theyperceive it profitable. As it would be a repeater operation for a number of PFIs, the experience gainedunder the first rural finance project would be a reliable basis for this. Participating in the project wouldalso help to improve the liabilities side of PFIs/MFIs balance sheets, in that it would increase the averagematurity of their resources.

4. BIDV. The project would promote the development of a US$300 million wholesale lendingportfolio (RFP I and RFP II). This would substantially contribute to BIDV's profitability and theoperational expansion of this institution. Net income from the project assuming complete use of project'sfunds is estimated to be in the order of US$3 million. Also, to ensure that undertaking of this wholesaleoperation does not impair the Capital Adequacy Ratio (CAR) of BIDV, it has been agreed that out of therepayment of first round sub-loans by PFIs, an amount equal to 8% of the outstanding RFP I and RFP IIresources would be converted from long term debt of BIDV to Government into equity. Furthermore, byparticipating in the project and effectively implementing its IDP under IDA supervision, BIDV wouldensure that its Restructuring Plan targets are met and necessary re-capitalization takes place. Projectionsfor BIDV's future performance, including implementing the project are shown in Annex 13.

5. Fiscal Impact. As the project would be implemented by Government corporations (BIDV andVBARD), PFIs/MFIs and the private sector, it would not directly require any Government counterpartfunding. The RDF and the MLF would be fully commercial operations with all costs being recovereddirectly. The interest rate margins would include a spread to cover: (i) Government's foreign exchange riskand the credit risk associated with BIDV's financial performance; (ii) BIDV's credit risk (vis-a-vis thePFIs) and cost of managing the funds including provisions for possible loan losses, and the PFIs/MFIsoperating costs including loan loss provisions related to sub-borrowers repayments. Those parts of the TAand training costs, for which ODA grant finance is not available, would be borne by BIDV and thePFIs/MFIs.

- 52 -

6. The actual cash flow to the Government depends on future inflation (stability of exchange rate) anddomestic interest rates. However, based on current parameters, GOV would earn a real income from thetwo lines of credit of about 4% on the outstanding amount. US$4 million p.a. initially, rising to US$12million by 2008, before falling back as the IDA Credit is repaid. This should be more than adequate tocover the real foreign exchange risks the BIDV credit risk the need to provide for the agreed increasedequity investment in BIDV. The gross figure does not include the indirect income to GOV that would stemfrom increases in taxes on employment and incomes of project beneficiaries, including sub-borrowers,PFIs/MFIs and BIDV or the potential dividend income from the incremental equity invested in BIDV.

7. Appendix A gives a detailed estimate of the net cash-flow to the Government of taking on thisproject, including an estimate of incremental taxes on business income, but not employees. The table doesnot take account of the interest margin GOV makes on RFP I, because it is already in place. Main benefitsare the interest rate spread, between the cost of IDA funds and the on-lending rate, incremental businesstaxes on BIDV, the PFIs/MFIs and some of the sub-borrowers, and the incremental dividends which shouldbe paid to GOV in the long run as a result of the incremental investment in BIDV which will be required tosupport RFP I and II. On the outflow side, GOV would be required to invest in BIDV so that the projectdoes not have a negative impact on its Capital Adequacy.

8. It is apparent that in the long run, RFP II would have a very positive fiscal impact, averagingabout US$1 million per year for the first three project years, before rising to US$6 million per year by theend of the project implementation period, eventually peaking at US$14 million in Project Years 8-14. Thebenefit would subsequently slowly diminish as the IDA credit is repaid. The Net Present Value of thisestimated cash flow to cash flow to Government, in nominal terms, discounted at a nominal 15% is US$47million, or US$80 million at a 10% nominal discount rate.

9. The analysis has been made assuming current inflation rates, 2% for both the VND and the SDRcurrencies, with interest rates set accordingly. Thus there is no assumed foreign exchange risk cost in thecash flow. If inflation increased in Vietnam, but not in the SDR countries, interest rates would go up (butthe IDA rate would stay the same). This would increase income to Government in the early years, but alsointroduce a foreign exchange risk cost. Provided that exchange rates move rationally, in response todifferential inflation, and this is reflected by interest rates, the real result would be similar. If interest ratesin SDR countries increase, then the real IDA interest rate subsidy would increase, and other things beingequal, benefits to GOV would be greater.

- 53 -

Appendix A

ImDact of RFP 1 on Government (Billion VND)

2!1 29 2 2W7 2 209 2010 2U 2012 2013 204 2015 2016 2017 2018 2019 M 2 D22

D 0 T C C (S19 ~~~~~~40 40 40 40 40 O (5 (5 pi (5 (5 (5 (5 (5 (5 5C ue Dhibmsa 3D 80 120 160 200 200 202200 200 2 195 190 185 180 175 170 165 160 155 10

Av4W FXRabfr ye1I/ 15.00 15.O0 15.OD 15.00 15.00 15.0 15.0 15.00 15.00 1520 15.00 15.20 15.C0 15.20 15.00 15.0 15.00 1520 15.0 15.ODtm and P qnfl -Bbn VND 600 600 600 600 600 - (7- ) (75 (75) (75 (5) (75) (75) (75) (75) (75)EdYaw8are0IuiWD 600 1,20D 1,800 240 3,00 2,0 2,DO 2aO,5 3,0D 3,000 925 2850 2775 27C0 26825 2550 2475 2400 Z325 2520Avmp Babcerin Year 300 SCO 1,500 2100 2700 aoo, lD0W 3,0D 2OOO 3,000 Z963 Z888 Z813 Z738 Z663 258 2513 Z438 2363 2,288

IQT ie b MOF/SBV baed r a, baar m wDietimnestRalsAdi8ge 11A 3K2 57.0 79B JO6 1140 110 110 1140 114.0 1126 1M09 fi2 1040 101,2 Su3 9550 an au8Irblll bw TaxBIDV 1.0 Z9 4.8 6.7 8.6 9.6 9.6 9.6 9.6 9.6 9.5 9.2 9.0 8.8 8.5 83 8.0 7.8 7f6 7.3PFIs 22 6.6 11.0 154 19.7 21.9 21.9 219 21.9 21.9 21.7 21.1 20.6 20.0 19.5 189 18A 178 17.3 1679-borbms 4.4 13.3 222 31.1 40.0 44.4 44A 4.4 44.4 44.4 43.9 428 41.7 40.5 39.4 38.3 372 36.1 35.0To__ _a_a__rr_eTa_ 32 139 291 443 595 715 760 760 760 760 756 74.2 723 7Q4 685 656 647 628 609 590

BIDV-DdonNNoEat*(say6%-1vaIbya 1.8 6.5 112 158 187 21.6 216 216 21.6 216 21.6 216 216 216 2 216 216 216

Tod GaisCashFbP bGovt 146 481 879 1306 173.3 201.4 2087 2116 211.6 211.6 209.8 205.6 2008 1961 1913 1866 181.8 177.1 172.3 1676

Eq* bCatubb ERBIDvReRFP II1/ 48.0 460 48.0 48.0 480Eqii Cao*hfn b BlDv Re RFP 121 S0. 30.0 300 30.0

NtCashPawb G ramt 146 181 9.9 526 95. 1534 1607 2116 211.6 2116 209.8 Z56 200.8 1961 1913 1866 1818 1771 1723 1676

USSEcjwA S$Mibm) L 12 0. 23. 64 102 107 141 141 2, 14 13.7 134 11 12.6 124 121 1 1 1t2

Mrnarseasi Eq*Wi h WsbdnBDV 30.0 108.0 1860 264.0 31Z0 3600 36D.0 36Q0 36030 3.0 360.0 360D 3600 360.0 360.0 360.0 3E0.0 360.0 360.0

IDAInbCesCosbGOV 0.7% Iaerwta prstruagin b PFI 20% De*t

RatIkmGOV bBIDV 4.5% AvNrrinal FRRbsLb(1yr ag) beore fn20 Z°0% AyF)XFC 0.2o%

Ave P mle kmn LBP b PR (2.003Ws 65% TaRi& 32% Red Rahe ex IDA -1.27%

Avage RabPFI - suoMer (5%sp) 11.5% Vebin amual Mitba ratB Z0% Real Rat 0BIDV Z45%

PFTsrrO cp 100% SDRCand a dab iab 20% ReidB VRate 4.41%

Wswa,etbAm Otord of p*tas9 20.0% % buSub8 &afx uAcu*Taed 30.0% Red Slxs1b GOV a73%

bk =W RPt Ngh b BIDV 1,0%

V Paidnucud etod n al(S16 mlinb , 1asvF r edbarb8 BDVu -8%015ts-2yearla 21881MEallonpkd moer4ayalrns 24

- 54 -

Annex 6: Procurement and Disbursement ArrangementsVIETNAM: Second Rural Finance Project

Procurement

General. About 95% of the Credit will be used as sub-loans through the RDF II and MLF and will behandled by BIDV and VBARD through PFIs and MFIs to be selected, and these same two institutions willalso handle the procurement of goods and services needed for the project.

A Procurement Capacity Assessment (PCA) was carried out, which reported that both BIDV and VBARDhave considerable experience in handling of such sub-loans during multiple past projects, including the useof the Bank's SBDs. The PCA highlighted the conflict between Vietnamese NCB procedures and those ofthe Bank. This matter will be addressed by including an Annex to Schedule 3 to the DCA and wasdiscussed and documented during Negotiations. The recommendations of the PCA on prior reviewthresholds have been reflected in the PAD. The ratio of contracts subject to post review is 1 in 5 contracts.There are no works contracts apart from those financed from sub-loans, for which special provisions apply.

A Procurement Plan has been prepared. It was discussed, modified and agreed during Negotiations andupdated during the implementation period.

In view of BIDV and VBARD being the only institutions involved in the procurement process, the riskfactor is relatively low and close supervision by the procurement staff in the Vietnam Country Office willensure that any problems will be dealt with expeditiously. These same procurement staff will also providerelevant training should this be necessary in any particular case.

Procurement for Technical Assistance and Project Management including related goods. eguipment andvehicles: About 3% of the Credit will be used to procure goods apart from those being procured under thesub-loans. The bulk of these goods, amounting to about $5,500,000, are double-cab 4-wheel drive pickupsmodified for carrying out mobile banking activities. About 210 such vehicles will be procured under theProject. In addition 3 general purpose vehicles will be procured for project supervision. To the extentpracticable, contracts for vehicles under Part B of the project will be grouped in bid packages estimated tocost US$0.5 million or more. These vehicles will be procured either through ICB or by using the catalogueservices of the Inter-Agency Procurement Services Office (IAPSO) of the United Nations and packaged tobe purchased over 2 years. IAPSO offers the advantages of speed of procurement and attractive low prices.

In addition, the participating institutions' MISs will be upgraded by the procurement of small packages ofIT equipment, with a total value of about $750,000, which will be procured through NCB or shopping overa period of several years.

Several small packages of office equipment, to upgrade the facilities of BIDV and VBARD, with a totalvalue of about $150,000, will also be procured through shopping procedures over a period of several years.

Procurement of goods, equipment and vehicles will be carried out in accordance with the World BankGuidelines: Procurement Under IBRD Loans and IDA Credits (issued in January 1995, revised Januaryand August 1996, September 1997 and January 1999).The World Bank's Standard Bidding Documentswill be used for ICB contracts. The documents for the procurement of goods through NCB prepared by theWorld Bank Office in Vietnam should be used for NCB contracts.

- 55 -

Contracts for goods and vehicles estimated to cost the equivalent of US$200,000 and more will be procuredby ICB or through IAPSO with an expected total value of US$5,500,000, and would be subject to priorreview by IDA. As far as possible, the vehicles will be grouped into packages of more than $500,000.Domestic Preference for locally manufactured goods will be applicable for all ICB contracts.

Contracts for goods, office equipment and IT equipment valued at US$100,000 and above but belowUS$200,000, will be procured by NCB with a maximum value of US$660,000. These contracts would besubject to post review.Contracts for office equipment and IT equipment valued at $50,000 and above but below US$100,000 maybe procured by International Shopping up to a maximum total value of US$150,000. Contracts valued atbelow $50,000 may be procured by National Shopping up to a maximum value of $100,000 in aggregate.All shopping contracts would be subject to prior review in accordance with IDA Guidelines.

Consulting Services for Technical Assistance and Training will be procured in accordance with theGuidelines for Selection and Employment of Consultants by World Bank Borrowers (issued in January1997 revised September 1997 and January 1999). The World Bank's Standard Request for Proposals andForms of Consultants' Contract will be used.

Technical Assistance required under the Project will be provided by consulting firms or individuals. Twocontracts of 2 or 3 years are envisaged for the Project Advisor and Environmental Specialist positions.These positions may be filled by individuals or through a firm. In addition there will be several short-termTA contracts for firms and individuals to provide technical assistance and advice on the upgrading of theMISs over a period of 5 years.

Training activities required under the Project, not being carried out by consultants, will be provided eitherabroad or in-country by universities, banking training centers and other institutions or individuals. It isestimated that 90% of the training will be carried out on the basis of individuals attending scheduledtraining courses or being seconded to other banks and other suitable institutions. Such training will beselected and paid for on a normal commercial basis.

Ten percent (10%) of the training will be carried out by firms, institutions or individuals which will providespecialized training, as needed, and be hired through the normal procedures used for consultants inaccordance with IDA's Consultant Guidelines.

Consultant firms and institutions carrying out Technical Assistance services or specialized Trainingservices will be procured using the QCBS method for contracts valued at $100,000 and above. Contractsbelow $100,000 will be procured using the CQ method.

Individual consultants carrying out Technical Assistance services or specialized Training services will beprocured in accordance with Section V of the Consultant Guidelines.

The maximum total value of consultant contracts for Technical Assistance and Training will beUS$1,180,000. The maximum total value of scheduled Training services will be US$3,420,000.

Consultant selection arrangements and contracts for amounts of US$ 100,000 and above for firms, and ofUS$50,000 and above for individuals would be subject to prior review by IDA.

The sum of $130,000 has been allowed in the Project for incremental operating costs related to auditing of

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the project accounts operated by BIDV. It is intended that auditing required under the Project will becarried out by the international auditors already appointed to audit BIDV because the firm is oneacceptable to IDA and it is simpler to use the firm already familiar with BIDV rather than procuring adifferent one. This service will therefore be selected on a single-source basis and the contract will beseparated from the auditors' main contract with BIDV. The draft contract is to be reviewed by the Bank.The incremental cost of this additional work is estimated at $26,000 per year for 5 years.

National Procurement Regulations and NCB Procedures. The current national Procurement Regulation(Decree No. 88CP dated September 1, 1999 and the amendment No. 14CP dated May 5, 2000) have beenreviewed by the Bank and found to still contain some major inconsistencies when compared to the IDAProcurement Guidelines. These major inconsistencies include (i) too short a time period for bid preparation;(ii) the use of merit point evaluation; (iii) the bidders qualification being given weight in bid evaluation; (iv)the absence of a conflict of interest policy; and (v) the use of price bracketing to determine awards. In orderfor the above mentioned regulations to be acceptable for IDA-funded NCB procurement, these deficiencieswill be addressed in a side letter to the DCA.

Procurement under sub-loans. Procurement of goods, works, and services financed by loans tosub-borrowers would comply with those customary for industrial development finance operations. BIDV,VBARD, the PFIs, and the MFIs would satisfy themselves that the goods, works, and services to bepurchased by sub-borrowers are for the investment sub-projects and are reasonably priced, by ensuring thatthe sub-borrowers have canvassed the main sources of supply and purchased from the most advantageoussource.

Contracts for works valued at US$2 million equivalent and above, and for goods valued at US$1 millionequivalent and above, will be procured by ICB in accordance with IDA Guidelines and would be carriedout using Bank standard bidding documents. However, no contracts of these sizes are expected because theloans to sub-borrowers will generally be relatively small, averaging at about $2,500 equivalent.

Contracts for works valued below US$2 million equivalent, and for goods and services valued at belowUS$1 million equivalent, would be procured following established private sector or commercial practiceswhich are acceptable to IDA.

Under this component, the total estimated value of works contracts is US$170,000,000, and of goodscontracts is US$117,000,000.

Eligibility of State Owned Enterprises (SOEs). SOEs under the direct supervisory authority of theEmployer shall be excluded from any bids for civil works, goods or services under the project. DependentSOEs are allowed to be sub-consultants under contracts with their line agency provided that no more than20% of the contracted value is sub-contracted to these SOEs for bids invited through January 1, 2003.From January 1, 2003 onwards, the SOEs will have to meet all eligibility criteria (legal, financial andcommercial autonomy and non-dependency). The project does not finance services or consulting contractinputs that are directly associated with the military or indirectly through military companies/enterprises.Military entities or SOEs under the Ministry of Defense are not eligible to participate in IDA-financedcontracts.

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Procurement methods (Table A)

Table A: Project Costs by Procurement ArrangementsUS$ million equivalent

Procurement Method /aExpenditure Category ICB NCB Other N.B.F. Total

Cost1. Rural Development Fund (sub- 0.00 0.00 255.00 0.00 255.00

projects) (165.70) (165.70)2. Micro-Finance Loan Fund (sub- 0.00 0.00 32.00 0.00 32.00projects) (24.00) (24.00)3. Goods 5.50 0.66 0.25 6.41

(4.84) (0.58) (0.18) (5.60)4. Training 3.42 0.00 3.42

(3.42) (3.42)5. Consultant Services 1.18 0.00 1.18

.(1.18) (1.18)6. Incremental Operating Cost 0.00 0.00 0.13 0.10 0.23

(0.10) (0._1_0)Total 5.50 0.66 291.98 0.10 298.24

(4.84) (0.58) (194.58) (0.00) (200.00)

a/Figures in parenthesis are the amounts to be financed by the IDA Credit. All costs includecontingencies.

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Table Al: Consultant Selection Arrangements(US$ million equivalent)

Selection Method

Consultant Services QCBS QBs SFB LCS CQ Other N.B.F. Total CostExpenditure Category Ca

A. Firms 0.40 0.00 0.00 0.00 0.28 0.00 0.00 0.68(0.40) (0.00) (0.00) (0.00) (0.28) (0.00) (0.00) (0.68)

B. Individuals 0.00 0.00 0.00 0.00 0.00 0.50 0.00 0.50(0.00) (0.00) (0.00) (0.00) (0.00) (0.50) (0.00) (0.50)

Total 0.40 0.00 0.00 0.00 0.28 0.50 0.00 1.18_ _(0.40) (0.00) (0.00) (0.00) (0.28) (0.50) (0.00) (1.18)

/a Including contingencies

Note: QCBS = Quality- and Cost-Based SelectionQBS = Quality-based Selection

SFB = Selection under a Fixed Budget

LCS = Least-Cost Selection

CQ = Selection Based on Consultants' QualificationsOther = Selection of individual consultants (per Section V of ConsultantsGuidelines), Commercial Practices, etc.N.B.F. = Not Bank-financed

Figures for Firms and Individuals are tentative at this stage

Figures in parenthesis are the amounts to be financed by the Bank Credit.

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Prior review thresholds (Table B)

Table B: Thresholds for Procurement Methods and Prior Review

Contract Value Contracts Subject toExpenditure Category Threshold Procurement Method Prior Review

(US$ thousands) (US$ millions)1. Works Sub-Loans 2000 ICB 0.00

<2000 Private Sector or 0.00Commercial Practices

2. Goods Sub-Loans 1000 ICB 0.00<1000 Private Sector or 0.00

Comrnmercial Practices3. Goods TA & PM 200 ICB 5.50

<200>100 NCB 0.00<100>50 IS 0.15

<50 NS 0.104. Services 100 QCBS 0.70

<100 CQ 0.0050 Other 0.50

<50 Other 0.00

Total value of contracts 6.95subiect to prior review:

Ratio of contracts subject to post review is 1 in 5 contracts

Overall Procurement Risk Assessment: Low

Frequency of procurement supervision missions proposed: Once every 6 months (includes specialprocurement supervision for post-review/audits) as needed, but generally averaging twice a yeartogether with regular project supervision missions.

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Disbursement

Allocation of credit proceeds (Table C)

1. Disbursement Arran2ements

The credit proceeds will be disbursed as indicated in Table C.

Table C: Allocation of Credit Proceeds

Expenditure Category Amount in US$million Financing Percentage(1) (a) Rural Development Fund 165.70 100% of Sub-loans disbursedSub-loans

(b) Micro-finance Loan Fund 24.00 100% of Sub-loans disbursedSub-loans2. Goods under Part B of the Project 5.60 100% of foreign expenditures, 100% of

local expenditures (ex-factory cost) and65% of local expenditures for other

goods procured locally3. (a) Consultant's Services under Part 1.18 100% for foreign individual consultantsB of the Project and 93% for local individual consultants,

local consulting firms, and foreignconsulting firms

(b) Audits of Project Accounts 0.10 the same as Category 3.(a)4. Training under Part B of the Project 3.42 100%

Total Project Costs 200.00

Total 200.00

Use of statements of expenditures (SOEs):

The proposed Credit of SDR160.2 million equivalent (US$200 million) would be disbursed over a periodof 5.5 years (mid 2003 to mid 2008). The project would be completed by March 31, 2008, and theexpected Credit closing date would be September 30, 2008. The projected disbursement schedule is basedon experience under the first Rural Finance Project (Credit 2855-VN). IDA would disburse against 100%of expenditures for the sub-loans financed by BIDV to PFIs and MFIs, up to the financing share made byeligible expenditures and requested for the respective sub-project(s). Retro-active financing of up toSDR1.68 million (US$2.1 million) equivalent is also proposed for eligible expenditures made after April30, 2002, under Categories 3 and 4. This retro-active financing of training and TA is necessary training toensure that project related staff in BIDV and PFIs/MFIs are adequately trained before the start of projectimplementation.

Disbursement for all expenditures would be against full documentation except for: (i) goods undercontracts costing less than $100,000 equivalent each; (ii) consulting services under contracts awarded toconsultant firms costing less than $ 100,000 each: (iii) consulting services under contracts awarded toindividual consultants costing less than $50,000 equivalent each; (iv) training; and (v) sub-loans costing

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less than $250,000 equivalent each, for which disbursement may be made on the basis of Statement ofExpenditures, all under such terms and conditions as IDA shall specify by Notice to the Borrower.Supporting documentation for statement of expenditures would be retained by BIDV and PFIs/MFIs forreview by IDA missions and external auditors acceptable to IDA.

Special account:To facilitate rapid disbursement, BIDV may establish a Special Account, in accordance with IDAguidelines, in a commercial bank acceptable to IDA. The authorized allocation for the Special Accountshall be limited to US$20.0 million (based on four months of estimated average disbursement). However,an initial deposit into the Special Account shall be limited to US$10.0 million until disbursements andoutstanding commitments against the Credit shall be equal to, or exceed, the equivalent of SDR32.0million, about US$40 million equivalent. Applications to replenish the Special Account, supported byappropriate documentation, would be submitted regularly (preferably monthly but not less than quarterly)or when the amounts withdrawn equal 20% of the initial deposit.

2. Financial Manaaement Assessment

Executive Summary

I. During the project preparation mission, the Financial Management Analyst conducted anassessment of the financial management system proposed for the project which was endorsed by theaccredited Financial Management Specialist. The review concluded that this project meets the minimumrequirement of the Bank's OP/BP10.02. The Project will adopt the traditional disbursement method andwill produce quarterly financial management reports. The project is ready to implement in terms of theproject financial management aspect provided the borrower successfully carry out the action plan.

2. The accounts of the on-going Rural Finance Project and the two major retailing Banks VBARDand BIDV have been audited by the international auditing firm Price Waterhouse Coopers (PWC). Theaudits were conducted in accordance with international auditing standards and in compliance with theindependent auditing regulations of Vietnam. The Auditor's Opinion for the ongoing Rural Finance Projectis unqualified. However, the Management Letter identifies several weakness regarding the project'sdisbursement system. In particular, sub-loan initiation and monitoring procedures need to be improved.Therefore, an action plan has been prepared and agreed with BIDV to address these issues under theirproposed Second Rural Finance Project.

3. BIDV will be responsible for the project's overall financial management system, and other projectimplementing institutions, including PFIs and MFIs will be responsible for the financial management of theproject resources to which they will have access under the respective project components. All projectimplementing institutions will have adequate financial management and accounting systems in place beforethey can use the proceeds of IDA Credit.

Country Issues and Risk Analysis

4. The Bank issued the Country Financial Accountability Assessment for Vietnam on October 15,2001. This report states that at present, there is clearly a certain degree of fiduciary risk in the use ofpublic resources, given that the budget process is not yet transparent, public access to government financialinformation is limited, and effective legislative oversight is not fully in place yet. Institutions responsiblefor ensuing financial accountability are also weak, auditing findings are not publicly available as a matter

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of act, and the reporting system does not support effective ongoing monitoring of public resources.Overall, fiduciary risk will be manageable on-budget items provided that the Government takes the stepsoutlined in the CFAA as well as those committed under the public expenditure review.

5. Though the CFAA reports degree of fiduciary risk in the use of public resources in the country, theRFI, which was completed on 12/31/2001 did not encounter such risk. The experience from the firstproject therefore indicates that there are no major risks that could have an adverse impact on this follow-upproject, though there were a few control risks identified and mitigating actions were taken to ensurefiduciary safeguards are in place, as discussed below.

6. Unlike other Bank-financed projects in Vietnam, this Credit will not be a grant allocated to theimplementing agencies, instead, the proceeds of the Credit would be made available to BIDV under anOn-lending Loan Agreement (OA), satisfactory to IDA, to be entered between MOF and BIDV. Under thisOA, which would form part of the RDF and the MLF Policy Manuals, funds would be lent to BIDV for aperiod of 25 years with a grace period of 8 years on the principal. BIDV will pay MOF the interestcollected from PFIs/MFIs less 2% spread to enable BIDV to cover its operating costs and risks. Thisshould be adequate to make the project attractive to BIDV and to encourage it to promote the flow ofresources into the two funds. Funding of the RDF and the MLF credit lines would be made available to thePFIs and MFIs, respectively, under subsidiary loan agreements (SLAs) drawn with BIDV.

7. Based on several weakness identified by the independent auditor on the RFI project, the lack ofintegrated financial information system can cause potential control risk to the proposed RFII Project. Forexample, VBARD has received almost 70 percent of the total Credit Amount and its disbursement coversmore than 40 provinces. With the excessive information on each sub-borrower all over the rural area in thecountry, it is extremely difficult for the HQs to reconcile the supporting documents which normally arekept at the intemal commune or district branch offices to the summary data of the provincial branch'swithdrawal application.

8. It was agreed that BIDV, through its PMU, and VBARD would review sub-borrowers' loanapplication to ensure it captures all the essential information to support the financial reports. Supervisionefforts would be strengthened (para. 30), during the project implementation years to ensure that supportingdocuments are accurate and up to date. In addition, with the on-going IDA financed BankingModemization Project, the implementation of an integrated financial management system will enable thePMU to produce the required financial data in a more timely, relevant, and reliable manner, for effectivemanagement of project funds. The initiative is underway at BIDV and VBARD.

Implementing Entity

9. The Project's Apex Bank, BIDV, would assume the overall responsibility for projectimplementation including its financial control. Day to day responsibility of the project's financialmanagement would rest with the accounting unit within the PMU. The PMU would be responsible formaintaining separate project books of accounts, managing the project's Special Account and disbursingproject's funds to the PFIs and MFIs. The PMU is responsible for coordinating the work with MOF andIDA.

10. BIDV would use the financial management system that is currently applied by ICPMU inimplementing the RFI Project. For the past several years, the three main implementing agencies for bothRFI and proposed RFII including ICPMU, BIDV and VBARD have been audited by the intemationalauditing firm, PWC. The financial management practices of these agencies as a whole has been improved

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significantly, to date.

11. Although other sub-projects implementing institutions including PFIs and MFIs will be responsiblefor the financial management of the project resources to which they will have access under the respectiveproject components, the PMU of BIDV would ensure that all project itnplementing institutions haveadequate financial management and accounting systems in place before the proceeds of IDA Credit wouldbe made available to them.

12. Under the project, BIDV as well as PFIs/MFIs would be required to apply higher financial standardswith regard to solvency, liquidity, profitability, and best management practices. One of the projectobjectives is to improve overall institutional/financial management of the Apex Bank, PFIs, and MFIswhich goes far beyond ensuring adequate project related financial management. PFIs and MFIs would beallowed to borrow project's funds only if they meet the related project's accreditation criteria includinglegality, solvency, liquidity, profitability and efficiency, operational procedures including accounting, andthe quality of management and staff.

13. PFIs/MFIs would each prepare an Institutional Development Plan (IDP) to be agreed with IDAbefore accreditation. The Institutional Strengthening component financed by the Credit would consist oftwo sub-components (a) the strengthening of BIDV; and (b) strengthening PFIs/ MFIs with special focuson VBARD performance as a potential key retailer of both the RDF I and the MLF. BIDV and VBARDwould each update its IDP, focusing on, but not be limited to, the following key areas: (i) implementing therecommendations outlined in the 2000 IAS audit report; (ii) improving its solvency and liquidity; (iii)meeting the NPL resolution targets for re-capitalization; (iv) increasing profitability and sustainability; (v)improving quality of loan portfolio; (vi) strengthening the risk management committee; (vii) becoming morecommercial; (viii) increasing resource mobilization; (ix) improving prudence and transparency; (x)improving accounting and reporting (IAS to be gradually applied) and introducing and improving themanagement information system to strengthen internal controls; and (xi) strengthening institutional capacityand human resources.

Funds Flow

14. BIDV already drafted the "Guidelines on Disbursement Process for Participating CreditInstitutions under RFII" including both general principle and detailed disbursement procedures. The PMUwould set a credit line for each PFI and MFI in accordance with the RDF II and MLF Policy Manual. Inparticular, the adoption of an agreed IDP by each of the PFIs/MFIs Board of Directors would be acondition for accreditation of each of these financial institutions.

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15. Sub-project review and disbursement. Except for sub-loans under US$50,000 equivalent, thePMU would review the sub-projects appraisal work which was carried out by the PFIs. It would reviewon an ex ante basis, the documentations of sub-loans above US$50,000 equivalent and if appropriate,would authorize disbursements. In order to expedite sub-loan approval, this ex-ante review may be waivedfor stronger and more experienced PFIs. The details would be provided in the Financial Management andDisbursement Manual. BIDV, through the PMU, would grant up to 60 days to PFIs to submit or makeavailable required sub-loan documentation and evidence of payment of procurement. The PMU wouldreverse the sub-loan- and charge a reversal fee- if a PFI has not submitted or made available the requireddocumentation within 60 days after PMU disbursement to the PFI. For sub-loan below US$50,000equivalent, the PMU would review the appraisal work and other related documents on an ex postdisbursement basis. Disbursement to PFI would be made automatically, although the PMU would alsorequire PFIs to submit or make available all required sub-loan documentation within 60 days. As in thecase above, reversal would be made and penalty fee imposed if PFIs fail to satisfactorily submit or makeavailable required sub-loan documentation within 60 days period following PMU disbursement. IDA priorapproval would be required for all sub-loans above US$150,000 equivalent for which full documentation ofthe sub-project will be submitted.

A - Initial Deposit and Replenishment to Special Account

MOF Service*IExternal Financing Dept. lo Bank IWR I

Director of PMUApproves

Responsible DivisionsCheck

(1) Responsible divisions in PMU of BIDV check the Withdrawal Applications beforesubmit it to the Director of PMU.

(2) The Director of PMU approves the Withdrawal Applications (Was) then transfer themto the External Financing Department in the Ministry of Finance.

(3) The External Financing Department in the Ministry of Finance checks and approvesthe WAs. Thereafter, the WAs will be transferred to the Service Banks for approval.

(4) Service Bank approve the WAs. Project staff brings the approved WAs to the WorldBank for the initial deposit to the Special Account.

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B- Disbursementfrom Special Account

Director of PMUIn BIDV Approves and a pecial AccountSigns/

Accounting DivisionCheck and Initial

Appraisal DivisionCheck and Initial

PFIs/MFIs HQsCheck and Approv,

t1Branches Prepares

SOE

(1) Branches of PFIs/MFIs consolidate the loan request from the sub-borrower, transmit to PMUin the HQ of PFIs/MFIs requesting for payments.

(2) PMU staff in the PFIs/MFIs check, prepare payment requests and payment authorizations thensend the full set of document to the Director of PMU for approval and signature.

(3) Director of PMU signs off the package and send to PMU in BIDV. The Appraisal Divisionreviews and approves the eligibility of the sub-projects and pass on to the Accounting Division tocheck the funds request. From the Accounting Division, the Director will conduct the finalreview and sign the Payment Request. Thereafter, funds can be withdrawn from the SpecialAccount. In case of Direct Payment, the PFIs/MFIs will prepare Withdrawal Applications, getapprovals from External Financing Department (MOF) and Service Bank then send to WorldBank Head Quarter for direct payment to suppliers/contractors.

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Staff Arrangement

16. The current accounting staff of the ICPMU from SBV has experience in implementing the FirstRural Finance Project, and to ensure continuity, the same staff would be assigned to the PMU of BIDV.It is planned that this unit will be led by an experienced Chief Accountant, supported by 5 accountants and1 cashier with qualifications acceptable to the Bank.

17. The responsibilities of the staff in this unit will be 1) managing the Special Account; 2) carryingout the accounting of all project activities, including bookkeeping, disbursement to PFIs/MFIs, recordingcollections and revenue and expenses, etc; 3) preparing the financial management reports; 4) paying interestand principals to MOF and 4) participating in the supervision mission conducted by PMU of BIDV to thePFIs/MFIs to make sure the IDA Credit be used for intended purpose.

Accounting Policies and Procedures

18. The accounting policies and procedures are governed by various directives issued by MOF. Thereare existing accounting and disbursement procedures applied to the First Rural Finance Project. The PMUof the BIDV has drafted the "Guidelines on Accounting Practices for Receiving, Managing and UsingFunds Under WB Rural Finance Project II", which includes the following aspects: (1) Chart of Accountsapplied to this project and relevant rules; (2) Rules on keeping separate project accounts, and detailedbookkeeping procedures for maintaining records of all the expenditure; (3) disbursement procedure; and (4)Financial Reports requirement.

19. It was agreed that BIDV would revise the manual to include the following aspects: (i) detailedresponsibilities of the accounting staff including supervision and monitoring compliance with the Manualrequirements; (ii) detailed and clear funds flow arrangement including flow chart of funds application; (iii)payment authorization and disbursement arrangements with all the required forms and supportingdocuments; (iv) standard forms for initiation of subsidiary loans with proper documentation of all thefinancial transactions; (v) current and fixed asset management; (vi) intemal control mechanism; and (vii)quarterly and semi-annual reporting formats. The revised manual would be submitted for IDA review andconcurrence by June 30, 2002.

Internal Control

20. The internal control mechanism includes development and adoption of simple, clear andtransparent financial and accounting policies which would govem the financial management system for theproject, including policies for regular monitoring of advances given to PFIs and MFIs, and for approvingeligible expenditures. Standard internal controls will be in place. Some of these controls cover thechecking of expenditures, requirement of appropriate documentation, segregation of duties, level ofauthorization, periodic reconciliation and physical verification. BIDV would extend its existing control andmonitoring system to cover these project activities including the eligibilities of sub-projects and fundsdisbursement. VBARD's Inspection Department and the PMU at HQs will conduct the random reviews toensure its provincial, district and inter-communal branch offices use the IDA funds for its intendedpurpose.

External Audit

21. The Management Letter of year 2001's audit report identified several weaknesses related to somePFIs. These include: (i) incomplete supporting information to the loan application; (ii) no separate

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accounting record of subsidiary loan interest expense, sub-loan income; (nii) missing detailed guidelinesregarding the use and record revolving fund and lacking of record of the number of extension of thesub-loan. The mission requests ICPMU to discuss and clarify with the Auditor on the issues identified inits Management Letter, and submit to IDA the project management's response by April 30, 2002. Anaction plan has been prepared to address all these existing issues to avoid recurrence in the proposed RFII.

22. The proposed project account including the potential key retailing bank VBARD will be auditedannually subject to international auditing IFAC standards by an independent external firm of publicaccountants. The audit will be carried out in accordance with TOR satisfactory to IDA. The Auditor shallbe appointed within 6-10 months after the first disbursement. Certified copies of the audit reports will bepresented to the Bank no later than six months after the close of the previous fiscal year. Auditing fees forthe project are incremental expenses and are to be covered by the Incremental Operating Costs category. Inthe second year of project implementation, an audit of all PFIs accounts in accordance with the IAS awould be a prerequisite to receive a line of credit of at least US$1 million equivalent.

Reporting and Monitoring

23. A set of financial reports will be prepared and submitted to the IDA on a quarterly basis. At theproject level, the PMU of BIDV will prepare the Sources and Uses of Funds for effective monitoring offunds received and disbursed. The other key information required for better management of this project arerelated to as the sector and regional distribution of the project funds, i.e. financial status of the PFIs andMFIs including (i) the PFIs/MFIs Credit Lines; (ii) on-lending interest rate; (iii) PFIs/MFIs key financialindicators; (iv) RDF II and MLF disbursement status; v) PFI/MFI borrowing and repayment; (vi)Summary of RDF II/MLF sub-loan disbursement status. The format of the financial reports will be agreedupon prior to Board approval with the first quarterly report due within three months from projecteffectiveness provided there is disbursement.

Information Systems

24. Currently the ICPMU and individual PFIs/MFIs have their independent computer program tocapture all the loan information. This project will install a MIS system in order to have an integratedprogram to conduct better project monitoring and evaluation. Th on-going Bank-financed project inVietnam, the "Banking Modernization Project", aims to introduce an automated, integrated intra-bank andinter-bank payments and customer accounting interface capability system. With the full operation of thisinformation system the weakness identified in implementing Rural Finance I will be addressed. Anintegrated financial management system not only for this project but for the whole banks including BIDVand VBARD will be put into place.

Financial Management Action Plan

25. The following action plan has agreed by the ICPMU/SBV and BIDV:

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Action Responsible Completed ByI Organization & Staffing

1) Establish Project Management Unit BIDV Effectiveness2) Appoint key accounting staff including Chief Accountant with BIDV Effectivenessqualifications acceptable to IDA3) Appoint the project accounting staff with qualifications acceptable PFIs/MFIs By Accreditationto IDA

2 Financial Management and Disbursement Manual1) Complete the Draft Manual BIDV Completed2) Adopt the Final Manual to: i) include the relevant sections of BIDV EffectivenessRDF/MLF PMs, all related forms, the SLA, and Funds WithdrawalApplication, acceptable to IDA; and ii) Extend existing BIDVinternal control and monitoring system to include project activitiessuch as eligibilities of sub-projects, and qualification for fundsIdisbursement.

3 Financial Management Reports (format and contents as under RF BIDV NegotiationsI) _1) Agree on the format of FMR, including Sources and Uses ofFunds (in addition to the six tables provided under RF I), and addinformation on gender borrowing. _

4 Training_ 1) Train BIDV staff on the Management of the Special Account SBV/ICPMU December 31, 2002

2) Train PFIsIMFIs accounting staff on the eligibility of sub-projects BIDV By Accreditationand project disbursement procedures.

5 Audit Arrangement_ 1) Appoint independent auditor acceptable to IDA BIDV December 31, 2002

2) Cause an audit to be carried out of BIDV's internal control BIDV June 30, 2003procedures to review BIDV's compliance with the provisions of theI Financial Management Manual

Supervision Plan

26. The PMU would require each PFI and MFI to submit an Accounting and Disbursement Procedurebefore disbursing the funds. The PMU will develop a focused supervision plan to include the loan initiationprocedures, loan monitoring procedures and accuracy and relevance of financial reporting. The PMUwould ensure that the PFIs and MFIs would: (1) establish and maintain adequate and separate accountingand internal control systems to reflect all expenditures made under the project in accordance with soundaccounting practices; (2) keep documentation to support disbursements; (3) audit the records of all outlaysunder the component each year by auditors satisfactory to IDA and in accordance with appropriate auditingprinciples consistently applied; (4) provide all necessary information, as may reasonably requested by theBank, to allow proper monitoring of activities financed under the sub-projects.

27. Prior to the accreditation of each PFIs/MFIs, the PMU needs to get the concurrence from the IDAto ensure all the criteria are met including demonstration of a sound project financial management system.The project financial management specialist will join the IDA's supervision mission to review the projectfinancial management system and conduct the random review of the supporting documents to the SOE.The supervision of the financial aspects of the Project would be conducted at least twice a year.

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Annex 7: Project Processing Schedule

VIETNAM: Second Rural Finance Project

Project Schedule Planned ActualTime taken to prepare the project (months) 12 15First Bank mission (identification) 01/01/2001 01/01/2001Appralsal mission departure 03/18/2002 03/21/2002Negotiations 04/22/2002 04/22/2002Pilanned Date of Effectiveness 09/30/2002

Prepared by:

Project Preparation Team (PPT). The PPT was composed of officials from the ICPMU of SBV, BIDV,VBARD, MPI and MOF.

Preparation assistance:

None

Bank staff who worked on the project included:

Name SpecialityPatricia Miranda Consultant, Legal DepartmentCarlos Escudero Chief Legal CounselKien Trung Tran Procurement AnalystRichard Leonard Procurement Specialist (Consultant)Minhnguyet Le. Khorami Program AssistantBrenda Phillips Program AssistantXiaolan Wang Micro-finance and Financial ManagementPham Duc Minh EconomistMiguel Navarro-Martin Financial Sector SpecialistDzung The Nguyen Operations OfficerPaul Harrison Banking Specialist (Consultant)Gregory Hung Economist (Consultant)Alexander Livnat Environment Specialist (Consultant)Kim Hung Phung Sr. Disbursement OfficerDuong Do Quyen Disbursement AnalystLe Thanh Huong Giang Team AssistantArie Chupak Task Team Leader (Consultant)

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Annex 8: Documents in the Project File*

VIETNAM: Second Rural Finance Project

A. Project Implementation Plan

1. RDF's Policy Manual2. MLF's Policy Manual3. Project Implementation Plan4. Financial Management Manual

B. Bank Staff Assessments

1. Project's Supervision Plan2. Working Paper- BIDV's Financial Performance - Paul Harrison3. Working Paper - VBARD's Financial Performance - Dr. Gregory Hung4. Working Paper - Environmental Protection - Dr. Alexander Livnat

C. Other

1. BIDVs IDP2. VBARD's IDP

*Including electronic files

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Annex 9: Statement of Loans and Credits

VIETNAM: Second Rural Finance Project02-Apr-2002

Difference between expectedand actual

Original Amount In US$ Millions disbursements

Project ID FY Purpose IBRD IDA Cancel. Undisb. Orig Frm Revzd

P051838 2002 VN-PRIMARY TEACHER DEVELOPMENT 0.00 19.84 0.00 19.79 0.00 0.00

P059936 2002 Northem Mountains Poverty Reductlon 0.00 110.00 0.00 110.22 0.00 0.00

P004850 2001 VIETNAM -POVERTY REDUC.SUPPORT CREDIT 0.00 250.00 0.00 149.66 -0.64 0.00

P042927 2001 VN-Mekong Transport/Flood Protection 0.00 110.00 0.00 103.41 22.70 0.00

P062748 2001 COMMUNITY BASED RURAL INFRASTRUCTURE 0.00 102.78 0.00 102.80 0.00 0.00

P052037 2001 VN-HCMC ENVMTL SANIT. 0.00 166.34 0.00 161.30 2.00 0.00

P059864 2000 VN-Rural Transport II 0.00 103.90 0.00 81.35 26.21 0.00

P042568 2000 COASTAL Wel/Prot Dev 0.00 31.80 0.00 27.73 11.69 0.00

P056452 2000 RURAL ENERGY 0.00 150.00 0.00 122.93 78.97 0.00

P004845 1999 MEKONG DELTA WATER 0.00 101.80 0.00 87.41 51.43 0.00

P051553 1999 VN-3 CrlTES SANITATION PROJECT 0.00 80.50 0.00 70.10 14.01 0.00

P004828 1999 VN-HIGHER EDUC. 0.00 83.30 0.00 66.10 29.71 0.00

P004833 1999 VN-Urban Transport Improvement 0.00 42.70 0.00 32.77 32.21 0.00

P004839 1998 FOREST PROT. RUL DE 0.00 21.50 0.00 17.14 10.91 0.15

P045628 1998 TRANSMISSION & DISTR 0.00 199.00 0.00 156.15 162.67 100.31

P004843 1998 VN-Inland Waterways 0.00 73.00 0.00 55.35 43.93 -2.73

P004844 1998 AGRI DIVERSIFICATION 0.00 66.90 0.00 39.74 8.13 -5.89

P004830 1997 VN-WATER SUPPLY PROJECT 0.00 98.61 26.85 31.68 61.59 4.38

P004842 1997 VN-Hwy Rehab II 0.00 195.60 0.00 53.19 72.10 0.00

P004838 1996 VN-NATIONAL HEALTH SUPPORT 0.00 101.20 0.00 48.72 55.36 0.00

P036042 1996 BANKING SYSTEM MODERNIZATION 0.00 49.00 0.00 29.21 36.77 34.36

P004841 1996 VN-POPULATION & FAMILY HEALTH 0.00 50.00 0.00 14.76 14.59 0.00

P004834 1g95 IRRIGATION REHABILIT 0.00 100.00 0.00 18.81 26.80 -7.47

P004835 1994 VN-PRIMARY EDUCATION 0.00 70.00 0.00 5.20 7.96 7.04

Total: 0.00 2377.77 26.85 1605.51 769.10 130.15

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VIETNAMSTATEMENT OF IFC's

Held and Disbursed PortfolioJan - 2002

In Millions US Dollars

Committed DisbursedIFC IFC

FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic

2002 F-V Hospital 8.00 0.00 0.00 0.00 0.00 0.00 0.00 0.001998 MFL Vinh Phat 0.30 0.00 0.00 0.00 0.15 0.00 0.00 0.001996 Mom.Star Cement 22.60 0.00 0.00 44.94 22.60 0.00 0.00 44.941997 NATL 16.80 0.00 0.00 16.80 16.80 0.00 0.00 16.801995/97 Nghi Son Cement 20.18 0.00 0.00 16.42 20.18 0.00 0.00 16.421996 SMH Glass Co. 7.78 0.00 0.00 2.25 7.78 0.00 0.00 2.252002 VEIL 0.00 0.00 12.00 0.00 0.00 0.00 0.00 0.001996 VILC 0.00 0.75 0.00 0.00 0.00 0.75 0.00 0.001996 Vimaflour 3.08 0.00 0.00 0.54 3.08 0.00 0.00 0.54

Total Portfolio: 78.74 0.75 12.00 80.95 70.59 0.75 0.00 80.95

Approvals Pending Commitment

FY Approval Company Loan Equity Quasi Parfic

1998 BA RIA 24.20 0.00 4.00 49.002002 Dragon Capital 0.00 2.00 0.00 0.002002 F-V Hospital 1.50 0.50 0.00 0.002000 Interflour 8.00 0.00 0.00 5.002001 RMIT Vietnam 7.50 0.00 0.00 0.00

Total Pending Commitment: 41.20 2.50 4.00 54.00

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Annex 10: Country at a Glance

VIETNAM: Second Rural Finance ProjectEast

POVERTY and SOCIAL Asia & Low-Vietnam Pacific Income Development diamond'

2000Population, mid-year (millions) 78.5 1.853 2.459 Life expectancyGNI per capita (Atlas method. US$) 390 1.060 420GNI (Atlas method, USS billions) 30.4 1,964 1,030

Average annual growth, 1994.00

Population (%) 1.5 1.1 1.9 GNILabor force (X) 1.7 1.4 2.4 GNI Gross

per primarMost recent estimate (latest year available, 1994-00) capita enrollment

Poverty (% of population below national povertV line) 37Urban population (X of total population) 20 35 32Life expectancy at birth (years) 69 69 59Infant mortalitv (per 1,000 live births) 37 35 77Child malnutrition (% of children under 5) 37 13 Access to Improved water sourceAccess to an improved water source (% of populatIon) 56 75 76Illiteracy (X of population age 15+) 7 14 38Gross primary enrollment (%of school-age population) 114 119 96 - ietnam

Male 116 121 102 Low-income groupFemale 111 121 86

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1980 1990 1999 2000Economic ratios'

GDP (USS billions) .. 6.5 28.7 31.3

Gross domestic investmentUGDP .. 13.0 25.4 27.4 TradeExports of goods and services/GDP .. 26.4Gross domestic savinqs/GDP .. 6.0Gross national savings/GDP ..

Current account balance/GDP .. -5.4 4.0 1.6 Domestic InvestmentInterest payments/GDP .. 0.7 1.1 1.5 tinveTotal debt/GDP .. 359.6 81.1 49.8 sInTotal debt service/exports .. 8.9 10.0 7.0Present value of debt/GDP .. .. 75.6Present value of debt/exports .. .. 153.1

Indebtedness1980-90 1990-00 1999 2000 2000-04

(average annual growth)GDP 4.6 7.9 4.8 5.5 6.8 VietnamGDP per capita 2.2 6.0 3.5 4.1 5.4 - Low-income groupExports of goods and services .. 23.4 22.6 14.6

STRUCTURE of the ECONOMY1980 1990 1999 2000 Growth of Investment and GDP (%)

(% of GDP) 6Agriculture .. 37.5 25.4 24.3Industry .. 22.7 34.5 36.6 40

Manufacturing .. 18.8 17.6 .. 20

Services *- 39.9 40.1 39.1 o<

Private consumption 86.5 68.8 66.6 -20 95 s5 9 95 s9 00General government consumption .. 7.5 7.1 6.4 - GDI P GDPImports of goods and services .. 33.4

1980-90 1990-00 1999 2000 Growth ot exports and Imports (%)(average annual growth)Agriculture 4.3 4.8 5.2 4.0 90

Industry .. 12.1 7.7 10.1 CManufacturing .. .. .. .. **

Services .. 7.8 2.2 5.6 20

Private consumption .. 10.2 .. ..General government consumption .. 10.9 2.5 95 go 97 as 99 00

Gross domestic investment .. 20.2 -3.0 10.9 -Exports e-Imports

Imports of goods and services .. 29.4 25.5 15.3

Note: 2000 data are preliminary estimates.

The diamonds show four key indicators In the country (In bold) compared with Its income-group average. If data are missing, the diamond willbe Incomplete.

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Vietnam

PRICES and GOVERNMENT FINANCE1980 1990 1999 2000 Inflation (%)

Domestic Prices(% change) 30-

Consumer prices 36.4 4.3 -t 8 20

Implicit GDP deflator .. 42.1 5.6 5.3

Government fziance(% of GDP, includes cunrent grants) 95 go 97 Oa 99Current revenue 14.7 19.6 19.6 -10Current budget balance 0.0 5.9 4.8 GDP deflator CPIOverall surplus/deficit .. 0.8 -1.8

TRADE

(USS millions) 1980 1990 1999 2000 Export and Import levels (USS mill.)Total exports (fob) . 1,731 11,540 14,448 20,000

Rice . 272 969 667Fuel .. 390 2,092 3,548 15.000Manufactures ._

Total Imports (citf) 1,901 13,480 14,259 10.0ooFood 86 86 ..

Fuel and energy 86 358Capital goods 561 .. o * l i

Export price Index (1995=100) 94 96 97 98 99 oo

Import price Index (1995=100) . . . * Exports M Imports

Terms of trade (1995=100) .

BALANCE of PAYMENTS

(UJSS millions) 1980 1990 199 2000 Current account balance to GDP (%)Exports of goods and services . 1,913 14,010 17,107 s

Imports of goods and services 1,901 13,480 17,344Resource balance 12 530 -237 o

Net Income -412 -427 -597 99 ooNet current transfers 49 1,050 1341 -4

Current account balance -351 1,154 507 10

Financing Items (net) 510 130 -412Changes In net reserves 19 128 9 5

Meno:

Reserves Including gold (US$ millions) ..Conversion rate (DEC, locallUS$) .. 6,482.8 13,944.0 14,170.0

EXTERNAL DEBT and RESOURCE FLOWS1980 1990 1999 2000

(US$ millions) Composition of 2000 debt (USS mill.)Total debt outstanding and disbursed 23.270 23,260 15.600

IBRD 0 0 0 0IDA ~~~~~~~~~~~~~~~~~~~~~~~G: 1,700 6: 1,1 13

IDA 2 59 989 1,113 C:316

Totaldebtservice . 174 1.410 1.218 D 1,141IBRD 0 0 0 0IDA 0 1 8 9 F: 3,110

Composition of net resource flowsOffidal grants 96 257Official creditors -86 839 973Private creditors 0 -781 -717Foreign direct Investment .. 16 1.609 ..

Portfolio equity 0 0 . E: 8.220

Worid Bank programCommitments 0 0 318 260 A -IBRO E -BilateralDisbursements 1 0 158 175 B-IDA D- Other multilateral F -PrivatePrincipal repayments 0 1 2 2 C -IMF G -Short-termNet flows 1 -1 156 173Interest payments 0 0 7 7Net transfers 1 -1 150 166

EASPR 9/6/01

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Additional Annex 11: Key Performance IndicatorsVIETNAM: Second Rural Finance Project

1. Key Performance Indicators (KPIs) have been developed both to measure the effectiveness of theCredit Components and the IDPs for VBARD as well as the PFIs and MFIs, including specific focus onVBARD. Several of the most critical KPIs have been selected to act as objective indicators of the Project'ssuccess, to be used in Project Classification at the mid-term review and completion assessment. These areshown as Appendix A.

The Credit Component

2. Credit Component-KPIs would measure: (i) the investment made under the project's sub-loans,which is a proxy for its economic impact; (ii) the number of sub-projects financed, which indicates projectoutreach; (iii) the collection performance, which is a proxy for the financial effectiveness of sub-projectinvestments, albeit modified by the 'responsibility' of the borrowers; and (iv) an ex-ante assessment ofincremental employment, which is an indicator of social benefits achieved.

3. More specifically, the KPIs would measure for each of the RDF and the MLF the following: (i)number of active sub-loan borrowers; (ii) amount of loan releases; (iii) amount of performing loansoutstanding; (iv) number of participating PFIs and MFIs; (v) collection rate under the two funds both fromPFIs/MFIs to the BIDV, and from sub-borrowers to their related PFIs/MFIs (vi) ex-ante estimates of jobcreation for all sub-projects for which an ex-ante analysis is required.

Institutional Strengthening Component

4. Apex Bank. The IDP for BIDV, the Apex Bank, is aimed at supporting its conversion from aninstitution which was largely a government cashier to a sound commercially based banking institution. Keyelements of this are (i) increased prudence, involving cleaning the balance bad 'directed' loans andincreasing transparency; (ii) taking measures to insure solvency as measured by international standards;(iii) increasing profitability and aligning growth targets to ensure sustainability; (iv) becoming morecommercial; and (v) appropriate resource mobilization.

5. Included within the IDP would be a series of IDP-KPIs that would measure BIDV's performancein relation to these objectives, specifically these are:

Prudence

* Cleaning the balance sheet of bad loans, resolving 40% of the originally identified bad loans byJune 2002, 80% by December 2002 and 100% by December 2003.* Operating a system of loans' classification so that NPLs, not just overdue installments, can bemonitored by June 30, 2002, specifically loans would be re-classified based on Decision 1627 and thelevel of provisioning (under VAS) increased accordingly.* Implementing full LAS accounting system from 2002 (in parallel to the VAS so long as VASdiffers from IAS) and issuing International Audits for 2001 and future years within 6 months of theaccounting year-end.

Solvency

Achieve acceptable IAS CAR by 31 December 2006, and maintain it thereafter. Interim targets

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involve equity capital increase to the larger of VND 2.3 trillion or 5% of risk assets by end 2002, VND3.65 trillion or 6% of risk assets by end 2003, VND 4.65 trillion or 6.5% of risk assets by end 2004,and VND 5.65 trillion or 7% of risk assets by end 2005, and 8% of risk assets by end 2006.* Net Past Due (on loans for which in the opinion of the auditor BIDV takes the credit risk) toEquity ratio (IAS) not to exceed 25% by YE 2002, 15% YE 2003.

* Additional capital to be introduced of at least VND 1.2 trillion in 2002, and VND 1.35 trillion in2003.

Profitability. Long Tern Self Sustainability & Growth Strategy

* Real rate of return on equity after tax to exceed 3% by 2004 and 5% by 2006.* Increasing spreads and diversifying its sources of income, hence increasing its return on earningassets. Target after tax profit to earning assets is 0.45% for 2002, 0.7% for 2003, and 1% for 2004and thereafter

* Setting growth targets that are internally consistent with profits and likely growth in equity

Becoming More Commercial

* Proportion of Lending to non SOEs: To increase by 25% p.a. for next 3 years (e.g. if non SOElending is 16% at end of 2001, target is 20% for end 2002, 25% for end 2003 and 31.25% for end2004).* Proportion of outstanding retail 'State Directed Loans' within the total loan portfolio to fall to lessthan 15% by YE 2003 and 10% by YE 2005 or VND 8 trillion by end 2003 and VND6.2 trillion byend 2005, whichever is less. Loans that are explicitly guaranteed by the Government will be excludedfor the purpose of calculating BIDV's exposure to retail 'directed lending'.

Funds Mobilization

* The proportion of non ODA Deposits, Bonds and CDs of over 1 year's duration within totalresources to increase by at least 5% p.a. until the outstanding resources of over one years durationmatches assets of over one year's duration.

6. Strengthening PFIs and MFIs. VBARD, as the likely main conduit for funds under the projectwould prepare an IDP that would be agreed prior to disbursement of funds to it, and which would besupported under the project. It would focus on four critical areas:

* improving solvency and liquidity;* increasing profitability and sustainability;* improving loan portfolio quality; and* increasing resources mobilization, particularly, increasing medium and long term savings.

7. The IDP would be approved by VBARD's Board and be satisfactory to IDA. Under this plan,VBARD would commit itself to achieve indicators embodied in a number of key targets. Such an IDPwould include an action plan with targets for:

Prudence:

* Operating a system of loans classification so that NPLs, not just overdue installments, can bemonitored by June 30, 2002, specifically loans would be re-classified based on Decision 1627 and thelevel of provisioning (under VAS) increased accordingly.

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* Implementing full [AS accounting system from 2002 (in parallel to the VAS so long as VASdiffers from IAS), issuing Intemational Audits for 2001 and future years within 6 months of theaccounting year end.

Improving VBARD's solvency:

* Achieve and maintain an acceptable CAR (8%) by end 2005, with interim targets of 5% by end of2002, 6% by end of 2003, and 7% by end of 2004.* Additional capital to be introduced of at least VND 2,730 billion in 2002 and VND 700 billion in2003.

Increasing profitability and sustainabilitv - achieving a net (after tax) real rate of return on equity (based onIAS accounting and after adequate provisioning) to exceed 5%

Improving VBARD's loan portfolio qualiW:

* Cleaning the balance sheet of bad loans, as indicated in the Restructuring Plan, resolving at least20% of the originally identified bad loans by June 2002 and 40% by December 2002.* Net past dues (IAS methodology) to be less than 10% of loan portfolio, and the NPD to equityratio (on IAS definition) to be not more than 25%, by end 2003.* Reducing loans concentration: reducing loans to sugar SOEs/total loans to less than 2% by the endof 2002. Loans to sugar SOEs that are explicitly guaranteed by Government would be excluded for thepurpose of calculating VBARD's exposure to this sub-sector.

Becoming more commercial: Proportion of non-commercial 'State Directed Loans' to be reduced by25% per annum. Loans that are explicitly guaranteed by the Government will be excluded for the purposeof calculating VBARD's exposure to non-commercial 'State Planning Loans'.

Increasing resource mobilization:

* Increasing savings and deposits, particularly in the villages and the communes. Proportion ofsavings from rural areas (villages and the communes) to increase by at least 25% p.a.* Increasing the proportion and volume of medium and long-term savings. Proportion of non ODAdeposits, CDs and Bonds issued of over I year's duration, within total resources to increase by at least5% p.a. until the outstanding resources of over one year's duration matches assets of over one year'sduration.

Training and capacity building: Establish targets for agreed programs identifying:

* number of courses and staff to be trained;* key areas of training.

8. Each of the other PFIs/MFIs that do not fully meet the RDF/MLF accreditation criteria will prepareits own IDP that will focus on five critical areas:

* improving solvency and liquidity;* increasing profitability and sustainability;* improving loan portfolio quality;* increasing resources mobilization, particularly, medium and long term savings; and* improving the capacity of its management and staff.

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9. Accomplishments of PFIs/MFIs with regard to their IDPs would be measured using a number ofindicators, including (i) capital adequacy ratio, (ii) net past due/equity ratio, (iii) liquidity ratio (liquidassets to short-term liabilities ratio), (iv) profitability and efficiency ratios which would include interest ratespread, net income/average equity, net income/average eaming assets, net income in real terms, and netoperating income/gross income, and (v) measurements of the quality of the loan portfolio (over-dueloans/total loans, net past due loans/total loans, collection rates, restructured loans/total loans).

Project Classification at Implementation Completion

10. At Completion, the Project's outcome will be classified as 'Highly Satisfactory', 'Satisfactory','Unsatisfactory' or 'Highly Unsatisfactory', depending upon the extent to which it has reached itsobjectives. It is proposed to use criteria based on the most critical Key Performance Indicators (KPIs) as amajor input in making this classification. Consequently, 70% of the project's classification would bedetermined by achievement of the pre set indicators shown in Appendix A, and 30% based on thequalitative assessment of the Implementation Completion Reporting team. This latter assessment will payparticular attention to the achievement of improved outreach of the Banking System to the private sector,increased confidence in the Banking System, the way in which BIDV has adapted to change over theproject period and the overall management of the project.

l. Calculation Details. Calculation would be made by assigning a weighting of 70% to the actualKPI achievement and 30% to the qualitative assessment. Assuming that the project were rated asUnsatisfactory on the qualitative assessment and that the achievement of KPIs were as in the example givenin Appendix A, the calculation would be as follows:

Weighting Numerical Score Grade in Weightin Example Example times Score

or GradeObjective KPI Achievement (see 70% 3.04 2.128Appendix A)

Qualitative Assessment of ICR Mission on 30% U = 2.0 0.600other factorsTotal 100% __2.728

Note: HS=4; S=3; U=2; andHU=l..With a weighted average score of 2.728, the project would be classified as Satisfactory overall (2.728being closer to 3 than to 2).

These targets are still to be finalized and need to be consistent with sustainable growth plans..

2 Without additional capital being paid in, a bank with an 8%o CAR at the outset, which has a net profit to earning assets of1%, can only prudently grow at less than about S% p.a. even if it pays no dividends, in order to maintain its 8% CAR..

To reach this target an increase in VBARD 's lending rate might be necessary. Based on VBARD 's current financial results,the estimated lending rate to cover cost offunds, administrative costs including, adequate provisions for possible loan losses,and an acceptable profit is estimated at 1.25% per month or 15% on annual basis.

Commercial 'directed lending' is defined as directed lending under which the financial institution is taking the credit risk andis free to select the borrowers and set the lending terms and conditions (interest rates, maturities, and collateral). Therefore,non-commercial directed lending is a program under which the borrowers and/or the terms and the conditions of the loans aregiven.

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Appendix A Key Performance Indicators at Mid Term

Mid Completion Importance Benchmarks for Mid TermTermTarget Target Weighting if less than target

Indicator End 2004 End 2007 A BCredit Component 45%No of Active Participating PFIs/MFIs 15 25 8% 11 7Balance of RDF II Loans Outstanding 1,000 2,400 10% 700 400(VND B)Number of RDF II Sub-Loans (Cumulative) 40,000 90,000 5% 20,000 10,000Max % RDF Loans Past Due to PFIs 3.0% 2.0% 5% 4.0% 6.0%Incremental Jobs Created - RDF (Cum) 25,000 50,000 7% 15,000 5 000Number of MLF Sub-Loans (Cumulative) 25,000 85,000 5% 15,000 8,000Max % MLF Loans Past Due Loans 2.0% 2.0% 5% 3.5% 7.0%Institutional Strenrthening - BIDV 40% -IAS & Loan Classification System in Place Y Y 5% Y YEquity to Risk Assets (CAR) to exceed 6.5% 8% 10% 7.0% 5.0%Net Past Dues to Equity to be less than 15% 15% 5% 20% 25%Profit in Real Terms (+ve ROE) 3% 5% 4% 1% 0%Real Net Profit as % Earning Assets to 0.7% 0.9% 4% 0.3% 0.0%ExceedProportion of State Planning Loans less than 13% 6% 4% 15% 20%Proportion Private Deposits above 40% 50% 4% 30% 20%Increase in % of I yr + VHD Liabilities a/ 15% 35% 4% 20% 10%Strengthening VBARD & PFIsIMFIs 15%VBARD Equity to RA (CAR) to exceed 7% 8% 3% 7.0% _ 5.0%VBARD Net PDs to Equity to be less than 15% 15% 3% 20% 25%VBARD Net Real Profit as % Equity 3% 5% 3% 1% 0%(ROE) IAll PFIs/MFIs Incr in % VHD Liabilities a/ 15% 35% 3% 20% 10%All PFIs increase in real volume of lending 60% 150% 3% 40% 20%to non State Sector. a/

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A Key Perfor ance Indicators Appenlix at CompletionBenchmarks for Example at Completion

Completionif less than target Actual Bank Numeric Grade

Indicator A B Out-tum Grade Grade X WeightCredit ComponentNo of Active Participating PFls/MFls 15 8 16 S 3 0.24Balance of RDF 11 Loans Outstanding (VND 2,000 1,500 2,400 HS 4 0.40B )__ _ _ _ _ _ _

Number of RDF 11 Sub-Loans (Cumulative) 60,000 30,000 70,000 S 3 0.15Max % RDF Loans Past Due to PFIs 2.0% 4.0% 5% U 2 0.10Incremental Jobs Created - RDF (Cum) 35,000 20,000 60,000 HS 4 0.28Number of MLF Sub-Loans (Cumulative) 50,000 15,000 10,000 HU I 0.05Max % MLF Loans Past Due Loans 3.5% 7.0% 8% HU 1 0.05Institutional Strenethenine - BIDVIAS & Loan Classification System in Place Y Y Y HS 4 0.20Equity to Risk Assets (CAR) to exceed 8% 6.0% 9% HS 4 0.40Net Past Dues to Equity to be less than 20% 25% 10% HS 4 0.20Profit in Real Terms (+ve ROE) 3% 0% -.01% HU 1 0.04Real Net Profit as % Eaming Assets to Exceed 0.6% 0.0% -0.1% HU 1 0.04Proportion of State Planning Loans less than 10% 15% 5% HS 4 0.16Proportion Private Deposits above 35% 25% 52% HS 4 0.16Increase in % of I yr + VHD Liabilities a/ 25% 15% 27% S 3 0.12Strengthening VBARD & PFIs/MFIsVBARD Equity to RA (CAR) to exceed 8% 6.0% 10% HS 4 0.12VBARD Net PDs to Equity to be less than 20% 25% 10% HS 4 0.12VBARD Net Real Profit as % Equity (ROE) 3% 0% -2% HU 1 0.03All PFIs/MFIs Incr in % VHD Liabilities a/ 25% 15% 30% S 3 0.09All PFIs increase in real volume of lending to 100% 50% 120% S 3 0.09inon State Sector. a/_ .a/ From a December 2001 benchmark leveL Weighted 3.04

AverageEquivalent nearest grade

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Additional Annex 12: Credit Operation ArrangementsVIETNAM: Second Rural Finance Project

1. The credit operation would be carried out by the Project Management Unit (PMU) within BIDV.The PMU would handle day-to-day implementation of the Rural Development Fund II (RDF II) and theMicro-finance Loan Fund (MLF) operations. While overall responsibility of the credit component wouldrest with BIDV, the responsibility to implement the RDF II and the MLF would rest with the PMU.

2. BIDV would on lend project funds to the Participating Financial Institutions (PFIs) or to the MicroFinance Institutions (MFIs) and provide them, as necessary, with technical assistance on RDF II or MLFoperations. It would process sub-loan applications from PFIs and MFIs; provide guidelines to PFIs/MFIson sub-project selection and appraisal; carry out selective end-use verification of sub-projects funded byRDF II and the MLF; monitor sub-project performance; conduct training with PFIs and MFIs; and managethe overall RDF II and MLF relationship with the PFIs and the MFIs, respectively.

The RDF

3. Credit Operating Policies and Procedures. Under the proposed project BIDV would develop itscapabilities as a second tier bank. The credit operation would be carried out on the basis of policies andprocedures established in a Policy Manual (PM) for each of the Funds. The PM would be periodicallyupdated to reflect necessary policy changes. The adoption and implementation of the PM, satisfactory toIDA would be a condition of Credit effectiveness. Key policy issues discussed below include: eligibilitycriteria under the RDF II; interest rate structure and foreign exchange coverage fee; PFIs accreditationcriteria; sub-projects appraisal sub-project review and disbursements; sub-loan rescheduling; sub-loanmaturities; environmental protection; and supervision of RDF II sub-loans; accounting and auditarrangements. The PM would not be revised without prior consultation with and approval of IDA.

Eligibility Criteria

4. Sub-borrowers under RDF II will be limited to individuals or privately owned enterprises, providedthat RDF II s' total exposure under sub-loans to any single borrower shall not exceed 5% of BIDV's equity.Eligible investment would be short, medium, and long term private investment financed for theestablishment of new enterprises, and expansion of existing operations. Agricultural and rural industriesbased projects would be eligible", including fisheries, agro-industries, and agricultural service enterprises.To qualify, proposed sub-projects would have to be appraised by the PFIs as technically feasible,financially viable, environmentally sound, and in the case of larger investment sub-projects exceedingUS$200,0000 equivalent, economically justified.

5. Project fmnancing is extended to basically support private small and medium-sized firms in the ruralsector, which do not presently have easy access to funds over one year's duration for their own operationand real new investments. VND sub-loans would be offered to small and medium sized sub-borrowers.Project funds would finance investments in fixed assets such as new buildings and machinery and workingcapital. Land, existing buildings, or other assets previously used within the rural sector (except breedinglivestock) would be ineligible. Under the RDF II, the PFIs and BIDV would each be required to provide,for each sub- project, at least 10% of the financing package from their own funds. The minimum equitycontribution by the sub-borrower would be deternined by the PFIs on the basis of its sub-project appraisal,but should not be less than 15%. IDA financing of any single sub-project, under the RDF II would notexceed, in any case, 65% of sub-project costs.

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On-lendinz Arrangements

6. The Socialist Republic of Vietnam, would be the Borrower. The proceeds of the Credit would bemade available to BIDV under an On-lending Loan Agreement (OA), satisfactory to IDA, to be enteredbetween MOF and BIDV. Under this OA, which would form part of the RDF II and the MLF PolicyManuals, funds would be lent to BIDV for a period of 25 years with a grace period of 8 years on theprincipal. The interest charged by MOF to BIDV would be such as to give BIDV at least 2% spread tocover its operating costs and risks. This should be adequate to make the project attractive to BIDV and toencourage it to promote the flow of resources into the two funds. Finance for the RDF II and the MLFcredit lines would be made available to the PFIs and MFIs, respectively, under subsidiary loan agreements(SLAs) between them and BIDV.

7. Under the proposed project interest rates would be as follows: for the US$ lending program interestrate would be variable market rate, adjustable monthly (or bi-weekly), and would cover the cost of IDA'sfunds plus an adequate spread to cover the cost of GOV credit and foreign exchange risks (SDR vis-a-visUS$), operating costs, and associated risk of BIDV and PFIs. The foreign exchange risks associated withthese sub-loans would be fully bome by the sub-borrowers. Interest rates on PFIs' participation would befreely set by the PFIs. Considering the current situation in rural Vietnam, this option would be granted to afew larger borrowers, primarily export-oriented clients, that would be in a proper condition to borrowforeign exchange sub-loans . A fixed rate option would be allowed calculated in a manner satisfactory toIDA. Maturity of PFI loans would conform to the composite maturity of related sub-loans.

8. For VND sub-loans interest rates from BIDV to the PFIs and MFIs, under these SLAs, would beadjustable periodically based upon criteria that fully reflect market interest rates. BIDV would manage thetwo funds and would bear the credit risk at the level of the PFIs/MFIs. Funds would normally be on-lent toPFIs/MFIs in local currency, in line with their clients needs. They would bear a variable rate of interestadjusted monthly and intended to be equal to the adjusted cost of medium term deposits. This rate wouldbe calculated based on the prevailing prime rate minus a 'spread'. The 'spread' would be fixed for threemonths, and would be determined by subtracting from the prevailing prime rate3'. the Weighted AverageInterest Rate (WAIR) for 3, 6 and 12 months deposits in the banking system in Vietnam, adjusted for the

reserve requirement imposed by the SBV4' . While the on-lending rate would reflect prime rate changesmonthly, variations in the 'spread', which are likely to be small, would be adjusted on a quarterly basis.

9. For local currency sub-loans, GOV would bear the foreign exchange risk against a 'fee' - thedifference between the on-lending rate to BIDV and the cost of IDA funds. This is because: (i) the smallsub-borrowers would not be in a position to bear the foreign exchange risk, and therefore, BIDV would notbe able to pass on this risk to the PFIs; and (ii) the US$ of IDA proceeds would actually remain with theGovernment who in return would provide BIDV with the equivalent local currency for on-lending to thePFIs and MFIs. Based on current conditions, the on-lending rate from BIDV to the PFIs would be about6.5% p.a., giving a pass on rate from MOF to BIDV of 4.5% p.a. This would leave MOF with anadequate margin to cover the foreign exchange and the credit risk of BIDV 3.8% p.a. (the differencebetween the cost of IDA's funds (0.7%) and the pass-on rate (4.5%). To limit MOF's exposure, a floor rateof 3% p.a. would be set for MOF's pass on rate to BIDV, consequently BIDV's pass on rate would have afloor of 5% p.a.

10. The PFIs and the MFIs would be free to set their spreads, so as to fully reflect market forces andassociated risk. To ensure the sustainability and the financial viability of MFIs without a Governmentsubsidy, an adequate lending rate must be in place. On-lenders under MLF would need to be permitted to

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charge interest rates that are sufficient to fully cover related operating costs, including cost of funds,provisions for possible loan losses, and adequate profits to allow for further lending expansion to the poor,without undermining the MFIs prudent equity to risk asset ratio. To meet these needs, higher ceiling rateswould need to be allowed for this specific sector.

PFI Accreditation Criteria

11. To safeguard the apex bank, the RDF II's financial assets, and to ensure a successfulimplementation of the credit component, the Participating Financial Institutions (PFIs) would be approvedon the basis of agreed accreditation criteria to be detailed in the RDF II's Policy Manual. Criteria to beselected need to be credible, transparent, unequivocal, and compatible with sound and generally acceptedfinancial principles, and with the banking regulations in Vietnam. Accreditation criteria of PFIs wouldinclude the following five fundamental elements: (a) compliance with banking law and audit requirements;(b) solvency; (c) liquidity; (d) profitability; and (e) quality of ownership, management, and staff.

(a) SBV Banking Regulations. Eligible FIs would comply with all SBV regulations,particularly those related to the review of loan portfolio and other risk assets, definition of past dueloan accounts, loan classifications, and adequate provision for expected loan losses.

(b) Solvency Requirements. Eligible FIs would comply with a minimum net equity base of atleast 8% of their risk assets. The net equity base would be computed applying the criteriaestablished by BIS, at the time of accreditation. Also, eligible FIs would maintain a net past dueover equity of not more than 25%.

(c) Liquiditv. Eligible FI would comply with minimum of liquidity ratio (liquid assets overshort-term deposits and bills payable) of 30%.

(d) Profitability Requirements. Eligible FIs would demonstrate their profitability in real termsduring the life of the sub-loans. If their adjusted profit obtained is positive, then it would beconsidered that the real profitability criteria has been met

(e) Ownership. Management, and Staff Qualitv Requirement. PFI's ownership, management,and staff quality should be satisfactory to BIDV. This would include qualified management teamof good reputation, presence of adequate and qualified staff, sound operation policies andprocedures, compliance with all relevant laws, decrees, and regulations.

12. However, a Financial Institutions (FIs) can be accredited even if it does not meet all theaccreditation criteria provided that an Institutional Development Plan (IDP) along with adequate trainingprogram and detailed time table for achieving them would be submitted to, and found to be acceptable by,BIDV and IDA.

13. In the event that a PFI loses its accreditation status (having failed to meet one or more of theaccreditation criteria, and/or to properly implement its IDP), then BIDV would: (i) cancel the uncommittedportion of the line of credit granted to the PFI; (ii) take the necessary actions to protect the interest of theBorrower, BIDV, and the PFIs; and (iii) notify the Borrower and IDA on actions taken.

14. The following types of FIs would be allowed to participate in the RDF II program, provided thatthey meet the financial and administrative criteria: Commercial, Urban Joint Stock Commercial, and Rural

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Joint Stock Commercial banks, including non-bank financial institutions.

Sub-proiect Appraisals

15. Sub-loan appraisals would be the responsibility of the PFIs, whose capability would bedetermined by BIDV according to RDF II qualifying criteria. Appraisals of medium- and long-termsub-loans would be based upon the technical and financial features of the sub-projects. For each medium-and long-term sub-loan, the PFI would prepare a financial plan including the sub-project's cash flow. ThePFI shall estimate a financial rate of return (FRR) for all sub-projects with sub-loans of more thanUS$50,000 equivalent. For the sub-projects to be acceptable, the real FRR shall be greater than the largerof the real interest rate of the sub-loan or 15%. BIDV would ensure that an estimation of an economic rateof return (ERR) would also be carried out for all sub-projects with sub-loans of more than US$200,000equivalent. These sub-projects should yield an ERR of not less than 15% in real terms or any other rateestablished from time to time by the Ministry of Planning and Investments (MPI). The appraisals ofsub-projects who borrow foreign exchange loans would have to ensure that this type of sub-loans would beoffered only to those sub-borrowers, regardless of their size, who: (a) are direct or indirect exporters andhave a need for a foreign exchange loan to match revenues earned in or tied to foreign exchange; and (b)have the capability to manage the risks associated with the foreign currency compositions of their assetsand liabilities.

16. Foreign Currency Lending. In addition to the above eligibility criteria, appraisals of sub-projectsfor a foreign currency loans must include an assessment of sub-borrowers' foreign exchange revenues and ademonstration that projected revenues are adequate to service the foreign currency sub-loan. For indirectexporters, revenues may be in VND, provided that the appraisal establishes a clear linkage betweensub-borrowers revenues and the related foreign exchange loan.

17. Sub-project's Review and Disbursements. As under the previous operations, BIDV would receivethe sub-project credit evaluation carried out by the PFI in all cases. On an ex-ante basis-beforedisbursing-BIDV would review a summary of the appraisal work prepared by the PFI, so as to ascertainthat the sub-projects are consistent with project guidelines, in that case it would authorize the respectivedisbursements. In order to expedite sub-loan approval and disbursement, this ex-ante review may bewaived, by BIDV, for stronger and more experience PFIs. Such waiver would require IDA's concurrence.BIDV would grant up to 60 days to PFIs to submit sub-loan documentation and evidence of payments andprocurement. BIDV would declare the sub-loans due and demandable and charge a penalty fee if PFIs donot submit the required documentation within the 60 day period after BIDV's disbursements or if thesubmitted documenta-tion does not satisfactorily support sub-projects that are eligible under the project.

18. In any case, BIDV would maintain rights to visit sub-projects after the sub-loan disbursementshave been made. IDA concurrence would be required for all sub-loans above US$150,000 equivalent.Disbursements to the PFIs would be subject to compliance with both pre-release and post-releasedocumentation required. Proceeds would be credited to an account opened with BIDV for this purpose. Ifa PFI advances a sub-loan release to a sub-borrower, the PFI can apply for rediscounting from RDF within120 days after the date of advance. On the other hand, the PFIs must release the full proceeds to thesub-borrowers within 15 working days of the receipt from BIDV.

19. Sub-loan Maturities. The repayment period for RDF medium- and long-term sub-loans will bebased upon the sub-project's cash flow and the sub-borrower's overall repayment capability. Repayment ofmost sub-loans would be within five to ten years, but would not exceed fifteen years or the pay-back period

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of the sub-project, whichever is shorter. Reasonable grace periods may be granted by BIDV for therepayment of the principal based upon the sub-project's cash flow projections and the sub-borroweresrepayment capability. Maturity of subsidiary loans to PFI under RDF II would conform the maturity of therelated sub-loan. Short term sub-loans shall be payable within a period of 12 months.

Environment

20. BIDV will specify that sub-borrowers for RDF II funded projects should comply with all laws andregulations of Vietnam related to environmental protection, consistent with environmental guidelines of theIDA. BIDV would be in charge of supervising compliance. To reduce the risk that sub-projects withundesirable environmental or social impacts would be financed by RDF 1I, a set of measures would betaken (see Annex 16). The Environmental Division (ED) of BIDV would provide BIDV, PFIs, and relatedsub-projects with environmental technical assistance and coordination services. The ED will be staffed bya core of professionals and administrative assistants, supported by qualified consultants that would provideperiodic short term services. In addition, the ED would be responsible for the implementation of thetraining program for the project related staff in BIDV and the PFIs. This program would include courseson environmental issues to increase RDF II staff capacity to review and monitor environmental aspects ofsub-projects.

Proiect Supervision

21. Supervision of Sub-projects. The supervision of the sub-loans would be the responsibility of thePFIs and BIDV with the requirements that specific officers would be designated for this purpose. PFIs andBIDV would ensure through supervision that sub-borrowers use the RDF II resources only for theapproved purposes. This would be achieved through direct payments to suppliers of inputs and materials,as practicable, and through a careful follow up of funds application. In fact, as BIDV would receivedocumentation and evidence of procurement after disbursements, BIDV would have an adequate basis fordetermining whether or not the RDF II have been used for approved purposes. Furthermore, sub-projectvisit would be a normal part of the supervision process. PFIs and BIDV would also obtain periodicoperating and financial reports from sub-borrowers and BIDV would conduct selective end-use verificationof funded sub-projects. In this manner, BIDV would issue an annual assessment of the overall financialcondition of the PFIs and shall use such findings in the annual renewal of PFI accreditation. Thus, thePFIs would be required to submit such reports as prescribed by BIDV (PMU) from time to time that allowBIDV to properly monitor the PFI's sub-loan appraisal, disbursement and supervision processes andcapabilities.

22. BIDV Supervision of PFIs would be a permanent activity. A monitoring system to enable BIDV totake corrective measures as soon as possible need to be established. This system would be used to monitorPFIs' performance under the proposed project. BIDV's supervision will focus on sub-loan promotion,appraisal, disbursements, and recovery, as well as sub-project supervision by the PFIs. The overallfinancial conditions of PFIs would be assessed and findings and recommendations included incomprehensive annual supervision reports to be prepared by BIDV on each of the PFIs. Also, BIDV wouldprepare an annual report on PFIs, summarizing their overall conditions and main issues affecting theprincipal categories of PFIs. This annual report would also include technical assistance as well as remedialaction recommendations to enhance the financial, technical, administrative and developmental conditions ofPFIs.

23. Accounting and Audit Arrangements for Project-Related Disbursements. The PFIs would berequired to maintain adequate records and accounting of RDF II sub-loans that are satisfactory to BIDV,

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especially to accurately reflect balances and movements in the RDF H. PFIs would also be required tofurnish their audited financial statements, at least annually. The external auditors and the formnat of thereport should both be satisfactory to BIDV. BIDV would communicate its requirements on external auditsof PFIs in a timely manner, so as to allow the external auditors know in advance about BIDV needs,especially those related to PFI accreditation requirements under the project.

MLF

24. The credit operation would be carried out by BIDV. Day to day implementation would be carriedout by the MLF unit within the PMU. Overall responsibility of the credit operation would rest withBIDV's management.

25. BIDV would on lend project funds to the MFIs and provide, as necessary, with technical assistanceon MLF operations. It would process sub-loan applications from MFIs; provide guidelines to MFIs onsub-project selection and appraisal; conduct selective end-use verification of sub-projects funded by MLF;monitor sub-project performance; conduct training with MFIs on MLF operations and manage the overallMLF relationship with the MFIs.

26. Credit Operating Policies and Procedures. Under the proposed project, BIDV would operate as awholesale lending institution to MFI conduits. The credit operation would be carried out on the basis ofpolicies and procedures established in a Policy Manual for the MLF. The Policy Manual would beperiodically updated to reflect necessary policy changes. Policies to be incorporated under the MLF areoutlined below and will be incorporated in the Policy Manual. The adoption and implementation of thePolicy Manual (PM) satisfactory to IDA would be a condition for disbursement under this Category. Keypolicy issues discussed below include: eligibility criteria for MLF resources; interest rate structure; MFI'saccreditation criteria; sub-projects appraisal, review and disbursements; sub-project loan rescheduling;sub-loan maturities; supervision of MLF sub-loans; and accounting and audit arrangements. The PMwould not be revised without prior consultation with, and approval of, IDA.

Eligibility Criteria

27. MLF will be available, only in VND, to finance short and medium term viable private ruralinvestment and the related working capital. Sub-borrowers under MLF will be limited to individual poor,poor households, and micro-enterprises operating in the country, except the urban areas of Hanoi, HaiPhong, Da Nang, and HCMC. Eligible sub-projects would be viable small scale and micro-enterpriseactivities such as trading, handicraft/small manufacturing, backyard animal production, food processingand production of vegetables and fruits. Purchasing of land, and financing of sugar plantation, sugarprocessing, and/or sugar marketing are ineligible. To qualify, proposed sub-projects would have to beappraised by the MFIs and/or BIDV as technically feasible, financially viable, and environmentally sound.

28. Project financing would also be extended to support private micro-enterprises that do not have easyaccess to formal credit facilities. Project funds would finance investments in fixed assets such as simplemachinery or equipment and working capital. The MFIs and their sub-borrowers would be required toprovide for each sub-project at least 25% of the financing package from their own funds. The minimumequity contribution by the sub-borrower would be negotiated with the MFI concerned. IDA financing ofany single sub-project would not exceed, in any case, 75% of sub-project costs.

29. Interest Rates. Under the proposed MLF, interest rates would be in line with market rates (for

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details see paras.6 to 10, above). Foreign currency sub-loans will not be allowed under the MLF. MLFwould allow free negotiation between BIDV and MFIs on the one hand, and between the MFIs and thesub-borrowers on the other, to set the rates which reflect market forces and the risks involved. The onlending interest rates charged by BIDV to MFIs would be based on the cost of funds to BIDV plusreasonable spread sufficient to cover operating costs and associated risks.

MFI Accreditation Criteria

30. To safeguard the apex bank, and the MLF's financial assets, and to ensure a successfulimplementation of the micro-credit sub-component, the Micro-Finance Institutions (MFIs) would beapproved on the basis agreed accreditation criteria to be detailed in the MLF's Policy Manual. Theaccreditation criteria ensure that the participating MFIs pass the tests of legality, solvency, liquidity,profitability and efficiency, quality of ownership, lending performance, financial management andmonitoring systems. It has two steps: (a) the MFI would meet certain minimum requirements before athorough evaluation of its financial performance and operations is made; and (b) the credit evaluationprocess upon satisfaction of the pre-qualifying criteria.

31. The following institutions would be allowed to participate in the MLF: commercial banks, jointstock urban and rural banks, cooperatives, PCFs, credit-granting NGOs, and any other financial institutionthat is interested in micro-finance activities and meet the related accreditation criteria.

32. SBV Banking Regulation. In the case of banks, compliance with SBV's minimum capitalrequirements is a necessary condition for accreditation. In the case of cooperatives, PCFs and credit NGOs,(i) submission of a capital build-up program ready for implementation that will be reviewed and approvedby BIDV; (ii) meet other MLF criteria; and (iii) provide collaterals at the discretion of BIDV.

33. Solvency Requirement. Eligible MFIs will comply with minimum net equity base of 10 percent oftheir risk assets or as may be required by SBV, whichever is higher. At the time of accreditation, the netequity base shall be computed applying the criteria established by BIS. Eligible MFIs would also maintaina net past due over equity of not more than 20%. The eligible cooperatives, PCFs and credit NGOs willmaintain a net capital (or fund balance for NGOs) ratio of at least 12 % of their risk assets.

34. Liguidity. Eligible MFIs would comply with a minimum liquidity ratio (liquid assets overshort-term liabilities, e.g., deposits and bills payables) of 30%.

Profitability Reguirements

35. See para.l 1(d), above.

36. See para. 11 (e), above.

37. However, a potential MFI can be accredited even if it does not meet all the accreditation criteriaprovided that an Institutional Development Plan (IDP) along with adequate training program and detailedtime table for achieving them would be submitted to, and found to be acceptable by, BIDV and IDA.

38. In the event that an accredited MFI loses its accreditation status (having failed to meet one or moreof the accreditation criteria), BIDV would: (a) cancel the uncommitted portion of the line of credit grantedor suspend the subsequent draw-downs to the MFI; (b) take the necessary actions to protect the interest ofthe Borrower, BIDV, and the MFI; and (c) notify the Borrower and IDA on actions taken.

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39. Sub-proiects Appraisals. Sub-loan evaluation and approval will be the responsibility of the MFIs,whose capability to undertake these activities will be determined by BIDV according to the MLF qualifyingcriteria. Evaluation of short and medium term loans shall be based on the technical and financialcharacteristics of the sub-project. For each short and medium term sub-project, the MFI shall prepare afinancial plan including sub-project cash flow.

Sub-projects Review and Disbursement

40. BIDV shall receive the list of sub-borrowers with corresponding sub-projects together with therequired report from the MFIs, as a general rule, on an ex-ante basis. It will review on an ex-ante basisthe said documentary requirements and check whether these are consistent with MLF guidelines toauthorize disbursements. BIDV may, at its option, allow ex-post review for MFIs with good track record.

41. BIDV will grant up to 60-day for the MFIs to submit post-release sub-loan documentation.Appropriate sanctions and penalties will be applied against the MFIs should they fail to meet the said30-day period, following loan release to the MFIs.

42. BIDV, on a selective basis, will conduct selective end-use visitation or verification of fundedsub-projects after loan release to ensure that the funds are properly used.

43. Disbursements to the MFIs will be subject to compliance with both pre-release and post releasedocumentation. Proceeds will be credited to a deposit account opened with BIDV for this purpose. If theMFI advances the loan release to clients, the MFI can apply for rediscounting within 90 calendar days fromdate of initial advances. In this case, the computation of the loan amount to be provided to the MFI iscomputed based on outstanding balance before the loan release (i.e. 75% of the outstanding balance).

44. Sub-loan Maturities. The repayment period for MLF short and medium term sub-loans will bebased on the sub-project's cash flow and the sub-borrower's overall repayment capacity. Repayment ofsub-loans would be within one to three years. Reasonable grace period for repayment of the principalcould be given based on the sub-project's cash flow projections and the sub-borrower's repaymentcapability.

Sub-proiect Loan Rescheduling

45. Loan restructuring may be effected by reason of force majeure directly affecting specific projectsof the sub-borrowers resulting in the inability of the sub-borrower to pay its loan to the MFI which in tumaffects the MFI's capability to repay its loan to BIDV. The loan restructuring will provide arecovery/rehabilitation period that will strengthen the paying capability of the MFIs sub-borrowers.

46. The MFI must submit a specific proposal at least 30 days after the occurrence of the fortuitousevent. Such restructuring will consist of a revision in the repayment terms of the outstanding sub-loan.

47. Supervision of Sub-loans and Sub-borrowers. Supervision of sub-loans will be the responsibilityof MFIs which will designate specific officers for this purpose. MFIs will ensure that sub-borrowers useproject funds only for approved purposes. MFIs will also obtain, on a selective basis, periodic operatingand financial reports from sub-borrowers.

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Supervision of MFIs

48. BIDV shall conduct an annual review of the overall financial condition and performance of theMFI and shall use the findings thereon as basis in the yearly renewal of the MFIs' accreditation under theMLF.

49. BIDV shall supervise, on a selective basis, sub-borrowers to determine if the sub-loans had beenused for the intended purposes.

Reporting Requirements

50. The MFI shall be required to submit the following regular reports in a format prescribed by theBIDV and such other reports as may be required by BIDV: (i) annual audited accounts; (ii) semi annualun-audited financial statements; (iii) quarterly status report; (iv) annual detailed status report; and otherreports as may be required by BIDV.

51. MFI shall maintain separate books of accounts and separate identifiable subsidiary ledgers for fullaccounting of the subsidiary loan and its utilization by the sub-borrowers .

52. Accounting and Audit. The MFIs will submit to BIDV their audited financial statements at leastannually. BIDV will ensure that the accreditation criteria are satisfactorily met. BIDV may also conductsurprise audit as may be deemed appropriate by the BIDV management. MFIs are enjoined to providetheir cooperation in complying with these control measures to safeguard the MLF.

1/ To avoidfinancing of uneconomic sub-projects, the project will notfinance crops that are not economically such as sugar.2/ In that case, thefirst roundforeign exchange risk would be borne by the initial sub-borrowers who would be required tohaveforeign exchange income or have income that is linked toforeign exchange.3/ Or such other representative rate which may be readily determined and tracked4/ VBARD/SB V has requested that three month deposits be also included in calculating the WAIR.5/ The adjustments proposed to the nominalprofits would simply be two: (i) the initial equity, multiplied by the inflation ratebetween the beginning and ending of the accountingperiod dates would be deductedfrom the nominalprofits; and (ii) theinitialfixed assets multiplied by the inflation rate between the same dates would be added to the nominalprofits. If theresulting number ispositive then it would be accepted that the realprofitability has beenpositive.6/ Micro-enterprises, individual and householdpoor will be defined in the MLF's Policy Manual. Generally, micro-enterpriseis defined as an enterprise that employs between 2 to 10 employees that are not members of the immediatefamily.

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Additional Annex 13: BIDV's Operations, Financial Performance, and ProjectionsVIETNAM: Second Rural Finance Project

1. BIDV was established in 1957 and is one of the four large commercial State-owned banks inVietnam. Traditionally, it had been the main provider of investment and development finance toState-owned companies. It is a full service bank which, in addition to operating directly, is also involved ina number of joint ventures covering insurance, stockbroking and banking together with overseas partners.It operates in all of the provinces and major cities in Vietnam, with a network of about 140 branches andsub-branches (there is normally at least one branch per province). BIDV has a staff of over 6,000 and totalassets of about $4 billion at the end of December 2001. Its paid up share capital, which all belongs to thestate, is currently about US$70 million.

2. In the past, Government channeled funds to State Owned Enterprises (SOEs) by directing StateOwned Commercial Banks (SOBCs) to lend to them, often with Government providing funding to theSOCBs for this purpose. BIDV has been widely used in this way. Implicitly, Government took the creditrisk on such loans, although this was not explicitly documented in each case. Often, these 'directed loans'were made for large-scale construction investment and were not subject to a searching credit and viabilityanalysis by BIDV, not least because BIDV was essentially compelled to make the loans. This policy hasnow changed, and there have been no additional commitments for 'directed loans' since 1999. BIDV nowonly makes loans under commercial conditions, and it explicitly takes the credit risk. In this case, BIDVmakes its own assessment of the risk involved in a potential loan, and if it does not want to take it, turnsdown the loan proposal. However, in many cases BIDV makes commercial loans to the same SOEs as ithas made 'directed loans'.

3. Accounting Systems and Audit. Because BIDV is supervised by the State Bank of Vietnam (SBV)it has had to follow the system of accounting prescribed by SBV - Vietnamese Accounting Standards(VAS). In company with various other Vietnamese banks however, BIVD has appointed internationalauditors (Price Waterhouse Coopers) and have had their accounts for the last five years (1996 to 2000)audited under International Accounting Standards (IAS) as well as using VAS for reporting to SBV and fortax purposes. In line with agreements under PRSC, BIDV is continuing to have intemational audits, andwork on the 2001 audit has already started.

4. There have been a number of differences between IAS principles and VAS, although, these arenarrowing and by the end of 2002, some of the major ones will have been eliminated as the VAS rules havebeen gradually changed to more closely accord with IAS. Principal differences in the past concernedaccruals of income and expense, (provided for by IAS but not until recently by VAS) and moreimportantly, the treatment of past due loans, and the effect this has on levels of provisions made in theprofit and loss account for bad and doubtful debts. Up until the end of 2001, only installments of loanspast due have been considered non-perforning loans (NPLs) under VAS, whilst under IAS, once a loan isclassified as past due, the whole loan amount is considered a NPL. A recent SBV decision (no. 1627) haschanged the VAS rules, and from February 2002, banks are required to classify the whole of overdue loansas non-performing, rather than just the overdue proportion. Also under VAS, (a) the bonus element of staffcosts and (b) capital tax, which was important (6% of capital up to 2000), but substantially reduced in2001 (1.8% of capital) and is being abolished in 2002, are both treated as a distribution of profits, whilstunder IAS, they are considered as operating expenses. Generally, VAS accounting results in higherapparent profits (therefore more tax) than IAS accounting.

5. Profitability BIDV has been profitable over the past five years, based on its VAS accounts,making an average of about $11 million per year, after tax or about 0.5% on earning assets. However

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under IAS and applying tough provisioning requirements BIDV showed a profit in 1997, 2000 and 2001(initial draft figures) but a loss in 1998 and a smaller loss in 1999. Most of BIDV's income stems from thespread between the interest collected on loans and cost of funds, with only about 12% coming from otheractivities. Over the past five years, the interest rate spread has averaged 2.4% on earning assets, but hasbeen falling. Operating costs (excluding provisions) are now at a well controlled level of about 1%.

BIDV - Profit & Loss Summary - LAS accounting (USS Million)

1997 1998 1999 2000 2001Draft

Interest Income 133.5 171.6 189.9 193.4 226.8Less Interest Cost (92.1) (124.3) (145.4) (117.4) (164.1)

Net Interest Income 41.4 47.3 44.5 76.0 62.7Other Income 3.9 9.1 4.9 6.0 9.8Total Income 45.3 56.4 49.3 82.0 72.5Staff Cost 9.0 8.6 8.7 12.2 10.3Other Operating Costs 14.0 14.4 16.9 19.6 20.4Provisions 8.5 99.2 21.5 40.4 31.7Total Non Interest Costs 31.6 122.1 47.1 72.2 62.4Net Profit Before Tax 13.7 (65.7) 2.3 9.7 10.1Business Income Tax 7.3 16.2 4.7 8.8 5.5After Tax profit 6.4 (81.9) (2.4) 0.9 4.6

Average Earning Assets 1,541 1,814 2,123 2,678 3,400

Key P&L Parameters 5 Year AvInterest Rate Spread as % EA 2.7% 2.6% 2.1% 2.8% 1.8% 2.4%Other Income as % EA 0.3% 0.5% 0.2% 0.2% 0.3% 0.3%Operating Costs (ex. Provs.) as % EA 1.5% 1.3% 1.2% 1.2% 0.9% 1.2%Provisions as % EA 0.6% 5.5% 1.0% 1.5% 0.9% 1.9%

6. This level of interest rate spread is low, and essentially restricts BIDV's potential to make goodprofits, and hence to grow fast using its own resources. Its level of operating costs is low for a financialinstitution of this type, and as a percent of earning assets; it compares favorably with the operating costs ofother Banks in developing countries (e.g. The Philippines). Staff compensation at only 0.3% is particularlylow; this is probably a result the very low real wages rates, which exist in Vietnam. While improvementsin operating efficiency are an important objective, the level of staff costs are so low that, there is not muchpotential benefit to be gained from focusing on staff cost reduction at this stage. The focus for improvedprofitability needs to be wider spreads, greater non-interest income and improved loan quality, hence lowernecessary provisions for loan losses.

7. Future projections (see Appendix A) indicate that BIDV is likely to be profitable under IAS, butthat the magnitude of future profitability will depend heavily upon re-capitalization by Government, asagreed under its restructuring plan and a concerted effort to diversify its income sources and raise itsspreads between lending and borrowing rates. The first re-capitalization tranche is planned for June 2001,or before effectiveness of this proposed IDA credit.

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8. Resources and Assets. By intemational standards, BIDV is undercapitalized, based on its LASbalance sheets, a summary of which are shown below:

BIDV Summary Balance Sheets 1996 - 2001 (US$ Million)

1996 1997 1998 1999 2000 2001Draft

Cash 9 10 11 42 22 29Deposits with SBV and 127 141 158 331 233 292Govermnent Securities & PreciousMetalsPlacements with Banks 113 285 323 378 587 763Commercial Loans - BIDV Risk 604 609 682 901 1,423 1,994Loans - GOV risk 648 774 900 970 951 891Total Loans 1,252 1,383 1,582 1,871 2,374 2,885Other Financial Assets 18 23 10 26 21 29Physical Assets 16 18 19 21 22 23

Total Assets 1.535 1.859 2.103 2.669 3.260 4.022

Financial Liabilities 1,473 1,788 2,088 2,637 3,228 3,985Net Equity 62 72 14 33 32 37

Total Liabilities & Capital 1.535 1.859 2.103 2.669 3.260 4,022

Contingencies and Commitments 121 228 331 362 474 571

Weighted Risk Assetsl/ 913 1,091 1,250 1,580 2,235 2,951Equity: Risk Assets Ratio 6.8% 6.6% 1.2% 2.1% 1.4% 1.3%1/Considered to include 100% of commercial loans, investments, other assets andfixed assets, 50% ofplacements with Banks and contingencies and commitments and 20% ofprecious metals, deposits with SBV,securities (GOV) and loans guaranteed by Government

9. Because of the losses, in 1998 and 1999, and the fact that BIDV has paid substantial businessincome tax (more than US$40 million over the past five years), its net worth, measured under IAS, hasbeen eroded and is estimated as about US$37 million at December 31, 2001, or only 1.3% of its weightedrisk assets. To meet with BIS standards, the Equity to Risk Weighted Assets ratio should be above 8%,and under the old OD 8.30, the World Bank called for mature DFIs to have an equity to weighted riskassets ratio of over 10%. Projections for BIDV, assuming the infusion of new capital as agreed under theRestructuring Plan and PRSC, indicate that it would meet the BIS standard by 2004. Given thatachievement of this depends to a large extent on re-capitalization by government, financial covenants in theIDA Credit are proposed which would require prudent criteria to be met over a predetermined time frame.

10. Loan Portfolio quality and Adequacv of Provisions. BIDV's total December 2001 gross loanportfolio of about VND 45 trillion, (US$3 billion) includes VND 10 trillion 'State Directed Loans', lent toSOEs on the instructions of Government, VND 1.2 trillion of 'frozen loans' and VND 2.5 trillion of loanson which it acts as a conduit for ODA projects and earns only a small spread of about 0.2%. The creditrisk on these three classes of loan (which have been financed with specific resources provided to BIDV for

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the purpose) is with Government, not BIDV. BIDV's own commercial loans, on which it is responsible forthe credit risk, amount to some VND 31.8 trillion. Accrued provisions for bad and doubtful debts withinthe loan portfolio, at the end of 2001 were VND 2.39 trillion under IAS and 1.03 trillion under VAS. Thesystem of loan classification and provisioning applied by the auditors under IAS for 2000 was quite strict,and resulted in higher provision levels than would be required in some other SE Asian countries. Forexample,. rates used by type of loan in BIDV's IAS accounts were 0% on 'high quality' 2% 'satisfactory',5% on 'pass', 20% on 'watch' 40% on 'substandard', 75% on 'doubtful' and 100% on 'loss'. Minimumrates required by the Central Bank in the Philippines (BSP) are 1% on performing unrestructured loans, 5%on performing restructured loans, 5% % on 'Watch List', 25% on 'substandard', 50% on 'doubtful' and100% on 'loss'. Had the minimum BSP levels of provisioning been applied to the BIDV portfolio, totalaccrued provisions would have been about 40% less, than shown in its accounts (some NVD 830 billion orUS$ 57 million less). Based on this, it would appear that while the provisioning under VAS will certainlyincrease substantially in 2002, to take account of decision 1627, the IAS levels are probably conservative.

11. Analysis of BIDV's data on credit quality, using VAS indicated that between December 2000 andDecember 2001, the absolute level of commercial NPLs, on which BIDV bears the risk, fell from VND 283billion to VND 275 billion or from 1.2% of the commercial portfolio of VDD22.7 trillion to 0.9% ofVND31.8 trillion. Over the same period substantial new provisions for bad debts were made, and atDecember 2001, accrued provisions were VND2.39 trillion, or VNDO.24 trillion higher than the yearearlier figure of VND2.15 trillion. Taken together, these figures indicate an improvement in net loanportfolio quality over the period.

12. Overview of Financial Situation. Initial accounts for 2001 indicate that BIDV is now a strongerinstitution financially than it was at December 1998. Over the past two years, BIDV has been profitableafter making substantial provisions for loan losses. In that its returns to SBV are based on VAS, furtherprovisioning will be necessary following the adoption of decision 1627 in 2002. This will almnost certainlymean that under VAS BIDV, in company with other SOCBs, will show a heavy loss for that year in theVAS accounts (and hence have to pay no income tax). In reality, the additional provisions required in 2002will be mainly be to correct an old imbalance, rather than to reduce estimates of earnings 1999 - 2001.(Under IAS accounting, this 'hit' was taken in 1998).

13. BIDV will certainly need additional equity capital if it is to comply with BIS capital adequacyrequirements and the World Bank's guidelines for Development Finance Institutions. Given its presentfunding, provision of such capital could be achieved by conversion of part of the long term financingprovided by Govemment from Debt to Equity. If BIDV becomes profitable and so can pay dividends onthat equity, equal to the previous long-term loan interest, this important element of BIDV's restructuringwould be achievable without any major negative fiscal impact on Treasury.

14. Institutional Development Plan (IDP). A Restructuring Plan for BIDV is already underimplementation as part of the SOCB's restructuring program, supported by the PRSC and the IMF. Keyelements of this are (a) clearly distinguishing between Government guaranteed 'state directed loans' andcommercial loans, identifying all loans with problems and cleaning the balance sheet of those debts whichwere bad at 31/12/2000, (b) the provision of additional equity by Government, to bring BIDV's capitaladequacy ratio to an acceptable intemational standard, (c) continuing with applying intemationalaccounting standards (IAS) and audit, (d) restructuring BIDV's organization and management, specificallyto (i) cover a broader range of activities, (ii) enhance effectiveness of supervision, (iii) improve riskmanagement, (iv) enhance human resources management and training and (v) upgrade BIDV's IT andbanking technology.

15. Carrying out this restructuring will provide a basis from which BIDV can develop and become aneffective Apex Bank. Even with the restructuring plan in place, however, BIDV will still need further

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strengthening in a number of key areas. Accordingly, BIDV is in the process of preparing a five-yearInstitutional Development Plan (IDP) which would be financially supported under the project, throughmaking available IDA funds for training, technical assistance and possibly hardware. Key elements, someof which provide strengthening and further quantification of the principles agreed in the restructuring planinclude:

* Continuing with the use of IAS2 for management purposes', and having accounts extemallyaudited by an international auditor even though some parallel use of VAS may continue to berequired for purposes of tax and reporting to SBV.

* Cleaning bad debts from the balance sheet as indicated under the Restructuring Plan and inconsequence being ready for re-capitalizing with a minimum of VND 1.2 trillion new equity tobe provided by July 31, 2002, and a further VND1.35 trillion by July 31, 2003.

* Striving to ensure that equity increases to be provided under the Restructuring Plan are timelyand that they result in BIDV meeting IAS/BIS standards for its Capital Assets Ratios by end2006.

* Enhancing asset quality by operating on a purely commercial basis, and not undertaking moreretail 'directed lending' and by classifying debts in line with decision 1627, analyzing risks,formalizing lending limits on a branch by branch basis, and strengthening intemal audit andsupervision.

* Setting business plan targets on margins and other eamings so that BIDV can eam sufficientprofits to prudently self finance its expansion, once the restructuring program is finished.

* Improving Govemance by clearly delineating the functions of the BIDV board and itsmanagement.

* Mobilizing more longer-term resources through a flexible range of financial instruments so asto more closely match the term of resources to the term of loans.

* Continuing to implement a phased program of modemizing bank technology* Implementing a training and staff development and recruitment program, which will raise the

average qualifications of BIDV staff, and provide for a growth in staff numbers sufficient tocope with the expanded and more diverse future operation of BIDV.

* Continuing to increase activities with the private sector, including lending to SMEs, andexpanding activities with foreign partners, including taking on the wholesaling role under thisproject.

16. A time-bound IDP, approved by the BIDV Board, with specific monitoring indicators would beagreed with the IDA by effectiveness. This would also include Profit and Loss and Balance SheetProjections through 2006 and the first year's proposals for training, technical assistance and hardware tobe funded under the project.

2/Because BIDV has Joint Venture enterprises in which its senior management and chairwoman are directly involved whichuse IAS, this type of accounting is familiar to BIDVand its introduction should therefore be straightforward.

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Additional Annex 13: BIDVs Operations, Financial Performance, and ProjectionsVIETNAM: Rural Finance II Project

Appendix A BIDV Projections

1. BIDV has made draft projections of its Balance Sheet and Profit and loss account for the next 5years, based on an Excel model, and discussed with the Pre-Appraisal Mission. These have been madeassuming a continuation of the present financial and inflation climate. Summary results are shown below,details of the underlying assumptions can be found in Tables I & 2.

2. These projections are essentially a compromise between BIDV's wish to continue to grow at highrates, and a realistic assumption on the earnings, which can be generated, and hence the constraint thatthese place on prudent growth rates. If the spreads in the lending market continue to allow net earnings ofonly about 1% of earning assets, as assumed here, then growth of 20% per annum plus could only occurwith regular additions to equity by the shareholder. In the models additional paid in capital is assumed tobe in line with the Restructuring Plan proposals, and so after 2004, growth is reigned back to about 12%p.a., and even then, if BIDV pays a modest dividend as well as tax, its capital adequacy ratio starts toweaken.

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Summary Profit & Loss Projections for BIDV (US$ Million)

2001 2002 2003 2004 2005 2006Average Within Year Exchange RateAssumed VND per US$ 14,750 15,000 15,000 15,000 15,000 15,000

Interest Income 227 256 277 297 320 342less Interest Cost (164) (196) (198) (210) (225) (239)

Net Interest Income 63 60 78 87 95 103Other Income 10 20 24 30 37 46Total Income 73 79 103 118 132 149

StaffCost 13 14 16 18 21 23Other Operating Costs 20 21 22 23 25 26Provisions 32 21 24 26 29 31Total Non Interest Costs 65 57 62 68 74 80

Net Profit Before Tax 8 23 41 50 58 68Business Income Tax 5 7 13 16 19 22After Tax profit 2 1X6 2 34 4-0 46

Key P&L Parameters

RealReturnonEquity 6% 18% 14% 11% 12% 12%Average Earning Assets 3,401 3,957 4,207 4,486 4,797 5,101Interest Rate Spread as % EA 1.8% 1.5% 1.9% 1.9% 2.0% 2.0%Other Income as % EA 0.3% 0.5% 0.6% 0.7% 0.8% 0.9%Operating Costs (excl. Provisions) as % EA 1.0% 0.9% 0.9% 0.9% 0.9% 1.0%Provisions as % EA 0.9% 0.5% 0.6% 0.6% 0.6% 0.6%

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Summary Balance Sheet (US$ Million)

2000 2001 2002 2003 2004 2005 2006Assumed Year End Exchange Rate 14,500 15,000 15,000 15,000 15,000 15,000 15,000VND per US$AssetsCash 22 29 31 33 35 37 39Deposits with SBV and Government 233 292 223 240 258 278 299Securities & Precious MetalsPlacements with Banks 587 763 783 836 894 956 1,023Comnmercial Loans - BIDV Risk 1,423 1,994 2,333 2,611 2,873 3,139 3,384Loans - GOV risk 951 891 765 645 611 572 540Total Loans 2,374 2,885 3,098 3,257 3,484 3,711 3,924Other Financial Assets 21 29 44 58 73 74 75Physical Assets 22 23 24 26 28 30 32

Total Assets 3.260 4.022 4.203 4.451 4.773 5.086 5.392

Financial LiabilitiesDeposits 1,553 2,016 2,206 2,415 2,644 2,895 3,170Borrowed from Banks & Others 338 486 248 243 292 309 320GOV Deposits including deposits for 707 734 865 785 791 792 760Specific ProgramsCertificates of Deposit 569 687 687 687 687 687 687Other Liabilities 61 62 64 70 75 81 87Total Liabilities 3.228 3.985 4,071 4.201 4.490 4.764 5.025Net Equity 32 37 132 249 283 321 367Total Liabilities & Equity 3.260 4.022 4.203 4.451 4.773 5.086 5.392Contingencies and Commitments 474 571 600 630 661 694 729Weighted Risk Assetsl/ 2,234 2,950 3,290 3,606 3,926 4,238 4,535

Equity to Weighted Risk Assets 1.4% 1.3% 4.0% 6.9% 7.2% 7.6% 8.1%RatioLiquidity Ratio 2/ 71% 70% 59% 57% 56% 55% 54%

1/ Considered to include 100% of commercial loans, investments, precious metal, other assets and fLxed assets; 50% of placements with Banksand contingencies and commitments; and 20% of deposits with SBV, securities (GOV) and loans guaranteed by Government.2/ Assuming 50% of deposits are short term and that liquid assets include cash, deposits with SBV, investment in GOV securities and 50% ofplacements with Banks.

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Table 1. BIDV Balance Sheets Projectlons 2000 -2006 (Billion VND)

Change over Perod 2000 2001 2002 2003 2004 2005 2006

01 -04 04-06 Audited Unaudited IDP Projectnons s-

ASSETS [AS IAS IAS [AS [AS IAS IAS

Cash & Cash equivalent Growth 6% 6% 315 441 467 496 525 557 590

Precious Metals Growth 0% 0% 25 23 23 23 23 23 23

Reserve Deposits at SBV % Deps 5% 5% 2,624 2,840 1,655 1,738 1,824 1,916 2,011

Securibes Growth 10% 10% 732 1,519 1,671 1,838 2,022 2,224 2,446

Placements with Other Banks -VND Growth 5% 5% 647 1,474 1,548 1,625 1,706 1,792 1,881

Placements with Other Banks -FX Balance Collection 7,869 9,978 10,192 10,920 11,704 12,549 13,459

Loans & Discounts

Commercial Loans - Private Growth 10% 10% 4,500 6,000 6,600 7,260 7,986 8,785 9,663

Commercial Loans - SOEs Growth 8% 8% 18,285 26,303 28,407 30,680 33,134 35,785 38,648

State Planning Loans -Directed Reduce 3,338 3,000 2,000 720 600 400 200

State Planning Loans- Other Reduce 7,955 6,683 6,200 5,700 5,200 4,700 4,200

Trust Loans (ODA) 7% 7% 2,019 2,500 2,675 2,862 3,063 3,277 3,506

Rural Finance I B 2 Schedule 1,500 2,100 2,700 3,300 3,300

Frozen Loans Reduce 475 1,182 600 400 300 200 200

Less Provisions for Bad debts 1% Prev 2Yr O/S Lns (2,152) (2,394) (1,511) (870) (718) (786) (855)

Sub Total Net Loans & Discounts 34,420 43,274 46,471 48,852 52,265 55.660 58,862

Investments Growth 199 204 400 600 800 800 800

Tangible Fixed Assets Growth 8% 6% 326 338 365 394 426 451 478

OtherAssets Growth 8% 6% 106 234 253 273 295 312 331

TOTAL ASSETS 47,263 60,325 63,045 66,758 71,590 76,284 80,883

LIABILITIES & CAPITAL

Deposits/Borrowings from Other Banks -VND Balancing Figure 473 2,717 (878) (980) (271) (52) 88

DepositstBorrowings from Other Banks -FX Growth 2% 2% 1,679 1,435 1,464 1,493 1,523 1,553 1,584

Depoits from Customers -VND Growth 10% 10% 17,086 22,153 24,368 26,805 29,486 32,434 35,678

Depoits from Customers- FX Growth 8% 8% 5,427 8,082 8,729 9,427 10,181 10,995 11,875

CDs Growth 0% 0% 8,247 10,309 10,309 10,309 10,309 10,309 10,309

Dep & Borrowings from SBV & Govt -SPLs Balances SPLs 6,568 6,494 8,200 6,420 5,800 5,100 4,400

Dep & Borrowings from SBV & Govt- FLs Balance FLs 260 812 600 400 300 200 200

Dep & Borrowings from SBV & Govt- Other Part Balancing Figure 1,832 1,642

MOF for Rural Finance 1 & 2 Balance 1,500 2,100 2,700 3,300 3,300

Borrowed Trust Funds Balance 1,590 2,063 2,675 2,862 3,063 3,277 3,506

Other Borrowed Funds Growth 0% 0% 2,755 3,135 3,135 3,135 3,135 3,135 3,135

Other Uabilities Growth 7% 7% 765 871 932 997 1,067 1,142 1,222

Dividends Payable Due for Yr 0 0 0

Income Taxes Payable one quarter 119 57 27 48 58 69 80

TOTAL LIABILITIES 46,801 59,770 61,061 63,016 67,351 71,462 75,377

Equity (Capital) perschedule 1,076 1,100 2,300 3,650 3,650 3,650 3,650

Funds (Reserves & Retained Profits) (614) (545) (315) 92 589 1,172 1,856

TOTAL CAPITAL 462 555 1,985 3,742 4,239 4,822 5,506

TOTAL LIABILITIES & CAPITAL 47,263 60,325 63,045 66,758 71,590 76,284 80,883

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ContIngencies & Commitments Growth 5% 5% 6,873 8,568 8,996 9,446 9,919 10,414 10,935

Eaming Assets 43,867 56,449 60,282 63,835 68,497 73,025 77,449

Weighted FRsk assets 1/ 32,392 44,244 49,347 54,089 58,893 63,572 68,021

Capital to Weighted Risk Assets 1.3% 4.0% 6.9% 7.2% 7.6% 8.1%

Net After Tax Profit to Av Total Assets 0.06% 0.37% 0.63% 0.72% 0.79% 0.87%

Net After Tax Profit to Av Eaming Assets 0.06% 0.39% 0.66% 0.75% 0.82% 0.91%

Inflation Adjusted Profit (2% Infl) 27 213 361 430 507 597

AfterTax Real Retum on Equity (assumes paid in capital comes mid year) 6% 18% 14% 11% 12% 12%

Year on Year Growth in Totl Assets 28% 5% 6% 7% 7% 6%

Year on Year Growth In Weighted Risk Assets 37% 12% 10% 9% 8% 7%

Average Numbers Outstanding In Year for P&L Estimates

2000 2001 2002 2003 2004 2005 2006

Elements Contributing to Income (Average Loan or Asset Amounts for Year)

Loans to Customers (exl Trust & RF & Provs & NP) 31,703 35,283 38,736 42,093 45,619

SP Loans 8,942 7,310 6,110 5,450 4,750

RFP I & 2 Loans 750 1,800 2,400 3,000 3,300

Placements (Domestc) 1,511 1,586 1,666 1,749 1,836

Plcements (Foreign Currency) 10,085 10,556 11,312 12,126 13,004

Secutites 1,595 1,754 1,930 2,123 2,335

Investments (to GiveDividend Income) 302 500 700 800 800

Trust Loans (to calculate comission) 2,675 2,862 3,063 3,277 3,506

Elements Contributing to Income Expanse (AV for Year)

Depositsd/Brroanngs from Other Banks -VND 920 (929) (625) (162) 18

DepostsBorrovlngs from Other Banks -FX 1,449 1,478 1,508 1,538 1,569

Depoits from Customers -VND 23,261 25,587 28,145 30,960 34,056

Depoits from CustDrners- FX 8,405 9,078 9,804 10,588 11,435

CDs 10,309 10,309 10,309 10,309 10,309

Dep & Boowingsfrom SBV & Govt-SPLs 7,347 7,310 6,110 5,450 4,750

Dep & Borrowings from SBV & Govt -Other 821 - -

MOF for Rural Finance 1 & 2 750 1,800 2,400 3,000 3,300

Other Borrwed Funds 3,135 3,135 3,135 3,135 3,135

Assumed Provision Change and Write Offs

Opening Provisionshfr Bad Debts 2,152 2,394 1,511 870 718 786

New Provisions Made in Year 468 317 353 387 421 456

Bad Debts Written Off 226 1,200 994 539 353 387

Closing Provisions 2,394 1,511 870 718 786 855

After 2004, Provisions assumed to cover NPLs 100% with W/O happening two years after loan becomes PD on average.

1/ Considered toinclude 100%ofcommerial bans, investments, predous metal, otherassets and fixed assets; 50%of placementswith Banks

and of Contingencies and commitments; and 20% of deposits with SBV, securibes(GOV) and bans guaranteed by Govemment

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Table 2. BIDV Profit & Loss Projections (VND Billion)

Billion VND in Nominal Terms (implicit assumption that present 2% inflation domestic and international inflation continues)

2001 2002 2003 2004 2005 2006

Interest Income 3,345 3,771 4,081 4,387 4,718 5,044

less Interest Cost (2,420) (2,887) (2,926) (3,102) (3,321) (3,525)

Net Interest Income 925 884 1,155 1,285 1,397 1,519

Other Income 145 288 361 450 552 674

Total Income 1,070 1,172 1,516 1,735 1,949 2,193

Staff Cost 190 214 240 270 304 342

Other Operating Costs 301 304 324 346 367 389

Provisions 468 317 353 387 421 456

Total Non Interest Costs 959 835 917 1,003 1,092 1,187

Net Profit Before Tax 111 338 599 731 857 1,006

Business Income Tax 81 108 192 234 274 322

After Tax profit 30 230 407 497 583 684

Key P&L Parameters

Real Return on Equity 6% 18% 14% 11% 12% 12%

Average Earning Assets 50,158 58,366 62,059 66,166 70,761 75,237

Interest Rate Spread as % EA 1.8% 1.5% 1.9% 1.9% 2.0% 2.0%

Other Income as % EA 0.3% 0.5% 0.6% 0.7% 0.8% 0.9%

Operating Costs (excl. Provisions) as % EA 1.0% 0.9% 0.9% 0.9% 0.9% 1.0%

Provisions as % EA 0.9% 0.5% 0.6% 0.6% 0.6% 0.6%

Summary Balance Sheet (VND BiRion)

2000 2001 2002 2003 2004 2005 2006

Cash 315 441 467 496 525 557 590

Deposits with SBV and Govermnent Securities 3,381 4,382 3,349 3,599 3,869 4,163 4,481

Placements with Banks 8,516 11,452 11,740 12,545 13,410 14,340 15,341

Commercial Loans - BIDV Risk 20,633 29,909 34,996 39,170 43,102 47,083 50,756

Loans - GOV risk 13,787 13,365 11,475 9,682 9,163 8,577 8,106

Total Loans 34,420 43,274 46,471 48,852 52,265 55,660 58,862

OtherFinancial Assets 305 438 653 873 1,095 1,112 1,131

Physical Assets 326 338 365 394 426 451 478

Total Assets 47,263 60,325 63,045 66,758 71,590 76,284 80,883

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Financial Liabilities 2000 2.001 2.002 2.003 2.004 2.005 2.006

Deposits 22,513 30,235 33,097 36,232 39,667 43,430 47,553

Bofrowed from Banks & Others 4,907 7,287 3,721 3,648 4,387 4,636 4,807

GOV Funding inci for Specific Programmes 10,250 11,011 12,975 11,782 11,863 11,877 11,406

Certificates of Deposit 8,247 10,309 10,309 10,309 10,309 10,309 10,309

OtherLiabilities 884 928 959 1,045 1,126 1,210 1,302

Net Equity 462 555 1,985 3,742 4,239 4,822 5,506

Total Liabilities & Equity 47,263 60,325 63,045 66,758 71,590 76,284 80,883

Weighted Risk Assets I/ 32,392 44,244 49,347 54,089 58,893 63,572 68,021

Equity to Weighted Risk Assets Ratio 1.4% 1.3% 4.0% 6.9% 7.2% 7.6% 8.1%

Liquidity Ratio 2/ 71% 70% 59% 57% 56% 55% 54%

1/ Considered to include 100% of commercial loans, investments, precious metal, other assets and fixed assets, 50% of placements with Banks

and of Contingencies and commitments; and 20% of deposits with SBV, securities(GOV) and loans guaranteed by Govemment.

2/ Assuming 50% of deposits are short term and that liquid assets include cash, deposits with SBV, investment in GOV securities and 50% of

placements with Banks.

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Additional Annex 14: VBARD's Operations, Financial Performance, and ProjectionsVIETNAM: Second Rural Finance Project

1. Background. VBARD was established in 1988 (under Decree 53/HDBT of 20 March 1988). Itbecame a formal institution, separated from the State Bank, and named the Vietnam Bank for Agriculture(VBA) only in 1990. In 1996, its name was changed to VBARD and its mandate extended to develop therural economy (Decision 280/QD), rather than just agriculture. VBARD is owned solely by the State; it issupervised directly by the SBV, and indirectly by the MOF and the Prime Minister's Office. VBARD'sinitial authorized capital was merely VND 200 billion in 1990 (USD$30 million at the then exchange rate).When joining the RFP, its capital had increased to VND 406 billion (end of 1996); this was subsequentlyincreased in 1998 to VND 2.3 trillion (VND 2.5 trillion using Vietnamese Accounting Standards (VAS)).

2. Compared to agriculture banks elsewhere in the region, VBARD is one of the youngest. During itsfirst decade in operation, VBARD has grown substantially in size and in scope. It is the dominant financialinstitution in the rural areas and the largest depository institution in the country. During the 1990s,VBARD made substantial contribution to Vietnam's most outstanding achievements under Renovation("doi moi"). VB3ARD is now the biggest bank in Vietnam. It has the largest work force (23 thousand) andthe most extensive network (over 1,400 branches). It serves 5.5 million households in rural areas or about45% of the total. It has been growing rapidly and has more than doubled in size over the past three years.Based on its draft VAS accounts, its total assets at the end of 2001 were almost US$5 billion and totaloutstanding loans were US$ 4 billion.

3. Profitability. Compared with other agricultural banks in the region, VBARD has been successfulin delivering funds effectively and relatively inexpensively to the rural areas, but due largely to interest raterestrictions, it has been unprofitable. Profit and Loss Accounts for the period 1997 - 2000 are summarizedbelow:

VBARD Summary Profit and Loss AccountsAudited IAS figures 1997-2000 (US$million)

1997 1998 1999 2000Interest Income 235.3 221.1 244.4 257.6Less Interest Cost (146.5) (149.8) (143.3) (127.0)NetInterestIncome 88.8 71.3 101.1 130.6Other Income 11.3 10.3 23.0 25.4Total Income 100.0 81.6 124.1 155.9Staff Cost 30.4 29.1 26.3 44.6Other Operating Costs 43.9 49.1 54.9 62.1Provisions For Bad Debts 67.6 37.5 43.4 103.6Total Non Interest Costs 141.9 115.6 124.6 210.3Net Profit Before Tax (41.9 (34.(0- (05 (54.4Business Income Tax 17.6 4.0 8.5 10.5After Tax profit (381) (4M O A&Average Earning Assets (EA)I/ 1,692 1,793 2,035 2,590

I/Average of opening and closing balances of net loans, investments, securities and placements with banks.

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Key P&L Parameters1997 1998 1999 2000 4 Year

AverageInterest Income as % EA 13.9% 12.3% 12.0% 9.9% 12.0%Interest Cost as % EA 8.7% 8.4% 7.0% 4.9% 7.2%Interest Rate Spread as % EA 5.2% 4.0% 5.0% 5.0% 4.8%Other Income as % EA 0.7% 0.6% 1.1% 1.0% 0.8%Operating Costs (ex. Provs.) as % EA 4.4% 4.4% 4.0% 4.1% 4.2%Provisions as % EA 4.0% 2.1% 2.1% 4.0% 3.1%Pre - Tax Profit as % EA -2.5% -1.9% 0.0% -2.1% -1.6%Business Income Tax as % EA 1.0% 0.2% 0.4% 0.4% 0.5%After Tax Profit as % EA -3.5% -2.1% -0.4% -2.5% -2.1%

4. VBARD's operating costs are quite low and have declined as a percentage of earning assetsbetween 1997 and 2000. Considering the type of lending it makes, VBARD's provisions, which under IAShave averaged 3.1% of earning assets, are also acceptably low. VBARD's main problems are firstly that ithas very little capital, hence only a small part of its resources comes to it at zero cost and secondly that it isnot eaming sufficiently large interest rate spreads. Given its near monopoly position in rural areas, thislack of adequate spread is almost certainly explained by the ceiling placed by SBV on the rates, whichVBARD can charge.

5. On the cost of resources side, VBARD is in competition with the other banks, and probably cannotdo a lot to lower the cost of funds. However, there should be considerable room for maneuver on the ratesthat it charges. It is clear from the Socio-Economic Impact Assessment of the Rural Finance Project thatthere is a strong demand for funds and that alternative informal funding at much higher interest is widelyused. This leads to the conclusion that the market, particularly that for small rural loans, where there islittle formal competition, would bear significantly higher interest rates. It will be important for SBV tocarefully review the level of rates it allows to be charged and to raise these, so that banks, and in particularVBARD, can charge interest at levels which allow them to be profitable, and preferably to the extent thatthey can self finance their own expansion.

6. To have grown at the average rate of the last four years (Risk Assets grew by an average of 21 %p.a. in terms of VND between December 1996 and December 2000), after tax profits as a percent ofearning assets would have needed to have been about 1.8% to have contributed incremental equity at 8% ofrisk asset growth. Given that the actual result over the period was an average loss of 2.1%, a turnaround inafter tax profit of about 3.9% would be needed. Assuming that this would have been taxed, at the marginat 32%, interest rates would have needed to have averaged about 5.7% p.a. higher for VBARD to havebeen profitable enough to have prudently financed its own expansion, i.e. they should have averaged about17.7% p.a. (1.475% per month), not 12.0% p.a., over the period as a whole and been about 15.6% p.a. in2000. In future, with a closer aligmnent between IAS and VAS, it can be expected that only profits asrecorded under IAS will be taxed. In that case, interest earnings would need to be 1.6% p.a. higher tobreak even, plus a further 2.7% p.a. (taxable at 32%) to give a 1.8% (on earning assets) after tax profit.That is they should average about 4.3% higher overall, i.e. if the future cost funds were to be the same asthe 1996 - 2000 (average 7.2% p.a.), and other costs and non-interest earnings also remain the same,average income from all earning assets would need to be 16.3% p.a. (1.36% per month ).

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7. Assets and Resources. A summary of VBARD's balance sheets for the past six years are shownbelow and detailed in Appendices 3 and 4. While most reliance should be placed on the audited IASfigures, the draft VAS figures are also shown for 2000 and 2001 to give a better indication of the presentsituation.

VBARD'S Summary Balance Sheets 1996-2001 (US$Million)

1929 1997 1998 1999 2000 2Q0 2001--------------- IAS Audited Figures-------------- ---Draft VAS---

Cash 44 42 45 91 61 61 67Deposits with SBV, Govt Securities 166 172 315 207 319 319 321& Precious MetalsPlacements with Banks 238 89 139 190 354 249 314Total Loans 1,579 1,675 1,751 2,049 2,717 3,103 4,040Other Financial Assets 81 22 18 34 48 101 157Physical Assets 30 41 44 50 61 47 57Total Assets 2.136 2.041 2.312 2.621 3.560 3.880 4.955

Deposits from Customers 784 876 950 1,388 1,670 1,476 1,839CDs & Bonds 494 575 598 520 524 526 667Deposits of SBV & Treasury 370 180 155 322 864 842 1,100Other Financial Liabilities 429 391 522 308 486 844 1,118Total Liabilities 2.078 2022 2.224 2.540 3.545 3.688 4 724

Authorized Capital 36 58 159 162 157 170 163Reserves 23 (39) (71) (81) (142) 22 68

Total Equity 59 19 88 81 15 192 231

Contingencies and Commitments 122 187 251 167 179 179 n.a.

8. A significant proportion of the resources for VBARD's expansion has come from mobilization ofdeposits from customers, which by December 2001 had grown to US$1.8 billion. Other major fundingsources have included CDs issued US$0.7 billion and deposits of SBV and Treasury amounting to US$1.1billion. These Government resources include about US$0.3 billion to support state planning loans andUS$0.8 billion of deposits. Because VBARD's growth over the past four years has not been profitable(under IAS accounting, it has lost an aggregate of about US$ 130 million pre tax in the four years1997-2000) and it has had to pay tax - about US$40 million over the same period, its equity position hasweakened, despite increases in Paid in Capital.

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VBARD Risk Assets to Eguitv based on Balance Sheets 1996 - 2001 (U1S$ Million)

1996 1997 1998 1999 2000 2000 2001--------------- IAS Audited Figures-- - ------- ---Draft VAS---

Weighted Risk Assets 3/ 1,902 1,911 2,071 2,353 3,156 3,529 4,575Total Equity 59 19 88 81 15 192 231Equity to Weighted Risk Assets 3.1% 1.0% 4.3% 3.5% 0.5% 5.5% 5.0%

9. Under IAS, VBARD's situation is very weak, and its suitability to act as conduit depends on theimplementation of re-capitalization agreed under the Restructuring Plan. The apparently better situationunder VAS is mainly caused by the fact that under VAS, only the proportion of the loan, which shouldhave been repaid, but has not been, is classified as past due and hence requires loss provisions to becreated. Under IAS, once a loan repayment installment has been missed, the whole loan (not just theoverdue installment) is classified as past due, and is therefore subject to provisioning. However even underVAS, VBARD is far from meeting the international minimum capital adequacy standard of 8%.

10. Loan Portfolio. As in the case of other SOCBs, VBARD has many bad and risky debts in itsportfolio. At the end of 2000, total problem loans, were estimated to have amounted to about VND 9trillion. Most of these loans are either "directed loans" or loans guaranteed by the government. Theresolution of these loans is an important element of VBARD's Restructuring Plan, agreed with SBV andpart of the actions required under PRSC tranche conditionality. Only VND 167 billion of the problemloans are collateralized loans that VBARD can deal with directly itself (through its AMC). Cleaning up theremainder and at the same time restoring VBARD's capital adequacy ratio to an acceptable level willrequire introduction of additional funding.

11. As a result of substantial provisions made over the past four years, the quality of VBARD's netloan portfolio has greatly improved, based on VAS accounting, and probably improved under IAS. Thelevel of accrued loan loss provisions is now more than 8 times greater than the level past due installmentsindicated in the 2000 audit (US$23 million), whereas in 1996, provisions had covered only 46% percent ofpast due loan installments. However, the 2000 lAS Audit did express concern over the lack of adequateinformation to fully support the level of provisioning made for bad and doubtful debts at the end of 2000(US$ 190 million). This appeared to be concemed lack of clear documentation on which loans would befully supported by Govemment and therefore the issue should be clarified and resolved during therestructuring process.

12. Future Policy. VBARD is conunitted to becoming a commercial rural bank, serving a widelybased rural clientele, meeting intemational criteria, and operating on a commercial basis. Its RestructuringPlan and IDP, which are discussed elsewhere in this report are geared to supporting this. VBARD's ownworking documents indicate that it wants to continue to expand quickly. This will only be possible if,firstly it is re-capitalized, at least to the extent planned, and secondly if it becomes much more profitableand so is able to build up reserves from its profits. Projections for VBARD have been prepared on thisbasis and are geared to ensuring that VBARD meets the equity to risk assets target of at least 8% by 2005.The policy implications, particularly with respect to the necessity for higher interest rate spreads, wouldneed to be considered and approved by SBV and VBARD's board before these projections could beconsidered as 'realistic'. A summary of the results from the model are shown below, and the details set outas Appendix B.

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Summary VBARD Balance Sheet (US$Million)

2000 2001 2002 2003 2004 2005 2006

Cash 61 67 77 88 101 112 123Deposits with SBV and Government 319 322 235 257 281 309 340Securities & Precious MetalsPlacements with Banks 354 400 534 585 642 705 774Net Loans - VBARD Risk 1,782 3,113 3,863 4,707 5,704 6,545 7,498Loans -GOV risk 935 593 347 188 133 93 60Total Net Loans 2,717 3,707 4,210 4,895 5,837 6,638 7,558Other Financial Assets 48 62 85 105 124 131 139Physical Assets 61 71 82 94 108 119 131Total Assets 3.5f0 4. 6 .624 7095 B&1l4 906Financial LiabilitiesDeposits 1,670 2,167 2,663 3,280 4,045 4,814 5,733Borrowed from Banks & Others 411 626 503 571 707 688 675GOV Deposits 864 1,067 1,027 987 967 960 960Certificates of Deposit 524 667 700 735 772 772 772Other Liabilities 76 82 92 112 131 146 162Total Liabilities 3.545 4.608 4.985 5.685 6,621 7,380 8.302Net Equity 15 20 237 339 474 634 762Total Liabilities & Equity 6 624 7,095 8,0&4 29064

Weighted Risk Assets'/ 2,408 3,720 4,517 5,406 6,477 7,379 8,400

Equity to Weighted Risk Assets 0.6% 0.5% 5.3% 6.3% 7.3% 8.6% 9.1%Ratio

1/ Considered to include 100% of commercial loans, investments, precious metal, other assets and fixed assets, 50% ofplacements with Banks and 20% of deposits with SBV, securities (GOV) and loans guaranteed by Government.

13. VBARD's projected balance sheet indicates total asset growth to VND 120 billion by 2005, withthe major share being in loans to small farmers. Borrowings from Banks & Others shown here, includesODA funding such as ADB and RFP I and II. Equity build up would be from new capital and retainedprofits. In this regard, it is assumed that no dividends would be paid, at least through 2005.

14. To earn sufficient profit to remain viable under growth conditions, VBARD needs to increaseinterest rates where it can, and to try to expand its non interest earnings. Interest rates on loans tocommercial enterprises and interest paid on deposits are largely market determined, and VBARD may nothave much flexibility in changing these. However, it should be able to increase rates charged to smallfarmers. In the projections, it has been assumed that the present conditions persist. Vietnam inflation isassumed to remain at. 2% p.a., in line with international inflation (hence constant exchange rate), interestrates on inter-bank loans in VND are projected at 6% p.a., average cost of deposits 5.5% p.a., and cost ofRFP I funds 6.5% p.a. In this environment, commercial loans are assumed to yield 8.5% p.a. and those tosmall farmers 13% p.a. Operating costs are expected to remain roughly at their present level as apercentage of earning assets, increased efficiency being offset by higher real wages. Provisions for bad anddoubtful debts are estimated to amount to 2% of the year end balance of loans outstanding, on whichVBARD takes the credit risk. Write offs are assumed to take place on bad loans an average of 18 months

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after the end of the year in which the became non-performing, so that the level of outstanding accruedprovisions in the balance sheet is approximately 3% of loans outstanding.

Summary Profit & Loss Projections for VBARD (US$ Million)2001 2002 2003 2004 2005 2006

Interest Income 366 471 565 663 772 880less Interest Cost (214) (263) (294) (340) (387) (433)

Net Interest Income 152 209 271 323 385 447Other Income 37 54 70 90 116 148Total Income 189 263 341 413 501 595

Staff Cost 54 65 78 94 112 135Other Operating Costs 66 83 94 106 118 132Provisions for Bad & Doubtful Debts 56 78 87 101 121 138Total Non Interest Costs 175 226 259 301 351 404

Net Profit Before Tax 14 37 82 112 149 191Business Income Tax 8 - 26 36 48 61After Tax profit 6 32 5 76 102 13

Kev P&L ParametersReal Return on Equity 44% 32% 20% 19% 18% 19%Average Earning Assets (EA) 3,655 4,615 5,343 6,256 7,229 8,193

Interest Rate Spread p.a. as % EA 4.2% 4.5% 5.1% 5.2% 5.3% 5.5%Other Income p.a. as % EA 1.0% 1.2% 1.3% 1.4% 1.6% 1.8%Operating Costs p.a. (ex. Provisions) as % EA 3.3% 3.2% 3.2% 3.2% 3.2% 3.3%Provisions p.a. as % EA 1.5% 1.7% 1.6% 1.6% 1.7% 1.7%

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Appendix ATable 1

VBARD Profit & Loss Accounts - IAS (billion VND)

1996 1997 1998 i99 2000EARNINGSInterest on Loans & Discounts 2,958 2,757 2,892 3,410 3,666Dividend Income 1 2 4 3 8Commissions, Fees, & Trust Dept 101 90 98 177 215Other Income 28 42 37 144 147TOTAL EARNINGS 3 088 2,891 3.031 3.734 4.036

Interest Expense 2,084 1,718 1,962 2,001 1,812

Earnings Net of Interest Expense 1 004 1 173 1 069 1 733 2 224

Compensation & Benefits 292 356 381 367 636Depreciation/Amortization 40 72 80 77 98Taxes & Licenses 52 61 80 143 143Other Administration Costs 349 382 483 547 645Total Operating Costs 733 871 1 024 1.134 1.522

Provision for Probable Losses & Write Offs 191 793 491 606 1,478

NET INCOME PRE TAX 80 (491) (446) 2 (776)

Tax 23 206 53 119 150

NET PROFIT FOR YEAR AFTER TAX 52 (19) (422) (126)

Opening Equity 597 656 234 1,226 1,141

After Tax RoE 9.5% -106.3% -213.3% -10.3% -81.2%Within Year Inflation 2.8% 7.5% -1.6% 0.0%Approximnate Real RoE 10% -106% -205% -9% -81%

Eaining Assets (EA) -Average Balance 16,402 19,846 23,494 28,418 36,939

Interest Income & Divs as % Earning Assets 18.04% 13.90% 12.33% 12.01% 9.95%Other Income as % of Earning Assets 0.79% 0.67% 0.57% 1.13% 0.98%Total Earnings as % Earning Assets 18.83% 14.57% 12.90% 13.14% 10.93%Interest Expense as % of Earning Assets 12.71% 8.66% 8.35% 7.04% 4.91%Income (net of interest cost) as Percent EA 6.12% 5.91% 4.55% 6.10% 6.02%Operating Costs as Percent of EA 4.47% 4.39% 4.36% 3.99% 4.12%Provisions as % of EA 1.16% 4.00% 2.09% 2.13% 4.00%Taxation as % of EA 0.14% 1.04% 0.23% 0.42% 0.41%Profit/Loss as % of EA 0.35% -3.51% -2.12% -0.44% -2.51%

1/ Net Loans plus investments, securities and placements with banks.

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Appendix ATable 2

VBARD Profit & Loss Accounts - IAS (million US$)

1996 1997 1998 1999 2000VNDperUS$ 10,827 11,727 13,100 13,963 14,263

EARNINGSInterest on Loans & Discounts 273.2 235.1 220.8 244.2 257.0Dividend Income 0.1 0.2 0.3 0.2 0.6Commissions, Fees, & Trust Dept 9.3 7.7 7.5 12.7 15.1Other Income 2.6 3.6 2.8 10.3 10.3TOTAL EARNINGS 285.2 246.5 231.4 267.4 283.0

Interest Expense 192.5 146.5 149.8 143.3 127.0

Earnings Net of Interest Expense 92.7 100.0 81.6 124.1 155.9

Compensation & Benefits 27.0 30.4 29.1 26.3 44.6Depreciation/Amortization 3.7 6.1 6.1 5.5 6.9Taxes & Licenses 4.8 5.2 6.1 10.2 10.0Other Administration Costs 32.2 32.6 36.9 39.2 45.2Total Operating Costs 67.7 74.3 78.2 81.2 106.7

Provision for Probable Losses & Write Offs 17.6 67.6 37.5 43.4 103.6

NET INCOME PRE TAX 7.4 (41.9' (34.0) (0.5) (54.4!

Tax 2.1 17.6 4.0 8.5 10.5

NET PROFIT FOR YEAR AFTER TAX 5X (59.4) (31 (9 (64.9)

Opening Equity 55.1 55.9 17.9 87.8 80.0After Tax RoE 10% -106% -213% -10% -81%

Earning Assets (EA) - Average Balance 1/ 1,514.9 1,692.3 1,793.4 2,035.3 2,589.9

Interest Income & Dividends as % EA 18.0% 13.9% 12.3% 12.0% 9.9%Other Income as % of Earning Assets 0.8% 0.7% 0.6% 1.1% 1.0%Total Earnings as % Earning Assets 18.8% 14.6% 12.9% 13.1% 10.9%Interest Expense as % of Earning Assets 12.7% 8.7% 8.4% 7.0% 4.9%Income (net of interest cost) as Percent EA 6.1% 5.9% 4.6% 6.1% 6.0%Operating Costs as Percent of EA 4.5% 4.4% 4.4% 4.0% 4.1%Provisions as %ofEA 1.2% 4.0% 2.1% 2.1% 4.0%Taxation as % of EA 0.1% 1.0% 0.2% 0.4% 0.4%Profit/Loss as % of EA 0.3% -3.5% -2.1% -0.4% -2.5%

Operating Costs as % of Gross Margin 73% 74% 96% 65% 68%

1/ Net Loans plus investments, securities and placements with banks.

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Appendix ATable 3

VBARD's Balance Sheet 1996-2001(VND billions)

1996 1997 1998 1999 2000 2000 2001---------------------- Audited - IAS-------------- - - Unaudited Draft - VAS

AssetsCash and Notes 489 512 623 1,275 886 886 1,000Precious Metals 4 3 4 3 4 4 6Deposits with SBV 1,842 2,114 3,823 2,662 4,484 4,484 3,480Treasury Bills 555 238 136 136 1,325Placements with, & Loans/Adv. to other Banks 2,654 1,094 1,927 2,668 5,131 3,605 4,703Loans and Advances to Customers 17,607 20,608 24,339 28,736 39,393 44,999 60,607Other Assets 760 137 161 385 594) 1,458 2,354Investments 141 139 96 93 101 )Tangible Fixed Assets 333 500 607 698 887 687 857

Total Assets 23.830 25.107 32.134 36.758 51.616 56.259 74.332

LiabilitiesDeposits and Borrowings from SBV & Treasury 4,124 2,208 2,148 4,519 12,531 12,202 16,506- Normal Short Term Borrowings 677 600 929 505)- Borrowings to Support State Planning Loans 647 661 1,236 1,889) 4,062 4,743- Borrowings to Support Frozen Loans 884 886 931 1,687)- Deposits from State Treasury 1,423 8,449 8,140 11,764

Deposits and Borrowings from Other Banks 3,685 2,715 4,376 1,128 3,150 6,237 9,447Deposits from Customers 8,745 10,779 13,205 19,472 24,216 21,406 27,585Certificates of Deposit 5,515 7,071 8,306 7,300 7,598 7,628 10,001OtherBorrowedFunds 0 1,216 2,274 2,504 2,808 5,384 6,523Other Liabilities 1,064 834 566 617 990 612 804Deferred Taxation 41 50 34 77 105

Total Liabilities 23,174 24,873 30,908 35,617 51,397 53,469 70,867

Capital and Reserves:Capital 405 711 2,207 2,279 2,279 2,464 2,450Reserves 251 -477 -981 -1,138 -2,062 326 1,015

Funds Employed (Equity) 656 234 1,226 1,141 217 2,790 3,465

Total Liabilities and Equit 23830 25.107 32.134 36.758 51.614 56.259 74,332

Contingencies and Commitments 1,364 2,303 3,494 2,337 2,598 2,598 3,000

Weighted Risk Assets 1/ 21,219 23,505 28,789 32,995 45,764 51.170 68,632Earning Assets 2/ 18,735 20,957 26,031 30,804 43,074 48,740 66,635Equity as% ofWeightedRisk Assets 3.1% 1.0% 4.3% 3.5% 0.5% 5.5% 5.0%

Year on Year EA Growth 12% 24% 18% 40% 37%Year on Year Loan Growth 17% 18% 18% 37% 35%

1/ Considered to include 100% of commercial loans, investments, precious metal, other assets and fixed assets, 50% of placements withBanks and Contingencies and Commitments and 20% of deposits with SBV, securities(GOV) and loans guaranteed by Govemment.2/ Earning Assets are loans, less provisions and frozen loans, deposits and placements with banks & investments.

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Appendix ATable 4

VBARD's Balance Sheets 1996-2001(US$ Million)

------Audited-- IAS--------------- ----- Unaudited Draft - VAS

1996 1997 1998 1999 2000 2000 2001VND perUS$ 11,154 12,300 13,900 14,025 14,500 14,500 15,000

AssetsCash and Notes 43.8 41.6 44.8 90.9 61.1 61.1 66.7Precious Metals 0.4 0.3 0.3 0.2 0.3 0.3 0.4Deposits with SBV 165.2 171.9 275.0 189.8 309.2 309.2 232.0Treasury Bills - - 39.9 17.0 9.4 9.4 88.3Placements with, & Loans /Advances to other 237.9 88.9 138.6 190.2 353.9 248.6 313.5BanksLoans and Advances to Customers 1,578.5 1,675.4 1,751.0 2,048.9 2,716.8 3,103.4 4,040.5Other Assets 68.1 11.1 11.6 27.5 41.0 100.6 156.9Investments 12.6 11.3 6.9 6.6 7.0 ) - -

Tangible Fixed Assets 29.9 40.6 43.7 49.8 61.2 ) 47.4 57.1

Total Assets 2,136.5 2.041.2 2,311.8 2,620.9 3,559.7 3,879.9 4,955.5LiabilitiesDeposits andBorrowings from SBV & State 369.7 179.5 154.5 322.2 864.2 841.5 1,100.4Treasury-Normal Short Term Borrowings - 55.0 43.2 66.2 34.8 )- Borrowings to Support State Planning - 52.6 47.6 88.1 130.3 ) 280.1 316.2

Loans- Borrowings to Support Frozen Loans - 71.9 63.7 66.4 116.3 )- Deposits from State Treasury - - - 101.5 582.7 561.4 784.3

Deposits and Borrowings from OtherBanks 330.4 220.7 314.8 80.4 217.2 430.1 629.8Deposits from Customers 784.0 876.4 950.0 1,388.4 1,670.1 1,476.3 1,839.0Certificates of Deposit 494.4 574.9 597.6 520.5 524.0 526.1 666.7OtherBorrowedFunds - 98.9 163.6 178.5 193.7 371.3 434.9Other Liabilities 95.4 67.8 40.7 44.0 68.3 42.2 53.6Deferred Taxation 3.7 4.1 2.4 5.5 7.2 - -

Total Liabilities 2,077.6 2,022.2 2,223.6 2,539.5 3,544.6 3.687.5 4.724.5

Capital and Reserves:Capital 36.3 57.8 158.8 162.5 157.2 169.9 163.3Reserves 22.5 (38.8) (70.6) (81.1) (142.2) 22.5 67.7

Funds Employed (Eguityl 58.8 19.0 88.2 81.4 15.0 192.4 231.0

Total Liabilities and Eguity 2,136.5 2,041.2 2.311.8 2,620.9 3,559.6 3,879.9 4,955.5

Contingencies and Commitments 122.3 187.2 251.4 166.6 179.2 179.2 200.0

Weighted Risk Assets 1/ 1,902.4 1,911.0 2,071.2 2,352.6 3,156.2 3,529.0 4,575.4Earning Assets 2/ 1,679.6 1,703.8 1,872.7 2,196.4 2,970.6 3,361.4 4,442.3Equity as % of Weighted Risk Assets 3.1% 1.0% 4.3% 3.5% 0.5% 5.5% 5.0%

YearonYearEAGrowth 1% 10% 17% 35% 32%Year on Year Loan Growth 6% 5% 17% 33% 30%

1/ Considered to include 100% of commercial loans, investments, precious metal, other assets and fixed assets, 50% of placements withBanks and Contingencies and Commitments and 20% of deposits with SBV, securities(GOV) and loans guaranteed by Government.2/ Eaming Assets are loans, less provisions and frozen loans, deposits and placements with banks & investments.

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Appendix ATable 5

VBARD Loan Portfolio & Provisions (US$ Million)

1996 1997 1998 1999 2000

Total Gross Loans (IAS) 1,618 1,771 1,869 2,191 2,914Provision for Loan Losses (39) (96) (118) (142) (197)Net Loans 1,579 1,675 1,751 2,049 2,717

Frozen Loans 145 65 60 76 122Past Due Loans (NPLs) -Installments (VAS) 84 78 81 68 23Total NPLs & Frozen Loans 229 143 141 144 145

Past due Loans as % of Gross Loans 5.2% 4.4% 4.3% 3.1% 0.8%Frozen Loans as % of Gross Loans 9.0% 3.7% 3.2% 3.5% 4.2%Total NPLs as % of Gross Loans 14.2% 8.1% 7.5% 6.6% 5.0%

Equity (IAS) 58.8 19.0 88.2 81.4 15.0

Net 'VAS Past Due' 45 (18) (37) (74) (174)Net 'VAS Past Due' Including Frozen Loans 190 47 23 2 (52)

As % EquityNet 'VAS Past Due' 77% -95% -42% -91% -1164%Net 'VAS Past Due' Including Frozen Loans 323% 247% 26% 2% -348%

Provisions as % of Installments PD 46% 123% 146% 209% 847%Provisions as % Installments plus frozen loans 17% 67% 84% 99% 136%

I/Average of opening and closing balances of net loans, investments, securities and placements with banks.2/ The figure shown here (1.36% per month) is of course, not the interest rate on loans alone, but the average return on allearning assets (loans deposits with banks, government securities, and dividends). As deposits, investments and securitiesgenerally yield less than loans, the average lending rate will have to be larger than 1.36% per month - if the VBARD's CAR of8% is to be maintained while expansion is proceeding at the same average of the last/our years.3/Considered to include 100% of commercial loans, investments, other assets andfixed assets, 50% ofplacements with Banksand contingencies and commitments and 20% o precious metals, deposits with SBV, securities (GOV) and loans guaranteed byGovernment.

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Appendix BTable 1

VBARD Balance Sheets Projections 2000 -2006 (Billion VND)Change over Perod 2000 2001 2002 2003 2004 2005 2006

01 -04 04-06 Audited Estimate IDP ProecdionsASSETS IAS iAS [AS IAS IAS lAS IASCash & Cash equivalent Growth 15% 10% 886 1,000 1,150 1,323 1,521 1,673 1,840Precious Metals Growth 0% 0% 4 4 4 4 4 4 4Reserve Deposits atSBV %Deps 5% 5% 4,484 3,500 1,998 2,097 2,202 2,312 2,428Securities Growth 15% 15% 136 1,325 1,524 1,752 2,015 2,317 2,665Placements with Other Banks -VND Growth 10% 10% 2,165 2,500 2,750 3,025 3,328 3,660 4,026Placements with Other Banks -FX Balance Collection 2,965 3,500 5,256 5,757 6,308 6,913 7,579Loans & Discounts

Commercial Loans -Private Growth 20% 15% 6,564 10,900 13,080 15,696 18,835 21,660 24,910Commerdal Loans -SOEs Growth 15% 10% 3,207 4,800 5,520 6,348 7,300 8,030 8,833Non Performing Loans (excd frozen) Reduce 6,866 5,000 2,000 720 600 400 200State Planning Loans-Other Reduce 2,300 2,100 2,000 1,500 1,100 800 500Trust Loans (ODA) 2,957Loans to Small Farmers etc. ind Trust Growth 21% 15% 18,925 35,000 42,350 51,244 62,005 71,305 82,001loansFrozen Loans Reduce 1,437 1,800 1,200 600 300 200 200Less Provisions for Bad debts 2% Prev 1.5 Yrs O/S Lns -2,863 4,000 -3,007 -2,690 -2,582 -2,825 -3,278

Sub Total Net Loans & Discounts 39,393 55,600 63,143 73,418 87,558 99,571 113,365

Investments Growth 101 130 400 600 800 800 800Tangible Fixed Assets Growth 15% 10% 888 1,068 1,22B 1,412 1,624 1,787 1,965OtherAssets Growth 10% 10% 594 800 880 968 1,065 1,171 1,288

TOTAL ASSETS 51,616 69,427 78,332 90,356 106,425 120,209 135,961

LIABILITIES & CAPITALDepositslBorrowings from Other Banks -VND Balancing Figure 2,938 6,092 3,755 4,277 5,788 4,965 4,195Deposits/BorrowingsfromOtherBanks-FX Growth 2% 2% 212 300 306 312 318 325 331Depoits from Customers -VND Growth 25% 20% 20,475 28,000 35,000 43,750 54,688 65,625 78,750Depoits from Customers - FX Growth 10% 10% 3,741 4,500 4,950 5,445 5,990 6,588 7,247CD Growth 5% 0% 7,598 10,000 10,500 11,025 11,576 11,576 11,576s

Dep & Borrowings from SBV & Govt -SPLs Constant 1,888 1,800 1,800 1,800 1,800 1,800 1,800Dep & Borrowings from SBV & Govt -FLs Balance FLs 1,687 1,800 1,200 600 300 200 200Dep & Borrowings from SBV & Govt -Other Constant 0 0 8,955 12,400 12,400 12,400 12,400 12,400 12,400BIDV for Rural Finance I &2 Increase 1,003 1,200 1,500 1,800 2,100 2,400 2,700Other Borrowed Funds (ind Trust Funds) Growth 10% 10% 1,806 1,800 1,980 2,178 2,396 2,635 2,899Other UabDiies Growth 15% 10% 1,096 1,200 1,380 1,587 1,825 2,008 2,208Dividends Payable Due fer Yr 0 0 0Income Taxes Payable one quarter 35 0 97 132 176 226

TOTAL LIABILITIES 51,399 69,127 74,771 85,271 99,313 110,699 124,533

Equity (Capital) per 2,279 2,279 5,000 5,700 6,600 7,500 7,500schedule

Funds (Reserves & Retained Profits) -2,062 -1,979 -1,439 -615 511 2,010 3,929

TOTAL CAPITAL 217 300 3,561 5,085 7,111 9,510 11,429

TOTAL LIABILITIES & CAPITAL 51,616 69,427 78,332 90,356 106,425 120,209 135,961Contingencies & Commitments Growth 15% 10% 2,598 2,700 3,105 3,571 4,106 4,517 4,969

Eaming Assets 44,760 63.055 73,073 84,552 100,008 113,262 128,435Weighted Risk assets 1/ 34,917 55,794 67,752 81,089 97,162 110,681 126,005

Capital to Weighted Risk Assets 0.5% 5.3% 6.3% 7.3% 8.6% 9.1%Net After Tax Profit to Av Total Assets 0.14% 0.73% 0.98% 1.14% 1.32% 1.50%Net AfterTax Profit to Av Earning Assets 0.15% 0.79% 1.05% 1.22% 1.41% 1.59%Inflafion Adjusted Profit (2% Infl) 96 529 770 1,044 1,380 1,764After Tax Real Retum on Equity (assumes paid in capital comes 44% 32% 20% 19% 18% 19%mid year)Year on Year Growth in Total Assets 35% 13% 15% 18% 13% 13%

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Appendix BTable I (cont)

Table I (continued) VBARD Balance Sheets Projections 2000 -2006 (Billion VND)

Averaae Numbers Outatandina In Year for P&LEstimates

2000 2001 2002 2003 2004 2005 2006

Elements Contributing to Income (Averaoe Loan or Asset Amountsfor Year)Loans to Commercial Customers net of provisions 17,150 20,322 23,327 26,936 30,441

Performing SP Loans 2,050 1,750 1,300 950 650

Loans to Small Farmers including Trust Loans net of 38,675 46.797 55,861 65,678 75,377provisionsPlacements (Domestic) 2,625 2,888 3,176 3,494 3,843

Placements (Foreign Currency) 4,378 5,507 6.032 6,611 7,246

Securities 1,424 1,638 1,884 2,166 2,491

Investments (to GiveDividend Income) 265 500 700 800 800

Elements Contrlbutino to Income Expense (Av for Year)

Deposits/Borrowings from Other Banks -VND 4,924 4,016 5,033 5,377 4,580

Deposits/Borrowings from Other Banks - FX 303 309 315 322 328

Depoits from Customers -VND 31,500 39,375 49,219 60,156 72,188

Depoits from Customers -FX 4,725 5,198 5,717 6,289 6,918

CD 10,250 10,763 11,301 11,576 11,576sDep & Borrowings from SBV & Govt -SPLs 1,800 1,800 1,800 1,800 1,800

Dep & Borrowings from SBV & Govt -Other 12,400 12,400 12,400 12,400 12,400

MOF for Rural Finance 1 & 2 1,350 1,650 1,950 2,250 2,550

Other Borrowed Funds 1,890 2,079 2,287 2,516 2,767

Assumed Provision Chanae and Write Offh

Opening Provisions for Bad Debts 2,863 3,457 3,007 2,690 2,582 2,825

New Provisions Made in Year 820 1,150 1,283 1,492 1,781 2,032

Bad Debts Written Off 226 1,600 1,600 1,600 1,538 1,579

Closing Provisions 3,457 3,007 2,690 2,582 2,825 3,278

After 2004, Provisions assumed to cover NPLs 100% with W/O happening one and a half years after the year end in which loan becomes PD, on average.

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Appendix BTable 2

VBARD Profit and Loss ProjectionsBillion VND In Nominal Terms -(implicit assumption that present 2% inflation domestic and intemational inflation continues)

Behaviour from 2001 20 2 2 200 1 2003 2004 2005

Audited Unaudited IDP Projec tnons[AS [AS [AS IAS [AS IAS [AS

EARNINGSInterest on Loans to Commercial Retail Eam 8.5% 3,666 5,400 1,458 1,727 1,983 2,290 2,587CustomersInterest on SPLs Eam 5.4% 111 95 70 51 35Interest on Loans to Farmers, incl Eam 13.0% 5,028 6,084 7,262 8,538 9,799Trust LoansInterest on Placements (Domestic) Eam 6.0% 158 173 191 210 231Interest on Placements (Foreign) Eam 4.5% 197 248 271 297 326Income from Securities Eam 6.0% 85 98 113 130 149Dividend Income Eam 6.5% 8 12 17 33 46 52 52Commissions, Fees, & Trust Dept Grow 30.0% 215 350 455 592 769 1,000 1,300Gain from Dealing Activities Grow 30.0% 36 50 65 85 110 143 186Other Income Grow 30.0% 111 135 176 228 297 386 501TOTAL EARNINGS 403 5.47 749 9,2 11.11 13096 15166

Interest ExpenseDeposits/Borrowings from Other Banks Cost 6.0% 295 241 302 323 275-VNDDeposits/Borrovings from Other Banks Cost 4.5% 14 14 14 14 15-FXDepoits from Customers -VND Cost 5.5% 1,733 2,166 2,707 3,309 3,970Depoits from Customers- FX Cost 3.5% 165 182 200 220 242CDs Cost 6.5% 666 700 735 752 752Dep & Borrowings from SBV & Govt - Cost 3.0% 54 54 54 54 54SPLsDep & Borrowings from SBV & Govt - Cost 6.0% 744 744 744 744 744OtherBIDV for Rural Finance 1 & 2 Cost 6.5% 88 107 127 146 166Other Borrowed Funds Cost 6.0% 113 125 137 151 166Total Interest Expense L1.2 315 3.872 4M332 i020 5.13 6a3m4Eamings Net of Interest Expense 222 2122 3.877 5.029 601 Z_ 8172Compensation & Benefits 2/ Grow 20.0% 637 800 960 1,151 1,381 1,656 1,987Depreciation/Amortization % FA 25% 98 120 307 353 406 447 491Taxes & Licenses (excl capital tax % TA 0.03% 143 48 23 27 32 36 41from 2002)OtherAdministration Costs Grow 12% 644 800 896 1,004 1,124 1,259 1,410Total Operating Costs I=22 176i 2.186 2= 2 3 3.3am 1222Provision for Probable Losses & Write % CL 2.0% 1.478 2 t150 122 12 1721 2.032OffsNET INCOME PRE TAX 20ML 2.2 2=Business Income Tax 1/ 150 121 - 388 530 705 903

NET PROFIT FOR YEAR AFTER TAX z ea 5gn 84 12 1422 L1Dividends Paid (nil)Transfer to Reserves 83 540 824 1,126 1,499 1,919

MemoItemsAverage Eaming Assets (EA) 53,908 68,064 78,812 92,280 106,635 120,848Interest & Dividend Income as % EA 10.04% 10.36% 10.73% 10.77% 10.85% 10.91%Interest Expense as % EA 5.85% 5.69% 5.50% 5.44% 5.36% 5.28%Provisions as % EA 1.52% 1.69% 1.63% 1.62% 1.67% 1.68%Lending and Investment Income Net of Provisions as % EA 2.67% 2.98% 3.61% 3.71% 3.82% 3.94%Other Income as % EA 0.99% 1.02% 1.15% 1.27% 1.43% 1.64%Operating Costs as % EA 3.28% 3.21% 3.22% 3.19% 3.19% 3.25%Pre Tax Profit as % EA 0.38% 0.79% 1.54% 1.79% 2.07% 2.33%Tax as % EA 0.22% 0.00% 0.49% 0.57% 0.66% 0.75%Net Profit as % EA 0.15% 0.79% 1.05% 1.22% 1.41% 1.59%

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Additional Annex 15: Potential Project's PFIsVIETNAM: Second Rural Finance Project

1. The initial list of financial institutions which potentially could participate under the project includessome 25 banks. This includes the project's Apex Bank, BIDV (the wholesaler) and 24 ParticipatingFinancial Institutions (PFIs), the retailers of project's funds, the Rural Development Fund (RDF). The listof potential PFIs includes the largest four Government banks in Vietnam (BIDV, VBARD, VCB, andICB), 12 Joint Stock Commercial Banks (JSCBs) and 8 Rural Joint Stock Comnmercial Banks (RJSCBs).The four State Owned Commercial banks (SOCBs) account for about 80% of the banking system inVietnam in terms of business activities, and about 90% in terms of branched and staff. The Bank forInvestment and Development of Vietnam (BIDV) was selected, by SBV, to function as the project's ApexBank. The other 24 banks, of which 20 are non-government banks, would operate as the project's PFIs, ifaccredited.

PFIs Accreditation

2. To safeguard the Apex Bank and the Fund financial assets, and to ensure successfulimplementation of the credit component, the PFIs would be approved on the basis of agreed accreditationcriteria to be detailed in the RDF II Policy Manual. Criteria to be selected need to be credible, transparent,unequivocal, and compatible with sound financial principles and with banking regulations; they wouldinclude the following five fundamental elements: (i) compliance with banking law and audit requirements;(ii) solvency; (iii) liquidity; (iv) profitability; and (v) the quality of management and staff. However, abank could be accredited even if it does not meet all the accreditation criteria provided that an InstitutionalDevelopment Plan (IDP) along with adequate training program and detailed time table for achieving themwould be submitted to, and found to be acceptable by, the Apex Bank (BIDV) and IDA. Accreditation ofanyone of the PFIs will have to be concurred by IDA.

3. All the seven PFIs that were accredited under the first Rural Finance Project (RFP) submitted theirrespective IDPs during project implementation and before their accreditation. It is also very likely thatmost, if not all, the PFIs under RF II will have to submit an acceptable IDP in order to participate in theproject.

Institutional Strengthening Component

4. The project's institutional strengthening component aims at strengthen the banking system'scapacity to better serve the rural economy. It would build on the implementation of the Restructuring Plan(RP) as agreed with IDA under the PRSC and would focus on strengthening all financial institutions thatare or will be associated with the project. A satisfactory implementation of the agreed RP by BIDV, andother SOCBs/JSCBs would be condition of Credit effectiveness, and a condition of accreditation,respectively. Due to the likely key role in the project, BIDV as the project's Apex Bank, and VBARD as apotential key retailer of project funds, special attention will be given to their performance, in terns of IDPs'elements and related KPIs.

5. Under this component, PFIs would also implement their own IDPs; the project will focus onVBARD, and the other large SOCBs and RDF's retailers (ICB, and Vietcombank). Each IDP would beprepared by the respective institution, approved by its own board of directors and be satisfactory to theBank. These IDPs would include building up the capital base, improving solvency position and

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profitability, accounting and internal control systems, and strengthening, through domestic and overseastraining, the capability of related staff, management, and Board members to carry out modem and prudentbanking and rural-finance activities.

PFIs Performance under the first Rural Finance Project

6. Seven PFIs actively participated under the first Rural Finance Project (Credit 2855-VN). Two ofthem (VBARD and BIDV) are SOCBs and the other 5 are relatively small private banks; these are AsiaCommercial Bank (ACB), Eastern Asia Commercial Bank (EAB), Phung Nam Bank (PhNB), Rach KienBank (RKB), North Asia Bank (NAB). All of them, as part of their accreditation process, had to submit adetailed IDP. The implementation of these IDPs along with their respective KPIs is closely monitored bythe Project's Management Unit (ICPMU).

7. The most current review of the fnancial performance as well as the implementation of therespective IDPs of the seven PFIs revealed that: (i) ACB and EAB financial performance in 1998, 1999,and 2000 were relatively strong in terms of solvency, liquidity, and profitability. The two banks enjoystrong management team and their respective IDPs are progressing well. Performance (during the sameperiod) of all other five PFIs (VBARD, BIDV, PhNB, RKB, and NAB) are varied. However, all of themrecorded substantial improvement in the implementation of their agreed IDPs. As BIDV and VBARDperformance discussed in Annexes 13 and 14, respectively, this part only addresses the performance of theremaining five PFIs: ACB, EAB, PhNB, RKB, and NAB.

8. The more general findings of the financial performance as well as the implementation of therespective IDPs of the five PFIs are:

* compared to 1997, the year which preceded RFP implementation, to the situation as reported at theend of the First Quarter of 2001, the financial performance of all these institutions was stronger interms of reducing overdue, improving solvency, and liquidity; and

* their performance in profitability, similar to those of most other banks in the country, was ratherpoor.

9. Overdue loans: all institutions made dramatic progress in reducing their net overdue ratio aspercent of total loan outstanding, particularly during the period under review (1997 to first Quarter 2001).At the end of the first quarter, 2001, three out of five banks achieved am overdue loan ratio of less than 1%(EAB, ACB, and RKB); the ratios for the other two, though much higher (4.3% for PhNB and 1.6% forNAB), were still in line with the project's accreditation requirement of being less than 10%.

10. Solvency: in spite of the fast growth in their lending activities, capital adequacy as measured by theratio of equity-to-risk assets remained either close to or reaching the 10% Project's benchmark (EAB andRKB, at about 8% and 10%, respectively), or exceeding it (ACB, PhNB, and NAB, at about 13%, 12%and 23%, respectively).

11. Liquiditv: two banks maintained very high liquidity as measured by the ratio of short termassets-to-short term liabilities: ACB with a ratio of 145% or tripling its 1997 level; and NAB, 89% or morethan five-fold its 1997 level. Progress of the other three banks varied: PhNB reduced its liquidity position to46% (as compared to 75% in 1997) which was still above the accreditation requirement of 40%; EABimproved its ratio somewhat to 28% as compared to 23% in 1997; and RKB increased this ratio to 20%, or

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quadrupled its 1997 level. As such, liquidity position of these two (EAB and RKB) were far below thebenchmark.

12. Profitabilitv: the banks performed rather poorly during the period under review compared to theresults in 1997. As of the end of Quarter I, 2001, profitability of all five institutions as measured by the netprofits-to-earning assets ratio was less than 1%, far below the 5% project's benchmark. The reasons for thelow profit are threefold:

* the narrow spread constrained on them due to SBV's ceilings lending rate policy;* the banks began, under SBV's banking reforms, to charge their annual income for the purpose of

building up provision for possible loan losses; and* the slowing down of the economy.

13. One very importance aspect of the Rural Finance Project was its Capacity Building component.The project provided assistance to the PFIs in preparing and implementing their own InstitutionalDevelopment Plans (IDPs). The implementation of this component was however, affected by a number offactors: (i) PFIs' unfamiliarity with the IDP concept, and therefore, its usefulness; (ii) their perception ofIDP as "conditionally" imposed by lender; (iii) their lack of up-to-date financial data; (iv) variance betweenaccounting standards of Vietnam (VAS) and that of IAS; (v) limited financial ability of the PFIs,particularly the small ones, to have their accounts audited by intemational firms; (vi) because of (iii) and(iv) above, those which have had their accounts audited by intemational firms would have the job done withconsiderable delay.

14. In spite of all these shortcomings, the mere fact that the PFIs did prepare their IDPs andimplemented them to a large extend, they were able to make steady progress in capacity building,particularly in reaching viability and sustainability as measured by financial performance, improvingmanagement quality, govemance, and training.

15. In this respect, ICPMU has contracted out a comprehensive project impact assessment which oncecompleted, would appraise the extend of the PFIs' IDP implementation as well as their impact on theperformance of the participating institutions. At this time, though not possible to quantify, it's safe to statethat all the five banks have recorded steady progress, with the degree of success varied from bank to bank,as following: (a) all have subjected themselves to extemal auditing; (b) internal control systems are inplace; (c) all have improved their accounting systems; (d) classification of overdue in terms of aging wascarried out; (e) most have strengthened credit appraisal and loan management procedures; (f) all have builtup equity and provision for loan loss; (g) most have benefited from IDP in improving financial outreach (insaving and lending services) to the rural dwellers and strengthen the finance system via institutionalbuilding; (h) most have improved collection; overdue debts from sub-borrowers to PFIs were consistentlyless than 0.5%; as such, overdue under RDF compared very favorably with PFIs' overall rate of overdueon loan portfolio; (i) the awareness of reducing concentration and improving asset quality was enhanced.

* all have implemented their training program to a large extend, either on their own and/orparticipating in training program organized by ICPMU; and

* most PFIs have improved substantially their performance in saving mobilization during the project.

Potential PFIs

16. The initial list of potential project's related financial institutions includes some 25 banks. This

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includes BIDV, the project's Apex Bank (the wholesaler), and the Participating Financial Institutions(PFIs), the retailers of the Rural Development Fund (RDF). The list comprises of the largest fourGovernment banks in Vietnam (BIDV, VBARD, VCB, and ICB) that accounting for about 80% of thebanking system in Vietnam in terms of business volume, and perhaps 90% in terms of branches and staff.

Briefing on the Second RFP

17. A Bank mission, accompanied by officials of ICPMU/SBV met with senior management(Chairperson of the Boards and General Directors) of 13 financial institutions who are interestedin actively participating in the project, and may become project's PFIs, if accredited by theproject's apex bank.

PFIs' interest in joining the project

18. The response of the banks visited to the briefing on the project was very positive. They requestedthat copies of the Policy Manual for RFP I be provided to them for operational information. All wereinterested in being considered for accreditation under RFP II. Two banks, Quoc Te Bank and Sacombankwondered if it would be too late to join the on-going RFP.

19. Management of all banks expressed great enthusiasm for the project. The reasons which wereexpressed by the banks for their favorable responses varied but can be summarized as following: (a) theimmediate availability of fund once accredited; (b) medium and long term deposits are very difficult tomobilize, therefore, project can help to make up partially for the shortage; (c) the cost of fund is reasonableas it is a reflection of the cost of fund mobilization in the country; (d) most of the banks want to focus onlending to SMEs in the years ahead; (e) they believe that IDP could be a good instrument for management;(f) they like the idea of being able to participate in project's training program to supplement their own; and(g) they believe that the prestige of being a PFI is of value to them in increasing equity.

Potential PFIs' Audited Accounts

20. The mission is please of the fact that all the banks visited did have audited accounts, many of themhaving up-to-date audits and by auditing firms which are recognized by the SBV. A review of auditedaccounts for 1999 and 2000 from nearly all these banks reveals that, by and large, these banks are doingeither fairly well or well in terms of solvency and liquidity and not so well in terms of profitability. Most ofthe banks indicated that interest rate ceilings were the main factor behind their very low profit margins,particularly the rural joint-stock banks which have to pay relatively the highest cost in fund mobilization.

Credit Lines Recommended

21. On the basis of (i) discussion with the potential banks' senior managers; (ii) preliminaryreview of the audited accounts; and (iii) in consultation with ICPMU, it is suggested that a creditline will not exceed 60% of each bank's equity be granted to it upon accreditation. The linesrecommended below are based on the banks' equities at the end of 2001. These lines can berevised when the accreditation process takes place, based upon equities and other indicators thatwill be applicable at that time.

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Estimated Credit Lines that might be allocated, if accredited, to interested potential PFIs *Hquity as of Dec. Existing Lines Estimated Total

31, 2001 of Credit Lines of Credit estimatedunder RF I ror interested Lines of Credit

potential PFis for interestedunder RF 11 potential PFIs

(RF I plus RF

In billion In million In Million In Million In millionVND IUSD USD USD USD

STATE OWNEDCOMMERICAL BANKS

Up to:

I Vietnam Bank for Agriculture and Rural 2,305.5 153.7 75.5 24 .0 99.5Development (VBA&RD)

2 Vietnam Bank for Industrial 1,057.5 10.5 40.0 40.0and Commercial (ICB)

3 Mekong River Delta Housing 483 .0 32 .2 20.0 20.00Commercial Bank (MRHCB)

4 Vietcombank 1,080.0 72.0 - 40.0 40.0sub-tot-1 75.50 124.00 199.50

URBAN JOINT STOCKCOMMERCIAL BANKS

1 Asia Commercial Bank (ACB) 350 .0 23 .3 3.0 11.0 14.02 East Asia Commercial Bank 102 .0 6 . 3.2 0.8 4.0

(BAB)

3 Southern Commercial Bank 81.0 S.4 1.8 1.2 3.0(PhNB)

4 North Asia Bank (NAB) 49.5 3 .3 0.6 1.4 2.05 International Bank (Quoc Te 76 .5 5.1 3.0 3.0

Bank)

6 Saigon Industrial and 142.5 9 .5 5.5 5.5Commercial Bank (SICB)

7 Saigon Thuong Tin 217 .5 14.1 8.5 8.5Commercial Bank (SACOMBANK)

8 South Asia Commerical Bank 78 .0 3.1 1.8 1.8(Nam A Bank)

9 Techombank 115.5 6.9 4.0 4.010 Military Bank 14.5 8.5 8.511 Orient Bank 5.2 3.0 3.0

12 Maritime Bank 7.7_ 4.5 4.5

Sub-total 8.6 53.2 61.8

RURAL JOINT STOCKCOMMERCIAL BANKS

1 Dai A Commercial Bank 9.0 0.6 0.30 0.302 Ninh Binh Commercial Bank 4 .5 0.3 0.15 0.15

3 Rach Kien Commercial Bank 6.0 0.4 0.2 0.204 Cai San Commercial Bank 12.0 0.8 0.40 0.405 Kien Long Commercial Bank 4.5 0.3 0.15 0.156 Nhon Ai Commercial Bank 4.5 0.3 X 0.15 0157 Tan Hiep Commercial Bank 4.5 0..3 0.15 0.158 Hai Hung Bank 4.5 0.3 0.15 0O15

Sub-total 0.2 1.45 1.65

TOTAL 84.3 178.65 262.95

* If the above estimated lines ofcredit will indeed be materialized, about 85% (US$260 million equivalent) of theavailablefunds of RF I and RF II (about US$305 million equivalent in total) will be allocated. It means that about 15% of thefunds or some US$40 million equivalent will be leftfor: (i) other PFIs or MFIs that will be willing to join, and accredited by,the project during itsfiveyear implementation period; and (ii) those accredited PFIs that will be willing to increase their linesof credit provided that their respective performance indicators would justify such an increase.

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Additional Annex 16: Environmental Protection ArrangementsVIETNAM: Second Rural Finance Project

Introduction

1. There are no major environmental issues anticipated under the project. Most of the project'ssub-borrowers would be rural poor people with an average loan size of below US$400. Micro-enterprisessub-loans would not exceed US$1,000 equivalent, and other project entrepreneurs sub-loans are estimatedto average at about US$2,500. It is very likely that most of these sub-projects would be exempted fromenvironmental assessment either because of their limited size and/or because they are operating in areas orsectors that under the Vietnamese laws and regulations are exempted.

2. However, in order to anticipate and deal with any environmental issue that may arise, the followingmeasures will be introduced: (i) review if any negative environmental impacts have been experienced underthe ongoing Rural Finance Project (RFP); (ii) review existing national regulations to determine the currentcriteria for EA exemptions; (iii) establish sub-projects screening criteria; (iv) evaluate the capacity of theMinistry of Science, Technology, and Environment (MOSTE) and the provincials Department of ScienceTechnology, and Environment (DOSTE) to provide timely assessment of non-exempted projects and grantenvironmental clearance prior to funds disbursement; (v) outline an Environmental Management Plan(EMP) and its overall scope, relationship to the legal documents, and implementation responsibilities; (vi)prepare Environmental Guidelines to be incorporated into the Policy Manual of the Second RuralDevelopment Fund 1' (RDF II); and (vii) propose institutional provisions to assist MOSTE/DOSTE inimplementing the guidelines of the RDF Manual.

3. The following findings and recommendations are based on two, three-week missions each toVietnam. During the first IDA mission (May-June, 2001), the environmental specialist (i) visited some

2/sixteen sub-projects funded under RFP in seven provinces in the Red River Delta, Northem Midlands,South Central Coast, and Central Highlands; (ii) met with the staff of the Intemational Credit ProjectsManagement Unit (ICPMU) of the State Bank of Vietnam (SBV) and with representatives of the chiefintermediary financial institutions (VBARD, BIDV, ACB, and EAB) in these provinces; (iii) interviewedDOSTE officials in Hung Yen, Phu Yen, and Dac Lac provinces; and (iv) discussed environmental policyissues with MOSTE's Environmental Policy and Legislation Director.

4. The purpose of the field tour and the meetings with representatives of the Participating FinancialInstitutions (PFIs) and with officials of the Govermment of Vietnam (GoV) during the first mission was to(i) discuss coordination between BIDV (the project's Apex Bank) and MOSTE in implementing theenvironmental aspects of RF II; (ii) gather information about the practices of environmental screening ofsub-projects funded by RF I and the enviromnental criteria applied by the provincial environmentalauthorities (DOSTE) towards environmental clearing of proposed sub-projects; and finally, (iii) gaininsight into the environmental impact of representative sub-projects financed under RF I.

5. During the second IDA mission (January-February 2002), the environmnental specialist (i) visitedsome eighteen sub-projects and mid-size manufacturing plants in Bac Ninh, Lam Dong, and Ba Ria - VungTau provinces, in suburban Hanoi and in HCM City; (ii) met with senior staff members of Hanoi'sNational Economic University Center for Enviromnental Economics and Regional Development (CEERD),the Deputy Regional Manager of the Mekong Development Project Fund (MDPF) in HCM City, theDirector of the Vietnam Institute for Tropical Technology and Environmental Protection (VITTEP), HCMCity, the Director of Hanoi University's Civil Engineering Center for Environmental Engineering of Town

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and Industrial Areas, and the Director of the Environmental Technology Institute, Technical University ofHanoi, to discuss the preparation and implementation of 'Train the Trainer' environmental course module;(iii) was debriefed by GTZ's staff in Hanoi about their recent endeavors to introduce energy-efficientceramics kilns in Bat Trang and in southern Vietnam; and finally, (iv) met with MOSTE's NationalEnvironmental Agency's Policy Director to discuss the contents of a Memorandum of Agreement (MOA)to be signed between MOSTE and the Apex Bank (AB), underlining the commitment of the AB to pursueenvironmental protection requirements in the conduct of RF II.

6. Most of the visited sub-projects visited during the first mission, excluding two that are State-ownedenterprises (SOEs), are household-operated and managed. They include fruit (longan) and cash cropplantations (coffee and sugar cane), fish and shrimp hatcheries/farms, forest management and woodprocessing farm, brick production yards, tuna transfer/refrigeration depot, silk and paper manufacturing,tea processing, and hog raising. Most plantation, cash crop, and aquaculture sub-projects occupy areasranging between 0.2 - 6 hectares and employ between several and up to (in the high season) twentyworkers. The manufacturing sub-projects employ between a dozen (tuna transfer/refrigeration depot) andsome 250 employees (tea processing). Finally, the two SOEs (fish hatchery and forest management farm)employ 29 and 290 employees each and occupy 14 and several thousand hectares each, respectively.

7. Nine of the sub-projects visited during the second mission are household-operated and managed orSMEs. These include ceramic kilns, paper production plant, smelter of scrap iron, rebar production plant,furniture production shop, flower, vegetables, and longan plantation farms, coffee processing, fishprocessing and fish-sauce production. The remainder are small to mid-size manufacturing facilities(pesticides distribution center, gas station and motorbike washing facility, textile factory, and a garage andbody shop - mostly SOEs), as well as joint venture horticultural and vegetable farms with export targetedproduction. The larger plants, while not typical of sub-projects such as had been funded by RF I,demonstrate Vietnam's current capacity of attaining modem production and operation standards.

Findings

8. In quite a few instances, there are encouraging manifestations of enforcing measures to mitigateenvironmental impacts and address worker safety issues. These include extensive use of dust protectionmasks in wood- and tea-processing activities, capture of paint fume emissions in furniture production, andrequirements to chlorinate shrimp hatchery effluents and treat paper pulp discharge water prior to theirrelease to the environment. Raising crops that require wood logs for support (e.g., pepper) is eitherdiscouraged altogether or, altematively, the introduction of durable materials (e.g., concrete, bricks) ispromoted that prevents natural resources degradation.

9. In many instances, traditional practices of recycling and application of waste from one process tothe benefit of another mitigate potential environmental impacts. Examples include the use of the followingwastes as fertilizers: hog farm effluents, zeolites that had exhausted their capacity as sinks for excessnitrates in shrimp ponds, coffee-peels, and sugar cane pulp residues. Another example involves ash residuefrom brick kilns that is used as an additive to cement for rooftop sealing and flooring.

10. Based on the limited overall amount of sub-projects visited (34 sub-projects in ten provinces), thefollowing sub-projects seem to involve a limited environmental impact (waste flows in parentheses): forestmanagement farm, longan (used pesticide containers), sugar cane, tea and coffee processing, and tuna

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transfer/ refrigeration (fish rejects).

11. The following sub-projects are associated with significant enviromnental damage, and/or adverseeffect on public health: traditional brick and ceramics production (air pollution, poor worker safety,land-degradation, low energy efficiency); silk manufacturing (improper disposal of used dye); hog farm(poorly controlled discharge of hog waste); paper production (untreated acidic and high BOD effluents, lowenergy efficiency); and pesticides distribution warehouse (improper disposal of accidentalspill-contaminated materials). Whereas the overall annual wastewater discharge of the visited silkmanufacturing and hog farm is estimated at several hundred gallons each, the paper SME's annualdischarge is estimated to be one- to two-orders of magnitude larger.

12. Many of the issues encountered are related to insufficient awareness and implementation of basicmeasures for workers' health and safety. Examples include electrocution hazards (substandard orlow-hanging electrical wiring associated with operating barefoot in a wet environment, in hatcheries andpaper production); high noise levels without appropriate worker protection (silk weaving); and improperstorage (open shed) and disposal of empty pesticide containers (plantations).

13. The environmental impact of shrimp farms, other than the improper disposal of spent engine oilused for operating pond aerators (approximately 150 liters/hectare/year), could not be satisfactorilydetermined in the course of this mission due to limited access to designated prospective pond areas.Likewise, the impact of fish hatcheries and fish farming on surface water quality is still insufficientlydocumented by DOSTE. Both of these issues require further examination, considering that extensivecoastal mangrove areas in the Mekong Delta and elsewhere that had been transformed into lucrative shrimpfarms are subjected to environmental degradation through reduced biodiversity, and increased erosion andsiltation rates. Moreover, the fast expansion of the shrimp industry leads to land pressures and concomitantescalation of land values. Additional issues that demand further scrutiny include the types and volume ofagro-chemical (pesticides and fertilizers) consumed through application to cash crops and plantations, andprospects of unsustainable groundwater extraction associated with coffee plantations.

14. Observations in the course of the second mission reinforced the conclusion reached during itspredecessor about the prevalent culture of recycling, e.g., paper/cardboard and scrap metal, and fishresidues (used as fertilizer and/or duck feed), effectively reducing the volume of solid waste. Additionally,the physical concentration of particular industry types, each in a specific artisan community, facilitates acost-effective provision of water treatment plants to serve multiple household enterprises, once they arerelocated to designated industrial areas outside residential quarters.

15. The following observations strongly suggest common environmental and worker health issues: (i)unsustainable use of groundwater and water quality degradation are inferred from a persistent drop ofwater table levels in shallow wells and from the need to boil well-water for human consumption, e.g., BaRia - Vung Tau Province; and (ii) widespread occupational health and safety infractions include improperrespiratory and body protection where fumes/heavy loads/red-hot liquids are handled (smelting and rebarproduction; traditional brick and ceramics production); electrocution hazard and risks of accidental injuryby untidy plant floor conditions, restricted spaces and flimsy gangue planks (paper industry); lack of SOPand appropriate equipment to handle indoors accidental pesticide spills (agricultural chemicals distributionwarehouse); and the presence of young kids (some employed as laborers!) next to their working mothers inan unsafe and/or non-hygienic production milieu (furniture and fish processing) . Furthermore, thereseems to be insufficient institutional awareness of the need for occupational safeguards: smoking is not

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officially banned in gasoline filling stations, and municipally-granted licenses to small manufacturers incrowded residential neighborhoods (e.g., coffee roasting in Da Lat) do not require fire extinguishingequipment nor respiratory protection. Finally, improper disposal of hazardous waste is practiced byburying pesticide-contaminated soil in trenches at the plant's site.

16. The exclusive processing of small fry (suggesting the use of fine mesh nets) and a recent three-foldhike in the cost of raw fish purchased for fish-sauce fermentation suggest that offshore fishing may beunsustainable. In addition, considering the extensive production of traditional, inlaid furniture, thesustainability of utilizing hardwood and mother-of-pearl needs to be assessed.

17. According to the 1994 Law on Environmental Protection and Annex 1 of Circular No.490/1998/TT-BKHCNMT (Guidance on Setting Up and Appraising the Environmental ImpactAssessment Report for Investment Projects), most, if not all the sub-projects financed under RF I areclassified as Category II. Appendix I of Circular No. 490/1998/TT-BKHCNMT exempts from therequirement that environmental impact assessment be prepared and appraised by DOSTE anymanufacturing establishment that does not exceed a certain level of annual output capacity. For instance,the EIA threshold is established at 10,000 tons for a tannery, 1,000 tons for a food processing plant, 20million meters for a textile/dye factory, and 200 hectares for an aquaculture farm1 . Category IIsub-projects require only that 'their proponents ...set up and analyze themselves their own environmentalimpact assessment reports'.

18. In reality, however, very few, if any, of the sub-projects are assessed for their potentialenvironmental impact. Furthermore, primarily due to severe limitations on DOSTE's staffing (four or lesstechnical slots per province), the sub-projects, once launched, are not effectively monitored. DOSTE'scomplacency may be also attributed to the practice of the local perrnitting authorities (the People'sCommnittees) to approve sub-projects based on general land use designations. Whereas the lax regulatoryatmosphere may be defensible in the context of a single sub-project, the cumulative impact of many suchsmall sub-projects can be quite significant. Moreover, they exacerbate the existing situation in Vietnamwhereby 82% of the worst polluters are located in residential areas. They are also incompatible with someof the GoV priority objectives to be achieved by 2010, namely significant reduction in industrial pollutionload and relocation of most manufacturing to industrial parks (Vietnam 's Development Report 2001).

19. As required by the law, sub-borrowers sign a commitment not to harm the environmnent as aprerequisite for being granted a loan. However, it seems that neither DOSTE nor the PFIs make an effortto verify that sub-borrowers have a substantive understanding of their commitment

20. In general, the project officers (POs) of the PFIs are technically knowledgeable and familiar withthe technical details of the sub-projects under their supervision. These individuals are charged withassessing the technical and financial viability of sub-borrower applications. However, while the PFIsinvest significant resources in the training of POs in project management and evaluation (ernployingbilateral trust funds and their own resources), insufficient training is given on sub-project screening orevaluation from environmental perspective.

21. There is an impressive in-country experience in addressing small enterprise pollution mitigation:the application of the Clean Production (CP) concept to SMEs (as well as to larger industrial facilities) isspearheaded by environmental research institution (primarily INEST and VITTEP), and backed by strongintemational aid organizations. This experience should not only be harnessed domestically for training

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credit officers; the policy of preserving traditional artisanship while mitigating its environmental impactshould be set as an example for emulation by other developing countries with economies that aretransitioning from traditional to modem manufacturing.

Recommendations

22. The combination of inadequate enforcement by DOSTE and limited environmental awareness ofthe PFIs and the sub-borrowers, requires that a set of remediative and preventive measures be instituted byRF II to strengthen the environmental enforcement authority and monitoring capacity of DOSTE and thePFIs. These include technical guidelines and sub-project screening criteria, and specific institutionalarrangements, administrative measures, and environmental training to be detailed in the followingparagraphs.

Screening Criteria And Environmental Assessment Field Guidelines

23. Prospective sub-projects are classified into three groups, based on their potential for adverselyimpacting the environment: sub-projects that are practically exempted from environmental clearance andonly require verifying with the sub-borrower that he/she is familiar with environmental impacts of thesub-project and with the appropriate mitigation measures (Type A); sub-projects that should be subjected toenvironmental scoping to assess their eligibility for loan approval (Type B); and sub-projects that based ontheir detrimental impacts should not be funded by RF HI (Type C; see Annex 1 of RF II Policy Manual).

24. The environmental screening criteria should encourage the introduction of cleaner, moreenergy-efficient, and safer technologies, with a prime example being brick production and ceramic kilns.Furthermore, although the program is demand-driven, sub-borrowers should be encouraged by the PFIs andDOSTE to invest in practices that improve public safety, i.e., crop (primarily coffee) drying equipment.By addressing the prevailing custom of on-road drying, safer driving conditions would be enhanced onmany of Vietnam's narrow and heavily traveled provincial roads.

25. In developing the screening criteria, particular attention should be given to: (i) degradation of forestresources and biodiversity on land and in the offshore; (ii) potential impact on erosion and siltation; (iii)increase in diseases with a water-borne vector due to changes in drainage configuration; (iiiv) degradationof wetlands due to the construction of flood protection measures or expansion of aquaculture; (iv)non-sustainable groundwater extraction resulting in prospects for aquifer degradation, (vi) aggravation ofwater and air pollution and soil degradation, particularly in proximity to residential areas; and (vii)ensuring workers' health and safety.

26. To facilitate effective environmental scoping of loan applications for prospective sub-project, FieldGuidelines would assist the POs in assessing the environmental and health risks posed by rural credit loans.The Field Guidelines will become an integral part of the RDF II Policy Manual (See Annex 2 to RF IIPolicy Manual) 61. They would be distributed to POs of PFIs, to provincial DOSTE officers, as well as tothe licensing authorities (People's Committees) at the district- and commune-levels.

Insdtutional Arrangements

27. MOSTE and BIDV (the project's Apex Bank) would sign a Memorandum of Agreement (MOA)underlining the commitment and the related responsibilities of both institutions to pursue environmental

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protection requirements in the conduct of RF II.

28. To ensure the sustainability of the environmental training program and the environmental auditingcapacity, the Project's Management Unit (PMU) within BIDV would establish an Environmental Division(ED). The ED will be staffed with technically qualified individuals and provided with sufficient budget toexecute its functions. This Division will be charged with the implementation of the following tasks:

Planning and implementing environmental training, both domestically and overseas:

(a) In consultation with a project's TA, local environmental consultants, and in coordination withMOSTE, identify appropriate training programs overseas that are capable of providing relevantand effective environmental training to the PMU staff, MOSTE's Environmental Division, and tokey management personnel of the PFIs.

(b) Help in defining the scope and in implementing domestic training programs targeting POs of thePFIs and key DOSTE personnel.

(c) In coordination with MOSTE and assisted by environmental consultants, and with IDA'sconcurrence, update and keep current the Environmental Guidelines to be used routinely inassessing the environmental and health risks posed by rural credit loans. This will enhance thefield implementation of Vietnam's Law on Environmental Protection.

* Assisted by BIDV liaisons and DOSTE's staff in the provinces, monitor the sub-projects'adherence to the Environmental Guidelines and project approval screening criteria by auditing asample of sub-project on a periodic basis. A formal accountability mechanism (e.g., environmentalscore cards) should be put in place. To ensure that a meaningful integration of environmentalconsiderations into sub-projects approval becomes a metric for the PFI's performance, the PFI'ssub-loan approval authorization would be conditioned, among others, on their environmental score.

Training

29. Environmental training should be extended to include all members of the Environmental Division(ED) of the PMU; related BIDV and PFI staff, including those in the provincial and district branches, aswell as associated MOSTE and DOSTE staff. Training of the ED/PMU team, and key MOSTE andDOSTE officials would be carried out in qualified environmental institutions overseas, through an ad-hoctraining program. The scope and details of the training program will be determined by consultationbetween the TA, the prospective trainees, and the selected training outfits.

30. Environmental training of PFI management and project officers would be either administeredspecifically through RF II, where it will be designed by consultation with the TA, and/or integrated into thenational environmental capacity building initiative. The latter would be accomplished through theIDF-fimded Project of Strengthening Environmental and Social Safeguards Implementation in Vietnam.Training of trainers will be administered at the provincial level by appropriate Vietnamese environmentalteaching and research institutions. A preliminary list of prospective 'Train the Trainer' providers and/orfacilitators includes the following:

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> Center for Natural Resources and Environment Studies (CRES), University of Hanoi.> Vietnam Institute for Tropical Technology and Environmental Protection [VITTEP; formerly,

Environment Protection Center (EPC)], HCMC.> Institute for Environmental Science and Technology (INEST), Hanoi University of Technology> Mekong Project Development Facility (MDPF) Bank Training Center, HCMC.> The Center for Science and Technology (CEST), lJniversity of Hanoi.> The Center for Environmental Engineering of Towns and Industrial Areas (CEETIA), Hanoi

University.> National Institute for Soil Fertility (NISF) (Hanoi, with extensions in HCMC, Bac Giang and

Dac Lac).> Center for Environmental Economics and Regional Development, Hanoi National Economics

University (NEU).

31. To be effective as well as sustainable in the long-term, training over 10,000 POs requires thattraining capacity be established within the PFIs. Ultimately the environmental training of POs must beinstitutionalized and integrated directly into the prevalent on-going training given to rural credit officers aspart of regular operations of the PFIs. However, in the short-term, selected personnel of major provincialPFI branches, designated as prospective trainers should undergo environmental training. Due to theurgency of quickly building the capacity of credit officers as a required tool for evaluating loanapplications, the possibility of retroactive Project financing to implement the environmental training as soonas possible will be considered.

32. The scope of training of PFI management and POs should include, among others, Vietnam'senvironmental laws, principles of environmental assessment, principles of soil, water and air quality, toxicmaterials and their pathways, concepts of integrated pest management, impacts of erosion and siltationprocesses and mitigation measures, industrial pollution prevention and mitigation and pollution prevention,Clean Production, and principles of occupational health and safety.

Administrative Measures

33. To assist in the enforcement of the Environmental Guidelines associated with the sub-projects, andpursuant to the stipulations of Vietnam's Law and Decree (175/CP) on environmental protection thatallows the use of economic instruments, MOSTE will propose, in coordination with BIDV, administrativemeasures to penalize violators of the Environmental Guidelines (e.g., fines, closure, or pollution charges).

34. Sub-borrowers would be provided, either by the project officers or by DOSTE, with writteninformation about measures they have to implement to prevent environmental degradation associated withtheir sub-projects, and would sign a commitment to implement and maintain them.

35. MOSTE should be instrumental in instructing DOSTE in a province yet to be selected, to embarkon a cooperative effort with the Development Strategic Institute within the Ministry of Planning andInvestment (MPI) or selected environmental research institutions, as appropriate. With adequate funding,DOSTE and the counter institution/agency will jointly prepare a provincial land use map employingGeographic Information Systems, that would incorporate conmpiled environmental baseline parameters of:(i) water and air quality; (ii) areas to be protected from development due to ecological and cultural assets;(iii) pollution dispersion vectors (e.g., wind directions and groundwater flow); (iv) well-head protectionareas; (v) areas susceptible to flooding and soil erosion; (vi) areas deployed or designated for wastedisposal, sewerage treatment, and industrial zone development. Available soil, water and air pollution

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information should be computerized and updated periodically. Made accessible to all stakeholders down tothe POs and sub-borrower level, this, and subsequently similar graphic databases in other provinces wouldstreamline DOSTE's enviromnental perrnitting process and facilitate effective sub-project screening by thePFIs.

1/ The RDF, a wholesale banking operation, is the Fund under which the project would lend its financial resources, throughaccreditedfinancial institutions, to its beneficiaries (mainly SMEs).2/As of March 31, 2001 about 650,000sub-projects werefinanced underRFI. Averagesub-projectand sub loan size underRF I were the equivalent of US$530 and US$320, respectively.3/ VBARD -Vietnam Bankfor Agriculture and Rural Development; BIDV- Bankfor Investment and Development of Vietnam;ACB - Asia Commercial Bank; EAB - East Asia Commercial Bank4/ Referenced in a late 1990's study in the ceramics community of Bat Trang, and addressed by recent press, e.g., "..41% ofthe nearly 20,000 samples taken from 475 enterprises in HCM City failed to meet work environment standards, with manyfactories found to be too hot, noisy or dusty, while a number of others had insufficient lighting. As a result, between 10-30%of workers at these enterprises have contracted occupational illnesses such as disorders of the respiratory andgastro-intestinal systems and reduced eyesight and hearing" (Thanh Nien newspaper, quoted in Vietnam News, February 4,2002).5/ Most, if not all, of sub-projects financed under RF I, are classified as Category 11. Average sub-project and sub loan sizeunder RF I were, as of September 30, 2001, the equivalent of US$710 and US$445, respectively.6/ These Field Guidelines will be a revised version of the Environmental Assessment of Rural Credit Loans in Vietnam, FieldGuidelines, November 2000, prepared by Jacques Whitford, Environment Ltd., in cooperation with the SBV andfunding by theCanadian International Development Agency (CIDA).

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Additional Annex 17: Structure and Staffing of PMUVIETNAM: Second Rural Finance Project

1. BIDV is the executive management of the RF I and the proposed RF 11. A Project ManagementUnit (PMU) within BIDV would be established by May 31, 2002. The PMU would be responsible forimplementing the RF 11 project and carry out the first Rural Development Fund (RDF 1) and the Fund forthe Rural Poor (FRP). It would handle day-to-day matters related to implementation of: (i) the creditcomponent, i.e. RDF I and 11, FRP, and the Micro-finance Loan Fund (MLF); and (ii) the institutionalstrengthening component, including training, and Technical Assistance (TA) to address skill gaps of projectrelated activities in BIDV, Participating Financial Institutions (PFIs) and Micro-Finance Institutions(MFIs). The PMU shall operationally be independent and would maintain a separate account (or accounts)for all project activities which would be audited annually.

2. The PMU would have the following six divisions: (i) PFIs and MFIs accreditation and follow-upDivision; (ii) Sub-projects appraisal Division; (iii) Monitoring and Evaluation Division; (iv) Accountingand Disbursement Division; (v) Environment Division; and (vi) Administrative Division; and (vii) ProjectDirector Unit. Total number of staff: 50.

3. The main duties of the PMU broken down by its divisions, and the number of staff are as follows:

(i) Accreditation of PFIs and MFIs Division (10 persons)

* Accreditation of PFIs and MFls through the application of an agreed set of criteria as spelled outin the respective Policy Manuals.

* Assigning a line of credit to each of the PFIs and IviFls. The size of the line of credit would bebased on the respective PFI/NIEFI financial strength (solvency, liquidity, profitability, and qualityof management and staff) and its rural outreach capacity.

* Monitoring PFIs/MFIs financial performance, at least semi-annually.* Reviewing each PFI/MFI Institutional Developmerit Plan (IDP) and following-up on its

implementation. Also, if needed, assisting PFls/MFIs in the preparation and the implementationof their respective IDP.

* Calculating, on a quarterly basis, the Weighted Average of Interest Rate (WAIR) of 6 month and12 month deposits including an adjustment for the reserve requirements imposed by SBV. TheWAIR would determine the pass-on rate from BIDV to PFls/MFIs.

(ii) Sub-Project Appraisal Division (12 persons)

* Approving RDF funded sub-projects applications in line with the RDF Policy Manual, andsupervising their implementation.

(iii) Monitoring and Evaluation (7 persons)

* Monitoring project implementation and preparing reports, implementation plans as required.* Contracting TA, consultant services, and implement the training program.

(iv) Environment Division (4 persons)

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* Together with MOSTE and selected environmental research and training institutions, prepare andconduct training program to project related staff at the BIDV and PFIs on environmentalprotection under the project

* Monitonng and supervising the environmental aspects of the project

(v) Accounting Division (7 persons)

* Carry out the accounting of all project activities, including bookkeeping, disbursement to PFls,record collections and revenue and expenses, etc.

* Preparing the Funds financial statement.* Paying interest and principals to MOF.

(vi) Administrative Division (7 persons)

* Being in charge of PMU's administrative activities.* Handling personnel matters.* Carrying out all procurement activities under the Project

Project Director: 3 persons.

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