Document ofThe World Bank

Report No: 23868 ME

PROJECT APPRAISAL DOCUMENT

ONA

PROPOSED LOAN

IN THE AMOUNT OF US$64.6 million

TO THE

UNITED MEXICAN STATES

FOR A

SAVINGS AND CREDIT SECTOR STRENGTHENING AND RURAL MICROFINANCE CAPACITYBUILDING

TECHNICAL ASSISTANCE PROJECT

Latin America and Caribbean RegionColombia, Mexico and Venezuela Country Management UnitEnvironmentally and Socially Sustainable Development Sector Management Unit

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CURRENCY EQUIVALENTS

(Exchange Rate Effective June 3, 2002)

Currency Unit = Pesos (P$).P$ 1 = US$0.10

US$1 = P$ 9.65

FISCAL YEARJanuary 1 - December 31

ABBREVIATIONS AND ACRONYMS

AMSAP Asociacion Mexicana de Sociedades de Ahorro y IPDP Indigenous Peoples Development PlanPrestamo

AMUCSS Asociaci6n Mexicana de Uniones de Cridito del Sector ISA International Standards on AuditingSocial

ANAGSA Aseguradora Nacional Agricola KPI Key Performance IndicatorsBANRURAL Banco Nacional de Credito Rural LAC Latin America and the CaribbeanBANSEFI Banco delAhorro Nacional y Servicios Financieros M&E Monitoring and EvaluationBANXICO Banco de Mexico MIF Multilateral Investment FundBP Bank Procedures NCB National Competitive BiddingCAC Cooperativos de Ahorro y Credito NGO Non Governmental OrganizationCAS Country Assistance Strategy MS National and International ShoppingCGAP Consultative Group to Assist the Poorest O0 Outreach IndicatorCNBV Comisi6n Nacional Bancaria y de Valores OP Operational PolicyCOMACREP Consejo Mexicano de Ahorroy Credito Popular PAD Project Appraisal DocumentCONAPO Consejo Nacional de Poblacion PAHNAL Patronato del Ahorro NacionalCPM Caja Popular Mexicana PATMIR Programa de Asistencia T&nica para el

Microfinanciamiento RuralDO Development Objectives PCD Project Concept DocumentEA Environmental Assessment Pi Performance IndicatorsEMP Environmental Management Plan PSR Project Status ReportFBS Fixed Budget Shopping QCBS Quality and Cost-Based SelectionFIRA Fideicomisos Instituidos en Relaci6n con la Agricultura SAP Sociedades de Ahorro y PrestamoFMR Financial Monitoring Report SAGARPA Secretaria de Agricultura, Ganaderia,

Desarrollo Rural, Pesca y Alimentaci6nFOBAPROA Fondo Bancario de Protecci6n al Ahorro SC Supervision CommitteeFSAP Financial Sector Assessment Program SCI Savings and Credit InstitutionGDP Gross Domestic Product SDI Subsidy Dependence IndexGOM Government of Mexico SEDESOL Secretaria de Desarrollo SocialIBRD International Bank for Reconstruction and Development SHCP Secretaria de Hacienda y Credito PuiblicoIDB Inter-American Development Bank SOE Statement of ExpensesIC Individual Consultants SS Single SourceICB International Competitive Bidding TA Technical AssistanceIFC International Finance Corporation TOR Terms of ReferenceILO International Labour Organization TU Technical UnitINI Instituto Nacional Indigenista USAID United States Agency for International DevelopmentIP Impact Performance WOCCU World Council of Credit Unions

Vice President: David de FerrantiCountry Manager/Director: Olivier Lafourcade

Sector Manager/Director: John RedwoodTask Team Leader/Task Manager: Carlos Cuevas

MEXICOSAVINGS AND CREDIT SECTOR STRENGTHENING AND RURAL MICROFINANCE

CAPACITY BUILDING

CONTENTS

A. Project Development Objective Page

1. Project development objective 32. Key performance indicators 3

B. Strategic Context

1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 42. Main sector issues and Government strategy 53. Sector issues to be addressed by the project and strategic choices 8

C. Project Description Summary

1. Project components 82. Key policy and institutional reforms supported by the project 133. Benefits and target population 134. Institutional and implementation arrangements 15

D. Project Rationale

1. Project altematives considered and reasons for rejection 152. Major related projects financed by the Bank and other development agencies 163. Lessons leamed and reflected in the project design 174. Indications of borrower commitment and ownership 185. Value added of Bank support in this project 18

E. Summary Project Analysis

1. Econornic 192. Financial 203. Technical 214. Institutional 225. Environmental 246. Social 247. Safeguard Policies 27

F. Sustainability and Risks

1. Sustainability 272. Critical risks 283. Possible controversial aspects 29

G. Main Conditions

1. Effectiveness Condition 292. Other 30

H. Readiness for mplementation 30

I. Compliance with Bank Policies 30

Annexes

Annex 1: Project Design Summary 31Annex 2: Detailed Project Description 35Annex 3: Estimated Project Costs 40Annex 4: Cost-Effectiveness Analysis Summary 41Annex 5: Financial Summary for Revenue-Earning Project Entities, or Financial Summary 44Annex 6: Procurement and Disbursement Arrangementsand Financial Management Assessment 46Annex 7: Project Processing Schedule 54Annex 8: Documents in the Project File 55Annex 9: Statement of Loans and Credits 56Annex 10: Country at a Glance 59Annex 11: Social Development Model 61Annex 12: Legal and Regulatory Framework and SCI Supervision 67Annex 13: Savings and Credit Sector Information Systems 71Annex 14: Indicators and Projections for Savings and Credit Institutions in Marginal Areas 74Annex 15: Studies, Infonnation Dissemination, Monitoring and Evaluation 80

MAP(S)IBRD 23547

MEXICOSavings and Credit Sector Strengthening and Rural Microfinance Capacity Building

Project Appraisal Document

Latin America and Caribbean RegionLCSER

Date: June 5, 2002 Team Leader: Carlos E. CuevasCountry Manager/Director: Olivier Lafourcade Sector Manager/Director: John RedwoodProject ID: P070108 Sector(s): BI - Institutional Development, FS - Financial

Sector DevelopmentLending Instrument: Technical Assistance Loan (TAL) Theme(s): Rural Development; Financial Sector

Poverty Targeted Intervention: Y

[XI Loan [ ] Credit [ ] Grant [] Guarantee [ Other:

For Loans/Credits/Others:Loan Currency: United States DollarAmount (US$m): $64.6

Borrower Rationale for Choice of Loan Terms Available on File: 1 Yes

Proposed Terms (IBRD): Fixed-Spread Loan (FSL)Grace period (years): 5 Years to maturity: 15Commitment fee: 0.85% for the first 4 years; 0.75% Front end fee (FEF) on Bank loan: 1.00%

thereafter Payment for FEF: Capitalize from Loan Proceeds

Initial choice of Interest-rate basis: Mamtam as variable

Type of repayment schedule:[X] Fixed at Commitment, with the following repayment method (choose one): level[ I Linked to Disbursement

Conversion options: [X]Currency [PXInterest Rate [X]Caps/Collars: Capitalize from Loan Proceeds

BORROWER 12.70 0.00 12.70IBRD 7.70 56.90 64.60INTER-AMERICAN DEVELOPMENT BANK 0.00 3.50 3.50LOCAL SOURCES OF BORROWING COUNTRY 4.60 0.00 4.60Total: 25.00 60.40 85.40

Borrower: UNITED MEXICAN STATESResponsible agency: BANSEFI / SAGARPANational Savings and Financial Services Bank (BANSEFI); Secretariat of Agriculture, Livestock, Rural Development,Fisheries and Nutrition (SAGARPA)Address: BANSEFI: Av. Cuauhtemoc 2, Col. Pueblo de TizapanDel. Alvaro Obreg6n, C.P. 01090, Distrito Federal, Mexico, D. F.; SAGARPA: Insurgentes Sur 489-PHI, Col.Hip6dromo Condesa, C.P. 06100, Mexico, D.F.Contact Person: Javier Gavito (BANSEFI); Gabriela Zapata (SAGARPA)Tel: Javier Gavito: 52-55-5481-3444; Gabriela Zapata: 52-55-5534-1135 Fax: Javier Gavito:52-55-5481-3449; Gabriela Zapata: 52-55-5524-0007 Email: Javier Gavito: jgavito@bansefi.gob.mx;Gabriela Zapata: forgfin.dgpr@sagarpa.gob.mx

Estimated Dlsbursements j Bank FY/US$m):Mg:9Sgti A 90 VO3V' i II w ' i.6VN QQ' 4 K , @g.

Annual 12.40 22.60 14.10 9.20 6.30Cumulative 12.40 35.00 49.10 58.30 64.60

Project Implementation period: June 2002 to June 2007Expected effectiveness date: 09/01/2002 Expected closing date: 12/01/2007

OM:a F*M Fam M. zat-

A. Project Development Objective

1. Project development objective: (see Annex 1)

The proposed project builds upon and enhances the Bank's overall program of strengthening Mexico'sfinancial sector, and providing targeted assistance to the rural poor. The project's main objective is tocontribute to the integration of low-income people into the national economy and to the realization of theirincome generating potential by increasing their access to financial services. To this end, the project aims atimproving the financial stability and outreach capacity of savings and credit institutions (SCIs) nationwide,and especially at expanding financial services in rural areas.

The project also builds upon the recent legal and regulatory reforms the Government of Mexico (GOM) hasenacted to restructure and strengthen the savings and credit sector, a much needed action given the state ofthis sector and especially the loss of confidence in the financial system among the poor. Most notableamong these reforms are the "Popular Savings and Credit Law" (Ley de Ahorro y Credito Popular, June 4,2001), and the law that creates the "National Savings and Financial Services Bank" (Banco del AhorroNacionaly Servicios Financieros, BANSEFI, June 1, 2001, see section B.2).

Specifically, the project will support the strengthening of the SCI sector through specialized assistance tothe retail institutions, enabling these intermediaries to reach more clients with improved services in asustainable manner, and through improving the supervisory capacity of the Comisi6n Nacional Bancaria yde Valores (CNBV) to oversee the SCIs as mandated by the Ley de Ahorro y Credito Popular. Inaddition, as a targeted element of this generalized financial sector strengthening, the project will supportactions to improve the access of low-income rural communities to sustainable financial services. Lastly,the project will include studies and actions designed to increase understanding of the constraints affectingthe extension of financial services to lower-income clients, monitoring the effectiveness of current policyand programs and developing new financial techniques adapted to Mexico.

2. Key performance indicators: (see Annex 1)

The key performance indicators listed below are expected to be met by the end of the project and have beenagreed with the implementing institutions. The targets will be monitored throughout the projectimplementation period to assess progress towards achieving project objectives.

Savings and Credit Sector

* The approximately 385 participating savings and credit institutions are assessed and classified intofour categories as follows: (a) qualify for certification into the new legal system (by CNBV) and mayrequire assistance to modernize and expand outreach; (b) require capacity-building to make them eligiblefor certification; (c) require major restructuring (e.g., merger with or acquisition by another SCIs); or (d)are unviable and will be liquidated.

* Technical assistance plans are designed and put in place for those institutions which requirestrengthening or restructuring - categories (a) though (c) above. As required, liquidation plans areprepared and begun to be implemented for unviable institutions. Some 300 or 80 percent of institutions areexpected to benefit from technical assistance for strengthening or restructuring.

* Institutions benefiting from technical assistance qualify for certification.

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* Basic information SCI system designed and developed. Services provided to about 100 SCIs thatrepresent approximately 1000 points of service (SCI branches). A fee-for-service cost recovery mechanismwill be designed that will have as objective the full recovery of operating costs by the fifth year of systemoperations.

* Approximately 800 SCI management and staff are trained in accounting, credit analysis, riskmanagement and govemance.

* CNBV supervision system is put in place. Some 200 institutions are expected to be under CNBVsupervision, under the auxiliary supervision system envisioned for the sector, at the end of the project.

Rural Microfnance

* Some 60,000 clients are served in project marginal areas at the end of the project. Participatinginstitutions meet criteria for certification by CNBV.

* Approximately 8,000 families in rural communities receive training (functional education) infinancial matters.

Monitoring and Dissemination

* Monitoring system covering performance of SCIs and federations, including the project-supportedrural microfinance institutions, and the program's social impact is put in place at BANSEFI.

* Dissemination campaign on SCI sector reform designed and put in place.

B. Strategic Context

1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1)Document number: R2002-0073; IFCR2002-0055 . Date of latest CAS discussion: 05/16/2002

The joint IBRD/IFC CAS is structured along five main thrusts - macroeconomic sustainability,enhancedcompetitiveness, human development, environmental protection, and good governance. It sets forth anintegrated approach to broad-based, sustainable growth for poverty reduction with a strong private-sectorrole. The proposed project contributes to the integration of a broad range of households, includinglower-income and rural-based clients, into a sustainable growth process, reinforcing the social stability andoverall capitalization of those segments of the population, especially rural communities. By improvingaccess to reliable financial services, especially savings, and helping create sustainable financialintermediation networks in rural areas, the project alleviates one of the major constraints to socialintegration and rural development. The project builds upon and complements the financial sectorstrengthening objectives of the Bank Restructuring Facility projects (No. 70600 and 70030), and the ruralpoverty alleviation objectives of the Rural Development in Marginal Areas program (No. 19877). It alsofollows on sector work carried out in 1995 (Rural Financial Markets, Report No. 14599-ME), 1997(Mobilizing Savings for Growth, Report No. 16373-ME) and 2000 (Rural Savings Mobilization, ReportNo. 21286-ME), and uses guidance resulting from the joint Bank/Fund FSAP mission of March 2001.

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2. Main sector issues and Government strategy:

The Savings and Credit Sector

The non-bank financial sector, and savings and loan institutions in particular, has a significant and growingpresence in areas and among clients not traditionally served by banks in Mexico. Non-bank financialintermnediaries in Mexico include a multiplicity of fornal and informal, regulated and unregulatedinstitutions which mobilize deposits from and/or extend credit to the public. Among formal non-bankintermediaries (i.e., licensed under a law) are those which are regulated as financial institutions, includingSociedades de Ahorro y Prestamo (SAPs) and Credit Unions, and those which are not, including CajasPopulares, Cooperativas de Ahorro y Credito , Cajas Solidarias, NGOs and others. Savings and creditinstitutions (SCIs), in this document, refer to both of these types of formal intermediaries. Informalintermediation, on the other hand, which is unregulated and not legally sanctioned, includes rotating savingsand credit associations (tandas), money lenders, savings groups and other personal savings and loanarrangements, which are not dealt with in this document.

It is estimated that the SCI sector, comprised of more than 630 institutions, extends savings and loanservices to approximately 2.3 million people or (about 7 percent of the economically active population) andhas assets of more than US$1.4 billion (or approximately I percent of banking sector assets). The SAPnetwork alone includes nearly 400 retail outlets with 500,000 members in 31 states. For many of theseSCIs, full reliance on mobilized deposits to support their loan portfolios protected them from the 1995cunrency crisis, as they had practically no foreign-currency liabilities. In addition, it gave the savings andloan societies an advantage vis a vis the banling system, as they were able to lend when banks weredrastically contracting credit flows. Well-fimctioning savings and credit institutions were thus able toattract new members and grow in scale when most of the rest of the financial system was shrinking.

While the relative stability and extension of the SCI sector towards lower-income and rural clients hasprovided for alternative access to financial services where commercial and development banks have notbeen successful, the lack of effective regulation and supervision until the passage of new legislation lastyear has meant that these institutions and their depositors are exposed to significant risks. These risks havebeen made apparent by several SCI failures, some of them openly fraudulent, which have seriouslyundermined public confidence in these institutions, especially among small depositors. Restoring clientconfidence, and enhancing the ability of financial intermediaries to reach more people thus became criticalobjectives of the Mexican administration.

Against this background, Government has embarked on a strategy to strengthen financial intermediariesactive among all market segments, including banks and non-bank institutions. The banking sector hasbenefited from a strengthening process supported by the Bank Restructuring Facility. Moreover, the recentBank/Fund FSAP mission has outlined additional strengthening measures, including a framework for therationalization of public development banks. In order to increase access to services and enhance thereliability of those services among lower-income households, which traditionally do not benefit frombanking services, the Government has devised a strategy towards strengthening and effectively supervisingSCIs. This strategy aims at further developing the capacity of these intermediaries, modernizing theirservices, substantially improving their image among the general public and increasing their overalloutreach, especially in rural areas.

To this end, key government entities concerned with financial sector issues, the Secretariat of Finance andPublic Credit (SHCP), the National Banking and Securities Commission (CNBV) and the Central Bank of

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Mexico (BANXICO), with Bank collaboration, and in close consultation with the practitioners and thelegislature, developed a new legal and regulatory framework for savings and credit institutions andorganizations (instituciones de ahorro y credito popular), perceived to hold a high potential to expandinstitutional outreach to under-served sectors of the population. In reality, the diverse range of non-bankfinancial institutions operating in Mexico serves a continuum of clientele, from the relatively wealthy topoor, marginalized households in rural and urban areas alike. (See Section C.3. for details on SCIs andclient profiles). The Ley de Ahorro y Credito Popular was passed on April 30, 2001 and became effectiveon June 4, 2001. It provides for the incorporation of all savings and credit (non-bank) financial institutionsinto a legal framework that covers the range of their intermediation activities.

The law recognizes two types of retail intermnediaries authorized to mobilize deposits from the generalpublic: Savings and Credit Cooperatives (Sociedades Cooperativas de Ahorro y Credito), and PopularSavings Associations (Sociedades Financieras Populares). After a period of two years from the date of thelaw's effectiveness, only those institutions which are able to demonstrate their financial viability, whichsubject themselves to regulation and supervision and which purchase private deposit insurance will beauthorized to remain in operation. Regulation and supervision will be tailored to four different categories ofSCIs, depending on the scale and types of liabilities and assets, number of shareholders or clients, nunberof branches, geographic coverage and technical operating capacity. More developed institutions will begranted authorization to provide a greater range of services and products, while being subject to stricterstandards than less developed ones. The institutional framework prescribed by the legislation will requireaffiliation in Federations, which will monitor and oversee SCI activities and status according to CNBVguidelines and under its overall sector monitoring.

The CNBV, per mandate of the new law, becomes the sole regulatory and supervisory authority fornon-bank entities providing savings and credit services and has the responsibility of issuing all rules andregulations associated with the new law. In this manner, the law aims at eliminating the opportunities forregulatory arbitrage that have thus far characterized the Mexican legal framework. The regulatory andsupervision framework for "popular savings and credit" institutions has thus been designed to be consistentwith the laws mandating prudential nonus and governing the activities of banks and other financialinstitutions.

While the CNBV is in charge of SCI supervision, the newly created BANSEFI has been charged with theresponsibility of developing the capacity of and preparing SCIs for their integration into the new system,and supporting the fornation and strengthening of the Federation(s) of SCIs and their associated auxiliarysupervisory bodies (Comites de supervisi6n) which will assist CNBV in its supervisory role. BANSEFI, assuccessor of the Patronato del Ahorro Nacional (PAHNAL) will continue to provide secure savingsinstruments to low-income clients and to educate and encourage savings habits among the public, but inaddition to PAHNAL's retail savings services functions, BANSEFI will arrange the provision of technicalsupport to savings and credit institutions, provide second tier central banking services, excluding on-lendingof funds, and will coordinate the Government's programs to develop the SCI sector.

On the practitioners's side and as a reaction to the legal reforms, the numerous entities in the sector created(in February 2001) the Consejo Mexicano de Ahorro y Credito Popular (COMACREP), whichencompasses all major second-level organizations (such as that of the SAPs, AMSAP, of the Uniones deCredito, AMUCSS, of the non-cooperative microfinance institutions, PRODESARROLLO, and the mostimportant confederations of savings and credit cooperatives, e.g., UNISAP, among others). TheCOMACREP, thus claiming at least 80 percent of the SCI sector by any measure of scale (clients, assets,deposits), is carrying the dialogue with the official entities involved, notably CNBV and BANSEFI, on bothregulatory and developmental issues.

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The Government of Mexico has requested Bank assistance to prepare SCIs for incorporation into thesystem and to build capacity among sector institutions to effectively provide supervision, monitoring andinstitutional strengthening functions. In addition to the SCI sector stabilization, integration and supervisionprogram, the Govermnent has sought Bank support for the preparation of a program to increase theoutreach of savings and credit institutions and organizations in rural areas, as well as to provide technicalassistance and training in poor, rural cornmunities interested in increasing formal savings.

Financial Services in Rural Areas

Rural Finance in Mexico suffers at present two main consequences of past government strategies: (i) ratesof participation in formal financial transactions for rural entrepreneurs and households lower than those incountries with one-half of Mexico's per capita GDP; and (ii) a severe scarcity of viable or potentiallysustainable financial institutions with a significant presence and outreach among low-income households,particularly in rural areas.

Directed credit at subsidized interest rates, subsidized credit guarantees, and debt forgiveness andrestructuring characterized rural credit in Mexico during the 1980s and early 1990s. Key public ruralfinance institutions, namely the Banco Nacional de Credito Rural (BANRURAL) and the FideicomisosInstituidos en Relaci6n con la Agricultura (FIRA) were the main means of intervention. In addition, theAseguradora Nacional Agricola (ANAGSA, closed in 1990) insured most of BANRURAL loans atsubsidized premium rates. These interventions created heavy fiscal outlays, estimated in the period1983-1992 at approximately US$28.5 billion (an annual average of about 13 percent of agricultural GDP),of which US$23.1 billion (81 percent) were associated with subsidized interest rates.

The government began introducing reforns in rural credit policies in the early 1990s, intended to reducetransfers to the sector and improve efficiency of its rural finance institutions. It reduced interest-ratesubsidies, made transfers to institutions more transparent and closed or reorganized inefficient governmententities.

The exchange-rate crisis of early 1995 induced further closings of rural branches by struggling banks, thusdiminishing the already dwindling presence of financial institutions in rural areas (then limited to less thanone third of the country's municipalities, including offices of development banks). Subsequent Bankdialogue with government focused on providing an environment conducive to increasing the outreach andsustainability of formal financial intermediaries in rural areas, as opposed to the traditional directintervention. Specifically, a Rural Finance Technical Assistance loan was approved in 1996 with theobjective of reviewing Government participation in the sector; and developing a package of appropriatefinancial products, lending technologies and incentive schemes to provide sustainable financial services tolow income populations through private, commercial banks. The project was not successfully implementeddue, in part, to the financial crises and controversial rescue package provided by the Banking Fund forSavings Protection (FOBAPROA), which induced commercial banks into much more conservativeapproaches. Banks chose the pursuit of profitable opportunities in their existing urban markets overexperimentation and the substantial investments in infrastructure and staff training needed to move into lessunderstood rural markets. Moreover, a collusive attitude among commercial banks and a struggle betweenGovernment offices for control over the initiative hampered the project viability and resulted in its closingin late 1999.

Currently, the Secretariat of Agriculture, Livestock, Rural Development, Fishing and Food (SAGARPA),and the Secretariat of Finance (SHCP) are concemed with increasing the presence of reliable financial

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intermediaries in rural areas as an essential base for a healthy development of savings and othermicrofmnance activities, and a restoration of rural people's confidence in the financial sector. In addition,SAGARPA is encouraging the establishment of adequate linkages mechanisms between emerging ruralcommunity funds (usually formed among producers that benefit from SAGARPA's transfer programs) andsustainable intermediaries that conform to the new law. The Secretariat requested Bank support tosubstantially re-structure and re-design a support program initiated in 2000 (the Programa de AsistenciaTecnica para el Microfinanciamiento Rural, PATMIR, which had no Bank support in 2000). This requestprovided an opportunity to ensure that activities under this program are fully consistent with the new legalreform and regulatory fiamework, and that institutional development approaches are coherent with those tobe applied for the implementation of this new framework.

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

The focus on existing SCIs represents a major shift in both the Government and the Bank's strategy tosupport improved access to formal financial services for broad segments of the population in Mexico ingeneral, and for poor rural households in particular. Drawing upon GOM's clear and coherent approach toconsolidating and strengthening the SCI sector, the proposed project addresses the issues associated withthe installed institutional capacity for financial intermediation in the sector, its potential for sustainablegrowth and the public confidence the sector conveys. In addition, the project supports actions thatcontribute to CNBV's capacity to effectively supervise the SCIs.

The project places emphasis on providing sustainable SCI services in rural areas and strengthening thecapacity of communities to mobilize and manage savings in ways which reduce the costs of access toformal savings services. In addressing intermediation capacity in rural areas, the project will work both onthe demand side and the supply side of financial services. On the demand side, it will enhance the abilityand skills of local communities to organize and manage savings programs and capitalization of funds byproviding technical assistance and training to local groups. On the supply side, the project will work withSCIs to enhance their sustainability and incorporate them into the new legal fuamework. In selectedmarginal areas, the project will focus on developing financial instruments adapted to the needs, habits andculture of rural communities.

C. Project Description Summary

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

The project supports the Government's efforts to strengthen the SCI sector, which serves the poorersegments of the market, so that sector institutions are able to provide secure and expanded services, andover time, increase their coverage. In addition, because rural areas are seriously underserved and becauseof the intrinsic problems in serving clients in this market, the project includes programs aimed at improvingaccess of rural communities to sustainable financial services. The main components of the project aresummarized below.

Component 1: Consolidation of the Savings and Credit Institutions Sector

The project supports a program to strengthen eligible institutions and liquidate institutions which are notsustainable, to improve SCI sector infrastructure, and to enhance sector supervision. As per its mandate,BANSEFI will manage the technical assistance programs. CNBV is the sole responsible for theauthorization of SCIs to operate as financial intermediaries.

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1.1 Strengthening SCIs

Support to Institutions. The project will support an assessment of existing SCIs to detennine whether thesequalify for certification by CNBV, require technical assistance either to strengthen or to restructure them(e.g., mergers or acquisitions), or need to be liquidated. Evaluation criteria have been prepared by a teamled by CNBV, and consisting of national and international specialists. It is expected that 385 institutionsoperating in rural and urban areas, with 1.8 million members or 78 percent of total sector membership, willparticipate in the program. Preliminary analysis shows that some 80 percent of institutions would meet thecapitalization requirements for certification provided they take measures to strengthen their management,financial performance and operations, or undertake some form of restructuring.

The project will support the preparation and implementation of plans to strengthen institutions which canbe strengthened or restructured and which have agreed to carry out plans to gain CNBV certification. It isanticipated that the institutional strengthening plans will last between one and two years, depending on thesize of the institution. BANSEFI will recruit institutions which are specialized in the provision of theseservices (referred to as technical assistance providers) to carry out the initial assessment using CNBVguidelines, and to prepare and implement the institutional strengthening plans. The technical assistanceproviders will enter into fornal agreements with the participating SCIs and their corresponding Federationsspelling out the program and the performance standards to be met in a designated time period. BANSEFIwill monitor the results of the technical assistance program and will review progress on a semi-annualbasis. BANSEFI intends to suspend assistance to institutions which do not achieve the agreed semi-annualtargets. In addition, CNBV intends to verify on a sample basis the accuracy of the classification given atthe outset to the institutions participating in the program. The CNBV will conduct its own evaluation of theinstitutions when the technical assistance program is completed, and decide independently whether theinstitutions are to be authorized under the law.

The project will also support, as required, the liquidation of institutions which have been determinedunviable and present risks to deposit-holders. As the legal status of sector institutions is very diverse,support for liquidation will be determiined on a case-by-case basis.

Technical assistance providers will be selected from among specialized institutions with demonstratedexperience in the field. The providers will support all institutions in a Federation (or ascribed to aFederation for supervision purposes) which are willing to enter into specific agreements. The Government,with financing by the Bank, will pay for the costs of the technical assistance program. The beneficiarieswill contribute some logistical support to the consultants. The participating institutions will also pay forthe full cost of the Federations which are being established as required by law. The loan does not includefinancing to shore up the capital, which may be required in the case of a few institutions. The contacts willcover the costs of the international and national specialists required to carry out the institutionaldevelopment plans as well as expenses directly associated with their work, including equipment andmaterials. No vehicles will be financed by the loan.

Providing SCI Information Infrastructure and Services. The project will support the design andestablishment of an information system for the sector as part of an integrated effort aimed at strengtheningthe SCIs, their federations and the sector at large. The informnation system will enable sector institutions toprovide required financial reports to the CNBV as their supervisor, and to other relevant governmentagencies. It will also have the capability to maintain accounts and financial inforrnation, and to provideother operational, control and reporting services, upon request by the institutions.

The core system will reside and will be operated at BANSEFI. The SCIs will link to the system with

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equipment, software, technical assistance and training provided by the project contractors. This componentwill support the design and development of the basic system infrastructure and software, and the provisionof services to about 100 SCIs that represent approximately 1000 points of service (SCI branches). TheGovernment will pay, with Bank financing, for the system development costs. A fee-for-service costrecovery mechanism will gradually be put in place that will have as an objective the full recovery ofoperating costs by the fifth year of system operations. The requisite telecommunications infrastructureexists in Mexico. BANSEFI has confirmned interest and service capacity from data commnunicationsproviders to participate in bids for provision of services to the information systems to be set up byBANSEFI.

It is anticipated that implementation of this component will be canied out in the first year of the project. Acomplementary initiative, expected to be prepared pari pasu with implementation and likely to constitute anew request for financing from the Government of Mexico, will enable the national roll-out of the system.This sequencing of efforts is fully consistent with the expected pace of SCI rehabilitation and strengthening,and follows international good practice in systems development for comparable scenarios.

Trainingprogramfor SCIstaff The project will support the implementation of a training program forSCI management and staff. The program will include modules in the areas of finance, accounting, riskmanagement, credit analysis and govemance and will be offered in six regions. The training, which will beavailable to all participating institutions, will be carried out by specialized consultants (for accounting)and tuaning institutes for the other subjects. It will be implemented over a two year period. Some 800members of participating institutions are expected to participate in the training. The Federations andmember institutions will provide the physical facilities for the courses and will pay for the transportationand living expenses of its participants in the courses.

1.3 Strengthening SCI Supervision.

The project will provide support to CNBV to strengthen its supervision procedures and competencies. Tothis end, it will provide training to CNBV staff on supervision practices and procedures for microfinanceinstitutions and technical assistance to CNBV to develop and adapt regulations as needed. In addition,CNBV will engage the advice of recognized international experts in systems of auxiliary supervision (e.g.,Germany, Canada, Spain) on a regular, semi-annual basis. The project will also provide technicalassistance to strengthen the Supervision Committees (Comites de supervisi6n) at the Federations,specifically charged with the auxiliary supervision flmctions. It will also provide support to theConfederations that group them. This support aims at ensuring clear definition of the functions of theFederations (and the Confederation that will group them), and specifically a demarcation between theauxiliary supervision role and other fimctions. The support to CNBV and the sector will seek to establishrules and procedures that ensure professional and transparent handling of entry and exit, and address andmitigate risks of conflict of interest, adverse selection and other issues that may emerge in the process ofimplementing the supervisory mechanism. The loan will finance technical assistance and training requiredto carry out the activities.

Component 2: Expanding Financial Services in Rural Areas

This component ains at expanding the supply of financial services the marginal areas, and builds uponwork initiated under the marginal areas progrmsu. The project will cover the marginal areas in some elevenstates. Activities under this component will be carried out by specialized international technical assistanceproviders under contract with the implementing agency.

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2.1 Expanding Institutions and Services in the Marginal Areas

The component aims at increasing outreach, ensuring financial sustainability, and improving anddiversifying the financial services offered by existing intermediaries that serve the marginal areas. In areaswhere no intermediaries exist, new institutions will be established using proven methodologies and whichwill fully comply with existing legislation. Participating institutions will be selected on the basis of theirtrack record in terms of outreach and sustainability, and their expansion plans. Institutions supported underthis component are likely to be'regional institutions, as these are the most inclined to serve the targetclientele. The participating institutions would enter into agreements with the technical assistance providerscommitting to perfomiance targets which will be closely monitored. Program activities will encouragecommitment and ownership at the local level while setting up institutional policies and structures thatencourage efficiency and profitability. The process will take time because new habits and skills will needto be developed. All participating SCIs will join or will be assigned to a Federation for supervisionpurposes, as mandated by the law, and will meet the requirements for certification by CNBV. The programdoes not include a line of credit, and it is expected that most of the credit given by participating institutionswill be from members' savings.

The marginal areas will be grouped into regions for developmental purposes. The population of themarginal areas covered total some 17 million people. The program will be implemented in six of thefollowing eight regions: (i) Chiapas, (ii) Huasteca (marginal areas in the States of Hidalgo, San Luis Potosiand Veracruz), (iii) Oaxaca, (iv) Veracruz excluding the Huasteca (v) Guerrro (and adjacent marginalareas in the State of Morelos), (vi) Michoacan (and adjacent marginal areas in the State of Mexico), (vii)Puebla (and adjacent marginal areas in the State of Tlaxcala) and (viii) Sierra Gorda (marginal areas inthe States of Queretaro and Guanajuato). The municipalities covered by the program appear in a documentprepared by SAGARPA which is based on the classification of the CONAPO for levels of marginality. Theregions have been selected taking into account the demand for services identified in market studies, and thewillingness of institutions or groupings of clients in the region to enter into performance agreements withthe technical assistance providers. The sequencing of the regional programs has also been determined onthe basis of the studies, although this order may be modified if developments justify advancing a regionahead of others.

The technical assistance providers will be selected following World Bank procedures. The process ofselection of the technical assistance provider which will implement the program in Chiapas is completeand the program will be initiated this month. The process of selection of the technical assistance providerfor the Huasteca Region is well advanced, and work should start later this year. At the end of five years ofthe project, some 60,000 families will be served in the six regions where the program will have beeninitiated. This figure takes into account that some of the regional programs would only be in their third yearof operation. Given that the regions served under the program have few existing institutions, much of theexpansion of services will come thrugh the establishment of new branches or new institutions. Some15-20 new branches (or local institutions) should be established in each of the marginal areas covered. Thecontracts will cover the costs of the intemational an national specialists required to carry out the regionaldevelopment plans as well as expenses directly associated with their work, including equipment andmaterials. No vehicles will be financed by the loan.

2.2 Community Training Programs (Social intermediation)

The project will provide training to the poorer segments of the population in the marginal areas on basicprinciples of household finance and participation in financial transactions. In some cases, the program willassist communities to set up simple record-keeping for indigenous savings organizations, and introduce

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them to forrmal institutions where they could set up formal accounts. Activities under this sub-componentwill be organized by the same technical assistance providers that will provide services undersub-component 2.1.

Component 3: SCI Sector Studies, Information Dissemination, Monitoring and Evaluation

This component aims at increasing understanding of the constraints affecting the provision of financialservices to low-income clients, at monitoring and evaluating the effectiveness of policies and programs, andat developing financial innovations adapted to Mexico. The project will finance consulting services andpreparation of information materials under this activity.

3.1. Sector-wide activities

Activities under this component include studies on, inter alia, financial intermediation, sector performanceand auxiliary supervision with a view to identify explanatory factors for performance, draw lessons fromthe Project results and identify areas for improvement and innovation. In addition, the component includesdissemination programs, including workshops and information campaigns, to inform SCIs, their clients andother stakeholders of the sector consolidation and strengthening program, and to disseminate lessons fromexperience in the areas of microfinance, savings mobilization, and auxiliary supervision. Disseminationefforts will also include the general public, with emphasis in the low-income segments of the population.The project will also support the introduction of systems to monitor sector development progress and theimpact of the government's development programs. The sector studies and monitoring function will becarried out at five different levels: (i) SCI supervision mechanism; (ii) SCI performance; (iii)federation/network performance; (iv) social and economic impact; and (v) fiscal impact. Lastly, thecomponent will also support periodic extemal evaluations by national and international consultants.

3.2 Rural microftnance activities

Studies will also cover financial intermediation in rural areas and other areas underserved by the Mexicanfinancial sector, with a view to defining new methodologies which are adapted to local conditions. includingtechnical and financial audits of the rural microfinance institutions supported under the project, and expertadvice to the project management team. This component will support monitoring and evaluation activitiesspecific to the implementation of component 2 (rural areas), including technical and financial audits ofSCIs supported under the rural finance component.

Component 4: Project Management

BANSEFI and SAGARPA are conscious of the importance of a strong project implementation team tocoordinate and supervise the work the consultants contracted to carry out the project activities, and haveassembled a strong team for this purpose. The project will support the operations of a Core Team atBANSEFI and of SAGARPA's technical unit which have been set up to carry out project management andimplementation follow up, including monitoring and evaluation of the activities.

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Institutions Sector Development .

2. Expanding Financial Services in Institutional 26.18 30.7 19.48 30.2Rural Areas Development

3. SCI Sector Studies, Information Financial Sector 5.69 6.7 4.67 7.2Dissemination, Monitoring & DevelopmentEvaluation

4. Project Management Institutional 4.88 5.7 1.57 2.4Development

Total Project Costs 84.76 99.3 63.96 99.0Front-end fee 0.64 0.7 0.64 1.0

Total Flnancing Re uhred 85.40 100.0 64.60 100.0Totals may not add up due to rounding

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

Key policy reformns for the savings and credit sector were enacted by GOM in 2001, notably the passage ofthe "Popular Savings and Credit Law" and the law that creates BANSEFI. The project will contribute tothe implementation of this new legal and regulatory framework through: (a) supporting the developmentalrole assigned to BANSEFI vis a vis the SCIs and its organizations (Federations and Confederations), and(b) assisting the CNBV in the acquisition of specialized capacities to carry out its new supervisoryfunctions. At the institutional level, the project is concerned with reforming governance structures,management systems, methods, procedures and instruments of financial intermediaries conducive toenhanced outreach, with an emphasis on rural and lower-income populations, and on substantial progresstowards self-sustainability.

3. Benefits and target population:

At the time of enactment of the new legislation in 2001, the SCI sector consisted of a wide variety ofinstitutions. The approximate number of clients served and indicative figures for average savings accountand loan size (table below) show the importance of the sector and the nature of its clientele, primarilymiddle- to low-income segments of the population which for the most part are not served by the bankingsector. Institutions vary widely in size; some are little more than informal groupings (such as neighborhoodsavings groups with a civil association legal status), while others are fairly sophisticated savings and creditinstitutions.

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SC I type Aprx. Ap rx. No. al Avg. Savings ANg. OriginalNo (iIII l Cliviits Accomit Size Loin Size

( QwNso ) / pesos )

Credit Unions 32 19,000 $10,000 $47,000Savings and Loan 11 675,000 $7,200 $5,000Societies (SAPs)Savings and Loan 157 1,081,000 $5,800 $4,000Cooperatives (CACs)Cajas Solidarias 210 190,000 $1,000 $1,100Cajas Populares 220 344,000 Not available Not available(estimated)TOTAL 630 2,309,000

The project is expected to benefit the diverse range of households which make up the current and potentialclientele of SCI institutions, by building the capacity of a large subset of these institutions and enablingthem to be certified by the CNBV, which will provide prudential oversight of their activities. Lack ofconfidence in SCIs helps explain the low rates of participation in these institutions, even when they aregeographically accessible. Consolidating the SCI sector and building confidence in these intermediaries isthus expected to increase the number of households that make use of their services.

The project will specifically support approximately 365 institutions which are members of federations, orassociations which will become federations, and are, for the most part, members of COMACREP (see tablebelow). About 210 of the 365 institutions are Cajas Solidarias. Although their legal form varies atpresent, all project institutions which benefit from technical assistance will convert into either cooperativesor "popular financial institutions" (Sociedades Financieras Populares), as required by law.

Regioni I.ederations Instittitijils Mlembuhers Total Assets(Sttlles) Associatiolls N (t1houtsands) (Imillionlls pesos)

National: AMSAP 1/ 1 10 628 5,882Cajas Solidarias 1 216 213 1,226

North-Center: Nuevo Le6n, 4 56 485 3,240Guanajuato, Michoacan, QueretaroWest: Jalisco and adjacent states to 3 51 272 1,324the NorthSouth-Center: Oaxaca, Puebla, 5 40 100 688Veracruz, MorelosSouth-East: Yucatan, Chiapas 1 12 64 591Total 15 385 1,762 12,951

t Includes Caja Popular Mexicana (CPM), with 464 thousand members and assets of $4.1 billion pesos.

Some 800 managers and senior staff of all institutions will participate in the training programs onaccounting, credit analysis, risk management and governance. All institutions will be eligible to purchaseservices from the information systems network supported by the project.

Support to institutions in the rural areas will assist households and micro-enterprises located in themarginal areas to obtain access to secure, liquid savings instruments which protect the value of depositedfunds and to lending and payments services at lower cost than those obtained from informal serviceproviders. By the end of the project it is expected that some 60,000 families will benefit directly from theincreased financial services of institutions supported under the project. SCIs expected to participate in the

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program should increase their client base and profitability, and gain authorization to operate under the newlegal framework as a result of project-sponsored technical assistance. At least a third of the branches to beopened in the marginal areas will be those of existing institutions. In addition, some 8,000 low incomefamilies will benefit from training programs in basic financial matters.

4. Institutional and implementation arrangements:

BANSEFI will be responsible for implementation of the project, including the project's financialmanagement and procurement. Key activities under the project will be subcontracted by BANSEFI totechnical assistance providers with demonstrated experience in the implementation of programs similar tothose envisaged under the project. The arrangements between BANSEFI and SAGARPA, which sharesresponsibilities for the rural microfinance component, and CNBV, which will provide technical oversightto the supervision component are described in the sections relating to executing agencies and projectmanagement in Part E of this report.

The project is innovative and ambitious as it seeks to support a major reform in the sector in a relativelyshort period of time. Because of its nature, priority is being given to monitoring activities. A mid-termreview will be carried out in 2004 to review progress on implementation of the SCI legislation, progress inthe technical assistance programs to participating SCIs and to approaches and schedules as required.

D. Project Rationale

1. Project alternatives considered and reasons for rejection:

Strengthening the SCI sector and developing the capacity of these intermediaries to provide safe financialservices to a broad range of Mexican households could conceivably be accomplished using differentdegrees of severity in the consolidation of sector institutions. This choice, in turn, would influence the sizeof the universe of institutions which the project would support through technical assistance. The option ofselecting only those institutions which are currently viable and with little need for additional capacitybuilding was rejected, as this alternative would result in the closure of many SCIs with a potential toimprove their capacity to deliver services and reach hundreds of thousands of people. Given that the newlaw provides for four different levels of institutional scale and scope of services, the project opted forproviding technical support commensurate to the requirements of these different levels of institutionaldevelopment.

Inproving access to finance by the rural population could be sought by means of: (i) financing lines ofcredit through the large government institutions such as BANRUTRAL and FIRA; (ii) supporting theexpansion of commercial banks' rural branch network's; and (iii) focusing solely or primarily on NGOsproviding microcredit. The dismal experience and standing negative image of government intervention ofthe 80s and early 90s, the extremely poor performance of BANRURAL, and FIRA's focus on operatingthrough commercial banks whose presence in rural areas continues to dwindle invalidate the first option.Bank and govermment efforts between 1996 and 1999 to induce the expansion of commercial banks' ruralbranch networks were unsuccessful, due primarily to the banks' critical financial situation, and theirincreased reluctance to intervene in rural areas. The rural NGO sector, on the other hand, is severelyunder-developed and, while the project intends to rely upon some NGOs for the provision of socialintermediation services, their capacity to become reliable financial institutions is extremely limited.

By strengthening the SCI sector at large and by drawing savings and credit institutions and othermicrofinance operators primarily as deposit-mobilizers into the cost-recovery mechanisms established inmany direct transfer programs for rural Mexico, the project aims at establishing a sustainable institutional

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base for rural finance. The project does not exclude the eventual involvement of commercial banks in thisinstitutional base.

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

. , ,Latest* 0up 0isi,SectorIssue, ,,ProJect , 'WSRiVRintina!

___ ___ ___ ___ __ ___ ___ ___ _ l , _ _ _ _ _ _ __ _ _ _ _ . ;(Bank"flin hebd-prJojects ;on!y)-n:

Implementation DevelopmentBank-financed Prgress (IP) Objective (DO)Small-scale municipal infrastructure, Decentralization and Rural S Sinstitutional strengthening Development (completed)Development of rural financial services, Rural Finance TA (cancelled) U Upolicy context

Small scale municipal infrastructure, Second Decentralization and S Sinstitutional strengthening Rural Development

(completed)Productive investments, community Rural Development in Marginal S Sdevelopment, technical assistance Areas I (ongoing)Productive investments, community Rural Development in Marginal S Sdevelopment, technical assistance Areas II (ongoing)Contractual savings development Contractual Savings II S S

(completed)Technical assistance, financial system Financial Sector TA S Sdevelopment/strengthening (completed)

Banking sector Bank Restructuring Facility HS HSrestructuring/strengthening (completed)

Banking sector Bank Restructuring Facility II S Srestructuring/strengthening (ongoing)Finance and business development Southeast Regionalservices for microbusinesses Development Learning and

Innovation Project (not yeteffective)

Other development agenciesIDB - Direct support to ruralcommunities and rural microenterprisesin Chiapas and OaxacaIDB/MIF - Support to system ofdelegated SCI supervision (training)IDB/MIF - Technical cooperation:US$3 million for BANSEFIinfornation systems equipmentUSAID - Technical assistance to CPM(WOCCU contract), US$2 million

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

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3. Lessons learned and reflected in the project design:

The proposed project relies on lessons from experience in fmancial sector development and rural andmicrofinance outreach expansion projects both in Mexico and intemationally. Intemational experience andbest practice strongly indicate the need for an effectively regulated and supervised non-bank sector as aprecondition for the sound growth and development of these financial intermediaries. Lessons have beendrawn from the Canadian and German systems of delegated supervision as a means for providing costeffective prudential oversight for numerous intermediaries, as is the case in Mexico.

The Rural Finance TA Loan closed in late 1999 also provided several important lessons regarding thedevelopment of more broadly accessible financial services in Mexico, which serve as inputs into the designof the proposed project. First, the project now closed was focused solely on encouraging large, commercialbanks to extend their presence in rural areas, which represented a significant investment in newinfrastructure and staff and the development of knowledge of nural economic activities. Partly as a result ofthe financial crisis, but also due to the pursuit of alternative, profitable opportunities, the interest of thecommercial banks was much less than expected. The proposed project will work instead with thosefinancial intermediaries which are already working with clients from a broad range of income groups andgeographic areas, including poor and rural households, and for whom the incremental costs of extendingclient outreach are lower. The focus will be on improving management systems, staff productivity anddesign of appropriate products which will permit increased leverage of the institutions' existing investmentsin infrastructure and staff. Second, the previous project sought to convince commercial banks thatinvestment in rural banking was a profitable opportunity. By contrast, the design of the.marginal areasoutreach expansion component of the proposed project is based on the expressed demand of institutionsalready working in these areas.

Third, experience elsewhere has demonstrated that to reach low-income households where literacy rates arelow and fimctional literacy is practically nonexistent, important efforts need to be made in the area of socialintermediation. This is particularly important given that the history of subsidized credit and lax financialdiscipline practiced by govemment agencies impairs the ability of rural entrepreneurs and households toknowingly and responsibly enter into formal financial transactions. Awareness raising and assistance at thecommunity level, provided for in this project, are therefore essential to improve the likelihood of successfulrural finance. Finally, most previous efforts have excluded the non-bank sector, with the notable exceptionof CGAP's investment in the NGO Compartamos, perhaps the only "success story" in microfinance inMexico. This project builds upon and applies to non-bank financial institutions a model of specializedassistance and advice similar to the one used in Compartamos, in Financiera Calpia (El Salvador),Bancosol (Bolivia) and Banco del Estado (Chile) to name a few in LAC, which offers a reasonablelikelihood of success for rural Mexico.

Several lessons related to provision of TA to develop village and institutional capacity for financialintermediation have been identified and incorporated into the project design. These lessons are consistentwith the general lessons which emerge from technical assistance projects:

* TA should be demand driven;* Beneficiaries of the TA should be involved in the design of the TA product as well as the delivery

mechanism;* Access to TA should be based on expressions of interest either through payment or technical

requirements;* Existing institutional environment should be well understood and inform TA program design;* Program should have a core set of quantitative and qualitative perfornance indicators which are

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monitored regularly and providers held accountable;* TA program design should be flexible to pernit modifications in response to feedback from M&E;* TA suppliers have to be well qualified and sensitive to local environment;* External TA providers have to provide strong supervision and management oversight of subcontracted

staff;* Supervision of large and complex TA contracts require sufficient and qualified staff in the project

management units.

4. Indications of borrower commitment and ownership:

The SHCP, CNBV and BANSEFI (formerly PAHNAL) have demonstrated their detennination to overhaulthe SCI sector with the passage of the Popular Savings and Credit Law, and of the complementary lawauthorizing the reform of PAHNAL and its transformation into BANSEFI, both in 2001. The leaders ofeach institution, including the Director General of BANSEFI, the Vice President for Supervision of CNBV,and the Deputy Director General for International Financial Organizations of the SHCP have activelyparticipated in the formulation of a comprehensive and consistent set of proposals to enable theimplementation of the law, and have sought support from the Bank and the 1DB, among other agencies, toleverage the Government's funds for program implementation.

As regards the outreach expansion of non-bank financial intermediaries in rural areas, SAGARPA hasalready requested and obtained a budget allocation to start a program of technical assistance to SCIs andrural communities with substantial input from Bank staff. At the community level, the demand forassistance in establishing savings and capitalization mechanisms has been clearly expressed at regionalawareness-raising workshops carried out under the Marginal Areas Program. For implementation purposes,SAGARPA will enter into an agreement with BANSEFI.

It is important to highlight the fact that in this particular case SHCP took the initiative to request fromSAGARPA (and the Bank) a proposal to develop a rural microfinance program. This is counter to thetraditional flow of program creation, and shows strong borrower commitment to the initiative.

5. Value added of Bank support in this project:

The Bank has been actively involved in stabilizing and strengthening the financial sector and in improvingaccess to productive opportunities in poor and rural areas in Mexico over the last decade, supportingoperations and sector work in banking, pensions, insurance and capital markets, as well as ruraldevelopment and municipal services projects in various regions.

The proposed project will help provide the required multi-year continuity to the policy refonns and capacitybuilding efforts initiated under BANSEFI, CNBV, SAGARPA and SHCP auspices.

Given the non-additionality of Bank lending in Mexico, the value-added of Bank lending consists primarilyin the technical guidance the Bank can contribute to the implementation of the new institutional and policyfiamework for SCI sector development in general, and outreach expansion in rural areas in particular. TheWorld Bank's intemational expertise in rural finance and microfmance, in legal and regulatory frameworkissues, in payments systems, and its increasing experience in institutional capacity building operations arealready being brought forth in its existing dialogue with govemment and practitioners in Mexico. Theproposed project provides a long-term horizon to this dialogue.

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 = % (see Annex 4)* Cost effectivenessO Other (specify)Economic effects are assessed for the most part on a qualitative basis, given the special difficulties thattechnical assistance interventions convey for quantitative analysis. Expected project impacts are assessedon three levels: (i) institutions (including SCIs and their organizations); (ii) clients; and (iii) fiscalimplications, the latter dealt with in section E.2 below.

Institutional Level: Consolidation, Scale Economies and Efficiency Gains. Approximately 385 savingsand credit institutions are expected to participate in the sector consolidation and strengthening activities tobe undertaken by the project. By most measures, these institutions represent at least 80 percent of thesector. The project will fund institutional strengthening for those participating SCIs with the potential tomeet the new financial and operating standards mandated by law, and will support the liquidation ormerging of those institutions which cannot meet the new standards. Preliminary diagnostic work indicatethat approximately 40 percent of the participating institutions may be either liquidated or merged in thesector consolidation process.

The approximately 240 institutions estimated to emerge from the consolidation process will be fullystrengthened and restructured as needed to be compliant with the new law. The liquidations and mergers arelikely to increase the average number of clients served by each of the remaining institutions from 5500 toabout 8700 clients at project's end. This estimated increase of nearly 60 percent in institutional scale, willallow the remaining SCIs to benefit from scale economies thus far unattainable given their limited size.

Efficiency gains will also accrue to the SCIs from staff training, upgrading intemal controls and buildingcredit appraisal and risk management capacity. The information platform for SCIs to be financed by theproject is expected to contribute significantly to the overall increase in operational efficiency and especiallyto a reduction in the costs of control, reporting and back-office functions .

The organizations formed by the institutions of the SCI sector are also expected to benefit from projectactivities designed to automate operations and professionalize the federations and confederations. Inparticular, the formalization of COMACREP into a Confederation where the auxiliary supervisioncapacities and deposit protection functions for the sector are likely to be housed, represents aninstitution-building effect for the sector.

Client Level: Increased Access and Depth of Outreach. The client base of the SCI sector is expected togrow by about 16 percent per year over the course of the project. This would result in the expansion in thenumbers of clients served by the participating SCIs from about 2 million to about 4.2 million at the end ofthe five year project implementation period, an increase in access from about 5 percent to almost 9 percentof the economically active population.

As for the depth of the SCI sector outreach, loan amount averages for the SCI sector were in the rangefrom 4 to 14 percent of GDP per capita in 1999, while average savings balances were between 8 and 12percent of per capita GDP. In contrast, average deposit balances in the banking system are estimated toamount to about 130 percent of GDP per capita. Expansion of the SCI sector, therefore, is likely toincorporate large numbers of the low-income segments of the population.

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Providing financial services as a means of integrating poor households into the national economy is clearlya poverty-alleviation tool. This is particularly pertinent for the rural microfmance component of the project,in which the population of rural marginal areas is expected to gain from the services provided by thestronger, more efficient SCIs through access to adequate deposit instruments and an improved ability totake advantage of productive investment opportunities. Sector work has shown that transfonning informal,non-earning financial assets, and monetizing even a fraction of the savings held in physical form by ruralhouseholds would have clear benefits in terms of safety and return. Informal means of savings thatdominate in the households' portfolios are, in principle, inferior to financial instruments in terms of safetyand returns. For example, informal lending suffers from a 20 percent arrears-default rate and loans areoften made at zero interest charges; tandas report a 6 percent rate of noncompliance (group members whocease to contribute once they have taken a turn); and the most common forms of livestock holding, pigs andchickens, have mortality rates above 40 percent. Since holding livestock as savings is more prevalent inpoorer areas and among indigenous people than elsewhere, this kind of asset transformation would benefitrelatively more the poorest segments of the population.

2. Financial (see Annex 4 and Annex 5):NPV=US$ million; FRR = % (see Annex 4)An evaluation of the financial situation of individual institutions and a program of remedial action arecentral elements of the technical assistance to be supported under the project. Available information oncapital and portfolio quality of sector institutions, however, provides insights into the potential projectimpact on participating institutions. A detailed analysis of the financial statements of 43 institutions in twofederations covering a wide range of institution sizes and accounting for 25 percent of mernbers and 20percent of assets of the beneficiary institutions shows that 34 of the member institutions, or 80 percent,would meet the initial capitalization-ratio requirements expected to be set by the regulations. This initialrequirements are estimated at 9 percent of risk assets with 40 percent provisioning of the non-performingportfolio, which is in line with current regulations. However, in the absence of measures to improve theiroperations and financial performance, only 16 of the 34 institutions in the sample would be able to meet therequirement of 100 percent provisioning of non-performing portfolios expected to be established after atransition period.

The enactment of the new legislation has had an impact on sector institutions. Some of the largest arealready part of federations which perform functions not unlike those mandated by the new legislation. Thesmaller institutions which did not belong to federations have begun associating with existing ones or are inthe process of establishing new federations. Existing federations charge for services (I to 4 percent ofassets). The incremental costs to the federation of performing their auxiliary supervision functions and theability to pay among different categories of institutions has been examined. The cost of the supervisory unitat the federation level has been estimated at 0.35 percent of assets. The incremental costs of the supervisoryunits should be affordable to most institutions; this is especially the case as the technical assistance to beprovided under the project is expected to increase substantially the efficiency of participating institutions.Financial projections for very small institutions in the rural areas show that they should be profitable andable to afford payments to the federations.

Financial projections for microfinance institutions (or branches of institutions) in marginal areas supportedunder the project show that these should be financially strong, given the relatively high interest rate marginswith which they are expected to operate. The projections were prepared with lending rates which are moreconservative than the prevailing rates in marginal areas (50 percent annual rate, as opposed to theprevailing 60 percent which is charged by microfinance institutions), as it can be expected that interestrates of microfinance institutions will decline as a result of an increased supply of financial services inrural areas.. Institutions will cover operating costs including depreciation in the fourth year of operations.

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This is even taking into account that the institutions must retain a high liquidity position and that they willcontribute to the costs of the federations which they join (estimated at some 7 percent of deposits per year).At the end of the project period, some institutions will just have been established, and the projections werethus extended to ten years, when all institutions supported under the program will be operational. At theend of 10 years, the return on equity of project institutions would be about 20 percent. Savings and creditinstitutions in marginal areas are expected to meet the requirements to be established by the CNBV forauthorization to operate.

Fiscal Impact:

The principal fiscal impact of the project will be the investment costs associated with the project and thecosts associated with the payment to depositors of SCI's which are not viable and would need to beliquidated. The Bank will not finance the bailout, but the Government is making the necessaryarrangements to ensure that the fimds are available.

Government estirates are that total liabilities of the institutions which will need to be liquidated are of theorder of some US$ 330 million (or about 0.06 percent of GDP). The actual cost to Government willdepend on the guarantees held by the institutions, including blocked savings which are customary in SCIs, afigure which is not yet available. Not taldng guarantees into account, the maximum payments todepositors will be US$490 per client, assuming the past practice of reimbursing 70 percent of deposits forsmaller depositors (deposits average US$700 per client). The resulting figures are insignificant whencompared to the bailout of depositors of banks in the late nineties which in 1999 amounted to 13 percent ofGDP, or US$85 billion.

All activities under the project are expected to be self-financing over time and not require Governmentsubsidies after project implementation. The operating costs of the SCI information system will be paid bythe users after a start-up period. Rural institutions will receive a partial subsidy of salaries (50-70 percentof salaries) in their first three years of operations but will be self-financing after the third year.

3. Technical:

Savings and Credit Sector Component

CNBV with assistance from BANSEFI and international and national specialists is designing a system ofclassification of institutions which will be used to evaluate and monitor performance under the project. Inaddition, an inventory of SCIs is being completed to make a preliminary assessment of the financialsituation of the SCIs, and to ascertain the coverage of the program and its priorities. The inventory includeskey financial data, membership and organizational structure of each institution in the sector.

The technical assistance programs will be designed and implemented by specialized institutions(consultants) with demonstrated experience in restructuring and liquidating savings and credit institutions.The specialized institutions will design and implement technical assistance plans initially on the basis ofinformation obtained in the survey. Each participating institution will enter into agreements with thetechnical assistance provider specifying performance indicators which will be monitored semiannually.Assistance will be suspended to institutions which do not meet agreed performance targets. Because of thenumber and geographic dispersion of institutions, it is not technically feasible for a single technicalassistance provider to cover all federations. The contracts for technical assistance will therefore include themember institutions of between one and three federations (depending on their size). It is expected that somesix contracts will be awarded. The above-referred standards, and the follow up by BANSEFI, and to some

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degree CNBV, will ensure consistency of approach among providers of technical assistance. Technicalassistance providers will work closely with the federations and will provide training to them as part of theirmandate. Terms of reference for a model contract have been prepared. Program costs are consistent withinternational experience in restructuring small banks.

Support to CNBV is designed to increase its competencies in supervision of microfinance institutions. Inparticular, the technical assistance will support CNBV to address issues relating to the auxiliarysupervision anrangements, drawing from international experience where these arrangements are in placeand have proven to be effective.

Expansion of Financial Services in Rural Areas

The approach used in the provision of technical assistance to assist in expanding services in marginal areasis similar to that used successfully in other regions both with Bank financing or supported by bilateraldonor institutions. As the program does not include credit, but focuses on introducing the savings habit anda culture of self sufficiency, in low-income areas, the programs necessarily have a long term horizon.

Preliminary studies have been conducted in the project regions which confinn the feasibility of the proposeddevelopment, given the population density, income levels and perceived demands of the beneficiaries. Workis focused in a specific region as there is ample evidence that institutions focusing on the poor need to beadapted to local conditions. Prior to the contracting of technical assistance, detailed regional market studieshelp determine the program targets in the region, which are then specified in the agreements with thetechnical assistance providers. The providers in turn enter into agreements with the beneficiary institutionsthat establish performance indicators and rules of conduct. Detailed market studies for three regions havebeen prepared (Chiapas, Huasteca and Oaxaca). A model for terms of reference for the consultant contractsis also available. The contract for the Chiapas region was signed at the end of March 2002, and the one forHuasteca was signed in April 2002.

4. Institutional:All key activities under the project will be subcontracted by the executing agencies to technical assistanceproviders which will have demonstrated experience in the implementation of programs similar to thoseenvisaged under the project.

4.1 Executing agencies:

BANSEFI will be responsible for the execution of components 1, 3.1 and most of component 4 of theproject. SAGARPA will retain decision-making responsibility for components 2 and 3.2, and will maintainthe technical unit referred to in Component 4 to carry out the tasks assigned to SAGARPA. SAGARPA,however, will transfer the funding to implement the components for which it has responsibility toBANSEFI, which will be charged with the administration of funds, disbursement, procurement andcontracting support for these components, acting as SAGARPA's agent. A fornal agreement reflecting thisarrangement is a condition of disbursement for the Expanding Financial Services in Rural Areascomponent. To facilitate project implementation, BANSEFI will contract the consultants and services to beused by CNBV.

4.2 Project management:

Overall project management will be the responsibility of BANSEFI, with due attention to the provisions ofthe agreement with SAGARPA referred to above. Project activities in Component 1, and the monitoringsystem and information campaigns under Component 3, will be managed by the departments of StrategicPlanning and Evaluation, and Information Technology of BANSEFI. The former will also bear overall

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project coordination responsibilities. Financial management of the project and procurement administrationwill be the primary responsibility of the Directorate of Finance. Overall leadership of the project will beprovided by the Director General of BANSEFI. The Core Team assigned to the project includes twofinancial management specialists; one procurement specialist; and about seven staff with competencies tosupervise the work of consultants in the restructuring of institutions, the training program and theinformation systems component Additional personnel will be assigned later this year. In addition,BANSEFI will seek the assistance of specialized international consultants which are not linked to any ofthe technical assistance providers to help in the follow-up of the large contracts in information systems. Theteam has highly qualified staff with both strong academic credentials and experience. The analytical workfor project preparation has been led by this team, which has produced technically solid work in a short timeperiod. The information systems feasibility work was contracted out to specialized consultants. The teamhas experience in contracting and following up consultant contracts both for the Mexican Govenmment andin the private sector and has received specialized training in contracting using World Bank proceduresduring project preparation. The process of selection of consultants has already begun.

Project activities under component 2 and the rural microfinance aspects of the studies included incomponent 3 will be carried out by the technical unit maintained by SAGARPA. The regional developmentprograms will be contracted out to technical assistance providers and supervised by the technical unit staff.Studies and evaluations specific to this component will also be contracted to specialized technicalassistance providers, by the TU, based on terms of reference, selection criteria and procedures acceptableto the Bank.

4.3 Procurement issues:

Most services under the project will be contracted out to specialized institutions which will be selectedthrough international competition following the Bank guidelines: "Selection of Consultants by World BankBorrowers, January 1997 revised September 1997 and January 1999." Most equipment will be purchasedunder intemational competitive bidding following the Bank guidelines: "Procurement under IBRD Loansand IDA Credits, January 1995, revised August 1996, September 1997 and January 1999." A procurementplan has been prepared and a detailed procurement schedule for the first year of the project will be includedin the Implementation Manual, which will be available by credit effectiveness. The Core Team and the TUhave received specialized procurement training during the past year. The first consultants contract forcomponent 2 was signed in March, 2002. Details on the procurement procedures arrangements for theproject are provided in Annex 6.

4.4 Financial management issues:

BANSEFI will be in charge of the overall administration of project funds, coordinate among the differentinstitutions involved, and fulfill the requirements for procurement of goods and services for its components,monitoring of financial management, disbursement and reporting requirements. BANSEFI will also be incharge of supervising the technical assistance plan and monitoring key indicators for the project.

In order to comply with Bank requirements per OP/BP 10.02, a certified Financial Management Specialistcarried out an assessment of BANSEFI's institutional capacity for financial management. The assessmentcovered the project's financial management system (budgeting, accounting, internal control, auditing andreporting), and the agency's equipment and staffing. Additionally, two analyses were carried out: onefocused on the strengths/weaknesses/opportunities/threats (or SWOT analysis), and the second focused onrisk assessment. The results of both analyses were incorporated in the financial management assessmentreport, which was based on applicable Bank guidelines. The Financial Management Assessment alsocovered the format and content of the financial monitoring reports, or FMRs. The assessment scope

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included an analysis of BANSEFI's institutional capacity as financial agency for this project as well.

The assessment concluded that BANSEFI's financial management system is adequate, and satisfiesminimum Bank's financial management requirements. For the production of FMRs, BANSEFI has initiatedefforts to enhance its financial management system according to applicable Bank requirements, guidelinesand procedures. Annex 6 provides additional infornation on financial managenient arrangements and on theresults of the assessment.

Action planforfinancial management. The following actions must be completed prior to Effectiveness: (i)completion of a project operational manual which specifies procedures and requirements for the projectaccounting system, intemal controls, planning, budgeting, financial reporting system (including format andcontents of the Financial Monitoring Reports), auditing and disbursing; (ii) full implementation of thefinancial management infornation system for this project; and (iii) completion of specialized training forthe financial management staff.

5. Environmental: Environmental Category: C (Not Required)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.

Not applicable

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

Not applicable

5.3 For Category A and B projects, timeline and status of EA:Date of receipt of final draft:

Not applicable

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?

Not applicable

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?

Not applicable

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

The project will promote the consolidation and strengthening of savings and credit institutions and theexpansion of financial services in marginal rural areas as a means of integrating poor communities andhouseholds into the national economy. Presently, the approximately 2.6 million people estimated to be SCIclients have no protection against the possibility of institutional collapse and loss of their savings deposits.While the profile of these clients includes broad segments of Mexico's population, a larger share of SCIclients are among lower-income and rural households than are the clients of mainstream banking

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institutions. Thus, the benefits of the project, in terns both of stabilizing and strengthening the SCI sectoras a whole and expanding outreach among poor rural households in marginal areas, are expected to accrueto these segments of the population in a greater proportion.

Technical assistance efforts, both among the universe of SCIs and among those selected forcapacity-building to expand outreach in rural areas, will also emphasize the tools, products and potentialbenefits of targeting those clients traditionally under-served by banks. Component 2 in particular, focuseson low-income households, women, and indigenous groups in communities within the marginal areas ofChiapas, Hidalgo, San Luis Potosi, Veracruz, Oaxaca, Guerrero, Morelos, Michoacan, the State ofMexico, Puebla, Tlaxcala, Queretaro and Guanajuato.

As identified during project preparation, indigenous populations of a variety of ethnic groups represent ahigh percentage of the rural population in marginal areas. To ensure that this population benefits from theproject, Indigenous Peoples Development Plans (IPDPs) have been prepared for the two regions where theproject will initiate outreach expansion activities under component 2 during the first implementation year:Chiapas and Huasteca. A consultation process with indigenous population was carried out in both regionsto incorporate their views into those EDP's. Results of this process in both regions show the great interestindigenous and women's organizations have in accessing reliable financial intermediaries and/or indeveloping their own capacity. These organizations have developed incipient saving and credit mechanismslinked to productive activities; they have leamed the importance of sustainability and accountability, andthey are eager to leam how to perform better.

On the basis of these experiences a Social Development Model comprising social analysis, consultationand an action plan, has been designed. It will be implemented in all regions in the project as they come intoimplementation. This Social Development Model is intended to promote participation not only ofindigenous people but also of women and poor populations who can benefit from the project. Annex 11includes a detailed description of the Model.

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

BANSEFI and CNBV meet regularly with the leadership and the members of COMACREP, which havebeen actively involved in project design. Specifically, they have assisted in the definition of the regions thatshould be covered by the technical assistance contracts. Representatives of the federations have alsoparticipated in the definition of the standards and, as is common practice, SCI institutions and theirfederations are providing inputs and feedback on the draft prudential regulations prepared by the CNBV.

Under the rural microfinance component, the project participatory approach builds on the experience of arecently completed survey and analysis of household finances in the marginal areas of Oaxaca andHuasteca regions (Report N. 21286-ME). During project preparation, consultations were made with mainstakeholders, including SCIs in various regions, the clients of SCIs, beneficiaries of public programs andnational and local institutions related to the savings and credit sector. Two consultation workshops withindigenous peoples organizations were carried out, one in Chiapas and other in the Huasteca region, toelicit their views about savings and micro-credit instruments, institutions and outreach methods andaltematives, which were incorporated into the project design.

Though the project will operate under a demand-driven approach, the proposed Social Development Modelis a tool to increase participation via mechanisms such as: (i) IPDPs to ensure that indigenous populationand other vulnerable groups can benefit; (ii) an action plan promoting community-based savings efforts;(iii) outreach strategies to link poor communities to SCI services; and (iv) a commnunication campaign tomake the rural population aware of the project's benefits and encourage participation. At midterm

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implementation, interregional workshops will take place to share experiences and lessons learned inexpanding financial services to underserved groups in the marginal areas.

The project will also benefit from the participatory mechanisms established under the Marginal AreasProgram such as Consejos Regionales and discussions with community groups held periodically in anumber of regions including Chiapas, Huasteca, Oaxaca and Guerrero to disseminate information about theproject and facilitate participation and discussions with all of the major stakeholder groups in the regions.Likewise, interaction initiated during preparation with PRODESARROLLO, a consortium of micro financepractitioners and second-tier organizations and a member of COMACREP, will continue throughoutproject implementation.

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

NGOs and civil society organizations, and the existing federations and confederations of SCIs, have beenconsulted throughout the initial conceptual design stage of the project. Consultations will continue throughthe implementation phase both through formal assessments of institutional capacity and demand fortechnical assistance, and through technical consultations. NGOs and other civil society groups will be keyparticipants in the process to evaluate the effectiveness of the proposed project's activities.

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

SAGARPA, through the technical unit (TU) will ensure that criteria for qualification and selection of TAproviders fits within the purpose of promoting participation of indigenous organizations and othervulnerable groups, and that those firm(s) selected prepare action plans taking into account results andrecommendations from IPDPs. The TU will also ensure that all steps of the project's social developmentmodel, comprising IPDPs and consultations, are prepared in a timely matter for each region according tothe project implementation schedule, and that their recommendations are incorporated as inputs in technicalassistance provider's Terms of Reference. Bidding evaluation procedures will take into account theexperience in working with indigenous population, the outreach strategy and communication proposals topromote indigenous peoples participation. Benchmarks to reach rural population and women will be definedfor each region based on identified organizations potential and willingness to participate identified throughIPDPs. The Terms of Reference for each region, including selection criteria and perfornance benchmarks,will be submitted for Bank no-objection. The technical committee that oversees the component will fosterimplementation in accordance with social development model steps.

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

Social development outcomes are to be built in as an integral part of the project's monitoring andevaluation framework; the main indicator will be the percentage of participation of indigenousorganizations and organizations benefiting indigenous population, as a percentage of the total beneficiariesin each region; this percentage will be defined upon the results of the social studies and IPDPs prepared foreach region. Technical assistance provider's quality outcome reports will include a section on indigenouscommunity participation in the project

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

Environmental Assessment (OP 4.01, BP 4.01, GP 4.01) 0 Yes 0 NoNatural Habitats (OP 4.04, BP 4.04, GP 4.04) 0 Yes * NoForestry (OP 436, GP 436) 0 Yes * NoPest Management (OP 4.09) 0 Yes * NoCultural Property (OPN 11.03) O Yes * NoIndigenous Peoples (OD 4.20) * Yes 0 NoInvoluntary Resettlement (OP/BP 4.12) 0 Yes * NoSafety of Dams (OP 4.37, BP 4.37) 0 Yes * NoProjects In Internatfonal 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 * No

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

The project's Social Development Model comprises several steps to ensure that indigenous population andvulnerable groups such as women can benefit from the project. It begins with a social analysis andconsultation workshops with indigenous organizations; which are integrated into an IPDP. This Model willbe applied in all regions in the project as they come into implementation. The TU will ensure that all stepsin the Social Development Model are carried out in a timely manner for all regions in the project, and thatIPDPs serve as inputs to guide technical assistance providers in preparing action plans. In each region themonitoring and evaluation system will track progress in achieving the performance benchmarks related tothe portion of indigenous population and women to benefit from service expansion as specified in thetechnical assistance contracts. Technical assistance providers will issue periodic outcome reports includinga section about indigenous peoples' participation in the project. In addition, SAGARPA will ensure thatINI provides its views throughout implementation of component 2 of the project.

F. Sustainability and Risks

1. Sustainability:

The focus of the project is to strengthen the SCI sector as a whole and develop financially sustainablemechanisms for improved provision of financial services nationwide and especially in targeted ruralcommunities. Technical support capacity will be developed through the transfer of training and TAtechnology to entities responsible for SCI sector development and supervision and to local organizationsthrough partnerships with the contracted international and national firms. The evaluation and supervisionmechanisms the CNBV is putting in place in consultation with the sector and with specialized technicalassistance (notably from Canada, Germany and the USA) enhance the probability of long run sustainabilityfor the savings and credit institutions.

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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 ObjectlveWeakening of Government's comnimitment M Active involvement all phases of projectto establishing SCI sector supervision preparation and implementation by BANSEFImechanism CNBV and SHCP management and staff.

Regulatory and supervisory framework S Expert technical assistance has been obtained byfor SCI's not conducive to sound and the Government in the preparation of the newviable SCI sector. framework for the SCI sector. Specialist input

will be sought during implementation. Progresswill be monitored closely by the Governmentand the Bank using specialized resources.

SCIs and clients are unwilling to M Broad dissemination campaign will explainparticipate or are unaware of the new benefits of new legal framework and program oflegal and regulatory framework and assistance.integration procedures.

Lack of information is not a significant N Review of data and analyses of Mexico's SCIconstraint to the development of effective sector and microfinance activities are beingSCI and microfinance development conducted to determine critical information gapspolicies. and specific policy applications.

Insufficient demand from qualifying M A priori demand assessment informs programfinancial intermediaries and communities. design.Lack of interest and availability of M A priori supply assessment informs programqualified technical assistance firms. design.From Components to OutputsInsufficient budgetary allocations. M First year funds are already available; funds for

subsequent years to be confirmed bynegotiations.

Unqualified personnel are appointed to M Terms of Reference for project team developedmanage and administer project activities in consultation with the Bank. Capable staffand resources. appointed to manage BANSEFI and SAGARPA

programs.

BANSEFI and SAGARPA staff use M BANSEFI will take lead in coordinatingconflicting approaches to sector program activities under implementationdevelopment and project implementation. agreement with SAGARPA.

Overall Risk Rating M

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

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3. Possible Controversial Aspects:

Legal, regulatory and supervisoryframeworkfor SCIs. The legislation regulating the SCI sector wasapproved by the Mexican congress in 2001, and represents a departure from past policies. There was aninitial concern that there would be a number of institutions unwilling to meet the requirements of the newlegislation. In practice, the key sector institutions accounting for the vast majority of assets andmembership recognize the merits of regulating the sector and have begun the process of adapting to thelegislation.

A number of risks associated with the new legislation were discussed with the authorities during projectpreparation and steps were taken to mitigate these risks and/or establish monitoring and early warningdevices. Major concerns were the transparency and adequacy of entry and exit procedures, conflicts ofinterest and regulatory capture in the auxiliary supervision mechanisms, incentives and delimitation ofresponsibilities between CNBV and the federations and confederations, adverse selection issues, andcapacities and roles of CNBV and BANSEFI. During the project preparation period, the team observed theclear assertion of supervisory responsibilities by CNBV, its highly professional handling of the definition ofentry, exit and supervisory standards, a strong commitment of BANSEFI to its developmental role, and theconstructively critical participation of the sector. These observations allow the reasonable expectation thatappropriate safeguards are being established, and that the authorities are prepared to react quickly tounforeseen developments that may threaten the stability and growth of the sector. Project preparationincluded supporting the provision of expert advice to CNBV, and a project component has been included tocontinue providing such support during implementation.

During project implementation, the matrix included in Annex 12 will serve as a tracking device for progressand resolution of issues and mitigation of risks associated with law implementation as part of regular Banksupervision. The matrix specifies all risks and issues raised at the time of the PCD review and alreadyreflects the resolution of, or progress made towards solving, the questions initially set forth. In addition, aspecific sub-component in Monitoring and Evaluation has been included that specifies the nature andfrequency of monitoring for this aspect of the project, as well as the indicators that such monitoring willencompass. Finally, an in-depth assessment of quality of SCI supervision will be part of the project'smid-term review.

SCIs in marginal areas. The development of SCIs in marginal areas requires time and discipline. There isan understandable desire to encourage these institutions to grow fast, sometimes using external lines ofcredit The project design, which relies on building competencies over time, was developed with theMexican authorities, which have had a long experience of failed institutions and have indicated acommitment to allow the technical assistance program to remain in place as required. As the program doesnot include lines of credit, it will likely be of lesser political importance than other transfer programs,increasing its likelihood of success. The program is innovative in that it calls for substantial technicalassistance in specialized fields. For this reason, annual reviews of progress are envisaged to adjustprogram as required in light of experience elsewhere.

G. Main Loan Conditions

1. Effectiveness Condition

* Project Implementation Plan, issued jointly by BANSEFI and SAGARPA, satisfactory to the Bankcompleted.

* Financial Management Anrangements satisfactory to the Bank completed.

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* Regulations (circulares) to operalionalize the Popular Savings and Credit Law for Art. 32, "Criteriato assign the level of operations of each entity", and Art. 116, 4Prudential rules by level of operation"issued by the CNBV.

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

* A formal agreement between SAGARPA and BANSEFI to carry out components 2, 3.1 and 4,satisfactory to the Bank completed prior to disbursement of funds for component 2 (ExpandingFinancial Services in Rural Areas).

* diigenous Peoples Development Plans (IPDPs) as agreed with QAT for this project, for each regionunder component 2 completed prior to disburemet of funds for the corresponding region.

* Exral financial audits of SCIs participating in component I of the project to be conducted every twoyears on a sample basis (10 percent sample). All those SCIs participating in component 2 will haveexteral audits and technical evaluations every two years.

* Project institutions (BANSEFI, SAGARPA and CNBV) will participate in an annual review of projectperformance, where program schedule will be adjusted as required.

H. Readiness for Implementation

C 1. a) The enginering design documents for the first yeae's activities are complete and ready for the startof project implemenation.

1 1. b) Not applicable.

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

El 3. The Project Implementation Plan has been appraised and found to be realisdc and of satishctoryquality.

1 4. The following iterns are lacldng and are discussed under loan conditions (Section G):

The first drai of dte Project Implementation Plan has been appraised and found to be realistic and ofsatisfactory quality. The plan will be completed prior to loan effectiveness (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 recommended for approval. The project complies with

all other applicable Bank policies.

Carlos E. Cuevas ha Rewood Olivier Lafou+ade'Team Leader Sector ManagerlDlrector Country Mmnl.geDirector

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Annex 1: Project Design Summary

MEXICO: Savings and Credit Sector Strengthening and Rural Microfinance Capacity Buildingr~~~~~~~~~W > ~ ~ ~ ~ ~ ~ ol lc Ul ir - -I,'

-.,~~~Fj¶PieR.onnma EMO -. o a iF'~~~ indj~~~~~~~~qato_

Sector-related CAS Goal: Sector Indicators: Sector/ country reports: (from Goal to Bank Mission)Expand employment, -Increased confidence in -Government financial and -Favorable macroeconomicinvestment and , sector reflected in increased monetary reports. conditions, particularlyincrease level of financial number of accounts is SCIs -Impact studies. monetary and exchangeservices parficularly to low -Increased deposits and loans stability.inrvcme poptlcular tion. l to small enterprises and -Favorable natural conditions

low-income households. in marginal areas.-Strengthened financial -Continued govemmentinstitutions serving the poorer support to sectorsegments of the population. strengthening and for-Elimination of government programs aimed at improvingtransfers (bail-outs) to SCI income distribution.sector.

Project Development Outcome I Impact Project reports: (from Objective to Goal)Objective: Indlcators:1. Sector institutions -Participating SCIs that -Progress reports of CNBV, -Government commitment tostrengthened and regulatory qualify are certified by BANSEFI. strengthening SCI sector isframework supportive of SCI CNBV. Procedures for -Annual audits. maintained.development put in place. liquidation of unviable SCIs -Bank supervision reports. -CNBV to establish adequate

initiated, as required. -Mid-term evaluation by regulatory framework and-SCI sector infrastructure put Government, Bank. supervisory mechanisms.in place. Implementation Completion -SCIs group into networks

- Regulatory framework and Report (federations) in a timelyappropriate methodologies for manner.supervising sector put inplace.

-About 60, 000 low-income -Progress reports of -Improved access to financial2. Access of rural families in marginal areas BANSEFI. services facilitates integration

financial services is improved. accessing financial services -External evaluations and into economy of low incomeprovided by SCIs. annual audits. population and small-Some 8,000 low income -Bank supervision reports enterprises.families trained in financial -Mid-term evaluation, -Participating institutionsmatters. Govenmment, Bank. maintain commitment to-Project institutions -Implementation Completion improved performance.strengthened and certified Report.under the law.

3 Studies, monitoring and -Sector consolidation plans Progress reports of BANSEFI.evaluation carried out and are understood by Extemal assessmentsector information participants, developments Bank Supervision reportsdisseminated. assessed and used to reform

policies and programs.

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Output from each Output Indicators: ProJect reports: (from Outputs to ObJective)Component:1. Consolidation of the -Progress reports of CNBV,Savings and Credit BANSEFI.Institutions Sector. -Annual Audits.

-Bank supervision reports1 .1 Strengthening SCls. -Mid-ternm evaluation.

-Implementation CompletionSupport to institutions -385 institutions are assessed Report -Government commitment to

and classified as: (i) requiring strengthening SCI sector isassistance (strengthening! maintained.restructuring) or (ii) to be -New legal framework isliquidated. conducive to the development

of a sound and viable SCI-TA action plans for those sector.needing strengthening andrestructuring are designed -SCI clients/entities willing toand implemented participate in new

regulatory/supervisory system-Liquidation plans are and able set it up.formulated and begun to beimplemented for SCIs which -SCls accept technicalare unviable and cannot be support.merged with otherinstitutions. (some 10% of the -Qualified TA providers aretotal) identified and implement

programs which are adaptedSCI information system -Basic system infrastructure to needs.

designed/ developed.-Services provided to about100 SCIs (1000 points ofservice or SCI branches). -System is adapted to needs.-A fee-for-service costrecovery mechanism designedwhich ensures full recovery ofoperating costs by the fifthyear of system operations

Training -Training provided to some -Trained staff remains in SCIs800 SCI management andstaff on finance, accounting;risk management; creditanalysis and govemance

1.2 Strengthening SCI -CNBV supervision system -CNBV regulatory andSupervision put in place and supervision supervisory framework

carried out. adapted to needs of sector.2. Expanding FinancialServices in Rural Areas.

2.1. Expanding Institutions & -15,000 new clients per region -External evaluations and -Specialized technical

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Services in Marginal Areas served after 5 years of the annual audits. assistance and eligibleprogram in each of the -Progress reports of intermediaries able to workmarginal areas (some 60,000 BANSEFI. effectively together.at the end of the project); -Reports of consultants -Intermediaries able to adopt-clients live in marginal areas developing individual regions. new approaches and-some 50% of clients are -Bank supervision reports technologies.women; -Mid-term evaluation.-some 70% of clients live inrural areas. -Project reports-participating institutions join -Bank supervision reportsfederation and are authorized -Implementation Completionto operate by end of project. Report-satisfactory performance asmeasured by portfolio andother indicators included inindividual contracts with TAproviders.

2.2. Community Training -8,000 families in ruralPrograms. communities trained in basic

household finance andfinancial transactions.

3. Sector Studies, -Progress reports of CNBV, -Lack of information inhibitsMonitoring and Evaluation, BANSEFI. development of Govemmentand Information SCI and microfinance policyDissemination. -External evaluations and and activities.

Sector studies on nural annual audits.Sector Studies microfinance in Mexico

carried out and results -Mid-term evaluation, -Government implementingdisseminated, Govemment, Bank. agencies use reports, findings,

disemiate.Gv n, B . to modify programs and

Monitoring, Evaluation, -Monitoring system covering -Bank supervision reports projects.performance of SCIs andfederations; and the -Implementation Completionprogram's social impact put Reportin place.--Audits of project beneficiary

Information Dissemination institutions carried out

-Dissemination campaignprepared and carried out,including workshops onSector Consolidation Plan andlessons.

4. Project Management. -Timely supervision and -Project Progress Reportsoversight of component -Project financial statementsovertigof. -Procurement records

execution. -Audit reports.-Disbursement reports.

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__________________ S~~C ti e sdn o

Project Components / Inputs: (budget for each Project reports: (from Components toSub-components: component) Outputs)1. Consolidating the Savings US$48.01million -Project Monitoring and Qualified personnel continuesand Credit Institution Evaluation reports to manage project.Sector.-Pjetads

-Project audits Qualified consultants1.1 Strengthening SCIs recruited and supervised.

-Support to SCls Timely provision of budgetaryresources

-SCI Infrastructure

-Training of SCImanagement and staff

1.2 SCI Supervision

2. Expansion of Financial US$26.18 million -Project Monitoring and Qualified personnel continuesServices in Marginal Areas. Evaluation reports to manage project.

2.1. Expansion of Institutions -Project audits Qualified consultants& Services in the Marginal recruited and supervised.Areas

Timely provision of budgetary

2.2. Training at the resources.Community Level.3. Sector Studies, Monitoring US$5.69 millionand Evaluation, and Qualified consultantsInformation Dissemination. recruited and supervised.

4. Project Management and US$4.88 millionExternal Evaluation. Qualified personnel continuesto manage project.

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Annex 2: Detailed Project Description

MEXICO: Savings and Credit Sector Strengthening and Rural. Microfinance CapacityBuilding

The project supports the Government's efforts to strengthen the SCI sector, which serves the poorersegments of the market, so that sector institutions are able to provide secure and expanded services, andover time, increase their coverage. In addition, because rural areas are seriously underserved and becauseof the intrinsic problems in serving clients in this market, the project includes programs aimed at improvingaccess of rural communities to sustainable financial services. The main components of the project aresummarized in the paragraphs that follow.

By Component:

Project Component I - US$48.01 millionThe project supports a strengthening program for eligible institutions, and the liquidation of institutionswhich are not sustainable. In addition, it will support the strengthening of SCI sector informationinfiastructure and supervision. BANSEFI will manage the technical assistance programs to sectorinstitutions. CNBV will be in charge of the licensing process of sector institutions and has set criteria forauthorization. It has also set the standards for evaluating the SCIs as to their readiness to qualify asregulated entities under the new law.

1.1 Strengthening SCIs

Support to Institutions. The project will support an assessment of existing SCIs to determine whether thesemeet standards which will enable them to be authorized, require technical assistance either to strengthen orto restructure them (mergers with other institutions), or need to be liquidated. Evaluation criteria have beenprepared by a team led by CNBV and consisting of national and international specialists. Theapproximately 385 participating savings and credit institutions will be assessed and classified into fourcategories as follows: (a) generally meet standards for authorization into the new legal system and mayrequire assistance to modemize and expand outreach; (b) require capacity-building to make them eligiblefor authorization; (c) require merger with or acquisition by another SCI; or (d) are unviable and should beliquidated.

It is expected that approximately 385 institutions, operating in rural and urban areas, with 1.8 millionmembers or 78 percent of total sector membership will participate in the program. Preliminary analysisshows that some 80 percent of institutions would meet the requirements for certification provided they takemeasures to strengthen their management, financial perfornance and operations.

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The project will support the initial assessment and classification of SCIs, and the preparation andimplementation of plans for those institutions which require strengthening or restructuring - categories (a)though (c) above, and which have agreed to participate in the program. It is anticipated that theinstitutional strengthening plans will last between one and two years, depending on the size of theinstitution. BANSEFI will recruit institutions which are specialized in the provision of these services(referred to as technical assistance providers) to carry out the initial assessment using CNBV guidelines,and to prepare and implement the institutional strengthening plans. The technical assistance providers willenter into formal agreements with the participating SCIs and their corresponding Federations spelling outthe program and the performance standards to be met in a designated time period. BANSEFI will monitorthe results of the technical assistance program and will review progress on a semi-annual basis. BANSEFIintends to suspend assistance to institutions which do not achieve the agreed semi-annual targets. Inaddition, CNBV intends to verify on a sample basis the accuracy of the classification given at the outset tothe institutions participating in the program. The CNBV will conduct its own evaluation of the institutionswhen the technical assistance program is completed, and decide independently whether the institutions areto be authorized under the law.

The project will also support, as required, the liquidation of institutions which have been determinedunviable and present risks to deposit-holders. As the legal status of sector institutions is very diverse,support for liquidation will be determined on a case-by-case basis.

Technical assistance providers will be selected from among specialized institutions with demonstratedexperience in providing assistance to savings and credit institutions. They will be required to support allthe institutions in a Federation provided the institutions are willing to enter into specific agreements. Theexpected beneficiary institutions have been determined on the basis of expressions of interest made by theinstitutions and their Federations. Some 56 percent of the beneficiary institutions are very small, withassets of less than US$0.5 million, (mostly Cajas Solidarias). Another 32 percent of institutions have assetsof less than US$5 million. There is only one very large institution in the system, the CPM, with assets ofover US$400 million. CPM has already initiated a strengthening plan with technical assistance from theWorld Council of Credit Unions (WOCCU) with financing by the USAID. The loan will finance thetechnical assistance contracts for rehabilitation and strengthening. These contracts will set objectives, andcover costs of the international and national specialists, as well as expenses directly associated with theirwork, including equipment and materials and transportation. No vehicles will be financed, if vehicles needto be purchased, these will be paid by the Govemment. The Govemment, with financing by the Bank, willpay for the costs of the technical assistance program. The beneficiaries will contribute some logisticalsupport to the consultants. The participating institutions will also pay for the full cost of the Federationswhich are being established as required by law. The loan does not include financing to shore up the capital,which may be required in the case of a few institutions.

Providing SC Inforrnation Infrastructure and Services. Along with the institutional strengthening referredto above, and as part of an integrated effort aimed at the SCIs, their federations and the sector at large, theproject would support the design and establishment of an information system for the sector. The systemwill enable sector institutions to provide required financial reports to the CNBV as their supervisor, and toother relevant government agencies. It will also have the capability to maintain accounts and financialinformation, and to provide other operational, control and reporting services, upon request by theinstitutions.

The core system will reside and will be operated at BANSEFI. The SCIs will link to the system withequipment, software, technical assistance and training provided by the project contractors. This componentwould support the design and development of the basic system infrastructure and software, and the

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provision of services to about 100 SCIs that represent approximately 1000 points of service (SCIbranches). The Govemment will pay, with Bank financing, for the system development costs. Afee-for-service cost recovery mechanism will gradually be put in place that will have as objective the fullrecovery of operating costs by the fifth year of system operations.

It is anticipated that implementation of this component will be carried out in the first year of the project. Acomplementary initiative, expected to be prepared paripasu with implementation and likely to constitute anew request for financing from the Government of Mexico, will enable the national roll-out of the system.This sequencing of efforts is fully consistent with the expected pace of SCI rehabilitation and strengthening,and follows international good practice in systems development for comparable scenarios. A summaryassessment of the system and analysis is given in Annex 13.

Training program for the SCI staff. The project will support the implementation of a training program forSCI managemnent and senior staff. The training program will include four courses lasting from 2 to 4 weekseach in the areas of finance, accounting, risk management, credit analysis and governance and benefit allparticipating institutions. The courses will include both classroom and on-the-job training and will betaught in six regional centers, at the offices of the beneficiary federations. Each regional center will trainsome 150 staff for a total of some 800 staff. The training will be carried out by specialized consultantsand will cover all participating institutions. The contracts will include the cost of the trainers and theexpenses associated with their work including training materials, and transportation, and living expensesfor the trainers. It will be implemented over a two year period. The program will also finance thepreparation of the courses and expenses associated with certification of the courses. The courses will besponsored by the federations and the participating institutions which will provide the facilities and pay fortransportation and accommodations of the participants.

1.2 Strengthening SCI Supervision.

The project will provide support to CNBV to strengthen its supervision procedures and competencies. Tothis end, it will provide training to CNBV staff on supervision practices and procedures for microfinanceinstitutions and technical assistance to CNBV to develop and adapt regulations as needed. In addition,CNBV will engage the advice of recognized international experts in systems of auxiliary supervision (e.g.,Germany, Canada, Spain) on a regular, semi-annual basis. The project will also provide technicalassistance to strengthen the Supervision Committees (Comites de supervisi6n) at the Federations,specifically charged with the auxiliary supervision functions. It will also provide support to theConfederations that group them. This support aims at ensuring clear definition of the functions of theFederations (and the Confederation that will group them), and specifically a demarcation between theauxiliary supervision role and other functions. The support to CNBV and the sector will seek to establishrules and procedures that ensure professional and transparent handling of entry and exit, and address andmitigate risks of conflict of interest, adverse selection and other issues that may emerge in the process ofimplementing the supervisory mechanism. The loan will finance technical assistance and training requiredto carry out the activities.

Project Component 2 - US$26.18 millionThis component aims at expanding outreach of SCIs in the marginal areas. Activities under this componentextend work initiated under the marginal areas programs. The project will cover the marginal areas in somenine states. Activities under this component will be carried out by technical assistance providers undercontract to BANSEFI, which will execute the program on behalf of SAGARPA.

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2.1 Expanding Institutions and Services in Marginal Areas

The project's support aims at increasing outreach; ensuring financial self-sustainability; and improving anddiversifying the financial services offered by participating intermediaries which serve clients in the marginalareas. The project will finance specialized technical assistance and training to strengthen and expandoperations of the selected SCIs. The institutions will be selected on the basis of their track record in termsof outreach and sustainability, and their existing or projected expansion plans. In some regions where nointermediary exists, savings and credit institutions will be established. The participating institutions wouldenter into agreements with the technical assistance providers commnitting to performance targets which willbe closely monitored. The process will take time because new habits and skills will need to be developed.All participating SCIs will join or will be assigned to a Federation for supervision purposes, as mandatedby the law, and will meet the requirements for certification by CNBV. The program does not include a lineof credit, and it is expected that most of the credit given by participating institutions will be from members'savings.

The marginal areas will be grouped into regions for developmental purposes. The population of themarginal areas covered total some 17 million people. The program will be implemented in six of thefollowing eight regions: (i) Chiapas, (ii) Huasteca (marginal areas in the States of Hidalgo, San Luis Potosiand Veracruz), (iii) Oaxaca, (iv) Veracruz excluding the Huasteca (v) Guerrero (and adjacent marginalareas in the State of Morelos), (vi) Michoacan (and adjacent marginal areas in the State of Mexico), (vii)Puebla (and adjacent margina areas in the State of Tlaxcala), and (viii) Sierra Gorda (marginal areas in theStates of Queretaro and Guanajuato). The municipalities covered by the program appear in a documentprepared by SAGARPA and based on the classification of the CONAPO for levels of marginality. Theregions have been selected taldng into account the demand for services identified in market studies, and thewillingness of institutions in the region to enter into perfornance agreements with the technical assistanceproviders. The sequencing of the regional programs has also been determined on the basis of the studies,although this order may be modified if developments justify advancing a region ahead of others. Thetechnical assistance providers will enter into agreements with the participating institutions.

The technical assistance providers will be selected following World Bank procedures. The process ofselection of the technical assistance provider which will implement the program in Chiapas is completeand the program will be initiated this month. The process of selection of the technical assistance providerfor the Huasteca Region is well advanced, and work should start later this year. At the end of five years ofthe project, some 60,000 families will be served in the six regions where the program will have beeninitiated. This figure takes into account that some of the programs, such as those in the populous regions inVeracruz and Puebla would only be in their third year of operation. Given that the regions served under theprogram have few existing institutions, much of the expansion of services will come through theestablishment of new branches. Some 15-20 new branches (or local institutions) should be established ineach of the marginal areas covered. Annex 14 provides outreach and performance indicators for theprogram as a whole and for the regions covered in the program. The technical assistance contracts includeperformance targets including the number of clients to be served and indicators of performance byinstitutions. The contracts will cover the costs of the intemational and national specialists required to carryout the regional development plans as well as expenses directly associated with their work, includingequipment and materials. The regional programs include partial payment of the salary of the manager of anew branch, which will be financed for three years on a declining basis (70 percent the first year; 50percent the second year and 30 percent the third year). The Govemment will pay for the subsidy. Novehicles will be financed by the loan.

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22 Community Training Programs (Social Intermediation at the Community Level)

The project will provide training to the poorer segments of the population in the marginal areas on basicprinciples of household finance and participation in financial transactions. In some cases, the program willassist communities to set up simple record-keeping for indigenous savings organizations, and introducethem to formal institutions where they could set up formal accounts. The main activities under thissub-component will be organized by the same technical assistance providers that will provide servicesunder sub-component 2.1.

Project Component 3 - USS 5.69 millionThis component aims at increasing understanding of the constraints affecting the provision of financialservices to low-income clients, at monitoring and evaluating the effectiveness of policies and programs, andat developing financial innovations adapted to Mexico. The project will finance consulting services andpreparation of information materials under this activity. The main features of the monitoring, evaluationand dissemination activitites are sunmmarized in Annex 15.

3.1. Sector-wide activities

Activities under this component include studies on, inter alia, financial intermediation, sector performanceand auxiliary supervision with a view to identify explanatory factors for performance, draw lessons fromthe Project results and identify areas for improvement and innovation. In addition, the component includesdissemination programs, including workshops and information campaigns, to inform SCIs, their clients andother stakeholders of the sector consolidation and strengthening program, and to disseminate lessons fromexperience in the areas of microfinance, savings mobilization, and auxiliary supervision. Disseminationefforts will also include the general public, with emphasis in the low-income segments of the population.The project will also support the introduction of systems to monitor sector development progress and theimpact of the govemment's development programs. The sector studies and monitoring function will becarried out at five different levels: (i) SCI supervision mechanism; (ii) SCI performance; (iii)federation/network performance; (iv) social and economic impact; and (v) fiscal impact. Lastly, thecomponent will also support periodic external evaluations by national and international consultants.

3.2 Rural microfinance acdvities

Studies will also cover financial intermediation in runal areas and other areas underserved by the Mexicanfinancial sector, with a view to defining new methodologies which are adapted to local conditions. includingtechnical and financial audits of the rural microfinance institutions supported under the project, and expertadvice to the project management team. This component will support monitoring and evaluation activitiesspecific to the implementation of component 2 (rural areas), including technical and financial audits ofSCIs supported under the rural finance component.

Project Component 4 - US$4.88 millionBANSEFI and SAGARPA are conscious of the importance of a strong project implementation team tocoordinate and supervise the work the consultants contracted to carry out the project activities, and haveassembled a strong team for this purpose. The project will support the operations of a Core Team atBANSEFI and of SAGARPA's technical unit, which have been set up to carry out project management andimplementation follow up, including monitoring and evaluation of the activities.

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Annex 3: Estimated Project Costs

MEXICO: Savings and Credit Sector Strengthening and Rural MicroflnEnce Capacli Building

1. Consolidating the Savings & Credit Institutions Sector 8.1 37.5 45.62. Expanding Financial Services in Rural Areas 7.7 17.2 24.93. SCI Sector Studies, Information Dissemination & Monitoring 3.9 1.5 5.44. Project Management 4.8 - 4.8

Total Baseline Cost 24.§ 56.2 00.7Contingencies 0.5 4.2 4.7

Total Plroect Cost 25.0t 60.4 _ _.4

Goods, Equip. & Vehicles 2.5 8.8 11.3Consultant Services 10.6 51.5 62.1Training 2.1 - 2.1Opera___g Costs 9.9 . 9.9

lTotal 25.2 60.3 85.4

1/ Include direct subsidies to rural financial institutions, operating & other indirect costs of the project.

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Annex 4: Cost Effectiveness Analysis Summary

MEXICO: Savings and Credit Sector Strengthening and Rural Microfinance Capacity Building

The economic analysis of technical assistance interventions is particularly difficult to quantify due toproblems of attribution, multiple-generation effects, and the lack of financial flows generated from projectinvestments, among others. Nevertheless, we discuss below the economic effects, primarily on a qualitativebasis, that are expected to stem from the project by evaluating expected project impact on three levels: (i)institutions (including SCIs and their organizations); (ii) clients; and (iii) fiscal implications.

Institutional Level: Consolidation, Scale Economies and Efficiency Gains

Approximately 385 savings and credit institutions are expected to participate in the sector consolidationand strengthening activities to be undertaken by the project. By most measures, including assets, depositsand numbers of clients, these institutions represent at least 80 percent of the sector, according todiagnostics conducted by BANSEFI. The project will fund institutional strengthening for thoseparticipating SCIs with the potential to meet the new financial and operating standards mandated by law,and will support the liquidation or restructuring (mainly mergers and acquisitions) of those institutionswhich cannot meet the new standards. Preliminary diagnostic work indicate that approximately 40 percentof the 385 participating institutions may be either liquidated or restructured in the sector consolidationprocess. Current estirates indicate that 72 institutions will be liquidated and another 68 will be merged inthis process, as a result of the screening, classification and technical assistance activities that the projectwill support.

The approximately 240 institutions estimated to emerge from the consolidation process will be ftllystrengthened and restructured as needed to be compliant with the new law. Given that the 365 SCIs toparticipate in the consolidation process currently serve about 2 million clients, with an average of 5500clients per institution, the liquidations and mergers are likely to increase the average number of clientsserved by each of the remaining institutions to about 8200 clients at project's end. This estimated increaseof nearly 50 percent in institutional scale, as measured by average number of clients, does not include thenew clients expected to be attracted to the strengthened and certified SCIs over the life of the project (nordoes it subtract the number of clients who may not migrate from closing institutions to strengthened ones).The remaining SCIs will therefore be able to benefit from scale economies thus far unattainable given theirlimited size.

Efficiency gains will also accrue to the SCIs from staff training, upgrading internal controls and buildingcredit appraisal and risk management capacity. Improvements in the applications and networkingcapabilities of SCIs will be funded to improve the efficiency and accuracy of reporting of financial andoperational indicators. The information platform for SCIs to be financed by the project is expected tocontribute significantly to the overall increase in operational efficiency and especially to a reduction in thecosts of control, reporting and back-office functions.

The organizations formed by the institutions of the SCI sector are also expected to benefit from projectactivities designed to automate operations and professionalize the federations and confederations into whichMexico's savings and credit entities are grouped. The formalization of COMACREP into a Confederationwhere the auxiliary supervision capacities and deposit protection functions for the sector are likely to behoused, represents an institution-building effect for the sector.

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Client Level: Increased Access and Depth of Outreach

The client base of the SCI sector is expected to grow by about 16 percent per year over the course of theproject. This would result in the expansion in the numbers of clients served by the participating SCIs fromabout 2 million to about 4.2 million at the end of the five year project implementation period. This indicatesand increase in access from about 5 percent to almost 9 percent of the economically active population.

As for the depth of the SCI sector outreach, the average size of current SCI deposit and loan balances canbe used as a proxy measure of the approximate income profile of those beneficiaries. In 1999, loan andsavings account averages for the Caja Popular Mexicana were $711 and US$593 respectively, whichrepresents an upper bound for the SCI sector averages; and the Caja Solidaria averages were US$212 andUS$424 for loans and deposit sizes, respectively, which are lower bound figures. As percent of GDP percapita loan averages for the SCI sector were in the range from 4 to 14 percent, while average savingsbalances were between 8 and 12 percent of per capita GDP. In contrast, average deposit balances in thebanking system are estimated to amount to about 130 percent of GDP per capita. Expansion of the SCIsector, therefore, even with increasing shares of the middle-income market, is likely to incorporate largenumbers of the low-income segments of the population.

Providing financial services as a means of integrating poor households into the national economy is clearlya poverty-alleviation tool. This is particularly pertinent for the rural microfinance component of the project,in which the population of rural marginal areas is expected to gain from the services provided by thestronger, more efficient SCIs through access to adequate deposit instruments and an improved ability totake advantage of productive investment opportunities.

A recently completed survey and analysis of household finances in the marginal areas of Oaxaca andHuasteca regions (Report N. 21286-ME) shows that the poor can and do save by building up lump sumsout of small and irregular income flows, or storing quasi-liquid assets. Study findings indicate that whilefew rural households have access to formal deposit services, an important proportion of the households inthe sample hold financial assets in infomnal mechanisms (primarily through holding cash at home,participating in informal rotating savings groups, or tandas, and lending to others). An even larger numberof households (62 percent of the total sample) keep savings in physical assets easily convertible to cash,especially livestock. Savings in all these forms amount, on average, to about 16 percent of averagehousehold income, a ratio comprised by 12.5 percent in quasi-liquid physical assets, 2.1 percent in informalfinancial assets and 1.6 percent in formnal deposits.

Transforming informal, non-earning financial assets, and monetizing even a frction of the savings held inphysical form would have clear benefits in terms of safety and return. Informal means of savings thatdominate in the households' portfolios are, in principle, inferior to financial instruments in terms of safetyand returns. For example, informal lending suffers from a 20 percent arrears-default rate and loans areoften made at zero interest charges; tandas report a 6 percent rate of non-compliance (group members whocease to contribute once they have taken a turn); and the most common forms of livestock holding, pigs andchickens, have mortality rates above 40 percent. Since holding livestock as savings is more prevalent inpoorer areas and among indigenous people than elsewhere, this kind of asset transformation would benefitrelatively more the poorest segments of the population.

Fiscal Effects

In addition to the investment costs associated with the project, the likely fiscal impact is determined by thecost of the resolution of the institutions which are not viable and whose depositors will have to be paid by

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the Government when these SCIs are liquidated. Estimates of the liabilities on the non-viable SCIs reachapproximately US$ 330 million (about 0.06 percent of GDP if all were paid off in one year), though theportion of uninsured deposits which the government will cover has yet to be deternined. The estimatedcosts of SCI liquidations will be negligible compared to the cost of the banking industry bail out, whichamounted to 13 percent of GDP as of 1999. The project will not support the government's bail out of theSCI sector directly, though the technical assistance to be financed will determine precisely whichinstitutions must be liquidated and thus provide for a programnmed approach to institutional resolutionsrather than a crisis management approach. By allowing the government to allocate fiscal resources in aprogrammed response to the need for SCI resolutions rather than having to re-allocate resources in a crisisadds a fiscal-management benefit to the effects of the project

Summary of benefits and costs:See above.

Main Assumptions:See above.

Cost-effectiveness indicators:See above.

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Annex 5: Financial Summary

MEXICO: Savings and Credit Sector Strengthening and Rural licrofinance CapacivyBuilding

Sa. Summary of Project Costs

.41, do. I* #A -,

-. E'.t~~~~uIIj~~ .200)4 IV "201)5 1?Y 2916d 1~ 10

Project CostsInvestment Costs 17.6 24.8 15.1 10.7 7.3 75.5Recurrent Costs 2.1 2.3 2.4 1.6 1.6 9.9

Total 19.7 27.1 17.5 12.3 8.8 85.4

Financing Sources (% of Total)World Bank 63% 83% 80% 75% 71% 76%

Others 23% 5% 6% 7% 4% 10%Government 14% 12% 13% 18% 25% 15%

Total 100% 100% 100% 100% 1100% 1100%

Sb. Financial Analysis Summary

Savings and Credit Institutions

A detailed evaluation of the financial situation of individual institutions and a program of remedial action isa central element of the technical assistance program to be supported under the project. Availableinformation on capital and portfolio quality of sector institutions shows the impact of the project onparticipating institutions. A detailed analysis of the financial statements of 43 institutions in twofederations covering a wide range of sizes and accounting for 25 percent of members and 20 percent ofassets of the beneficiary institutions shows that 34 of the member institutions, or 80 percent would meet theinitial capitalization requirements under the new law. The initial requirements are estimated at of 9 percenton assets with 40 percent provisioning of non-performing portfolio, which is in line with current regulationsfor Sociedades de Ahorro y Prestamo (SAPs). However, in the absence of measures to improve theiroperations and financial perfornance, only 16 of the 34 insfitutions in the sample would be able to meet therequirement of 100 provisioning of non-performing portfolio expected to be established after a transitionperiod

Typical Federations: Capitalization IndexCapitalization Index Non-perforning portfolio Non-performing portfolio(capital/ portfolio- provisioned at 40% fully provisioned

provisions) (number of institutions) (number of institutions)More than 9 % 34 160-9% 6 7Negative 3 20Total 43 43

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The enactment of the new legislation has had an impact on sector institutions. Some of the largest arealready part of federations which perform functions which are not dissimilar to those mandated by the newlegislation. The smaller institutions which did not belong to federations have begun associating withexisting ones or are in the process of establishing new federations. Existing federations charge for services.The charges are related to the services rendered and the size of the institutions in the federation, and rangefrom 1 to 4 percent of assets. The more sophisticated federations in central and northern Mexico chargemember institutions around 3 percent of assets.

The costs of auxiliary supervision and the ability to pay among different categories of institutions has beenexamined. The cost of the supervisory unit at the federation level has been estimated at 0.35 percent ofassets. The analysis was based on detailed costs for one representative federation (comprising of 31institutions of varying sized and accounting for 10 percent of assets and 12 percent of the membership ofthe institutions that will benefit from the technical assistance program) and compared to costs of otherfederations. Unit costs would be slightly lower in the few federations which include very large institutions.Unit costs would be higher for the network of Cajas Solidarias, the only federation likely to have very smallinstitutions. The incremental costs of the supervisory units should be affordable to most institutions; this isespecially the case as the technical assistance to be provided under the project is expected to increasesubstantially the efficiency of participating institutions. Financial projections for very small institutions inthe rural areas show that they should be profitable and able to afford payments to the federations, even ifthese were higher than is currently the practice (see paragraphs below).

The costs of supervision has prompted the industry to study the eventual consolidation of supervisoryfunctions in a national confederation, which should reduce costs. Ensuring reasonable costs and hence theaffordability of mandated federation functions is an important element of the support to the sectorenvisaged under the project.

Expansion of Services In Rural Areas

Financial projections for microfinance institutions (or branches of institutions) in marginal areas supportedunder the project show that these should be financially strong notwithstanding the clientele and low averagesize of deposits and loans. Information of expected performance of the SCI's in marginal areas is given .Performance and outreach indicators after 5 and 10 years of operation are given in Annex 13 .Tbe financialsolidity of the rural institutions stems from the relatively low operating costs but more importantly becauseof the high interest rate margins with which they operate. The projections were prepared with lending rateswhich are more conservative than the prevailing rates in marginal areas (50 percent annual rate, as opposedto the prevailing 60 percent which is charged by microfinance institutions), as it can be expected thatinterest rates of microfinance institutions will decline as a result of an increased supply of financialservices in rural areas. Institutions will cover all costs including depreciation in the fourth year ofoperations. This is even taking into account that the institutions retain a high liquidity position even afterthe startup period, and that they will contribute to the costs of the federations which they join (estimated atsome 7 percent of deposits per year). At the end of the project period, some institutions will just have beenestablished, and the projections were thus extended to ten years, when all institutions supported under theprogram will be fully operational. At the end of 10 years, the return on assets will be of the order of 8percent and the return on equity about 20 percent Savings and credit institutions in marginal areas areexpected to meet the requirements to be imposed by the CNBV for authorization.

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Annex 6: Procurement and Disbursement ArrangementsMEXICO: Savings and Credit Sector Strengthening and Rural Microfinance Capacity Building

Procurement

Procurement for the project will be carried out by BANSEFI which has assigned a core team of staff toimplement the project, as described in Section E 4 of the PAD (although procurement decisions, to beimplemented by BANSEFI, will be taken by a SAGARPA unit with regard to SAGARPA components ofthe Project). The project will not finance civil works. A Procurement Capacity Assessment for the projectwas carried out by the Country Procurement Specialist and approved by Regional Procurement Advisor onApril 25, 2002.

Grouping of contracts. To the extent practicable, contracts for goods shall be grouped in bid packagesestimated to cost US$500,000 equivalent or more each.

Procurement methods

The procurement methods are described below, and the estimated amounts for each method are summarizedin Table A. The threshold contract values for the use of each method are given in Table B.

Notification and Advertisement

The General Procurement Notice is to be published in the Development Business and shall be updatedannually for all outstanding procurement All invitations to bid shall be published in the "Diario Oficial dela Federaci6n nand in COMPRANET. There are no contracts expected to cost the equivalent of US$10million or more. Were contracts of such amounts occur, invitations to bid shall follow the procedures inparagraph 2.8 of the Bank's "Guidelines for Procurement under IBRD Loans and IDA Credits, January1995, revised August 1996, September 1997 and January 1999." To obtain expressions of interest for largeconsultant assigmnents (contracts expecting to cost more than US$200,000 equivalent), a specific noticeshall be published in the Development Business.

Procurement Plan

The Borrower will present a procurement plan to the Bank for comments by Negotiations. The procurementplan will provide aggregate amounts for each procurement method. Each June, the Borrower will updatethe procurement schedule for the following year, including the number and estimated costs of the items tobe financed under the loan following the model procurement plan.

Goods

Goods will be procured in accordance with the Bank's Guidelines referred to above. The total cost of goodsis estimated at US$11.3 million, of which the loan will finance US$5.3 million. Most procurement of goodswill follow ICB procedures. Goods estimated to cost less than US$500,000 equivalent per contract, up toan aggregate amount of US$1.9 million, may be procured through NCB procedures.

Goods that are estimated to cost less than US$100,000 equivalent per contract, up to an aggregate ofUS$0.6 million, may be procured through (International or National) shopping procedures in accordancewith the Bank Guidelines.

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Services

The selection of consultants will follow the Bank's guidelines, "Selection of Consultants by World BankBorrower, January 1997 revised September 1997 and January 1999." The total cost of WorldBank-financed consultant services and technical assistance is estimated at US$56.2 million equivalent forthe entire project.

Consultants services will be selected through the Quality- and Cost-Based Selection (QCBS) methodexcept as otherwise provided in the following paragraphs.

Consultants services contracts for carrying out of assessments of the financial and managerial condition ofindividual SCIs and technical assistance to support the design and implementation of regional developmentplans associated with the expansion of financial services in the rnual areas, up to an aggregate of US$9.3million, may be procured through the Selecton under a Fixed Budget method (paragraph 3.5 of theConsultants Guidelines).

In exceptional cases or when selection of consultants through competitive process is not practicable,contracts estimated to cost less than US$30,000 equivalent per contract, up to an aggregate of US$0.3million may be procured through Single-source Selection method as stipulated in paragraphs 3.8-3.11 ofthe Guidelines upon prior clearance with the Bank.

Individual consultants services contracts that meet the requirements in paragraph 5.1 of the ConsultantsGuidelines, up to an aggregate of US$2.6 million, may be procured under the provisions of paragraph 5.1through 5.3 of the Consultants Guidelines (Selection of Individual Consultants).

The following provisions shall apply to consultants' services to be procured under contracts awarded inaccordance with the provisions of the preceding paragraphs. The short list of consultants, estimated to costless than US$200,000 equivalent per contract, may be comprised entirely of national consultants inaccordance with the provisions of paragraph 2.7 of the Consultant Guidelines. The Request For Proposalsformat and selection process agreed upon by the Bank and the GOM will be used for requesting proposalsand for the selection and appointment of consultants. Simplified contracts will be used for short-termassignments with simple missions of a standard nature (i.e. those not exceeding six months) to be carriedout by individual consultants or firms.

Prior review thresholdsThe prior review arrangements are presented in Table B. For consultant contracts not subject to priorreview, the terms of reference related to such contracts are subject to prior approval by the Bank.

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Procurement methods (Table A)

Goods, Equipment &Vehicles 7.5 1.9 0.6 1.3 11.3(3.2) (1.6) (0.5) -(5.3)

Consultant Services 62.1 62.1- - - ~~~~~(56.2) (56.2)

Trainiing -- 2.1 2.1----- o (0.6) (0.6)

Operating Costs -- 9.9 9.9__ ~~~~~~~~~~, , . - - ( 2.5) 25

Totol,Project Cost 7.5 1.9 0.6 .754 18.4of which lDA Fundedby WB (3l2) (1-6) (0.5) (59) (3)

1/ Figures in parenthesis are the amnounts to be financed by the World Bank loan. All costs include contingencies.2/ Includes goods to be procured through national shopping, consulting services, services of contracted staff of the projectmanagement offEce, training, technical assistance services and incremental operating costs related to (i) managing the project,and (ii) re-lending funds to local government units.

Table A2: Consultants Selection Arrangements(in US$ million equivalent)'

A. Firms 51.3 - 9.3 60.6(45.6) - (8.6) (54.2)

B. Individuals - 2.6 - 2.6(2.0) - (2.0)

Total 51.3 2.6 9.3 63.2____________ (45.6) (2.0) (8.6) (59 .2)

1/ Including contingencies.2/ In exceptional cases, upon prior clearance by the World Bank, sole-sourcing may be used as a method ofselection of consultants in accordance with the provisions in paras. 3.8 to 3.11 of the Guidelines.QCBS = Quality- and Cost-Based SelectionCQ= Consultants QualificationsFBS = Fixed Budget Selection

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Prior review thresholds (Table B)

Expenditure Category Contract Value Procurement Method Contracts Subject to PriorThreshold Review

(lJS$)_Goods: >500,000 ICB All

<500,000 NCB First two contracts<100,000 NIS None

ConsultantsFirms >100,000 QCBS, SS, FBS All

<100,000 QCBS, FBS None<30,000 SS All

Individuals >50,000 CQ None<50,000 IC None

OveraUl Procurement Risk Assessment: Average

The procurement activities under this project are straight forward, thus the overall risk assessment isconsidered AVERAGE.

Frequency of procurement supervision missions proposed: One every six months (includes specialprocurement supervision for post-review/audits).

Procurement Responsibilities and Capacity and Risk Management

Procurement staff will be assigned to the Core Team (BANSEFI). The main functions of the procurementstaff in the Core Team are to supervise the selection of consultants and the procurement of goods financedby the project (except that procurement decisions for SAGARPA components of the Project will be takenby a SAGARPA unit). Project staff involved in procurement and financial management functions attendeda special course designed for procurement activities under the project. Technical Unit staff (Rural Financecomponent) attended training courses in procurement in 2001. A procurement system will be installed at theCore Team which will enable adequate monitoring, administration and production of reports for WorldBank funded procurement activities based on an agreed and acceptable format. Core Team will alsomonitor compliance with the Procurement Implementation Plan agreed with the World Bank. The CoreTeam consists of BANSEFI staff and short-term consultants including Procurement Specialists,Monitoring and Evaluation Experts, Training Experts, Accountants and Technology Specialists.

Procurement Records Keeping

Record Keepmg ana me nimg system for the procurement activities under the project are mostly thoseinvolving the recruitment and selection of consultants. The Core Team procurement staff are well trainedand capable of implementing and administering the procurement system without major difficulties.Procurement Reports in the agreed format would be submitted annually to the Bank. The report wouldinclude updates and highlights of the current status of the record keeping and filing system.

- 49 -

An Action Plan is shown below:

a) Audit reports to be submitted annually to the Bank should include a review of the record keeping andfiling system;

b) A general procurement plan for the project and a detailed procurement plan for the first year of projectexecution has been presented to the Bank.

c) Core Team and Technical Unit project staff should participate in workshops on procurement as theybecome available during project implementation; I

d) By Effectiveness, the Core Team and the Technical Unit (Expanding Financial Services in Rural AreasComponent) should have finalized an Operational Manual for the project activities, includingprocurement procedures and model evaluation reports satisfactory to the Bank.

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Disbursement

Allocation of loan proceeds (Table C)

I. Goods under Part A of the Project (excluding vehicles) 4.86 85%

2. Consultants Services (except as covered by Category (3) below:

(a) under Part A of the Project 29.9,100% Foreign Expenditures; 83% Local(a) under Part A of the Project 29.98 ~~of Local Expenditures

(b) under Part B of the Project:

(i) for the Chiapas & Huasteca regions of the 6.10Expansion Project

(ii) for an Expansion Project Area region other than 3.00the regions covered by sub-Category (i) above

(iii) for an Expansion Project Area region other than I 00% Foreign Expenditures; 83% Localthe regions covered by sub-Category (i) and (ii) 3.0of Local Expendituresabove

(iv), for a'n E"x'pansion Project Area region other thanthe regions covered by sub-Category (i), (ii) and (iii) 3.00above

(v) for an Expansion Project Area region other thanthe regions covered by sub-Category (i), (ii), (iii) and 3.00(iv) above

(c) Other Consulting Services:

(i under Part C.lI of the Project 2.05 1 00% Foreign Expenditures; 83% Local(i) ~~~~~~~~~~~~~~~~~of Local Expenditures

(ii) under Part C.2 of the Project 0.73

(iii) under Part D for the Technical Unit of the Project 0.72

3. Training under the Project 0.55 ~1 00% Foreign Expenditures; 83% Local

3. Training under the Project 0.55 ~~~~~of Local Expenditures

4. Incremental Operating Costs

(a) incurred for the Core Team 1.91 85% through the end of 2004; 55%(a) incurred for the Core Team 1.91 ~~~~~~thereafter

--- - - - ~~~~~~~~~~~~~~~85O%t1iFilitTi~iiEd 6f Z0U4- 535'V.(a) incuffed for the Technical Unit 0.37

5. Premnia for Interest Rate Caps & Interest Rate Collars

6. Fee 0.64

Unallocated 4.70

Total 64.60

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Use of statements of expenditures (SOEs):

The Core Team and the Secretaria de Hacienda y Credito PzIblico may opt for Financial MonitoringReports (FMRs) based disbursement procedures, however the project will use statements of expenditures,special commitments and direct payments (mostly SOEs) for disbursement procedures until an agreement isreached and the project is ready to migrate from SOEs to FMRs. The Core Team will prepare all necessarydocumentation for prompt disbursements. Based on thresholds recommended, fiull supportingdocumentation will be required for all contracts for goods higher than US$500,000, consultant firmcontracts above US$100,000, individual consultant contracts above US$50,000. All expenditures foroperating costs and training, except those which relates to contracts with firms and training institutions willbe disbursed by SOE.

Accounting and auditing. The Core Team and the Technical Unit will maintain separate project recordswhich will reflect, in accordance with sound accounting practices, the operations, resources andexpenditures of each project activity. Independent annual audits will be carried out based on theInternational Standards on Auditing (ISA) and all applicable Bank guidelines and legal agreements betweenthe Government of Mexico and the implementing agency (including the technical memorandum ofunderstanding on auditing dated June 2001). This audit will be carried out by an acceptable private firmand the report will be submitted to the Bank within the six months after the end of each fiscal year..

Special account:

Disbursement, flow of funds and Special Account. A Special Account in US dollars will be establishedby BANSEFI on terms and conditions satisfactory to the Bank at the Central Bank (Banco de Mexico), orinstead, with the Bank's prior written agreement at either (i) BANSEFI, or (u) a commercial bank. Theauthorized allocation is US$4.0 million. The initial deposit will be limited to US$2.5 million and based onproject operations and cash flows. Traditional documentation requirements apply for direct payments,special commitments and statements of expenditures, therefore, full documentation is required for contractsthat are above the prior review limit. If project is converted to FMR-based disbursement methodology, allprocedures should be satisfactory to the Bank. For prompt disbursements, the Core Team will prepare thenecessary documentation.

The Core Team might opt to request a higher pre-authorized revolving fund. In this case, when theaggregate disbursements under the loan have reached US$10.0 million, this allocation may be increased upto the total allocation. Accordingly, the Special Account will be replenished monthly and will be used forall transactions.

Staffing. Based on discussions with the BANSEFI Core Team, it seems that there is a good financialmanagement team, skilled and well trained although some staff roles still need clarification i.e.responsibilities sharing/accountability between the Core Team and Technical Unit (Rural FinanceComponent), responsibilities related to project reporting and disbursing. The Project Operational Manualwill reflect the requirements of the project on staffing i.e. organizational chart, job descriptions, specificresponsibilities for this project, etc. An experienced local consultant was hired as extemal short termsupport during preparation period to ensure project readiness.

Financial Management Assessment. A financial management assessment was carried out based onapplicable Bank guidelines and procedures. The conclusion of this assessment was that the implementing

- 52 -

unit is currently prepared to implement the project, but all systems need to be customized and strengthenedas necessary, to specifically handle all responsibilities as financial agency and implementing agency. Boththe BANSEFI Core Team and TU are currently fully staffed and operational, and the Core Team isoperating a sound financial management system which meets minimum Bank financial managementrequirements. However, the system does not yet have in place adequate project financial managementarrangements to provide, with reasonable assurance, accurate and timely information on the status of theproject (FMR and SOEs) as required by the Bank for project management, disbursement and reporting. Atime-bound action plan acceptable to the Bank will be submitted before project effectiveness. The aim ofthis plan is to ensure project readiness and constant financial management strengthening.

FMR Reporting. The project will produce FMRs for each six-month period starting after projecteffectiveness. The format and contents of the FMR will be agreed before Negotiations.

Management Information System. The BANSEFI Core Team will carry out all needed activities toensure proper systems for this project. Existing systems are acceptable to the Bank as they satisfyminimum Bank requirements on financial management. However, some adjustments will be made to befully satisfactory to the Bank for this specific project.

Budgeting. Financing for the proposed project would be included in the standard budget and, therefore, itwould be 100 percent pre-financed by the government. The flow of funds will be clearly identified inrecords and reports. Project financial management arrangements will be similar to those in other projectsi.e. a private firm acceptable to the Bank will be designated to carry out annual project reviews. The TORsfor the firm will be agreed annually and prepared/based on Bank guidelines. The Core Team will beresponsible for analogous federal activities related to project flow of both funds and information and so on.

The Core Team would be responsible for budget consolidation and supervision of the projectimplementation activities.

Fmancial Agency. The Core Team will be responsible for all activities related to a financial agent i.e.Special Account control and management, flow of funds and reporting coordination, disbursements andreimbursements processing, and all similar activities carried out by analogous financial agents for WorldBank projects in Mexico, i.e, Banco Nacional de Obras y Servicios Puiblicos and Nacional Financiera.

Retroactive Financing. The project is considering retroactive financing for expenditures prior to loansigning for up to US$3.0 million.

Operational Manual. The operational manual, or Documento de la Implementaci6n del Proyecto, willprovide additional information and details on the issues described above.

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Annex 7: Project Processing Schedule

MEXICO: Savings and Credit Sector Strengthening and Rural Microfinance Capacity Building

13fd6d'vSchedulerBs- ,fi ,, ,;^, mW^Fan"P d,'~ , A-. ,r; ;I^tbC, Al;Time taken to prepare the project (months) 6 9First Bank mission (identification) 10/24/2001 09/24/2001Appraisal mission departure 04/08/2002 04/10/2002Negotiations 05/29/2002 05/29/2002Planned Date of Effectiveness 09/01/2002

Prepared by:

Bank staff and consultants.

Preparation assistance:

PHRD Trust Fund

Bank staff who worked on the project included:

.Name , Speciality, .Carlos Cuevas Task ManagerAdolfo Brizzi Sector Leader, LCSES (until 03/15/02)Mathew Mcmahon Acting Sector Leader, LCSES (as of 03/16/02)Herminia Martinez Consultant assisting the ClientLisa Taber ConsultantKaren Ravenelle Team AssistantMaria Elena Castro Mufnoz Social Scientist, LCSESFerenc Molnar. Legal Counsel, LEGLALea Braslavsky Procurement Specialist, LCOPRVictor Ordofiez Financial Management Specialist, LCOAAJoseph Paul Formoso Sr. Disbursement Officer, LOAG3Reynaldo Castro ConsultantRobert Keppler Sr. Advisor, Payment Systems, FSDAlain Laurin Lead Financial Sector Specialist, Banking Supervision, BFR

- 54 -

Annex 8: Documents In the Project File*MEXICO: Savings and Credit Sector Strengthening and Rural Microfinance Capacity Building

A. Project Implementation Plan

B. Bank Staff Assessments

* Financial Projections for Microfinance Institutions in Marginal Rural Areas, February 2002.* Technology and Infornation Systems Components, March 2002.

C. Other

* Diagn6sticos de Entidades de Ahorro y Credito Populary del Sector Rural, PAHNAL, August 2001.* Ley Organica del BANSEFI* Ley de Ahorro y Credito Popular* Preliminary Results: Popular Savings and Credit Sector Census and Diagnostic, BANSEFI, March

2002.* Study for the Strengthening and Development of Rural Finance Institutions in the Marginal Areas of

the State of Chiapas, SAGARPA, August 2001.* Study for the Strengthening and Development of Rural Finance Institutions in the Marginal Areas of

the Region of Huasteca, SAGARPA, January 2002.* Plan de Desarrollo de Pueblas Indigenas para la Region de Chiapas, SAGARPA, March 2002.* Plan de Desarrollo de Pueblas Indigenas para la Region de Huasteca, SAGARPA, March 2002.* Guia Operativa del Programa de Asistencia Tecnica al Microfinanciamiento Rural, SAGARPA,

March 2002.* Terminos de Referencia para el Desarrollo de Instituciones de Microfinanzas en el Estado de

Chiapas* Terminos de Referencia para el Desarrollo de Instituciones de Microfinanzas en la Region de

Huasteca* Estudio para el Dessarrollo y Fortalecimeinto de Instituciones no Bancarias Rurales de las Regiones

Marginadas de Oaxaca, dentro del Marco del Proyecto PA TMIR* Principales Caracteristicas del Estado de Oaxaca* Evolution of Outreach and Performance Indicators in the Marginal Areas by Region* Poblacion Indice de Marginalidady Densidad de Municipios Marginales en los Estados del

Programa* Lenguas Indigenas en los Municipios Marginales en los estados del programa* Nivel de Ingreso en los estados del programa* Diseno del Programa de Capacitacion BANSEFI* Requerimientos de Consultores de los Contratos Regionales* Reglas de Caracter Prudencial para Instituciones de Ahorro y Prestamo. CNBV*Including electronic files

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Annex 9: Statement of Loans and Credits

MEXICO: Savings and Credit Sector Strengthening and Rural Microfinance Capacity Building03-Jun-2002

Difference between expectedand actual

Original Afmount In US$ Millions disbursements

Prolect ID FY Purpose IBRO IDA GEF Cancel. Undlsb. Orig Frm Rev'd

P057531 2002 MX Basic Ed Dev Phase II 300.00 0.00 0.00 0.00 300.00 0.00 0.00

P060577 2002 MX Southeast Reg1 DeveWpment UL 5.00 0.00 0.00 0.00 5.00 0.17 0.00

P065988 2002 MX-CnsoIdatLPMectd Areas (SINAP I11) 0.00 0.00 16.10 0.00 6.82 0.00 0.00

P064887 2001 DISASTER MANAGEMENT (ERL) 404.05 0.00 0.00 0.00 395.74 65.03 0.00

P063463 2001 METHANE CAPTURE & USE AT A LANDFILL 0.00 0.00 6.27 0.00 6.43 2.22 046

P060906 2001 GEF MX-MESO AMEFRCAN CORRIDOR 0.00 0.00 14.84 0.00 14.02 3.25 0.00

P065779 2001 FEDERAL HIGHWAY MAINTENANCE PROJECT 218.00 0.00 0.00 0.00 202.36 -15.64 0.00

P066321 2001 MX. It BASIC HEALTH CARE PROJECT 350.00 0.00 0 o00 0.00 35.00 000 000

P066674 2001 GEF MX4ndigenous&Comminity Badlverslty 0.00 0.00 7,50 0.00 6.63 2.35 000

P071323 2001 Bank Restnzcuing Fadifty II 505.06 0.00 0.00 0.00 350.01 0.01 0o00

P057530 2000 RURAL DEV.MARGARII (APL) 55.00 0.00 0o00 0.00 38.92 4.09 000

P060718 2000 ALTERNATIVE ENERGY 0.00 0.00 8.90 0.00 7.06 7.09 0.00

P066938 2000 UX GENDER (UL) 3.07 0.00 0.00 0.00 3.07 1.74 0o00

P048505 1999 AGRICULTURALPRODUCT 44445 0 0.00 000 0.00 135.38 52.27 -23.28

P007T0O 1S99 FOVi RESTRUCTURING 505.50 0.00 000 0.00 31ZO0 312.0 000

P007711 1g98 MX RURAL DEV. MARGAREA (APL) 47.00 0.00 000 0.0o 28.77 23.1t 0.00

P007720 1998 MX: HEALTH SYSTEM REFORM -SAL 700.00 0.00 0.00 0.00 150.00 150.00 100.00

P044531 1S98 KNOWLEDGE & 1NIIOV. 300.00 0.00 0.00 0.00 19i37 B4.54 0.00

P055061 1998 MX: HEALTH SYSTEM REFORM TA 25.00 0.00 0.00 0.00 1.27 1.27 0.00

P049895 1998 MX: HIGHER ED. FINANCING 180.20 0.00 0.00 o.00 139.15 78.85 0.00

P007700 1997 COMMUNTTY FORESTRY 15.00 0.00 0o00 o.0 £.18 4.94 0.0O

P007713 1996 WATER RESOURCES MANA 1586.50 0.00 0.00 40.00 77.29 103.88 46.84

P007889 1996 MX BASICHEALTHII 310.00 0.00 0.00 0.00 18.95 18.95 18.95

P034490 1995 MX ECHN CALEOUCrrRAINNG 265.00 0.00 0.00 69.69 48.07 117.75 87.72

P007710 1994 N.8ORDERIENVIRONM 368.00 0.00 0.00 313.36 21.92 335.29 61.89

P007848 1993 MX MEDIUM CMES TRANSP 20o.00 0.00 0.00 65.50 39.08 104.58 8158

Total: 5366.83 o.0o 53.6i 488.55 2858.50 1457.74 374.17

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MEXICOSTATEMENT OF IFC's

Held and Disbursed PortfolioJan - 2002

In Millions US Dollars

Committed Disbursed

IFC IFC

FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic

1988191192V93195 Apasco 10.80 0.00 0.00 43.20 10.80 0.00 0.00 43.20

1998 Ayvi 8.57 0.00 0.00 0.00 8.57 0.00 0.00 0.00

1990/92/96 BANAMEX 75.71 0.00 0.00 5.49 75.71 0.00 0.00 5.49

o BBVA-Bancomer 86.47 0.00 0.00 0.00 86.47 0.00 0.00 0.00

1995/99 Baring MexFnd 0.00 2.73 0.00 0.00 0.00 1.90 0.00 0.00

1998 CMA Mexico 0.00 4.80 0.00 0.00 0.00 4.80 0.00 0.00

1998 CIMA Puebla 7.00 0.00 0.00 0.00 3.50 0.00 0.00 0.00

1994 CTAPV 2.88 0.00 1.69 0.00 2.88 0.00 1.69 0.00

0 Chiapas-Propalma 0.00 0.82 0.00 0.00 0.00 0.82 0.00 0.00

1997 Comercializadora 2A1 0.00 1.72 4.38 2.41 0.00 1.72 4.38

2001 Compartamos 1.00 0.66 0.00 0.00 1.00 0.66 0.00 0.00

1999 Corsa 11.14 3.00 0.00 0.00 11.14 3.00 0.00 0.00

2001 Ecomex 5.00 0.00 1.50 0.00 3.00 0.00 1.50 0.00

2000 Educacion 6.50 0.00 0.00 0.00 4.90 0.00 0.00 0.00

1997 Fondo Chiapas 0.00 4.18 0.00 0.00 0.00 0.54 0.00 0,00

1998 Foia Monterrey 12.07 3.00 0.00 12.07 12.07 3.00 0.00 12.07

1991/96 GIBSA 18.93 0.00 10.00 63.67 18.93 0.00 10.00 63.67

1993 GIDESA 2.50 0.00 0.00 0.00 2.50 0.00 0.00 0.00

1996/00 GIRSA 45.00 0.00 0.00 60.00 45.00 0.00 0.00 60.00

1993 GOTM 0.49 0.00 0.00 0.00 0.49 0.00 0.00 0.00

1997/98 Gen. Hipotecaria 0.00 1.20 0.00 0.00 0.00 1.20 0.00 0.00

0 Girupo BBVA 0.00 2.67 0.00 0.00 0.00 2.67 0.00 0.00

1998 Grupo Calidra 10.00 6.00 0.00 7.50 10.00 6.00 0.00 7.50

Grupo FEMSA 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

1989 Gnipo Minsa 12.00 10.00 0.00 18.00 12.00 10.00 0.00 18.00

1997 Gmrpo Posadas 25.00 0.00 10.00 0.00 25.00 0.00 10.00 0.00

1992193/95/96/99 Gnipo Sanfandila 8.09 0.00 0.00 3.61 6.76 0.00 0.00 2.95

1998 Heller Financial 0.00 0.32 0.00 0.00 0.00 0.32 0.00 0.00

1994f96/98100 Hospital ABC 30.00 0.00 0.00 14.00 1.76 0.00 0.00 1.24

2000 ITR 14.00 0.00 0.00 4.00 14.00 0.00 0.00 4.00

2000 Innopack 0.00 15.00 0.00 0.00 0.00 15.00 0.00 0.00

2000 lntemraniic 5.00 0.00 4.00 0.00 5.00 0.00 4.00 0.00

1994 InverCap 0.00 0.07 0.00 0.00 0.00 0.06 0.00 0.00

2000/01 Merida Ul 29.59 0.00 0.00 72.15 29.59 0.00 0.00 72.15

1998 Mexplus Puertos 0.00 1.41 0.00 0.00 0.00 1.41 0.00 0.00

1995/99 NEMAK 0.00 0.00 1.51 0.00 0.00 0.00 1.51 0.00

1996/99/00101 Pan American 0.00 9.00 0.00 0.00 0.00 9.00 0.00 0.00

2000 Rio Bravo 50.00 0.00 0.00 59.50 50.00 0.00 0.00 59.50

2000 Saltillo S.A. 35.00 0.00 0.00 43.00 35.00 0.00 0.00 43.00

2000 Servicios 10.50 1.90 0.00 10.00 10.50 1.90 0.00 10.00

2000 Su Casita 0.00 10.62 0.00 0.00 0.00 10.62 0.00 0.00

2001 Sudamerica 0.00 15.00 0.00 0.00 0.00 15.00 0.00 0.00

1999 TMA 2.58 0.00 2.60 8.95 2.58 0.00 2.60 8.95

1997 Toluca Toll Road 4.83 0.00 0.00 0.00 4.83 0.00 0.00 0.00

1992Total Portfolio: 533.06 117.68 33.02 429.52 496.39 102.67 33.02 416.10

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Approvals Pending Commitment

FY Approval Company Loan Equity Quasi Partic

1999 BANAMEX LRF 11 50.00 0.00 0.00 0.002001 BBVA-Bancomer CL 100.00 0.00 0.00 0.001998 Cima Hermosillo 7.00 0.00 0.00 0.002002 Coppel 30.00 0.00 0.00 0.002001 Ecomex 3.50 0.00 0.00 0.002000 Educacion 3.20 0.00 0.00 0.002001 GFNorte-CL 50.00 0.00 0.00 100.002001 Greenmanor 7.00 0.00 0.00 0.002001 La Colorada 4.30 6.00 0.00 18.302001 PanAme-La Colora 0.00 0.00 1.20 0.002002 Puertas Finas 13.00 0.00 0.00 0.002001 Su Casita 0.00 2.40 0.00 0.00

Total Pending Commitment: 268.00 8.40 1.20 118.30

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Annex 10: Country at a GlanceMEXICO: Savings and Credit Sector Strengthening and Rural Microfinance Capacity Building

' 'Litit Upper-POVERTY and SOCIAL Amrnilc' middiS-

M:l ico a Cirlb. Income Devalopment diamond-2000PopulatIon. mid-year (millions)f 98:0 ' 516 647 Life expectancyGNI per capita (Atlas method, USS) 6,070 3.680 4,620GNI (Atlas mtrnhod. USS billions) 497.0 1,895 2.986

Average annual trowth. 1994-00.

Population (I6) 11.$' 1.6 1.3LaborJorce (X ) 2.6 2.3 2.0 ONI Gross

per primaryMost recent estimate (lbatt year availaibl. 199440) capita enrolment

Poverty (X' o5population below natiorial poverty'llne) ..Urban population (X 1total poputation) 74 76 76Life, expectancy at birth (yarsJ) 72 70 69intant mortality.(per 1;000l ive bIbths) 29 30.. 28Child malnutrItion (56 of children under 5) 8 9 -9 Access to Improved water sourceAccess to jn Imprnved water source (% otpopustlotn) 8.0, 80 ". 85 87IillterIcy (5 of populatIn age 15+) -. . 9 -12 10Gross primary enrollment (X6of 'chool-ege populatIon) 114 It3 107 Uex/co

Male ' 116 .. 106 Upper-middle-income groupFemale . 113 105

KEY ECONOMIC RATIOS and LONG-TERM TRENDS :

1980 1980 '19998 2000'Ecenanemic rte

GDP (USMbillions) 223.5 262.7 479.4 '574.5Gross domestic,investmentIODP1 27.2 23.1 . 23.5 . 23.3Exports of goods and servIces/GDP 10.7 16.6 30, 9 TradeGross domettc sevingslG0P 24.9 22.0 ' 1;9 ' 21.5Gross national savingslGDP 22.4 20.3. 20.5- 20.1

Current accourit balance/GDP -4.7 '-.28 -'34.0 .1 Domestic Interest paymenbn/GDP ' - 2.0 ' 2.2 - - 21 _.: 2.0 ''4jIc -- Investment

- . ---~~~~~~~9i 5. savingsTotal debtWGDP : - 25.7 39.8 35.0 ' 26.9.Total debt servicelexponts 48.4 20,9 : 25.1 ' 32.7.Present value of'debttGDP : .'.. 33:9 .. 26.1 .Present value bt debttexports . . 102.6' '77.86

Indebtedness-1980-90 19910 1999 2'v000 2000044

(avervepsnnualgrdwth)GOP . ... 1 '3.8 .9 4.3 - MexicoGDP:pet capita . . -1.0 1.4. ' 2.3 8.4 2.'m'2i3-.Upper.mlddle-income groupExportsof'goodsandtaervice6s 7.0 4. ''12.4 1680 ' 5

STRUCTURE of the ECONOMY1900 1990 1999 2000 Growth of Investment and GDP (%)

(X of GDP) 40Agriculture 9.0 7.8 4.7 4.4 .Industry 33.6 28.4 28.8 28.4 20

Manufacturing 22.3 20.8 21.1 20.7Services 57.4 63.7 66.5 67.3 96 97 W go 00

Private consumption 68.1 69.6 67.1 67.5 o40General govemment consumption 10.0 8.4 10.9 11.0Imports of goods and servIces 13.0 19.7 32.4 33.2 - G O P

1980-90 1990-00 1999 2000 Growth of exports and Imports (5)(avrage annual growth) .Agriculture 0.8 1.8 2.0 2.1 45 Industry 1.1 3.8 4.2 6.6 ff 3J0.

Manufacturing 1.5 4.4 4.2 7.1 jIsServices 1.4 2.9 3.7 7.4 o '

Private consumptlon , 1.4 2.4 4.3 9.5 * 5 0 0 DO 05l 00General govemment consumption 2.4 1.8 3.9 3.5Gross domestic Investment -3.3 4.6 4.1 8.8 - Exports - lmportsImports of goods and services 1.0 12.3 13.8 21.4

Note: 2000 date 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 dlamond willbe Incomplete.

-59-

Mexico

PRICES and GOVERNMENT FINANCE1980 1990 199 2000 InnaUan

Domestc prices(96 change)Consumer prices .. 26.7 16.6 95 30Implicit GDP deflator 33.4 28.1 14.9 10.9 20.

Government flnance 10(% of GDP, hc/udes cunfent grants) oCurrent revenue 27.4 25.3 20.9 21.8 9S 96 Dr 98 9

Current budget balance 4.1 0.9 1.5 2.0 - GDP deflator CPiOvermll surplus/deflcit -3.6 -2.6 -1.1 -1.1

TRADE

(US$miions)1980 1990 1999 2000 lExport and Import levels (US$ mill.)

Total exports (fob) 16,284 40,711 136.391 166,455 00.000Oil 10.441 10,104 9.928 16,383Agriculture 1.528 2,162 3,926 4,217 150,000Manufactures 3,802 27,828 122,085 145,334

Total Imports (cif) 19,342 41,593 141,975 174,458 100000Consumer goods 2,448 5.099 12,175 16,691 50_000Intermediate goods 11,720 29,705 109,270 133,637Capital goods 5,174 6,790 20.530 24,130 o

Export prce index (1995=100) 134 99 98 106 4 95 gs 97 aS D9 ooImportpriceIndex(1995=100) 67 90 99 102 *Exports *ImportsTermsof trade (1995=100) 201 110 99 103

BALANCE of PAYMENTS

1980 1990 1999 2000 Current account balance to GOP ^%)(US$ mllions)

Exports of goods and services 22,600 48.732 148,083 180,167 oImports of goods and services 27,430 51.535 155,465 190,494 E I lResource balance -4,830 -2,803 -7,382 -10,326 -2.

Net income -6,438 4.626 -13,306 -14,747Net current transfers 833 3,978 6,313 6,994 4

Current account balance -10,434 -7,451 -14,375 -18.079 -

Financing items (net) 11.453 10,999 14,969 20,901Changes in net reserves -1,019 -3.548 -594 -2,822 .4

Memo:Reserves Induding gold (US$ millions) 3,052 9,909 31,829 33,595Conversion rate (DEC, local/US$) 2.00E-2 2.8 9.6 9.5

EXTERNAL DEBT and RESOURCE FLOWS1980 1990 1999 2000

(US$ millions) ComposItIon of 2000 debt (US$ mIll.)Total debt outstanding and disbursed 57,378 104,442 167,626 154,687

IBRD 2,063 11,030 11.027 11,444 A 11,444IDA 0 0 0 0 G: Z,744 D: 4.863

Total debt service 10,958 11.311 39.760 63,038 E:4.494IBRD 255 1,552 2.155 2,220IDA 0 0 0 0 /

Compositon of net resource flows _

Offidal grants 14 54 ..

OfficIal creditors 795 4.168 -1,708 -525 i 1

Private creditors -524 -582 13,181 -5,059 ....

Foreign direct Investment 2,156 2,549 11,915 13,286Portfolioequlty 0 563 3,901 478 F:111,142

Would Bank programCommitments 625 2,562 1,671 1.130 A - IBRD E -BilateralDisbursements 422 3,326 844 1,647 B -IDA D -Olier multilateral F- PrivatePrincipal repayments 89 801 1,323 1.330 C -IMF G -Sho^-termNet flows 333 2,525 -479 318Interest payments 166 751 832 890Net transfers 167 1,774 -1.311 -573

Development Economics 911012001

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Additional Annex 11: Social Development Model

MEXICO: Savings and Credit Sector Strengthening and Rural Microfinance Capacity Building

The Savings and Credit Sector Strengthening and Rural Microfinance Capacity Building project aims tostrengthen the savings and credit sector that serves lower income segments of the market, and to improveaccess of rurl comnmunities to sustainable financial services. The target population in component 2comprises population in marginal areas (as defined by CONAPO) in 13 states grouped in regions. Theproject will be implemented in six of the following eight regions: (i) Chiapas, (ii) Huasteca (marginal areasin the States of Hidalgo, San Luis Potosi and Veracruz), (iii) Oaxaca, (iv) Veracruz excluding the Huasteca(v) Guerrero (and adjacent marginal areas in the State of Morelos), (vi) Michoacan (and adjacent marginalareas in the State of Mexico), (vii) Puebla (and adjacent marginal areas in the State of Tlaxcala, and (viii)Sierra Gorda (marginal areas in the States of Queretaro and Guanajuato).

According to CONAPO data on rural marginal areas, a large proportion of the population in these areasincludes indigenous peoples of various ethnic groups (e.g., indigenous groups represent between 70 and 90percent of the population in Chiapas and Huasteca). This population is not only poor but has beensubjected to different types of social exclusion that have limited their opportunities to participate indevelopment projects. Therefore, in accordance with OD 4.20, Indigenous Peoples Development Plans(IPDPs) will be prepared for each region on the basis of a social analysis and a consultation process. TheseIPDPs include only those aspects relevant to the purpose and scope of the project. Their preparation willtake into account the following factors: (i) there is no expected negative impact, on the contrary the projectwill offer alternatives to access sustainable SCI services under culturally suitable conditions; (ii) the projectwill be implemented under a demand-driven approach hence it is not possible to define up-front specificbenefits; (iii) the project provides technical assistance, therefore many of the traditional sections of IPDPsare not relevant. It is in this context that the following matrix has been prepared to guide preparation ofIPDPs.

Item RelevanceLegal Framework Indigenous peoples rights are protected under the Mexican Constitution and specifically

detailed in the Indigenous Peoples Law. Mexico has signed the ILO 169 Agreement.Baseline Data Relevant information about socioeconomic conditions and cultural background are

_incorporated in the social analysis section.Land Tenure The legal framework protects indigenous peoples land tenure rights. The project does not

involve land tenure.Participation The social strategy would propose alternatives to address social issues that can hinder

indigenous peoples' participation and will design mechanisms to promote participation.However, participation is an option under the project's demand-driven approach.

Mitigation o negative impacts are foreseen.Institutional Capacity Bidding documents for technical assistance consultants will include expertise in dealing

with diverse ethnic groups.Schedule IPDPs will be prepared for each region as scheduled in the project implementation plan.Monitoring and Outcome reports will include a section on indigenous peoples participation in the project.Evaluation Mdterm evaluation will identify deficiencies and will propose remedies accordingly.

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Upon this basis, simplified IPDPs will be prepared for each region included in the project over a three yeartime period as each region comes into implementation, rather than preparing all IPDPs prior to projectappraisal. This timeframe is more strategic, because it allows for use of up-to-date information in eachIPDP and avoids raising expectations before actual implementation. In accordance with the projectimplementation schedule, IPDPs have been prepared for the two regions where implementation will begin inthe first year of the project: Chiapas and Huasteca (see Attachment A). Terms of reference for the carryingout of IPDPs are available in the project files.

The IPDPs will be part of several steps integrated in a Social Development Model intended to benefit notonly indigenous population but also other vulnerable groups, such as women and the generally poorer ruralpopulations in the marginal areas of the above-mentioned regions. The project's Social Development Modelincorporates changes made to the methodology and content of the IPDPs, based on the lessons leamed incarrying out the analyses and consultations in Chiapas and the Huastecas.

Social Development Model

The specific objectives of the Social Development Model include the following: (a) To identifymechanisms to ensure that indigenous populations can benefit from the project taking, into account itsdemand-driven approach; (b) To identify opportunities and overcome obstacles for the poorer andvulnerable population segments in marginal rural areas to participate in the project; and (c) To guide theefforts of the consultants providing technical assistance for the Expanding Financial Services in RuralAreas component.

The Social Development Model comprises the following steps:

1. Simplified IPDPs. The simplified IPDPs will include the following:

(a) Social analysis, including: (i) Regional Overview, pointing out the importance of the project in theregion and an overview of its main features; (ii) Socioeconomic and cultural analysis, comprisinganalysis of basic demographic data, indigenous population, poverty conditions, productive activities, andsocial organizations; (iii) Ethnographic characterization, comprising an analysis of main ethnic groups inthe region, their organizations, traditions and cultural perspectives.

(b) Recommendations from the Consultation process.

2. Consultation process

Consultations will be carried out for all regions in the project using the workshop format, materialprepared, and lessons learned from the experiences in Chiapas and Huasteca The purpose of this exerciseis to identify potential beneficiaries' perspectives on savings, credit, and technical assistance, as well astheir perspectives on the mechanisms (previously) identified to enable their participation. The potentialbeneficiaries will also be asked for their suggestions as to how materials and targeting mechanisms mightbe made more effective in achieving their participation in the project.

3. Schedule

The timetable for preparing simplified IPDPs and consultations will be linked to the project implementationschedule for each region.

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4. Technical Assistance Selection

The TOR for the international technical assistance providers contracted under Component 2 of this projectwill include: (a) a requirement to have and/or incorporate staff who have experience working withindigenous peoples; and, (b) an annex with the Social Analysis, simplified IPDPs, and results of theconsultations held in each region. The consultant will use these inputs to present proposals and guideinterventions in the regions.

5. Action Plan and Annual Reports

Using the results of the Social Analysis, simplified IPDPs, and consultations, the technical assistanceprovider will prepare an action plan to implement the recommendations that emerged and to promoteindigenous participation. Actions plans will comprise activities such as: (a) a communication campaign tomake the rural population aware of the project and encourage participation; (b) an outreach strategy to linkpoor communities to SCI services: and (c) identification of and support for community-based savingsefforts.

The annual reports of the technical assistance provider will inform on progress in executing these actionplans and report on how indigenous peoples are benefiting from the project

6. Budget

The project will provide resources for preparation of Social Analyses, IPDPs, and consultation workshopsand carry out a mid-term review workshop to exchange experiences among regions.

7. Institutional Arrangements

The Technical Unit will in be in charge of the above activities and their supervision. The World Bank willreview and clear the TORs, consultant CVs, and the results of the IPDPs and workshops. SAGARPA willestablish armangements to ensure that INI provides its views regarding the implementation of component 2of the project throughout implementation. At present, INMs views are provided within the framework of thePATMIR technical committee, of which INI is a member.

8. Monitoring and Evaluation

The evaluation system will incorporate as an indicator the percentage of indigenous peoples benefiting fromthe project in each region. This percentage will be estimated using the baseline population data collected inthe Social Analysis and consultation processes. The social impact evaluation, to be designed duringimplementation, will incorporate a section on the impacts of the project on indigenous communities and/ororganizations.

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Attachment A. Summary of IPDPs in Chiapas and the Huasteca (Complete IPDP reports are in theproject ifies)

Though there are regional differences in the results from the Chiapas and Huasteca lPDPs, somecommonalities have been identified and incorporated into the design of the project's Social DevelopmentModel and into the recommendations to guide the efforts of the technical assistance provider in theseregions. These common observations are as follows:

1. There is a great interest among indigenous, and poor communities in general, in developingalternatives to access a variety of financial services and promote savings efforts. A number oforganizations have been working on such activities for many years with mixed results, thus technicalassistance is much needed and welcome.

2. All organizations consulted agreed on the value of sustainable and secure financial services. Therewas a consensus on the need for clearer rules and enforcement of regulations to govern financialintermediaries, even if the cost of supervision translates into higher interest rates.

3. Cultural factors have great influence on decisions about the use of financial resources in generaland savings in particular; many savings and credit organizations have developed on the basis of trust andsolidarity. Community activities, in addition to individual needs, are the driving force behind these efforts.However, in some areas, organizational efforts must take into account the conflicts that exist betweendifferent groups, which may have deep historical roots or be caused by recent demographic and politicalevents.

4. , Savings capacity and credit requirements are typically seasonal because they are usually linked toagricultural activities and/or temporary jobs. Designing financial products linked to communities'productive cycles is likely increase credit recovery and savings rates. The interest in expanding productiveactivities, particularly to improve commercialization, as well as investing in children's education andimproving family conditions, were mentioned as the main reasons for saving and accessing other financialservices.

5. Women usually play an important role in family savings and credit activities, but their capacity toborrow and save is likely to vary considerably according to economic conditions and social norms in theircommunities. Women's involvement in productive activities oftentimes generates goods used for exchangeor own-consumption, rather than cash income, for example. The degree to which women are responsible formanaging the cash resources which are ultimately produced by their individual activities, if any, or theactivities of their productive organizations, community groups (such as religious or civic groups), or oftheir families, will vary among communities and ethnic groups. Savings and credit organizations must takethese particular social and economic structures into account when designing programs to target women asclients.

6. Govermment programs have proved inefficient either because have operated under temporarypolitical waves and then disappeared, or their temporary effects have not been sustainable. In general thereis mistrust towards government programs and govemment institutions, particularly among indigenousorganizations.

7. Communities' incentives to save may be linked to their incentives to develop productiveinfrastructure and commercialization processes, which are among their main concerns.

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(a) Huasteca IPDP Summary

The Huasteca region hosts a great variety of productive activities as well as a ethnic and cultural diversity;and modem and traditional ideas and methods often coexist with little conflict or difficulty. Despite its richnatural resource base, around 85% of the municipalities in the Huasteca region are defined as having highor very high marginality; 53% of the population is indigenous and, in the case of Hidalgo, the portion ofindigenous population reaches 72%. Women are the heads of 15% of the households due to widespreadmale migration.

There are two main ethnic groups in the Huasteca: maya-totonaca, comprising huastecos, pames, tepehuasand totonacas; and nahuas, comprising four different types of families, each having its own traditions,cultural expressions and language. Family ties are strong as are social or political alliances. There areofficial and traditional authorities in the Huasteca, though the latter have been losing influence beyondreligious and social activities. Land ownership is communal and community services are mandatory amongall groups; solidarity and reciprocity nrle most relations. However, new religious and social influences aswell as migration patterns have negatively affected this balance. Still, the general assembly is the supremeauthority deciding upon the use of resources, including access to community funds, which exists in manycommunities, to be used in case of urgent group or family need. Savings and credit functions are imbeddedwithin traditions: prestigious community leaders (mayordomias) are responsible for financing civic andreligious celebrations; religious traditions involve the savings and transfer of funds (through the saintsaving box or wedding endowments, for example). Many communities also have access to remittances frommigrants to the United States.

There is a variety of local organizations that have been playing an important role in promoting land rights,productive activities and credit and savings organizations. Though the govemment has promoted many ofthese organizations, there are also independent organizations that are mostly concerned with productiveactivities or the organization of women's groups, for example. These groups, particularly in San LuisPotosi, are well organized, have experience in managing productive projects, and are generally eager to getinfornation and training.

(b) Chiapas IPDP Summary

Chiapas, one of the largest states in the country, has a variety of natural resources, a diversity of economicactivities, and a rich cultural background. The population of Chiapas comprises several ethnic groups,European and Asian descendants and, more recently, Mayan migrants from Guatemala. According to theCONAPO classification, 20.6% of the population is indigenous. Most of the population, 92.3%, livesunder the poverty level.

The 67 municipalities included in PATMIR are those with the highest poverty as measured by marginalityconditions, including lack of basic services, illiteracy, and poor health services, among other indicators. Inthese municipalities, 83% of the population earns less than two minimum salaries; most of them areengaged in agricultural activities of low productivity. Indigenous populations in these municipalitiesrepresent between 35 and 80%/c of the total; counting only the monolingual population. If the indigenouswho also speak Spanish are included, the portion of indigenous peoples would be higher still. The largestgroups are tsetzal, tzotzil, cho'l, zoque and tojolobal.

In the last thirty years, several indigenous movements have helped to integrate a shared indigenousperspective and to develop stronger organizations. Tzeltal has become a lingua franca in much of the state,

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almost as common as Spanish, and many Chiapanecos speak a variety of indigenous languages. Thecommunal assembly is the highest authority in the community, though there are other traditionalauthorities, closely associated with religious practices, who maintain social cohesion and, in some cases,display little tolerance for alien practices that are perceived as a menace. A communal work ethic andstrong family ties are common to all groups. Women do not have access to land ownership and are totallydependent on male fmiily members.

Among indigenous groups, savings are closely connected to religious activities, wedding and communityactivities. Among Protestants, contributions are paid to the church. Temporary jobs, such as working onfarms in other regions of the state, have become an important source of savings for many families. Earningsfrom intrastate migrants are a more common source of income than remittances from those who havemigrated to the USA.

There have been several attempts to develop alternative financial services linked to poverty alleviationprograms in Chiapas, the most recent and extensive of which is the promotion of the Fondos Regionales deSolidaridad, established in the 1990's as revolving funds to finance sustainable productive activities. Theseactivities were managed directly by indigenous groups and helped to developed a new awareness about theuse of financial resources. From the 98 such funds created, a dozen have been successful in terms ofsustainability and enhancing indigenous peoples organizations.

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Additional Annex 12: Legal and Regulatory Framework and SCI Supervision

MEXICO: Savings and Credit Sector Strengthening and Rural Microfinance Capacity Building

The effective implementation of the Ley de Ahorro y Credito Popular is closely correlated with theoutcomes the project intends to obtain. A "weak regulatory infrastructure and supervisory mechanism forSCIs" has been highlighted as a "Substantial Risk" in the PAD, and the subject has been a matter ofpriority in project preparation.

The new legislation regulating the SCI sector was approved by the Mexican congress in 2001, andrepresents a departure from past policies. A number of risks associated with the new legislation werediscussed with the authorities during project preparation and steps were taken to mitigate these risksand/or establish monitoring and early waning devices. Major concems were the transparency andadequacy of entry and exit procedures, conflicts of interest and regulatory capture in the auxiliarysupervision mechanisms, incentives and delimitation of responsibilities between CNBV and the federationsand confederations, adverse selection issues, and capacities and roles of CNBV and BANSEFI.

During the project preparation period, the team observed the clear assertion of supervisory responsibilitiesby CNBV, its highly professional handling of the definition of entry, exit and supervisory standards, astrong commnitment of BANSEFI to its developmental role, and the constructively critical participation ofthe sector. These observations allow the reasonable expectation that appropriate safeguards are beingestablished, and that the authorities are prepared to react quickly to unforeseen developments that maythreaten the stability and growth of the sector. Project preparation included supporting the provision ofexpert advice to CNBV, and a project component has been included to continue providing such supportduring implementation.

During project implementation, the matrix included below will serve as a tracking device for progress andresolution of issues and mnitigation of risks associated with law implementation as part of regular Banksupervision. The matrix specifies all risks and issues raised at the time of the PCD review and alreadyreflects the resolution of, or progress made towards solving, the questions initially set forth. In addition, aspecific sub-component in Monitoring and Evaluation has been included that specifies the nature andfrequency of monitoring for this aspect of the project, as well as the indicators monitoring will encompass(see Annex 15). Finally, an in-depth assessment of quality of SCI supervision will be part of the project'smid-term review.

Mexico. Savings and Credit Law Issues - Update on March 30. 2002 (*)Issues/risks How addressed and pending Resolution/ Critical dates/

questions as of Progress by Next stepsNovember 4, 2001 March 30, 2002

Enty, screening, and exitThe initial classification of savings A team of high-level specialists Expert team led by CNBV Final report by expertand credit institutions (SCls) is a will establish standards and and comprised by team to be assembled atcrucial step. Both the authorities at methods for the initial international specialists a workshop April 4-5,the highest levels and the Bank need categorization of SCIs. working since February 28, 2002.to be satisfied that this process is Assessments and categorization of 2002. "Guia de Autorizaci6nadequately performed. individual SCIs using these Draft consolidated proposal " (screening, entry andAdequacy of exit (liquidation or standards and methods will be by expert group prepared exit guidelines) to beresolution) fuamework is not clear. contracted out to international and under review at CNBV. issued by CNBV

firmns (see project activities and shortly thereafter.SC law matrix)

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Pending questions alo 4/11/01:Composition of expert team.Resolution mechanisms and costs.

Conflicts of interest and regulatorycapture The law gives CNBV strong Strong leadership of CNBV Completion of issuanceThe law establishes that Federations monitoring and enforcement established, with active of regulations, end ofof SCIs will exercise "auxiliary powers over Federations (Art. 47). sector (practitioners) April 2002.supervision", as mandated by CNBV currently exercising veto participation.CNBV, through their respective powers on composition of Guidance on govemanceSupervision Committees (Art. 3). Supervision Committees to ensure issues and risk mitigationConflicts of interest may arise professionalism. at SCI and Federationsbecause the SCIs collectively own CNBV and BANSEFI discussing (and Confederations)and control their Federations which with practitioners the placement provided by CNBV expertthus become "juez y parte" in the of Supervision Committees and " group.supervisory process. Fondos de Protecci6n" above the Enhanced role ofThe governance structure put in Federation level (at Confederation Confederation in auxiliaryplace by the law seemingly ensures level). supervision, in advanced"regulatory capture" at the Pending quesdons alo 4/11/01: stage of discussion withFederation and Confederation level. Could CNBV have a strong direct COMACREP, would

presence at Supervision mitigate conflicts of interestCommittees at least in the first at federation level.few years of law implementation? Independence ofDegree of autonomy of Supervision CommitteesSupervision Committees to established in the Law,prevent regulatory capture. with veto powers for CNBV

on removal of Committeemembers.

Incendvesfor CNBV andFederadonsThe bank-regulation activities of CNBV clearly established by the Roles of CNBV vis a vis No critical stepslender of last resort, deposit law as primary and ultimate the SCIs and the pending.insurance and supervision are regulator and supervisory Federations wellinterrelated and require authority. established.coordination. The incentives faced Pending questions a/o 4/11/01: CNBV clearly notby the agencies in charge of these Clarify and confirm CNBV role relinquishing authority tothree activities might lead to and authority vis d vis the SCIs any other entity. Its "Guiaconflicts and incompatible and the Federations. de Autorizaci6n" will guideobjectives. The proposed Is CNBV relinquishing its diagnostic, classificationsupervisory structure does not authority by outsourcing the and rehabilitation of SCIs,resolve the question of asymmetric diagnostic and resolution of outsourced throughinformation between regulators. existing SCIs to BANSEFI and BANSEFI to internationalClients, managers and different the supervision to the consulting firmssupervisory layers will have Federations? (component in WB project).different informational advantagesand it is not clear that thefederations have the incentive (inspite of tougher criminal sanctions)to share information on its affiliateswith the CNBV.Scope of activides of Federadonsand ConfederadonsComparative advantages of Most major Federations already Liquidity provision by Completion of issuanceFederations in the provision of exist and provide services to their federations and of regulations, end of

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services (versus other providers) is affiliates before having any confederations to member April 2002.not clear. Risk of having captive auxiliary supervisory role. SCIs limited and regulated.markets, forcing CNBV to Pending questions alo 4/11/01:determine prices for Federation Liquidity provision (lender of lastservices. Provision of liquidity by resort function) by ConfederationsConfederations is risky givenimperfect information aboutaffiliates, and given its role asdeposit insurer.Adverse selecdonVoluntary affiliation of SCIs into This is likely to occur, e.g., Cajas Establishing the Fondo de On going.Federations would allow, a priori, Solidarias. But the law allows for Protecci6n as a generalthat stronger SCIs group together small scale and less-developed fund for the entire systemand exclude weaker ones. The latter institutions to operate (nivel de as opposed to separatewould then form Federations "of the operaciones 1), subject to less funds managed by theweak" which may create foci of stringent conditions than larger Federations in advancedinstability in the system. and more complex institutions. It stage of development with

does not allow for unviable COMACREP.institutions to be licensed. Theproblem of "lax Federations" is adifferent issue, addressed throughprofessionalizing SupervisionCommissions, and through amodem off-site supervisioninfrastructure that the project willhelp create.Pending questons alo 4/11/01:Establishing the Fondo deProtecci6n as a general fund forthe entire system as opposed toseparate funds managed by theFederations would help reduceadverse selection. Is this anoption?

Regulatory arbitrageThe recognition of four different " The fact that CNBV issues the Relevant regulation criteria Completion of issuanceniveles de operaci6n" subject to rules and regulations for all levels to assign SCIs to the four " of regulations, end ofdifferent standards may give way to of SCIs and for the banking niveles de operaci6n" in April 2002.regulatory arbitrage, especially in system provides some assurance final stage of issuance atthe case of level IV SCIs with that regulatory arbitrage will be CNBV, after extensiveauthorized activities similar to those avoided. dialogue with sector.of banks. It is anticipated that no SCI will Regulatory thresholds andA related issue refers to the specific be granted level IV of operations standards preventingcase of the Sociedades Financieras until several years after the law is arbitrage, as well asPopulares which, in principle, could in effect, as a way of ensuring that provision not to grant levelcollect deposits from the general distinctions between level IV and IV category to any SCI atpublic while being controlled by a banks are clearly established. the outset, clearly stated insmall number of individuals. They draft regulation.could constitute their own Pending quesdons a/o 4/11/01: Substantial and clearFederations and their owners exact Regulatory thresholds and differences between levelrents through related lending, standards truly preventing IV authorized activities and

arbitrage. those of banks (derivatives,Effectiveness of oversight (on and forex operations, payments

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off-site) for all Federations system, investmentbanking).

Capacity and commitment of theregulator/supervisorCentral to a successful CNBV has already created and Staff training on-going. Unit already created.implementation of the new law is staffed (25 people and expected to Interaction with specialists On-going staffing andCNBV's capacity to exercise its new grow) a Direcci6n General, under form USA, Canada and training.functions, and especially to detect the VP for Supervision 3, Germany in CNBV expert Support to CNBV forflaws and irregularities in the exclusively devoted to the group on-going. specialized advice andperformance of auxiliary functions supervision of SCIs. It includes training included inby the Federations. inspectors already familiar with WB project.Aside from capacity, a clear SCIs (from SAP inspection) andcommitment to expeditiously is gathering expertise in the areaimpose sanctions and take legal through basic training, study toursaction when needed is required. and workshops with specialists

from Canada, Europe and LatinAmerica.Pending quesdons alo 4/11/01:Test effectiveness of CNBVpreparedness.

Roles of BANSEFIThe law that transforms PAHNAL BANSEFI's institutional Second-tier lending No critical stepsinto BANSEFI assigns the latter a transformation does not envisage function not to be exercised pending.number of roles as a "central bank" exercising a second-tier lending by BANSEFI.of the SCI sector, including that of a function. It focuses instead onsecond-tier lender. This role would providing the sector with servicesinvolve risk-taking by BANSEFI, such as MIS, clearing house,which is considered undesirable and transfers and others with the helppotentially distortionary of its other of a modem technologicaldevelopmental roles. platform that will also feed into

the off-site supervision system.Pending questions alo 4/11/01:Assurance of no second-tierlending.

(*) Responsible agencies/officials:* CNBV: Dr. Jonathan Davis, President; Lic.Pablo Escalante, VP for Supervision; C.P. Luis FelipeMariscal, DG for SCI Supervision.* BANSEFI: Lic. Javier Gavito, DG.

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Additional Annex 13: Savings and Credit Sector Information SystemsMEXICO: Savings and Credit Sector Strengthening and Rural Microfinance Capacity Building

Background and Context

In November 2001 PAHNAL was transformed into BANSEFI with three objectives:* To continue the role of PAHNAL of promoting a savings culture throughout Mexico;* To become A "banker's bank" to all Popular Banking Institutions (mostly savings and creditinstitutions of varying sizes)* To coordinate the support offered by the Federal Government to the sector, including thedevelopment and management of an integrated technological infrastructure which will enable the SCI sectorto provide necessary services in a structured and cost effective manner.

The envisaged information systems component will support BANSEFI in its mission to provide a range ofsafe, secure and affordable operational, control and reporting services to approved institutions offeringbasic savings and credit services to low income customers throughout Mexico. The availability of suchservices on a centralized communal basis will reduce the need for individual institutions which do not havesuch systems to incur in the costs of associated system development. It will thus increase efficiency andreduce investment and operating costs and allow the grass roots institutions to focus on providing soughtafter operational services at optimum cost while satisfying the essential management control and prudentialreporting requirements mandated by the new legislation.. BANSEFI discussions with sector institutionsindicate that most institutions will link up to the system which will be an effective way of providing ofmeeting requirements for regulatory and economic reporting to Government. The larger institutions havetheir operations and management information systems. However, smaller institutions will use thecommunal system which is the most cost-effective way of modernizing their systems. The operational costsof the system will be paid by the users.

BANSEFI launched a technical diagnostic study to assist in developing a conceptual design of the requiredtechnical architecture and prepare a feasibility analysis. Outputs from this study and their implications forthe implementation of this component are discussed below.

Technical Architecture

A Discussion Document-outlining the provisional results of the diagnostic study is available and contains adescription of the envisaged Technical Architecture. This document is comprehensive and describes theoverall system architecture from an organizational and a technical perspective. It contains quite detaileddescriptions of all critical data communications, computer processing, data management and applicationsystems perspectives. The presentation style adopted conforms to industry best practice and willcommunicate BANSEFI requirements in a clear and non-ambiguous manner to suitably experienced andqualified system architects.

The overall technical architecture is soundly based and is suitable for its intended use from an operationaland performance perspective. In particular, the critical data communication performance requirements havebeen assessed and have been taken into account in sizing the capacity of the telecommunications andprocessing requirements. Care has also been taken in conceptualizing the data base managementrequirements and the essential efficient linkages of the required large volume databases with the envisagedcommon application systems. The conceptual design also caters for high volume and low volumeintermediaries from a system access viewpoint. It is also evident that careful thought has also been given to

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the need for the system to support application systems that are yet to be conceived and thus modularexpandability and future flexibility requirements have been recognized. Finally, it is noteworthy that theconceptual design makes appropriate use of rapidly expanding internet based and appropriately secureaccess to the envisaged services.

The initial range of common applications are appropriate and cover basic banking systems (savings,remittance and loans), accounting systems, risk management and risk evaluation systems, treasurymanagement, physical cash management, and comprehensive reporting systems. In summary, the envisagedintegrated system will provide the essential computer support to intermediaries covering basic front andback office banking activities as well as management information & reporting systems and decision supportsystems.

The architecture also recognizes the need for appropriate levels of logical and physical security to protectthe system from external interference and assure the integrity of the data residing within and processed bythe system. The envisaged security regime is sound and appropriate. The envisaged data processingarchitecture to be housed in the Central data Center is appropriate and makes use of high quality devicesfrom reliable manufacturers and proven technology (NT/XP and UNIX platforms).

In its design, BANSEFI is analyzing the specific support to be made available to intermediaries to enablethem both to access the new centrally provided services and to use them effectively. This support is likelyto include both equipment (terminal access devices) and business training and is critical to the delivery ofthe sought after benefits.

The system architecture proposed is sound and appropriate. By its very nature, the system is complex. Forthis reason, BANSEFI intends to recruit a specialized firm to assist in supervising the development andimplementation of the system.

A Two-phased Approach

The cost estimates resulting from the initial consulting feasibility study are substantially greater than thoseused in developing the preliminary cost profile for the technology and application software elements of theoverall BANSEFI initiative. As the project cost ceiling had already been approved at the time the estimateswere available, it is now necessary to adopt a two phased approach to the acquisition and implementationof the technology and application systems component. Adopting a phased approach will also have benefitsin that overall project risk can be better managed and emphasis can be placed on delivering the targetedbusiness benefits at optimum cost to both BANSEFI and approved user institutions.

The BANSEFI initiative can be sub-divided quite logically into two discrete clusters of activitiescomprising: (a) the development, testing and pilot implementation of the primary data communications,data processing infrastructure and core application systems; and (b) the national roll-out of the coresystems to all approved institutions and the development, testing and implementation of the remainingnon-core application systems.

An essential feature of the Phase I work program will be the inclusion of a formal Pilot Implementationstep during which the core application systems will be installed in a small but representative sample ofapproved user institutions. Initial implementation experience - both operation and support - will beevaluated during a minimum period of two calendar months using a formal post implementation reviewprocess and a pre-determined set of pilot phase technical and business objectives.

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The post implementation review will assess the success of the Phase I activities in a quantitative andqualitative manner. A critical additional feature of the post implementation review will be the preparationof a Phase II project plan, timing and estimated costs that will be incurred in the structured national roll-outof the core systems as well as the development, testing and implementation of the non-core applicationsystems. Non core application systems should be carefully evaluated and justified prior to inclusion in thePhase II work program.

Phase I Planning, assumptions and cridcal Issues

The Phase I software, hardware and consultant requirements are well described in the BANSEFITechnological Strategy Presentation and cover the essential elemnents required to acquire and establish thecentral BANSEFI Data Center and the core application software systems.

The justifications for the BANSEFI initiative would be strengthened from the development of a formalstatement of sought after benefits. The availability of a benefits statement would also provide a basis forfocused project management as suggestions for enhancements can be evaluated primarily on theircontribution to the realization of the sought after benefits. Proposals that do not directly contribute to thedelivery of tangible benefits should be rejected or deferred.

Phase I Cost estimates have been prepared by BANSEFI and amount to about US$20 rnillion includingcontingencies. There are no reasons for not accepting these estimates as a basis for project planning. Itshould also be noted that a rigorous IT Systems procurement approach will be initiated using either a singlestage or two stage methodology depending upon the degree of certainty with which the technicalrequirements can be specified.

All complex computer based initiatives such as that envisaged require three independent but integratedarchitectures: (a) the data communications architecture used to transmit data between participants; (b) thecomputer processing architecture and the equipment used by the application systems; and (c) theapplication systems themselves. The BANSEFI work program assumes that data communication servicescan be acquired from a suitably qualified commercial service provider. This is a critical assumption andshould be verified in a formal manner as the availability of high quality data communication services at anaffordable cost are essential. BANSEFI has confirmed that interest and adequate capacity to provide therequired services exist among qualified commercial firms.

As a minimum the direct operating costs of the Phase I application systems should be recovered via acarefully designed cost recovery and pricing policy. BANSEFI has prepared a provisional cost recoveryand pricing strategy based on a suitable schedule of item processing / transaction fees. Coupled with arealistic forecast of transaction volumes this will provide a basis for calculating a break-even point as wellas the need for temporary or permanent subsidies.

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Additional Annex 14: Indicators and Projections for Savings and Credit Institutions inMarginal Areas

MEXICO: Savings and Credit Sector Strengthening and Rural Microfinance Capacity Building

The indicators for outreach and sustainability of savings and credit institutions in rural areas have beendetermined on the basis of projections based on information from a review of the principal characteristicsof the marginal regions to be supported under the project. The projections are based on conservativeassumptions of the performance of similar institutions in Mexico and elsewhere. Outreach andperformance indicators will be incorporated in the contracts with the international consultants which will becharged with catrying out the technical assistance program in the marginal regions. Definitions andassumptions are summarized below.

* The years in the projections for each region reflect the time when activities will be initiated in eachregion.

* New SCIs are either new institutions or branches of existing ones. A new SCI is counted when it hasat least 200 members, the capital is fully paid, and all CNBV requirements for its creation as abranch or as a new institution have been met.

* The target population is the population which lives in the marginal areas (level of marginality 3,4,5as defined by the Mexican Population Council -CONAPO

* Target households are the target population mentioned above divided by the average number ofpersons per family in the concerned region.

* Outstanding savings and credit are average amounts over the period under review and not those at theend of the period.

* Loan repayment rates are relative to the average annual outstanding loan portfolio.

* Extemal funds are funds that do not come from the savings of SCI members.

* The outreach objective is focused on membership, while the number of SCIs can vary.

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Projections for SCIs In Marginal Areas - AssumptionsSCIsMembers Year 1 200Members year 5 1 152 pesosAverage savings year 1Lending to deposit ratio 1 000 pesosLiquid assets (% of total deposits)

50% - 70% over 5 years

15%Average Credit Year 1 3 000 pesosAverage Credit Year 5 3 647 pesosAverage length of credit 6 monthExtemal financing (% of savings) 5% - 10% of years 3 - 5Interest Rate (% annual)

Lending 55%Deposit 4%on investments 8%on borrowings (for lending) 5%

Arrears (%of outstanding balances) 5%Payments to federation (annual % of 7%deposits)Social Capital 250Buildings (construction) 30 000Equipment and materials 47 000Fumishings 30 000Subsidies for Equipment, Materials, etc 100%Staff 2 if > 1 500 membersAverage monthly salary 12 000 pesosSubsidies on salaries (direct transfers)

Year 1: 70%; Year 2: 50%; Year 3: 30%

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All regions at year 5 of Evotiet6of Outfieach andt Performgance Indicatorseach

Total Chiapas Huasteca Oaxaca Veracruz Michoacan Guerrero Puebla Sierra(With*out GordaSierra ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~edGorda)Ou^tr,each i1ndIcaterse1

Number of new branches 189 30 23 24 36 20 20 36 36ExistingSCis 8 3 5 0 0 0 0 0 0New SCIs 181 27 18 24 36 20 20 36 36

Number of members 129 592 16 488 16 560 17 360 25 544 14 048 14 048 25 544 25 544Of which percent of women 50% 50% 50% 50% 50% 50% 50% 50% 50%Number of members/SCIs 686 550 720 -723 710 702 702 710 710Coverage: target families 2.9% 1.8% 3.5% 2.9% 3.4% 2.4% 3.2% 3.4% 3.5%

Performance Indicators

Totalsavings(000-pesos)151963 18463 19 590 20 501 30 138 16 567 16 567 30 138 30 138Average saving/member 1 173 1 120 1 183 1 181 1 180 1 179 1 179 1 180 1 180Savings in Savings groups 4 726 601 604 633 931 512 512 931 931

Total outstanding loan92757 11 014 12079 12567 18439 10110- 10110 18439 18439portfolio ( 000 pesos)From memberssharesand 85253 10232 11071 11527 16934 9278 9278 16934 16934savingsFrom extemal source 7 504 782 1 007 1 040 1 506 832 832 1 506 1 506Number of loans 27 408 3 256 3 568 3 713 5 449 2 987 2 987 5 449 5 449Average credit 3 384 3 383 3 385 3 385 3 384 3 384 3 384 3 384 3 384

Number of SCis Staff 189 30 23 24 36 20 20 36 36Number of members/staff 686 550 720 723 710 702 702 710 710

Profit (loss) at SCis 2 938 23 730 463 152 483 180 640 730 343 259 343 259 640 730 640 730040

Average profit (oss)/SCls 15 545 791 20 137 20 133 17 798 17 163 17 163 17 798 17 798

Financial Ratios MeansOperational self-sufficiency 94.4% 82.8% 97.4% 97.3% 96.1% 95.4% 95.4% 96.1% 96.1%(excludes direct subsidies toSCI's )Capitalization rate 22.3% 24.7% 22.1% 21.8% 21.9% 21.9% 21.9% 21.9% 21.9%Outstanding loan/savings 61.0% 59.7% 61.7% 61.3% 61.2% 61.0% 61.0% 61.2% 61.2%Surplus/Assets 1.4% 0.1% 1.8% 1.8% 1.6% 1.5% 1.5% 1.6% 1.6%Surplus/Equity 6.4% 0.4% 7.9% 8.1% 7.2% 7.0% 7.0% 7.2% 7.2%Surplus/outstanding loans 3.1% 0.2% 3.8% 3.8% 3.5% 3.4% 3.4% 3.5% 3.5%

Direct annual transfer to12 670 2642 1 385 1 431 2295 1 311 1 311 2295 2295SCIs ('000'pesos)Direct annual transfer to $1 408 $294 $153 925 $159 017 $254 948 $145 685 $145 685 $254948 $254SCis (000 US$) 948Total direct transfer (000'$6 103 $875 $759 $795 $1 182 $655 $655 $1 182 $1 182US$)Total direct transfer/SCls $32 289 $29 154 $32 996 $33 138 $32 839 $32 736 $32 736 $32 839 $32 839(US$)

1US$ = 9 Desos

Total Populagon marginal 21 830 4 426 2 292 2884 3630 2 805 2 161 3631 3 573areas(thousands)

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'A' r.elbns at year 10 of each E 'indleatorsTotal Chiapas Huasteca Oaxaca Veracruz Michoacan Guerrero Puebla Sierra(Without GordaGorda)

v0Za,~ ~ t'Ou'trea'ch In'ldic,at'ors ,,...Number of new branches 189 30 23 24 38 20 20 36 36

Number of members 310 784 45 973 44151 39 130 58 401 32 364 32 364 58 401 58 401Of which percent of women 50% 50% 50% 50% 50% 50% 50% 50% 50%Number of members/SCIs 1 644 1 532 1 920 1 630 1 622 1 618 1 618 1 622 1 622Coverage: target families 6.2% 4.5% 8.3% 5.8% 7.8% 4.9% 6.4% 6.9% 7.0%

,P.e,tnnan,ce'ln"dIc,atw,,

Total savings (In '000' posos) 452 564 63 643 64151 57 719 85 948 47 577 47 577 85 948 85 948Average saving/member 1 456 1 384 1 453 1 475 1 472 1 470 1 470 1 472 1 472Savings In Savings groups 14 464 2 140 2 055 1 821 2 718 1 506 1 506 2 718 2 718

Total outstanding loan portfolio 327 438 47 267 48114 41 616 61 938 34 282 34 282 61 938 61 938(In '000' pesos)From members'shares and 286 508 41 359 40 350 36 414 54 196 29 997 29 997 54 196 54 196savingsFrom external source 40 930 5 908 5 764 5 202 7 742 4 285 4 285 7 742 7 742Numberof loans 71 190 10 309 10035 9 038 13455 7448 7448 13455 13455Average credit 4 600 4 585 4 595 4 605 4 603 4 603 4 603 4 603 4 603

Number of SCis Staff 302 41 42 39 58 32 32 58 58Number of members/staff 1 029 1 121 1 051 1 003 1 007 1 011 1 011 1 007 1 007

Profit (loss) at SCIs 55 480 9 081 7 850 517 6 838 400 10 192 5 661 896 5 661 896 10 192 786 10 192269 988 786 786

Average profit (loss)/SCIs 293 546 302 733 341 327 284 933 283 133 283 095 283 095 283 133 283 133

Financlal Ratios MeansOperational self-sufficiency 147.7% 157.6% 147.8% 145.5% 145.6% 145.9% 145.9% 145.6% 145.6%(excludes direct subsidies toSCI's)Capitalization rate 35.9% 37.3% 34.9% 35.9% 35.8% 35.8% 35.8% 35.8% 35.8%Outstanding loan/savings 72.4% 74.3% 71.9% 72.1% 72.1% 72.1% 72.1% 72.1% 72.1%Surplus/Assets 7.2% 8.2% 7.3% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0%Surplus/Equity 20.1% 21.9% 21.0% 19.4% 19.5% 19.6% 19.6% 19.5% 19.5%Surplus/outstanding loans 16.9% 19.2% 17.0% 16.4% 16.5% 16.5% 16.5% 16.5% 16.5%

Total Direct Transfers to SCis

Total direct transfers ('000' US$) $6 822 $1 031 $838 $874 $1 311 $728 $728 $1 311 $1 311Total direct transfers/SCls (US$) $36 097 $34 377 $36 421 $36 421 $36 421 $36 421 $36 421 $36 421 $36 4211US$ 9 pesos

Total Populafton marginal areas 24 222 5 008 2 593 3 263 3 631 3 174 2 445 4 108 4 043(thousands)

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Income Statement of a Typical Rural Savingsand Credit Institution (SCI)

Amounts In thousands of Mexican pesosYear 1 Year 2 'Year 3 Year 4 'Year 5.

Basic InformationNumber of members 200 400 800 960 1152Average savings 1 000 1 050 1 103 1 158 1 216Total savings ('000) 200 420 882 1 111 1 400% deposits in Banks 35% 25% 15% 15% 15%Available savings 100 310 651 997 1 256% Savings to be converted into 50% 60% 70% 70% 70%creditCredit - own funds ('000) 50 186 456 698 879Credit- other funds (% savings 0% 0% 5% 5% 10%previous year)Lines of credit ('000) 0 0 21 44 111% Liquid assets 15% 15% 15% 15% 15%Total Liquidity ('000) 30 63 132 167 210Owners' equity 50 100 200 240 288Share 250 250 250 250 250

Interest Rate AssumptionsCredit to members (from savings) 55.0%Credit to members (external 55.0%sources)SCI deposits in banks 8.0%Line of Credit 5.0%Member deposits 4.0%

Other AssumptionsSCIs' contribution 7.0%Default rate % 5.0%

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Income Statement of a Typical Rural Savings and Credit Institution (SCI), cont.Amounts In thousands of Mexican pesosYearl Year2i7 ,,Year3, Y.e,r4 YIear5

Income statement

Financial IncomeInterest Income from credit (using 25.0 93.0 227.9 348.8 439.5own funds)Interest income credit (using 0.0 0.0 10.5 22.1 55.6borrowed funds)Interest income from deposits In 4.8 12.2 19.8 29.6 36.2banks?Total Interest Income 29.8 105.2 258.2 400.4 531.3

Financial costInterest paid on borrowings 0.0 0.0 1.1 2.2 5.6Interest paid on blocked savings 4.0 12.4 26.0 39.9 50.2Provisions for non performing 3.8 14.0 35.8 55.6 74.3loansContribution to Union or 14.0 29.4 61.7 77.8FederationTotal Interest expenses 7.8 40.4 92.2 159.4 207.8

Gross Financial margin 22.1 64.9 165.9 241.0 323.4

Operational expensesStaff 144.0 148.3 152.8 157.4 162.1Maintenance expenses 3.0 3.1 3.2 3.3 3.4Utlities and telecommunications 6.0 6.2 6.4 6.6 6.8Office supplies 15.0 15.5 15.9 16.4 16.9Other expenses 3.0 3.1 3.2 3.3 3.4Total operating expenses 171.0 176.1 181.4 186.9 192.5

DepreciationFixed assets 1.5 1.5 1.5 1.5 1.5Equipment and materials 9.4 9.4 9.4 9.4 9.4Fumiture 3.0 3.0 3.0 3.0 3.0Total amortIzatIon 13.9 13.9 13.9 13.9 13.9

Total expenses 184.9 190.0 195.3 200.8 206.4

Surplus/deflcit -162.9 -125.2 -29.4 40.2 117.1

Management salaries subsidy 100.8 74.2 45.8 0.0 0.0Profit/loss Including subsidy -62.1 -51.0 16.4 40.2 117.1

Cash flowGross Financial margin 22.1 64.9 165.9 241.0 323.4Operational expenses 171.0 176.1 181.4 186.9 192.5Management salaries subsidy 100.8 74.2 45.8 0.0 0.0New shares 50 100 200 240 288Cash flow 1.9 62.9 230.3 294.1 419.0

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Additional Annex 15: Studies, Information Dissemination, Monitoring and EvaluationMEXICO: Savings and Credit Sector Strengthening and Rural Microfinance Capacity Building

Component Objectives

The main objective of the Savings and Credit Sector Strengthening and Rural Microfinance CapacityBuilding project is to contribute to the integration of low-income people into the national economy and tothe realization of their income generating potential by increasing their access to financial services. To thisend, the project aims to improve the financial stability and outreach capacity of savings and creditinstitutions nationwide, and to expand financial services in rural areas, by strengthening and consolidatingthe sector under the new legal framework established by the Ley de Ahorro y Credito Popular. TheStudies, Monitoring and Evaluation component of the project will detennine the degree to which projectobjectives are achieved by regularly measuring and analyzing performance indicators (PI) in regularprogress reports, and by carrying out a number of in-depth assessments.

The achievement of project objectives will largely depend on the performance of individual SCIs and theirnetworks, or federations, on the establishment of an effective governance and supervision framework forthe sector, and on the impact SCIs have upon the households and communities which make use of theirservices. The Studies, Information Dissemination, Monitoring and Evaluation component will thereforemonitor and analyze: i) the performance of SCIs and their federations, ii) progress in implementing the newsupervision framework, ii) the social and economic impact of the SCI which are strengthened on thehouseholds and communities they serve, and iv) the reduction of govemment's direct funding formicrofinance activities.

Component Structure and Contents

The component is organized into activities which cover five main topic areas, or modules. These are:

Progress Monitoring1. Progress and issues in the establishment of the supervision mechanismPerformance Monitoring and Evaluation2. SCI Institution performance3. Federation performanceImpact Assessment4. Social and economic impact5. Fiscal impact

Performance indicators for each module, listed in Attachment 1 to this Annex, will be analyzed in AnnualProgress Reports, to detennine how project activities are advancing relative to stated objectives. In-depthStudies or assessments of the factors contributing to the results observed, will be carried out half waythrough implementation to determine any potential modifications to the project that might be needed.These assessments will also be conducted at the end of project to determine impact and explain the factorswhich most contributed to these results. In addition, the component will generate a number of CaseStudies to document specific lessons learned from experience as the project is being implementing, interms of expanding SCI outreach, for example.

Seminars and workshops will be conducted throughout implementation to disseminate information aboutthe project activities as well as the results of selected studies. Dissemination efforts will initially focus onworkshops to be held at the project's inception with SCIs and their Federations to inform the sector about

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the project and the new legal, regulatory and supervisory framework, answering questions and providingpractical information about how to participate and adjust to the new framework. Approximately half-wayinto project implementation, a second round of workshops will be held to: i) present an update onprogress in project implementation; ii) obtain feedback and discuss main issues that may have emerged inthe process; and iii) identify and evaluate potential new areas in which the SCI sector integration and/orthe supervision mechanism can be advanced to improve overall system efficiency.

Finally, a Synthesis Study will be done towards the end of the project (tentatively in 2006 to coincide withthe end of the "sexenio") to provide an overall assessment of project results with respect to all five areasof interest. Table 1 below presents the activities, outputs and execution responsibilities for eachcomponent module, as well as the Synthesis Study and Dissemination activities. Performance indicatorsand an extensive (indicative) list of measures are included in Attachment 1. Indicators considered criticalto measure results and prompt corrective measures during implementation are highlighted in thisAttachment.

Table 1Activity Module Executed by Activity Output

coveredProgress Supesion CNBV/BANSEFI 1. Expert advice to CNBV and 1. Periodic reports andmonitorng BANSEFI recommendations

2. In-stu visits of Supervision 2. Annual progress reportsCommittees and CNBV

Performance SCI performance BANSEFVSAGARPA 1. Computation of Pi 1. Nonermonitoring and 2. Evaluation of Pi for Components 2. Annual Progress Reports andevaluation 1 and 2 In-depth Studies

Network performance BANSEFI 1. Computatlon of Pi 1. None2. Evaluation of Pi for Components 1 2. Annual Progress Reports and

and 2 In-depth Studies3. Case studies 3. Reports

Impact Evaluaton Sodal and economic BANSEFVSAGARPA 1. Household survys and community Annual Progrss Reports andImpact Impact studies In-depth Studies

2. Computaton of PiFiscal Impact BANSEFI Computation of Pi Annual Progress Reports and

In-depth StudiesSynttesis Study All BANSEFI Compilation of PI and Case study data In-depth StudyDisseminaton All BANSEFI Seminars and conferences at natonal Event summary reports

and International level; mediadisemninaton

Note: - This table presents a sumnmary of all activities to be perforned under this Component 3 (Studies, Monitoring andEvaluation System ) of the project and the responsibilities that will be assumed by each of the parties involved. Not includedin this table are other uses made, or outputs produced that the different institutions (BANSEFI, CNBV, SAGARPA) maydeem necessary but do not constitute a required output of the Component 3.

Module Descriptions

1. Supervision - progress monitoring

For this module, a close advising relationship will be established between CNBV and international expertsto monitor progress and make adjustments as needed. Experts will assist CNBV and BANSEFI inmonitoring the progress of implementation of the new supervisory framework by providing input onsupervisory practices and results. Supervision-related PI will be computed and their evolution described inprogress reports to gain insights into both the principal and auxiliary supervision performance. The focusof these activities will be on the interactions between expert advisors and the professionals from the CNBVresponsible for implementing the new framework, with the goal of providing support and expert technical

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feedback.

2. SCI performanceThis module focuses on tracking indicators that provide an assessment of the performance of individualSCIs, including their performance as financial institutions, the type of clientele that they serve and thequality of the services they provide. The PI include: (i) a set of Critical indicators that include basicoutreach measures and a few core financial ratios that define whether the work of a particular technicalassistance provider should continue, including measures of profitability, asset quality, operating efficiencyand capital adequacy Detailed lists of indicators will be part of the termns of reference for technical assistanceproviders.; (ii) an Outreach index (01) which is a composite index combining measures of breadth ofoutreach, innovation/services, depth and profile of clients; (iii) a subsidy dependence index (SDI); and (iv)numerous other indicators which will be tracked as needed for annual reports and studies.

Most of the data used to compute PI are based on financial reports that must be provided to the SupervisionCommittees (SC) of the federations and the CNBV. Given the outreach expansion goals of Component 2,however, the data reported for supervision purposes will be supplemented with data that will be obtainedfrom a representative sample of SCI operating in the areas covered by Component 2 (the sample sizeexpanding as a function of the growth of numbers of SCI). These data will incorporate more in-depthmeasures of outreach such as gender distribution and ethnic origin of clients).

In-Depth Studies will provide an analysis of the factors that contributed to explain the performance of SCI,with the purpose of providing guidance for project implementation. At least two types of in-depth studieswill be executed: i) studies designed to explain financial fragility of the SCI, to support both Components Iand 2; and ii) designed to explain differing levels of performance in terms of outreach, mostly to supportComponent 2.

3. Federation performanceThe performance of SCIs Federations is of vital importance to project outcomes. The level of developmentand performance of the federated networks can be evaluated by the degree of separation of flmctions that isachieved by the regional federations, as this specialization is crucial to the success of federated networks ofSCI. The evaluation of Federation performance would thus consist of measuring the degree to whichprimary SCI concentrate on core competences and have delegated the function of input production andinfrastructure management to the second-tier organizations in the federations.

Assessment of performance of the federations will be established according to the following main criteria:input pooling (products and infrastructure); govemance, branching practices, standardization of processes,contractual solidarity, subsidiarity and decentralization (detailed PI are listed in Attachment 1). These datawill be collected through the delegated monitor (Supervision Committee), Deposit Protection Fund,BANSEFI reports and Federation reports, and analyzed in the annual progress reports. Field visits will beconducted to collect additional data and information for two Case Studies envisioned under this module.

4. Social and economic impactThe project seeks to strengthen SCIs and thus provide access to savings and liquidity managementinstruments, credit, and other financial instruments and services (such as cashing of remittance payments,cashing of government transfer payments, insurance, credit rating and contingent credit lines) that decreasehousehold vulnerability to shocks, increase the ability of households to take advantage of productiveopportunities, decrease the costs associated with financial transactions, among other benefits. The purposeof this module is to assess the impact of increased access to financial services on the economic situation of

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client households and, for selected rural areas, on the community as a whole.

Monitoring and evaluation will be based on surveys of representative samples of households andcommunities with and without SCI that will be followed throughout the project period. The sampling willbe carried out within three population groups. The first two groups correspond to clients of the SCIsundergoing strengthening on a nationwide basis under Component I of the project, the first sample drawnfrom urban communities and the second taken from rural communities; the third group includes thepopulation of selected rurl marginal areas, which are the focus of Component 2. Control samples ofhouseholds not served by SCI will be used. The data collected will serve to assess issues such as themonetization of savings by households, the shift from informal sources of financing to formal SCIfinancing, and the reduction in household vulnerability to shocks. Specific design and modeling of impactanalysis will be carried out during implementation.

For SCIs operating in rural areas, the community in which the household operates will also be evaluatedwith the objective of detemiining the impact of the SCI's presence on local development outcomes. Whenatlalyzing the impact of SCIs in a rural environment, it must be considered that every household is part of alarger community in which uncountable interactions occur between the SCI, the households and theeconomic structures of the community. SCIs may affect the welfare of a community and the empowermentof its members through: (i) financing community projects through credits or grants; (ii) providing financialand organizational training to members of the community; (iii) for coopeative SCI, encouraging theparticipation of members in community promoting activities, in participatory governance structures (of theSCI) and other social networking activities, for instance. To determine the extent to which an SCI hascontributed to the development of infrastructure, social services or the economic activity in a community,data from secondary sources will be used, along with interviews conducted with community members,NGOs and SCI staff.

In order to complete the information obtained in this module and in the SCI performance module, a casestudy combining quantitative and qualitative analyses will be conducted based on a survey of SCI-customerhouseholds, to identify the mechanisms that allow some households to benefit from the actions of the SCIbetter than others, particularly focusing on women and indigenous peoples access and use of SCI services.

The objectives and inputs for the studies to be conducted under the Social and Economic Impact modulecan be summarized as follows:

Objectives Inputs1. To compare welfare indicators for 1. Household surveys of SCIs clients and non-

households which use SCI services with SCI clients.those that do not. 2. Data on economic activity, infrastructure,

2. To analyze social and economic and social indicators from sources such asdevelopment indicators for communities INEGI, CONAPO, PROGRESA, SHCP,in which SCIs are present, in comparison IFE, INI, CNDH and others. Interviewswith those where no SCIs are present. with SCIs, local authorities and other

3. To determine the factors which individuals and institutions.contributed to improved SCI outreach 3. Small sample survey of SCI households;among women, indigenous, and other interviews with SCIs, other localvulnerable household groups. organizations.

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S. Fiscal impactThe project is expected to have a positive impact on Govermnent fiscal position as a result of a transfer ofthe main means of provision of financial services to middle and low-income clients from government fundedschemes to SCIs operating under market parameters and free of subsidies. Fiscal impact will be estinatedtakdng into consideration government funding requirements for the SCI development effort, the (expected)reduction in subsidized financing through government development finance institutions (e.g., FIRA,BANRURAL), and changes in govenment transfer programs, and taxes on net income of SCIs andnetwork operations.

O,bJec-tv Key p Obn c a key In4lci...,- . . .Indlflr M .sure...,;

Supervision1 . Supervisionprogress 1.1 Supervision (Auxiliary) a Number of SCIs under supervision relative to the totalmonitoring * Ratio of # of inspectors to nmber of SC]

* Ratio of of inspections to number of SCI* Average schooling of SC staff (years)* # of supervisory committees* Control of coalition formation:

* National or federation level SC?* Ratio of largest SCI assets to total assets under control of

a SC1.2 Supervision (Principal) * Ratio of largest federation assets to total assets under

control of SC

* Ratio of # of spot inspections to number of SCI infederation* Ratio of # of dedicated inspectors to # of SCI* Ratio of # of sructuring plans to numnber of SCI* Ratio of # of sanctions to number of SCI* Use of a common IT platform (yesno)* Entry and exit standards

* % of SCI in recupertion progrms.1% of SCI in with failed reuperation progams* % of SCI in with failed recuperation programs closed.

* Common accounting and repoting standards and theimplementation of a common IT platform

* % of SCI using common accounting standards (perfederation)

* % of SCI that have adopted common IT

SCI performance (all indicators for Components I and 2 unless otherwise noted)I . Outreach 1.1 Critical indicators (from the * Number of clients

list below) * Averge loan and deposit size to per capita GDP

1.2 Breadth * Number of clients* Evolution of assets* # of municipalities with federated SCI* # of rural municipalities (<25,000 h.) with federated SCI

1.3 Innovation/Services. * # of financial productstservices offered by SCI (list)

IA Depth* Average loan and deposit size to per capita GDP

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* Herfindahl Index of loan concentrationComponent 2 only

1.5 Profile of clients * Ratio of quintile loan and deposit size to GDP

Component 2 only* Distribution of assets and liabilities by

* gender,1.6 Composite Outmach * ethnic groups,Indicator (01) * habitat (urban/rural),

________________ __________________ * An index of arbitrarily weighted measures of outreach.2 Sustainabilioy 2.1 Critical indicators (from the * Return on assets

list below) * Ratio of non-performing loans to total loans* Ratio of opeating costs to intermediation margin* Solvency ratio: ratio of equity to (risk adjusted) assets

2.2 Risk management/ Control omoral hazard * Ratio of non-performing loans to total loans

* Interest rate risk exposure (dollar gap)* Liquidity risk exposure (liquidity ratios)* Outstanding loans to members of governing bodies (% of

total loans)* Number of members of governing bodies as net borrowers* Ratio of borrowings to total liabilities* Outstanding loans to top management (0/oof total loans)* Herfindahl of loan concentration* Herfindhal of deposit concentration

2.3 Sustainability * Nwnber of staff trained in risk management* Credit decision taken by credit committee (yes/no)

2.4 Operational efficiency/ * Return on assets (net of subsidies)Control of agency costs * Solvency ratio: ratio of equity to (risk adjusted) assets

2.5 Management Training * Capital accumulation (retained earnings over equity)

* Ratio of total loans to total liabilities* Ratio of operating costs to intermediation margin

2.6. Govemance* # of managers trained over the period* # of loan officer trained over the period* Cumulative # of managers trined since beginning of

project2.7 Subsidy Dependence Index(SDI) * # of general assemblies

* Average arnount of honoraries to members of Board ofDirectors per meeting

* % of board members as net borrowers* Number of meetings of auditing committee

* SDI computed according to standard methodology

Source of data:Annual reports collected by the delegated/principal monitor(Federation/ CNBV)

Federation performance1. Input Pooling [1.1 Access to pooled * Payment clearing by network (yes/no)

infrastructure management services * Liquidity pooling by network (yes/no)* Back-office management by network (yes/no)

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* IT pooling by network (yes/no)* Access to national electronic banling system through ATM(yes/no)

1.2 Access to products generated * # of inter-SCI transactions possibleby federations / BANSEFI * # of infrastructure management services generated by

network

* Remittances cashing service (yes/no)1.3 Contingency/Deposit * Fiduciary services provided by network (yes/no)Insurance Fund (CF) * Credit card services by network (yes/no)

* # of products generated by network/total products offered

* Yes/No* Ratio of CF assets to federation loans

1.4 Personnel Management * Ratio of CF assets to federation deposits

* Ratio of premium collection to disbursements* Level of training of top five officers

1.5 Pooled investment * Case studies (*)

* Personnel training managed by federation (yes/no)* Personnel hiring managed by federation (yes/no)* Common trade union (yes/no)

* Ratio of assets of portfolio subsidiaries of federation tototal federation assets

Source of dataAnnual reports collected by the delegated monitor (Federation),Deposit Insurance Fund, BANSEFI reports, federation reports andCase studies.

2. Governance 2.1 Representative structure * # of meeting of the federation board of directors/year* Ratio of # of resolutions initiated by first-tier SCI to total

resolutions in federation board of directors2.2 Equilibrium in size of SCI * Ratio of assets of largest to smallest SCI

* Ratio of # of members of largest to smallest SCI

Source of dataAnnual reports prepared by the Federation and the PrincipalSupervisor, annual reports of SCI collected by the Federation andCase studies

3. Branching Practices 3.1 Control over branching * Federation controls branching decisions (yes/no)practices * Prohibition to operate in tenitories of other SCI of the

federation (yes/no)

Source of dataFederations

4. Standardization of 4.1 Systems * Unified informatics' systems (yes/no)operations * Unified accounting systems (yes/no)

4.2 Products * Ratio of # of products standardized by federation to total

products offered by SCI* Ratio of # of products produced by federation to total

products offered by SCI

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4.3 Benchmarking4. ois* # of common benchmarks established by the federation

4.4 Policies* # of policies established by the federation (credit, liquidity,

4.5 Marketing interest rates, dividend policy, capital accumulation, etc.)

* Common image/branding (yes/no)* Advertising made by federation (yes/no)

Source of dataAnnual reports prepared by and surveys of Federations and Casestudies.

(*) Case studies will be perforned to assess the extent to whichfederations have advanced in the standardization of theiroperations with respect to each of the 5 key indicators.

5. Contractual solidarity 5.1 Membership * Membership/subscription fees as % of assets of memberSCI

* Ratio of largest to smallest membership fee as % os assetsof member SCI

* Ratio of minimum to maximum # of services offered byfederation

Source of dataAnnual reports prepared by and surveys of Federations

6. Subsidiarity and 6.1 Respect of subsidiarity pple. * Redundant centralization of tasks (yes/no)Decentralization * Second tier organizations do business with /accept

membership of individuals (yes/no)

Source of dataAnnual reports prepared by and surveys of Federations

7. Other 7.1 General statistics * # of SCI in the federation* # of members in the federation* Total assets of the federationSource of dataAnnual reports prepared by and surveys of Federations

Social and economic frnpact (all measures are changes n the variables between surveys)1. Proflle of Community 1.1 Ethnic groups * Proportion of indigenous population in the sampledIClients households (beneficiary and non-beneficiaries)

* Proportion of indigenous beneficiaries of SCI services byproducts: savings, credit, remittances, transfers, etc

1.2 Gender* Proportion of women beneficiaries of SCI services by type

Source of dataHousehold surveys

2. Real effects (households) 2.1 Education * Schooling of household children

2.2 Health * Health expenses* Sanitary installations

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2.3 Productivity * Factor productivity

2.4 Asset diversification * Fluctuation of output and income

Investment in productive

Source of dataHousehold surveys

3. Financial effects 3.1 Asset portfolio structure and * Evolution of savings indicators(households) management (savings levels and * Ratio of financial (and liquid) assets to total assets

behavior) * Ratio of assets held in SCIs to total, by type of instruments* Ratios of informal and formal assets to total assets* Ratio of quasi-liquid physical assets to total assets

3.2 Liability portfolio structure andmanagement * Ratio of informal sector liabilities to total

* Ratio of liabilities with SCIs to totalUse of financial products,especially remittances * Access to credit and type of credit

* Changes in maturity of credit

* Use of other financial products offered by SCI and benefits

Transaction costs of use

* Transaction costs, explicit and implicit of carrying outfinancial transactions, overall and with SCIs

Source of dataHousehold surveys

4. Social and economic 4.1 Social impact * Marginality index of communitiesimpact on communities

4.2 Economic impact * Financing by the SCI of community projects through creditsor grants

* Changes in the number of microenterprises registered

Source of dataSecondary data

Fiscal impact1. Governmentfunding * Government participation in project funding, all fundingrequirements including external debt net of grants received

Source of dataGovernment statistics

2. Reduction in subsidized * Evolution of government spending on subsidized financefinancing by Government programs

* Evolution of governnent spending on direct transfers

Source of dataGovemment statistics

3. Taxes on net income of * Tax income of SCI operationsScI

Source of dataGovemment statistics

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