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LESSONS:

Banking Sector Reform Program

sector: Finance | country: Lao, People’s Democratic Republic

Political support and macroeconomic stability are vital to the success of a development assistance program. At the time the Banking Sector Reform Program (BSRP) was approved, the government had just come out of a severe macroeconomic and fiscal crisis. The fiscal situation had stabilized by 2003 with a deficit equivalent to 5.6% of gross domestic product (GDP). The severe constraints on budget resources and suppressed spending on the economic and social sectors meant that the MInistry of Finance’s (MOF) priorities were not closely aligned with the goals of the Bank of the Lao PDR (BOL) and the BSRP (which required a substantial placement of interest-bearing government recapitalization bonds in the two state-owned commercial banks or SOCBs).

Focus in scope is important. The extended time period, the considerable amounts of counterpart and staff time, and the breadth of technical assistance (TA) support involved in program implementation (6 years and about $6 million in loan and grant-based TA resources) clearly indicate the scope and complexity of the program. Significant additional support was also provided under rural finance-related projects to address Agriculture Promotion Bank (APB) and microfinance-related measures. The BSRP’s core and immediate objective was to address the crisis facing the banking sector by restructuring and restoring the SOCBs to financial health. Reforms directed at this objective required close attention and significant support given their urgency and fundamental nature. As noted above, however, the program’s scope also included a wide range of other measures (e.g., reform of the judicial system) that diluted focus and complicated implementation (involving a significant number of implementing agencies, for one, made coordination more difficult) without directly supporting the achievement of the program’s main objective, partly because of the much longer time and greater resources needed for effective implementation. Closer assessment of the judicial system at the time of program formulation could have highlighted the very basic level of capacity present, the long-term nature of the support needed, and inherent difficulties in meaningfully achieving the proposed goals within the program time frame and available resources.

The program’s approach to dealing with nonperforming loans (NPLs) might have concentrated more fruitfully on strengthening credit assessment with a focus on future cash flows rather than security, through greater support for the development of needed procedures and capacity in this regard. Attempting concurrent reforms of a fundamental nature in the legal and judicial system requires a significant commitment of resources over the medium to long term, well beyond those available under the program and its associated TA.

The program’s significantly longer than anticipated implementation also meant that there was considerable turnover of key staff within executing and implementing agencies as well as on the ADB team (six mission leaders over the course of implementation). These changes contributed further to delays as new staff learned their responsibilities and adjusted to the many exigencies of a complex and wide-ranging program. A program of more focused scope would have helped reduce the effective transition period for new staff, thereby allowing more effective and timely implementation.

The tranche conditions were overloaded with complicated policy reforms and involved too many implementing agencies with different interests, overstretching the weak administrative capacity of the government. Policy conditions included adherence to complicated and lengthy governance agreement agreements; legislative reforms, among them, amendments to the Secured Transactions Law, the Law on (Civil) Judgment Enforcement, the Law on Civil Procedure, and the Anti-Money Laundering Law; the establishment of a financial intelligence unit at the BOL; and the placement of recapitalization bonds at the two SOCBs. A governance agreement to insulate a state bank from political interference was a relatively new instrument; its use in the Lao PDR was therefore tantamount to an experiment.

Flexibility can help strengthen stakeholder ownership and support effective implementation. The first set of governance agreements had to be revised to unlock progress in implementation.

Funding should be commensurate to the size and scope of the program to align incentives. The total amount of funding under the program was $15 million (spread over three tranches), yet the release of funds was contingent on compliance with some 42 conditions, some of which carried costs significantly greater than the program amount (e.g., recapitalization of the SOCBs). Interest payments alone on the recapitalization bonds were estimated at $18-$20 million over the originally anticipated program period of 3 years. Many conditions also involved fundamental and far reaching institutional changes that contributed to prolonging the implementation period by 3 years. This suggests a mismatch between the magnitude and scope of the reforms undertaken and the program amount, further diluting the incentives for timely and effective implementation.

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