Document o f The World Bank

Report No: 25636-BD

PROJECT APPRAISAL DOCUMENT

ON A

PROPOSED CREDIT

IN THE AMOUNT OF SDR 27.20 MILLION (US$37.0 MILLION EQUIVALENT)

TO THE

PEOPLE'S REPUBLIC OF BANGLADESH

FOR THE

CENTRAL BANK STRENGTHENING PROJECT

May 1,2003

Finance and Private Sector Development Unit South Asia Regional Office

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CURRENCY EQUNALENTS

(Exchange Rate Effective March 30, 2003)

Currency Unit = Taka (Tk.) Tk.l = US$0.0172

U S $ l = Tk.58.145

ACH ADB AML ARCS BB BBO BCA BOP BP BRC C & A G CAS CBSP CEO CFT CIB CMDP CQ DBH DCA DGM DO DOSA EA ED EDP EMP ERP ERR ESW FlDP Flu FM FMR FRP FRR FSAC FSAP FT FY GDP GM GNI GOB GP

FISCAL YEAR July 1 -- June 30

ABBREVIATIONS AND ACRONYMS

Automated Clearing House Asian Development Bank Anti Money Laundering Audit Report Compliance System Bangladesh Bank Bangladesh Bank Order Banking Companies Act Balance of Payment Bank Procedures Bank Reforms Committee Comptroller and Auditor General Country Assistance Strategy Central Bank Strengthening Project Chief Executive Officer Countering of Financing of Terrorism Credit Information Bureau Capital Market Development Program Selection Based on Consultants' Qualifications Delta BRAC Housing Finance Corporation Limited Development Credit Agreement Deputy General Manager Development Objective US Dollar Special Accounts Environmental Assessment Executive Director Export Development Project Environmental Management Program Enterprise Resource Planning Economic Rate of Return Economic and Sector Work Financial Institutions Development Project Financial Intelligence Unit Financial Management Financial Monitoring Reports Financial Recovery Plan Financial Rate of Return Financial Sector Adjustment Credit Financial Sector Assessment Program Financing of Terrorism Fiscal Year Gross Domestic Product General Manager Gross National Income Government of Bangladesh Good Practices

HR HRMS IAS IBRD CAB ICB IDA IDLC IMF IP IPDC ISA ISG ISSP LCS M&E MlCR MIS ML MMTU MOF MOU N.B.F. NBFl NCB NGO N PV NS OD OP OPN PD PHRD PMR PSlC QBS QCBS RFP SAP SDR SFB SLA SOE TA TAPP TNA TOR ULC USPCL VERS WBI

Human Resource Human Resources Management System International Accounting Standards International Bank for Reconstruction and Development Institute of Chartered Accountants of Bangladesh International Competitive Bidding International Development Association Industrial Development Leasing Company International Monetary Fund Implementation Progress Industrial Promotion and Development Company of Bangladesh Ltd. International Standards on Auditing Information Solutions Group Information Systems Strategy Plan Least-Cost Selection Monitoring & Evaluation Magnetic Ink Character Recognition Management Information System Money Laundering Monetary Management and Technical Unit Ministry of Finance Memorandum of Understanding Not Bank-financed Non-Bank Financial Institution Nationalized Commercial Bank Non Government Organization Net Present Value National Shopping Operational Directives Operational Policy Operational Policy Note Project Director Japan Policy and Human Resources Development Fund Project Management Report Private Sector Industrial Credit Quality-Based Selection Quality-and Cost-Based Selection Request for Proposal Systems and Application Program Special Drawing Rights Selection under a Fixed Budget Subsidiary Loan Agreement State Owned Enterprise Technical Assistance Technical Assistance Project Proposal Training Needs Analysis Terms of Reference United Leasing Company United Summit Power Company Ltd. Voluntary Early Retirement Scheme The World Bank Institute

Vice President: Mieko Nishimizu Country ManagedDirector: Frederick T. Temple

Joseph del mar Pernia Shamsuddin Ahmad

Sector ManagedDirector: Task Team Leader/Task Manager:

BANGLADESH CENTRAL BANK STRENGTHENING PROJECT

CONTENTS

A. Project Development Objective

1. Project development objective 2. Key performance indicators

B. Strategic Context

1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 2. Ma in sector issues and Government strategy 3. Sector issues to be addressed by the project and strategic choices

C. Project Description Summary

1. Project components 2. Key policy and institutional reforms supported by the project 3. Benefits and target population 4. Institutional and implementation arrangements

D. Project Rationale

1. Project alternatives considered and reasons for rejection 2. Major related projects financed by the Bank and/or other development agencies 3. Lessons learned and reflected in the project design 4. Indications o f borrower commitment and ownership 5. Value added o f Bank support in this project

E. Summary Project Analysis

1. Economic 2. Financial 3. Technical 4. Institutional 5. Environmental 6. Social 7. Safeguard Policies

F. Sustainability and Risks

Page

2 2

3 3 7

11 11 12 13 14

14 15 15 15 17 17 18

1. Sustainability 2. Critical r isks

19 19

3. Possible controversial aspects 20

G. Main Credit Conditions

1. Effectiveness Condition 2. Other- Financial Management Condition

H. Readiness for Implementation

I. Compliance with Bank Policies

Annexes

Annex 1: Project Design Summary Annex 2: Detailed Project Description Annex 3: Estimated Project Costs Annex 4: Business Benefits Review Annex 5: Financial Summary Annex 6: Procurement and Disbursement Arrangements Annex 7: Project Processing Schedule Annex 8: Documents in the Project File Annex 9: Statement o f Loans and Credits Annex 10: Country at a Glance

20 21

20

21

22 26 31 32 35 36 48 49 50 52

BANGLADESH Central Bank Strengthening Project

Project Appraisal Document South Asia Regional Office

SASFP

Date: May 1,2003 Sector ManagedDirector: Joseph del mar Pernia Country ManagedDirector: Frederick Thomas Temple Project ID: PO62916 Lending Instrument: Specific Investment Loan (SIL)

Team Leader: Shamsuddin Ahmad Sector(s): Banking (100%) Theme(s): Standards and financial reporting (P), International financial architecture (S)

For LoanslCreditslOthers: Amount (US$m): 37.00

Proposed Terms (IDA): Standard Credit Grace period (years): 10 Commitment fee: 0.00%-0.50

Years to maturity: 40 ervice charge: 0.75%

Total: 14.17 1 31.96 I 46.13

Responsible agency: BANGLADESH BANK Address: Motijheel Commercial Area. Dhaka - 1000 Contact Person: Dr. Fakhruddin Ahmed, Governor Tel: (880-2) 712-0106 Other Agency(ies): Ministry o f Finance Address: Bhaban 7. Bangladesh Secretariat. Dhaka Contact Person: Mr. Zakir Ahmed Khan, Secretary, Finance Division Tel: (880-2) 861-0406 Economic Relations Division Address: Sher-e-Bangla Nagar, Dhaka Contact Person: Mr. Anisul Huq Chowdhury, Secretary, ERD Tel: (880-2) 81 1-2641

Fax: (880-2) 956-6212

Fax: (880-2) 861-5581

Fax: (880-2) 81 1-3088

Annual 15.60 I 10.70 6.00 3.70 I 1 .oo Cumulative 15.60 1 26.30 32.30 36.00 I 37.00

Email: governor@bangla.net

Email: fsoff@bdmail.net

Email: I Estimated Disbursements Bank FY/US$mk

. I

FY I 2004 I 2005 I 2006 I 2007 I 2008 I

Project implementation period: 4 years Expected effectiveness date: 0811 512003 Expected closing date: 1213 112007

A. Project Development Objective

1. Project development objective: (see Annex 1)

The objective o f the project i s to achieve a strong and effective regulatory and supervisory system for Bangladesh’s banking sector. This would be accomplished by supporting the overall strengthening o f Bangladesh Bank (BB), the central bank, to enable it to play i t s due role as the country’s monetary authority and bank regulator and supervisor. At the end o f the Project period, BB’s capacity for introducing and enforcing international prudential regulations and for complying with the Core Principles for Effective Banking Supervision would be improved so that it can effectively regulate the banking system. I t i s also envisaged that, at the end o f the project period, a strong and restructured BB would lead the design and implementation of a medium to long-term reform program for achieving a sound and efficient financial system.

2. K e y performance indicators: (see Annex 1)

I. Legal Framework indicators: BB Circulars to ensure the soundness and stability o f the banking system enforced effectively, by December 3 1,2005. BB staff trained to implement effectively AMLEFT provisions in the law, by December 3 1,2004. Systems installed in BB to capture and share data on ML/FT, by June 30,2006.

11. A) Functional Reorganization indicators: New BB Organogram showing three major wings according to i t s three core functions, adopted by June 30, 2004. Functioning o f BB streamlined by reducing i t s hierarchy from nine to seven layers, b y December 3 1, 2006.

11. B) Automation indicators: Key staff in computer department receive adequate training by December 3 1, 2004. BB work processes fully automated by December 3 1,2006. About hal f o f a l l the commercial banks report to BB on-line by June 30, 2006.

11. C) Human Resources Development indicators: Modern HR policies adopted by BB, by December 3 1,2004. BB’s s k i l l leve l enhanced through recruitment o f around 100 fresh graduates each year, from year 2004, under new recruitment policy. Training needs assessment o f BB officials completed and training plan initiated, by June 30,2004. A modem performance management system in place by December 3 1,2004.

111. A) Research Capacity indicators: Quality research reports on vital issues, such as inflation, interest rates and spreads, etc., prepared and disseminated by BB, by December 3 1,2005.

111. B) Prudential Regulations and Supervision Capacity indicators: All private domestic banks comply with BB’s capital adequacy requirements by March 3 1,2005. All private domestic banks comply with BB’s loan classification and provisioning standards by December 3 1,2004. Bank Supervisory Policy Manual upgraded by June 30,2004. BB comply fully with Basle Committee’s Core Principles o f Bank Supervision, by June 30,2007

Supervisory staff training plan adopted and implemented by December 3 1,2005.

111. C) Accounting and Auditing Capacity indicators: International central banking accounting and auditing standards adopted by June 30, 2004. BB’s Financial Statements for the year ended 2003, and onwards, prepared according to international standards.

B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1) Document number: 21326-BD

IDA supports the Government’s poverty reduction strategies o f (a) promoting rapid, job-creating economic growth; and (b) interventions that directly assist the poor, by restoring the financial health o f the commercial banking sector. The core strategic goal o f the CAS i s to assist Bangladesh to strengthen and rationalize the capacity o f existing institutions to accomplish their missions. This project will strengthen Bangladesh Bank, the central bank of the country, by assisting i t to build greater capacity to supervise and enforce regulations, thus achieving the progress indicator specified in the CAS.

Date of latest CAS discussion: 12/12/2002

The implementation o f the banking reforms in the CAS involves helping the government rebuild the three institutional pillars o f sound banking, which are: a strong regulatory and supervisory system; well-managed banks; and an effective legal framework. The CAS envisaged that until enough political support i s attained to go through with the longer term reform program, IDA would assist wi th technical assistance in the short te rm to strengthen Bangladesh Bank’s sk i l ls and capacities as a f i r s t step towards improving the banking system. A recently concluded (October 2002) jo int Bank-Fund Financial Sector Assessment Program (FSAP) mission has recommended that Bangladesh Bank be made independent and i t s capabilities greatly strengthened. This project i s being proposed to strengthen BB so that it can discharge i t s functions and responsibilities more effectively and efficiently. If and when the government decides to pick up the pace o f implementation, by achieving three specific short term outcomes o f the broader financial sector reform program, IDA would respond by preparing the f i rs t o f several operations to assist in restoring the health o f the commercial banking sector. Meanwhile, in the absence o f a more comprehensive banking reform program, IDA’S low case support in the financial sector will include: (i) a possible micro-enterprise credit to assist the micro-credit sector; and (ii) this Central Bank Strengthening Project to assist BB in regulating, supervising and monitoring the entire financial sector.

2. M a i n sector issues and Government strategy:

The ESW entitled “Strategy for Establishing a Sound and Competitive Banking Sector” has identified three basic problems afflicting the financial system in Bangladesh. These are:

(a) a weak central bank; (b) poor governance; and (c) a deficient legal framework.

(a) Since i t s establishment as the central bank, under the Bangladesh Bank Order, 1972 (BBO), very little efforts were made to strengthen BB. Moreover, no serious attempts were made to stem the institutional decay, nor any attention was given to strengthen management and staff incentives, or control the politicized union activities aggravating the institutional weakening process.

The principal weaknesses of BB are caused primarily by the lack o f skilled manpower in sufficient numbers, unclear and diffused functions and responsibilities, ineffective personnel policies, absence o f

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technological know-how, and the inability (due to the lack o f both competence and authority) to enforce remedial actions. Some o f the specific weaknesses o f Bangladesh Bank as identified in the ESW are:

Lack of Focussed Role: The functions and responsibilities o f BB are poorly defined and incoherent, if not contradictory. Until the recent amendments to BBO, BB's so called "developmental role" made it difficult for it to discharge some o f i t s most important responsibilities, i.e. the regulation and supervision o f the banking system and the conduct o f monetary policy. The recent amendments have provided some focus and removed most o f the development roles and provides the scope for BB to concentrate on i t s core functions only.

Organizational Structure and Culture: Too many hierarchical levels and poor delegation o f authority made BB an over-staffed bureaucracy where the emphasis i s on procedural compliance. Over a period o f time and as a result o f factors enumerated elsewhere, a culture developed which provided disincentives for being decisive, and encouraged the tendency to refer to the government for guidance on important matters.

Poor Professional Competence: While there are certainly many competent officials in BB, human capital at officer levels i s severely depleted because o f poor salaries, promotion o f clerical staff to officer level and restriction on direct recruitment o f fresh candidates. Only about 28 officers have advanced business or economics degrees from overseas. At the officer level, BB salary i s less than one-half o f that in private banks, while at the management level it i s less than one-fifth. The influence and role o f the staff unions have also had a negative impact on the institution's professionalism.

Overstaffing: With around 5,800 staff (1,720 clerical), BB i s excessively overstaffed, by as much as 20 percent, for the size o f the banking sector and the scope o f i t s work (1 BB staff for every 15 staff in the banking system).

Lax Prudential Regulations: BB's prudential regulations are loose enough to compromise the very objectives for which they are issued. Thus, i t s loan classification guidelines are lower than international standards and based primarily on length o f overdues. Moreover, investments other than loans are normally not evaluated, collateral valuation i s not systematic and rigorous, provisioning requirements for agricultural loans need tightening, and internal control requirements are not wel l defined. Thus, the guidelines do not lead to a proper assessment o f the quality o f the banks' assets. The capital adequacy guidelines have recently been raised to 9% o f risk-weighted assets as capital, but not all banks are in a position to comply. Non-compliance was not dealt wi th effectively until recently.

Weak Enforcement: The lax prudential regulations are compounded by weak enforcement. Thus, the loan classification and provisioning guidelines are not fully enforced. Although many banks have not made the required provisions, no punitive measures have been taken against them yet. The Nationalized Commercial Banks (NCBs) have serious capital deficiency and even have negative capital when adjusted for the needed provisions. Yet, the banks are allowed to continue to operate on an "as i s " basis. Although BB has recently taken punitive measures against some non-complying banks in the private sector, it i s s t i l l lax in enforcing al l the prudential regulations.

Inadequate Capacity to Deal with Crises: BB i s not adequately prepared to deal wi th a banking crisis should one arise. This i s perhaps one o f the reasons why i t has not taken decisive steps to deal wi th some o f the banks in critical condition. Recently, the Problem Bank Unit has helped some private banks to meet the prudential guidelines but the NCBs, which control around hal f o f the assets and liabilities o f the banking system, have remained outside the purview o f BB. Moreover, BB i s ill-equipped to take difficult

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and decisive actions to deal with problem banks in a timely fashion e.g. to close a bank and/or to arrange for i t s merger, amalgamation or acquisition by another bank.

Interference by Staff Union: BB has traditionally had little control over i t s staff unions which are politicized and whose activities are not always compatible wi th BB's institutional interests. The unions' influence on personnel policies, including promotions and transfers, i s excessive and clearly harmful to BB as an institution. A reflection o f the excessive influence o f the unions i s the fact that presently out o f about 2,900 officers in various grades from Assistant Director to General Manager level, about 80 percent were promoted from the clerical level without adequate competencies at the behest o f the unions. The unions have been able to get away with extremely disruptive activities because o f political support f rom outside BB, and also because o f BB's own weaknesses and lack o f autonomy.

L a c k of Accountability: The lack o f accountability stems from the lack o f autonomy and authority and poorly defined functions and responsibilities. This lack o f accountability perpetuates poor performance.

Unclear Financial Condition: O n i t s balance sheet, BB shows a large amount o f loans to specialized development banks, and to other financial institutions for refinancing sectoral lending. These are being carried at "par value" which i s clearly overstating the realizable amounts. The true financial condition o f BB, which i s perhaps different from the stated position, wi l l be determined when i t s financial statements for the year ended June 30,2003, w i l l be prepared in accordance wi th international accounting standards.

W e a k Technological Base: BB has not yet automated i t s internal and external functions and activities. Most o f the recording, data analysis, reports and M I S are s t i l l accomplished manually. I t s capacity to monitor Foreign Exchange Reserves i s also severely limited. All financial institutions report to BB through paper copies o f schedules and reports.

L a c k of autonomy: BB has to consult wi th and at times seek approval from M O F on important matters, such as, monetary and exchange rate policies, licensing o f new banks, supervision o f NCBs, and in determining the compensation levels for i t s own staff. The M O F consider the strengthening o f BB as a pre-requisite for granting it full autonomy and independence.

Most o f the above weaknesses o f BB have also been identified by the Bank Reforms Committee (BRC) set up by GOB to identify problems in the banking sector and to suggest remedial measures. The government and the BB Governor generally agree wi th the diagnosis o f the BRC and the Bank and wish to address the technical issues within the context o f the proposed project. They have requested IDA assistance in satisfactorily resolving these issues.

(b) Poor governance in i t s broadest sense i s the most serious problem besetting the banking system. It i s manifest in: the "default culture" leading to a high level o f non-performing loans in the banking system (amounting to Tk.239.6 bi l l ion as o f December 3 1,2002, which i s around 28.1% o f the total gross portfolio according to BB standards, but i s perhaps lower on a net basis) which has albeit been declining over the years; insider lending in the private domestic banks which has also been declining recently; and poor work culture and operating environment in the NCBs. I t i s also perhaps the most difficult to resolve since the remedy may l i e in identifying, selecting and appointing professionals o f integrity, which i s a very difficult task under the best o f circumstances. It may also involve self-regulation as the fundamentals o f good governance have to be practiced by the government as the owner and manager o f financial institutions.

Poor governance in the banking system starts f rom the top. Few, if any, board members o f a public or

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private bank are fully aware o f hidher fiduciary responsibilities. There i s also a lack o f understanding on the proper functions o f a Board Chairman in relation to the Chief Executive Officer and manangement. The Chairmen wrongly try to exercise executive authority and interfere in operational matters.

Poor governance i s perpetuated through poor auditing practices. External auditors have, unfortunately, not played their due role in helping maintain good governance because o f their perhnctory audits which are severely limited in scope, quality, and public disclosure. This i s sustained by the general lack o f accountability for the auditors work. Few legal cases have been filed against an auditor by a depositor or a shareholder, and BB hardly holds any audit firm responsible for unsatisfactory work. The need for improvements in professional accounting and auditing standard has been recognized by the Institute o f Charted Accountants o f Bangladesh (ICAB), which organized several Seminars on IAS-30 to explain to al l stakeholders the need for proper disclosure in financial statements o f banks and other financial institutions. Such disclosure needs have been accepted by BB which has made the adoption o f IAS-30 mandatory for a l l banks starting from the year 2003. A recent Bank Report on Standards and Codes relating to accounting and auditing has identified several weaknesses in the accounting and auditing practices and made recommendations for their removal.

The government has adopted a strategy to implement the broader banking sector reforms at a slower pace. Therefore, those reforms are not included under this project, other than the pi lot for improving the management o f one NCB. The broader banking sector governance and corruption issues will be addressed under a more comprehensive banking reform program, which i s under discussion at this time. However, corruption and governance issues are also being addressed under a Public Procurement Reform Project under implementation. Moreover, several governance-related analytic work led to the issuance o f a report entitled "Bangladesh: Improving Governance for Reducing Poverty," which may lead to an operations in the near future for implementation o f the recommendations coming out o f that report.

(c) An effective legal framework i s the third essential pillar for a sound banking sector. If the legal framework i s deficient, even a financial structure built according to a finely designed architecture would only provide a grand facade. The structure i t se l f would be constantly in danger o f tumbling down and requiring costly repairs al l the time. The present legal framework in Bangladesh i s far f rom being satisfactory and has fairly lost the confidence o f many as i t cannot provide prompt and effective recourse to a breach o f contract or any wrong perpetrated by anyone.

The deficient legal framework i s the result o f outdated and inefficient laws and antiquated court procedures. Cases once fi led take years to be resolved. In the meantime, more cases are filed and the backlog builds up. As o f June 30,2002, there were around 44,660 cases pending in the Money Loan Courts alone, for a total amount of almost Tk.90 bi l l ion (US$1.5 billion.) Cases settled between 1990 and 1997 accounted for a mere 7 percent o f the amount under litigation. The legal framework i s so weak that it needs an overhaul and not just tinkering at the margin.

The government has agreed to address the legal reforms under the Legal and Judicial Capacity Building Project, under implementation. However, some o f the laws that are directly related to the banking sector, such as the Bangladesh Bank Order, 1972, the Bangladesh Banks (Nationalization) Order, 1972, the Banking Companies Act, 1991, the Bank Deposit Insurance Ordinance, 1984, the Negotiable Instruments Act, 188 1, and the Money Loan Court Act, have been amended to facilitate the implementation o f this Project. The recently amended Money Loan Court Act allows for out o f court settlements and outsourcing collections to a private collection agency, among others, which will have a beneficial impact on collecting overdues.

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

This project will address only the technical weaknesses o f Bangladesh Bank, which are grouped under three major components focusing on: A) Strengthening the legal framework and BB's legal capacity, to effectively utilize the greater

B) Reorganizing and modernizing BB by: autonomy and independence achieved through the recent legal amendments.

(i) Designing, reviewing and implementing the functional reorganization o f BB along with the delayering o f decision making, and strengthening the core functions. (ii) Automating the entire BB functions, including bank supervision and on-line reporting by commercial banks, and developing a strong and dependable MIS, based on the Information Systems Strategy Plan. (iii) Designing and implementing a new human resources development program including revisions to the recruitment, training and promotion policies, and addressing the staff compensation and downsizing issues.

C) Capacity building o f BB by focusing on: (i) Strengthening the Research Department. (ii) Introducing and enforcing international prudential regulations and strengthening bank supervision capacities to comply wi th the Core Principles o f Bank Supervision, and (iii) Designing, adopting and implementing the international central banking standards o f accounting and auditing at BB.

An important issue that will be adressed under this Project w i l l be the rationalization o f staff through a Voluntary Early Retirement Scheme (VERS). Given the various level o f sk i l l s in BB at the moment, it i s probable that not al l staff will be able to enhance their s k i l l s to the level that wi l l be required in the restructured bank. To provide for an orderly exit o f these staff, a VERS, offering benefits similar to that offered to other public service employees plus a partial write-off o f outstanding staff loans, w i l l be announced and kept open for a certain period. The scheme, to be financed by BB from i t s own resources, will be available to those that are over 45 years o f age and have completed at least 10 years o f service. BB would reserve the right o f refusal in order to retain better performers to whom a revised compensation package may be offered in the restructured bank.

An analysis o f the potential impact o f VERS found that departing staff would be left wi th unencumbered assets acquired with the staff loans, the income from which would provide adequate financial security. Since BB staff have, on an average, between 2.0 to 3.3 dependents, departing staff and their families would not face much hardship. Moreover, BB has i t s own schools, staff welfare fund and medical facilities, the benefits o f which would be extended to the departing staff and their children to reduce any social costs.

In designing this project, a strategic choice has been made to leave out the politically sensitive issues, such as, the privatization o f the four NCBs, and the governance and corruption issues, to a broader financial sector reform project being discussed with the government. This project will, therefore, not be leveraging the broader banking reforms. The strategic choice allows the proposed project to be implemented now since the technical weaknesses o f BB have to be addressed regardless o f whether or not the broader reform program i s implemented. Moreover, the successful strengthening o f BB under this project could turn i t into a Champion for Reforms o f the entire banking sector.

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C. Project Description Summary 1. Project components (see Annex 2 for a detailed description and Annex 3 for a detailed cost breakdown) :

This Project wi l l assist BB in three major areas: (I) Strengthening the Legal Framework; (11) Reorganizing and Modernizing BB by focusing on (A)Functional Reorganization, (B) Automation, and (C) Human Resources Development; and (In) Capacity Building o f BB focusing on (A) Strengthening the Research Department, (B) Strengthening Prudential Regulations and Bank Supervision, and (C) Strengthening Accounting and Auditing.

11. Reorganization and Modernization A. Functional Reorganization B. Automation C. Human Resources Development

A. Strengthening Research Department B. Strengthening Prudential Regulations & Supervision C. Strengthening Accounting and Auditing

111. Capacity Building

IV. Unallocated Total Project Costs 46.13

1.20 31.89

3.70

2.15 2.40 0.90 3.29

0.0 2.6

69.1 8.0 0.0 4.7 5.2 2.0 7.1

100.0 Total Financing Reauired I 46.13 I 100.0

0.48

0.96 24.9 1

2.96

1.74 1.92 0.74 3.29

37.00 37.00

1.3 0.0 2.6

67.3 8.0 0.0 4.7 5.2 2.0 8.9

100.0 100.0

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

i. Strengthening the legal framework to provide greater administrative and operational autonomy to

ii. Rationalizing the staff strength at BB through a Voluntary Early Retirement Scheme (VERS). iii. Modernizing the human resource development functions at BB. iv. Delinking the BB compensation structure from the civ i l service pay structure, and raising the

v. Automating the entire BB operations.

BB and to bring the Nationalized Commercial Banks (NCBs) within the purview o f BB.

compensation levels.

3. Benefits and target population:

The proposed project i s expected to generate the following benefits: (a) For the financial sector, this project wi l l lay the foundation for moving towards a sound banking system by improving bank supervision and enforcing international prudential regulations. I t will also be a critical step in the process o f restoring discipline in the banking system; (b) For the overall economy, i t w i l l contribute towards building depositor and investor confidence in the banking system thereby encouraging financial savings and efficient private investments to enhance economic growth and employment.

4. Institutional and implementation arrangements:

(a) Organization responsible for the Project: BB will be responsible for the implementation o f the project.

Management o f the Project would be as follows:

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(i) Policy and Overall Coordination. A Steering Committee comprising o f the Governor, the three Deputy Governors, and a senior representative from the Finance Division w i l l meet every month or more frequently to decide on policy and major implementation aspects o f the project. The Deputy Governor o f BB, who will be the Project Director, w i l l act as Member Secretary to the Committee.

(ii) Implementation. The implementation o f the Project would be entrusted to a Deputy Governor o f BB who wil l act as the Project Director (PD). The PD will lead the Central Bank Strengthening Project Cell (CBSP Cell) staffed by eight BB officers drawn from various Departments. The PD wil l be assisted by a Modernization Expert, who would coordinate and monitor the activities o f the various BB Teams and their consultants. The consultants w i l l work under the direct supervision o f the respective Deputy Governors. BB wil l set up five teams, one each for: Human Resources Development; Information Systems and Automation; Functional Reorganization; Prudential Regulations and Bank Supervision; and Accounting and Auditing components o f the Project. Each Team w i l l be headed by an Executive Director (ED) and comprise o f a General Manager (GM) and a Deputy General Manager (DGM). These Teams wil l be assisted by the consultants and together they wi l l monitor progress and be responsible for the day-to-day implementation o f the project in their areas o f concern. A diagram o f the implementation arrangements i s shown below:

I Steering Committee I

(Deputy Governor- 3)

1 -

- VERS Counseling & Training Cell

Communications

.I

Governor (1)

Modemization Expert

Procurement

Specialist

Supervision and Regulatory

Accounts & Audit

Accounts & Budget Financial Management Disbursement

BB Team headed BB Team headed 1 headed 1 1 byanED I 1 byanED 1 1 1 1 E:ziFheaded 1 (b) Role o f IDA during Project Implementation: IDA w i l l carry out a facilitation role during project implementation. Initially, i t will assist BB and i t s teams in finalizing the TORS and then, if needed, in

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identifying and selecting suitable international experts, to assist in project implementation. IDA w i l l also provide best practice examples f rom around the world on any specific area or instrument for implementation, if requested by BB. I t w i l l also assist BB in organizing awareness campaigns, workshops and seminars during implementation. Finally, i t w i l l undertake periodic supervision missions, including a mid-term review.

(c) Administrative Arrangements for Project Implementation:

Procurement: Procurement under the project will be carried out by BB under the supervision o f the Project Director, with the assistance o f a procurement consultant. The project w i l l not have any works contracts. Procurement o f goods and services under the project w i l l be carried out following the Bank's Procurement and Consultants' Guidelines. Under goods category, the largest procurement, estimated to cost $23.59 million, wi l l be for supply and installation o f BB information systems. This w i l l be a single responsibility contract which wi l l include supply & installation o f hardware, software, integration & commissioning o f the automated system, training o f BB staff and operational support to the automated system for a period o f four years. This procurement w i l l be subject to IDA's prior review. There may be other contract packages o f small values which will be procured through N C B andor Shopping methods. There w i l l be selection o f f i rms as well as individual consultants under the project. Firms w i l l be selected following the QCBS method except for the training institutes/organizations which w i l l be selected on a Single-Source basis. Selection o f individual consultants w i l l be in accordance with Section V o f the Bank's Consultants' Guidelines.

IDA wil1.can-y out prior review o f the following contracts: (a) for Goods, al l contracts estimated to cost the equivalent o f US$200,000 or more irrespective o f procurement method and the f i rs t contract through NCB; and (b) for Services, IDA's prior review will be required for consultants' services contracts estimated to cost the equivalent o f US$lOO,OOO or more for f i r m s and US$50,000 or more for individuals. The arrangements for procurement o f other services subject to prior review by IDA wil l include: all single-source contracts and terms o f reference for al l contracts for consultants' services. IDA wil l carry out sample post review o f contracts that are below IDA's prior review threshold. Such post review o f contracts below the thresholds will be carried out for approximately up to 20% o f the contracts awarded.

Financial Management: BB, the executing agency for this project, operates within the framework provided b y the Bangladesh Bank Order, the Banking Comapnies Act, and the banking supervision and regulation codes. GOB'S Project Accounting Manual and BB's Banking Department Manual and Expenditure Regulation Manual provide a comprehensive and integrated financial management framework which w i l l be followed for the project. The proposed project w i l l largely follow BB's current financial management arrangements which i s adequate to meet project financial management requirements. Borrower's Implementation Plan has satisfactorily outlined BB's current financial management arrangements which will be applicable to this Project. However, there i s a need for appropriate coordination among various departments that w i l l be responsible for implementation o f various project activities.

The Expenditure Management Department and the Accounts and Budget Department are responsible for expenditure, accounts and budget management. BB maintains partially computerized accounting system using double entry bookkeeping principles and accrual basis o f accounting. The project will follow BB's current accounting principles and procedures. The Accounts and Budget Department w i l l be responsible for consolidating financial transactions, maintaining supporting papers and preparing timely consolidated financial statements on a monthly basis. A set o f Financial Monitoring reports (FMRs) duly updated w i l l

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be submitted to the Bank within 45 days o f the end o f each quarter.

Bank-financed Introducing prudential regulations for the f i rs t time, liberalizing interest rates, recapitalizing NCBs, and improving supervision o f the banking sector. Improving availability o f export credit; strengthening availability and capacity o f export credit guarantee and duty drawback institutions. Promoting private sector development

private financial institutions and supporting further interest rate liberalization and loan recoveries. Promoting the development o f non-bank financial institutions (NBFIs) in particular and investment financing in general on a sustainable basis, contributing to improvements in the quality o f intermediation, and the speed and efficiency o f industrial growth in Bangladesh. Enhancing the efficiency o f the judicial and legal system through

by strengthening term lending by

Disbursement: The transaction based disbursement procedures w i l l be applicable for withdrawal o f funds from the Credit. For utilization o f IDA'S share o f project expenditures, Bangladesh Bank may open and maintain a Special Deposit Account in U S dollars under terms and conditions acceptable to IDA.

Financial Sector Adjustment Credit (FSAC)

Export Development Project (EDP)

Private Sector Industrial Credit (PSIC)

Financial Institutions Development Project (FIDP)

Judicial and Legal Capacity Building Project

D. Project Rationale 1. Project alternatives considered and reasons for rejection:

A more ambitious project covering the broader banking sector reforms, including a TA component to strengthen the central bank, was rejected on the ground that i t would be complex and hence difficult to manage. Therefore, a strategic decision has been taken to separate the BB strengthening measures from the N C B restructuring efforts. GOB i s discussing a possible SOE and N C B Reform project which would assist the government in dealing with excess manpower in publicly owned manufacturing and financial organizations and in restructuring the NCBs. Proper sequencing o f the banking reforms demand that the strengthening o f the central bank be carried out prior to the implementation o f the broader banking reforms and hence this project.

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

Sector Issue I Project Latest Supervision

(PSR) Ratings (Bank-finance

Implementation Progress (IP)

U

S

S

S

S

projects only) Development

Objective (DO)

U

S

S

S

S

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improvement o f the legal framework, streamlining the court systems and strengthening judicial capacity, improving legal education, strengthening institutional and physical infrastructure and improving the access to justice. Planned Rationalizing manpower to enhance s k i l l levels and restructuring management and operations to improve productivitiy and efficiency o f publicly owned manufacturing and financial. organizations. Xher development agencies ADB: Accelerating the development o f the domestic capital market by strengthening market regulations and supervision, developing capital market infrastructure, modernizing capital market support facilities, increasing the limited supply o f securities, developing institutional sources o f capital and strengthening policy coordination. DIDO Ratings: HS (Highly Satisfactory), S (

OE and N C B Reforms Projecl

apital Market Development rogram (CMDP), approved in lecember 1997.

itisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory)

3. Lessons learned and reflected in the project design:

The lessons learned from the previous projects in the financial sector include the following: i. The sustainability o f the banking sector reforms require that the autonomy and technical skill o f the

regulator be enhanced. This project aims at enhancing the technical sk i l l s o f Bangladesh Bank officials so that they can utilize the greater autonomy provided through the legal amendments more effectively and efficiently.

Parliament has passed the amendments to the Bangladesh Bank Order, the Banking Companies Act and the Bangladesh (Banks) Nationalization Order, providing a legal basis for greater autonomy and independence to BB and more powers to regulate and supervise the entire banking sector.

iii. The sequencing o f the reforms i s important for their successful implementation. Strengthening the central bank, as anticipated under this project, should be high in the priority l i s t o f reforms and should precede the implementation o f the reforms o f the Nationalized Commercial Banks.

iv. Reforms should include rationalization o f the processes and procedures and should be backed by vigorous enforcement and firm political commitment. The project w i l l deal wi th the details o f processes and procedures within the central bank and w i l l provide assistance for strict enforcement o f prudential regulations and legal requirements. Political commitment to the central bank reforms i s confirmed through the approval o f the amendments to the three Acts, mentioned above, and the implementation o f a number o f preparatory actions by BB.

components concentrating on legal framework, reorganization and modernization, and capacity building o f BB.

ii. The amendments to the legal framework are critical to ensure the success o f implementation.

v. Reforms should focus on main activities. This project wi l l have only three highly focussed

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vi. Forcing reforms from outside without creating the necessary environment for sustainability does not pay in the long run as those reforms are reversed upon completion o f Bank assistance. This project has been designed by BB through a highly participatory process involving almost al l BB staff, in close cooperation with and assistance from the Bank.

implemented by BB with the help o f international experts. By strengthening the institutional capacity o f BB this project w i l l create an effective "Champion for Reforms" in the banking sector to work closely with GOB.

vii.The institutional capacity o f implementing agencies i s generally weak. This project w i l l be

4. Indications of borrower commitment and ownership:

The borrower i s committed to the reforms o f the banking sector in Bangladesh. The Fifth Five Year Plan (1 997-2002), which relies more on market forces and the private sector, calls for more emphasis to be placed on "strengthening the financial and capital markets through appropriate policy measures so that there can be a better mobilization o f resources, in particular private resources from abroad, for productive investments." The Agenda for Action for Development o f Private Sector includes the acceleration o f the financial sector reforms to establish a viable financial sector. The Macro Policy Reforms during the Fifth Plan envisages that "with the completion o f the f i r s t phase o f the Financial Sector Reform Program, the government will consider reform measures in areas such as Bangladesh Bank's monitoring and supervision capacity, loan classification and provisioning guidelines, loan defaults; .... The Bangladesh Bank w i l l ensure, through regulatory means, better internal governance in private banks. The issue o f providing autonomy to Bangladesh Bank within a framework o f accountability w i l l be addressed during the Plan." Although the pace o f structural reforms has been disappointingly slow in Bangladesh, the Government, and the Finance Minister in particular, has identified the financial sector as one area in which it i s committed to reforms. The new BB Governor i s the "Champion for Change" and i s fully committed to the strengthening o f BB, which has already implemented the following actions in preparation for the implementation o f this project:

i. hired consultants to carry out a study o f the Functional Reorganization and Human Resource Development o f BB, which was completed in M a y 2002;

ii. hired consultants to prepare an Information Systems Strategy Plan (ISSP) for the automation o f BB, which was completed in M a y 2002;

iii. constituted an internal BB Committee to review the recommendations o f the consultants that carried out the two studies and make recommendations for implementation. The Committee submitted i t s report in October 2002;

iv. nominated the newly hired Deputy Governor from the private sector, as the Project Director for implementation o f this Project;

v. formed four focus groups, wi th members drawn from the foreign and private banks, to improve corporate governance in four operational areas o f banks, which are -- credit risk management; foreign exchange and Balance Sheet risk management; compliance risk management; and AML and CFT management;

vi. prepared the Borrower's Project Implementation Plan for the Project; vii. processed the Technical Assistance Project Proposal (TAPP) for GOB approval; v i i i h a l i z e d a voluntary early retirement scheme (VERS) to reduce staff; and ix. finalized the bidding documents for the procurement o f the IT component.

GOB'S commitment to the Project has been indicated by the Cabinet approval o f the amendments to the three Acts that provide adequate operational and policy autonomy for Bangladesh Bank. These amendments were passed by Parliament on March 9,2003, without any changes. Moreover, both GOB and the new Governor have dealt strictly with Union interference in the operations o f the central bank.

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5. Value added o f Bank support in this project:

Business Functional Area and IT Enabler

Overall ISSP Project

1.

11.

111. ...

iv.

V.

Internal Process Benefits to Benefits for Work process Efficiency internal and compliance, and manpower

external clients regulatory and efficiency control framework

Transforming Improved services to . Improved regulatory Automated

IDA'S participation in the proposed project w i l l be beneficial because: I t possesses in-depth knowledge o f the banking sector in Bangladesh from i t s involvement in the

Bangladesh Bank into a modem central bank with management and business practices that are based on best practice

Improved image o f the Bangladesh Bank

f i r s t phase o f the banking sector reforms (through implementation o f FSAC) and i t s preparation of the report entitled "Strategy for Establishing a Sound and Competitive Banlung Sector" in 1998, which provides a strategy to deal wi th the serious problems afflicting the country's banking system. I t has gained experience and valuable lessons from implementing the FSAC in Bangladesh. It wi l l provide global knowledge and experience in designing and implementing various instruments for strengthening the central bank through different kinds o f expertise within and outside the bank. I t w i l l complement the actions being pursued under the IDA-financed Financial Institutions Development Project (FIDP) and the Legal and Judicial Capacity Building Project being implemented by GOB, and the Action Plan being developed by the Fund for possible assistance and the Capital Markets Development Program under implementation with the assistance o f ADB. At the request o f GOB and BB, a jo int World Bank-IMF Financial Sector Assessment Program (FSAP) was carried out recently, which evaluated the strengths, potential vulnerabilities, and key development opportunities in the Bangladesh financial system. The follow-up to the FSAP w i l l address the broader financial sector problems and weaknesses.

the public and to Scheduled banks

Improved financial sector performance and reduced transaction costs

-

Application software suite for Banking, Treasury, Accounting, Budgeting, Human Resources, Data warehouse and Clearing House

framework supported by information systems automated information wil l have a systems significant impact . Improved and timely on BB work statutory reporting and ad hoc analysis for better manpower decision making and rationalization o f compliance between 10-25%. ' Management o f fiduciary risks . Support for anti-money laundering efforts

processes and

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2. Financial (see Annex 4 and Annex 5): NPV=US$ million; FRR = % (see Annex 4) The benefits accruing under this project cannot be fully quantified. Moreover, the earning capacity of BB i s not dependent on the reforms implemented under this Project but are primarily linked to the volume o f GOB's borrowing from BB. Improvements in the capacity to manage the public debt and a reduction in fiscal deficits may actually lead to a decline in BB's profitability. However, i t i s expected that BB's profits, which amounted to approximately US$140 mill ion in the year ended June 30,2002, will continue to be more than the debt service requirements under this Project.

Fiscal Impact:

The entire BB contribution to this project would be financed from i t s operational profit which amounted to Tk.8.35 bi l l ion (approx. US$140 million) last year. N o allocation from the national budget would be required. The fiscal impact arising from the lower transfers to the treasury by BB from i t s operational profits due to recurrent costs would be around US$3 mi l l ion per year during implementation.

3. Technical: The technical specifications for the automation o f BB have been prepared by the Computer Department at BB assisted by their IT consultant, working together with the Bank team. The technology chosen i s appropriate for BB and conforms to acceptable standards for a central bank. The technical specifications and the budget have been cleared with the Bank's Information Solutions Group (ISG).

The automation o f BB w i l l have spill-over effects in the banlung sector as the commercial banks would be forced to automate in order to submit the BB-required returns on-line. The automation o f the commercial banks will improve their productivitiy and the quality o f their services.

4. Institutional: The institutional arrangements for project design and implementation have been described above. I t i s evident that BB would require national and international experts to assist in the implementation o f the various components under this project. Therefore, national and international experts wi l l be hired to assist the management and staff to implement the project successfully and to train them adequately to sustain the changes after the project closes. BB's institutional capacity w i l l be strengthened substantially through this project which wi l l address the technical weaknesses identified in the Bank's strategy report and the reports issued by GOB's Bank Reforms Committee. Special focus w i l l be given to i t s supervisory and regulatory capabilities.

4.1 Executing agencies:

BB wil l be the executing agency. The national and international experts and f i r m s hired to assist BB w i l l be required to transfer technology by training the counterpart BB staff so that those staff can sustain the changes after the experts leave.

4.2 Project management:

The newly hired Deputy Governor from the private sector will be the Project Director (PD) and w i l l oversee the entire implementation o f the project together with the Modernization expert hired under this project. The PD w i l l receive assistance on policy matters from the Steering Committee and on implementation from the national and international experts and the respective BB task teams.

4.3 Procurement issues:

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IDA carried out an assessment o f the BB's procurement handling capacity following IDA'S procurement policies and procedures. For assessment, the team used the Bank's Procurement Capacity Assessment questionnaire and discussed with various BB personnel. The assessment included organizational aspects, sk i l ls o f staff, and suitability o f BB's procurement procedures. Based on the review, there are normal r isks associated with procurement under the project, as BB has prior experience in executing IDA financed projects. To mitigate r isks further, BB has agreed to appoint an individual procurement consultant on a full-time basis, as there will mostly be the procurement o f services under this project. BB hired an IT and a procurement consultant, using i t s own funds, for the preparation o f the bidding documents for the supply, installation o f the IT component.

Annex 6 describes a time-bound action plan for strengthening the procurement management capacity and advanced procurement arrangements.

4.4 Financial management issues:

The project financial management arrangements are satisfactory and an adequate financial management system i s in place. Agreement has been reached to address the weaknesses that have been identified during assessment, The factors considered for satisfactory fiancial management arrangements are: (i) The Forex Reserve and Treasury Management Department has extensive experience in managing DOSA accounts for Bank financed projects and has staff having previous experience in IDA project; (ii) The sound project FM system in FIDP implemented by another department o f BB has allowed satisfactory IDA fund disbursement based on Project Management Reports (PMRs); (iii) The project wi l l not experience delay in release o f government funds as the counterpart funds wil l be provided by BB from i t s own source; (iv) The high level commitment o f BB's top management and the Finance Division on various reform activities would be o f great help to address any potential weaknesses during project implementation.

The weakness in the project financial management system i s the absence o f a wel l coordinated management approach in the Accounts and Budget Department. Lack o f Coordination may lead to delay in receiving timely flow o f financial information, monitoring o f funding status and making periodic cash forecast for the project. It has been agreed that the Accounts and Budget Department would develop formats for financial data or information to be submitted at month end and would clearly indicate the input needed from different departments. The project has started a process to develop a M I S without having any link to project financial information. I t has been agreed that the M I S w i l l have features to receive financial data maintained by the Accounts and Budget Department so that there i s no discrepancy in project financial information. The system i s expected to be fully operational by December 3 1, 2003.

As the implementing agency for two IDA projects, BB demonstrated good financial discipline in the closed Flood Emergency Rehabilitation Project and has been complying with financial covenants in the on-going Financial Institutions Development Project (FIDP). BB's annual Financial Statements and accounts are audited by a private audit firm under an agreed TOR. That TOR w i l l be expanded to include an independant audit o f the Project account. The project account wi l l also be audited by the C & AG, which wil l provide a copy o f their report to the Bank.

4.5 Disbursement Issues:

Most o f the experienced and trained BB staff involed in earlier IDA Credits have moved to other departments o f BB. The current staff in the Accounts and Budget Department will require comprehensive training with respect to withdrawal o f funds from IDA Credit. This training will be completed by August 3 1,2003.

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5. Environmental: 5.1 Summarize the steps undertaken for environmental assessment and EMP preparation (including consultation and disclosure) and the significant issues and their treatment emerging from this analysis.

None.

5.2 What are the main features o f the EMP and are they adequate?

No t Applicable.

5.3 For Category A and B projects, timeline and status o f EA:

Environmental Category: C (Not Required)

Date o f receipt o f final draft: Not Applicable

5.4 H o w have stakeholders been consulted at the stage o f (a) environmental screening and (b) draft EA report on the environmental impacts and proposed environment management plan? Describe mechanisms o f consultation that were used and which groups were consulted?

No t Applicable.

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

Not Applicable.

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

There are no major social costs in this project. A Voluntary Early Retirement Scheme (VERS), based on consultation and sound social and economic analysis, i s offered to BB staff. The design o f the VERS package, to be financed entirely by BB from i t s own resources, considered al l aspects o f possible present and future financial and social impact on the employees. The analysis indicated that social cost o f early retirement would be negligible as BB staff had received generous housing loans early in their career, and were able to accumulate assets and income from this source. Furthermore, data show that BB staff have on average between 2.0 and 3.3 dependents, which indicate that after taking early retirement under VERS, they and their families would not face much hardship. BB would reserve the right o f refusal in order to retain better performing and ski l led key staff, and i s developing a selection criteria to choose staff for retention in a fair and transparent manner without the possibility o f patronage. BB has i t s own schools, a staff welfare fund, and medical benefits, the services o f which will be made available to departing staff and their children to further reduce the possibility o f any social costs.

Social development outcomes for this project include: (a) an efficient working environment by reducing conflicts and diturbances; (b) improved performance by a cohesive workforce; (c) increased transparency through an effective communications strategy; and (d) negligible social impact on staff opting for early retirement.

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

A communications program i s being developed for sharing information with staff, maintaining transparency in latest project developments, and preparing them for the forthcoming changes. An internal Committee has been established at BB to carry forward consultations and feedback from each Department. The reports o f the consultations were compiled and circulated through the internal BB newsletter. Several workshops were organized for developing a Communication for Reforms Strategy which has now been finalized. Similalrly, the communications program wil l also inform stakeholders outside BB about the progress in implementing the proposed changes.

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Participatory Approach Preparation Beneficiaries/community groups X

Intermediary NGOs

I Academic institutions I I I I

Implementation Operation X X

Local government

Other donors Other

6.3 H o w does the project involve consultations or collaboration with NGOs or other c iv i l society organizations?

Consultations were organized with staff and their Unions.

6.4 What institutional arrangements have been provided to ensure the project achieves i t s social development outcomes?

A Human Resources Development program, wi th proper incentives and career path, being developed in consultation with staff, w i l l be implemented under this project. Functional reorganization will be one o f the key components. Non-performing staff will be reduced by offering a suitable VERS. The legal framework has been strengthened to give BB greater autonomy. Capacity and skill o f remaining staff w i l l be enhanced through training and technology transfer. International standards in accounting and auditing w i l l be introduced.

6.5 How w i l l the project monitor performance in terms o f social development outcomes?

The communication program and MIS would track the social development outcomes. Within the proposed poverty and social impact o f reforms study, GOB would conduct periodic survey o f former public sector staff (including BB employees that received VERS) to monitor social development outcomes. A Counseling and Tracking Cell will be set up at BB under this project to track the progress o f a small sample o f departing staff over a number o f years.

X X X

7. Safeguard Policies:

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

- 1 8 -

Not Applicable.

~~

‘From Components to Outputs There may be delays in hiring consultants. There may not be supportive and close supervision and monitoring by BB and Bank. There may be lack o f close co-operation between MOF/BB and the Fund.

F. Sustainability and Risks 1. Sustainability:

Sustainability o f the Project beyond implementation depends on three factors: (a) capacity o f BB to attract high caliber, professional staff; (b) successful transfer o f technical knowledge by consultants to BB staff; (c) continued strict enforcement by BB o f the reform measures; and (d) continued efficient performance by BB. This project w i l l assist BB in attracting high caliber professional staff by changing recruitment and promotion policies and increasing the benefits that BB can offer i t s staff. Transfer o f technical know-how from consultants to BB staff would be an important component for evaluation o f the consultants. The consultants would work closely wi th the respective BB Teams and coach, train and mentor them constantly to ensure technology transfer. The Modernization Expert would work closely with the Project Director at BB and the core team in the CBSP Cell. Formal training programs would ensure that BB officials are trained properly so that they continue to perform effectively and efficiently.

2. Critical R i s k s (reflecting the failure o f critical assumptions found in the fourth column o f Annex 1):

Risk I Risk Rating From Outputs to Objective Strong local “ownership”, consensus and responsibility for effective implementation o f the project components may not be there. Core group o f committed BB professionals may not be available or wi l l ing to provide leadership. Timely resolution o f excess labor issues may not take place, and sufficient funds for severance payments are not budgeted.

Trade Unions may successfully resist or interfere wi th the implementation o f the reforms.

At least some o f the broader financial sector reforms may not be undertaken by GOB. Successful legal challenges may block the proposed amendments, or the decisions o f BB.

M

M

S

M

M

M

M

N

N

Risk Mitiaation Measure

Confirmation o f local “ownership” and zonsensus has been demonstrated by the passage o f the legal amendments and through implementation o f Negotiation conditions. The Core Group has been identified and appointed in the CBSP Cell to assist in the preparation and implementation o f this project. Resolution o f excess labor issues through a VERS, and allocation o f the budget for severance payments has been approved by BB Board. Attempts by Trade Unions to stop the reforms have been dealt wi th strictly by GOB and discussions with them to explain the reforms w i l l continue. Dialogue on a possible SOE and N C B Reforms Project i s progressing satisfactorily.

The Judicial Capacity Building Project, which i s under implementation, wi l l look into this issue, if it arises.

Consultants’ TORS have been finalized and RFPs w i l l be issued prior to Effectiveness. Bank Supervision Missions will include BB and GOB officials as members.

IMF inputs have been sought during preparations and greater coordination has been

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Overall Risk Rating

ensured through the joint FSAP missions. A representative from M O F has been included in the Steering Committee for implementation.

M Satisfactory implementation o f the risk mitigation measures w i l l ensure that the overall risk i s minimized. Vegligible or Low Risk)

3. Possible Controversial Aspects:

1. The staff rationalization through a VERS w i l l be controversial given i t s negative impact on the livelihood o f the staff leaving the organization. The negative impact would be minimized by offering a separation package to retiring staff and making the scheme voluntary rather than mandatory. 2. The delinking o f BB staff salaries from the civ i l service pay structure i s another politically sensitive issue for which GOB has committed to review a new structure after the new HR systems are in place.

G. Main Credit Conditions 1. Effectiveness Condition

e Legal opinion confirming that the Development Credit Agreement and the Project Agreement have been duly authorized or ratified by the Borrower and Bangladesh Bank and are legally binding upon GOB and BB respectively. Signing o f the Subsidiary Loan Agreement (SLA) between GOB and BB and legal opinion on the SLA.

e

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

Financial Management Condition

The Central Bank Strengthening Project Cell at BB shall maintain, throughout the project implementation period, a satisfactory financial management system in accordance with the agreement reached during negotiation. The Cell shall, no later than November 15,2003, start preparing and submitting to IDA the quarterly Project Financial Monitoring Reports (FMRs.)

H. Readiness for Implementation 1. a) The engineering design documents for the f i r s t year's activities are complete and ready for the

1. b) No t applicable. start o f project implementation.

3 2. The procurement documents for the f i rs t year's activities are complete and ready for the start o f project implementation.

quality. 3. The Project Implementation Plan has been appraised and found to be realistic and o f satisfactory

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

This Project i s expected to become Effective by August 1,2003.

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1. Compliance with Bank Policies

c 2. The following exceptions to Bank policies are recommended for approval. The project complies

.

1. This project complies wi th al l applicable Bank policies.

with all other applicable Bank policies.

n /7

Shamsuddin Ahmad Team Leader Sector ManagerlDirector

&seph del mar Pemia

- 2 1 -

Annex 1: Project Design Summary BANGLADESH: Central Bank Strengthening Project

Hierarchy of Objectives iector-related CAS Goal: i n efficiently operating ianking sector, conducive o sustained, ion-inflationary, ob-creating economic yowth.

'roject Development Ibjective: To achieve a strong and :ffective regulatory and ,upervisory system for 3angladesh's banking ,ector.

Key Performance Indicators

Sectorhdicators: 0 Domestic Savings and Gross Investments rise from 18% and 23% o f GDP to 20% and 25% o f GDP by 2006.

Deposits increase by at least 10% each year, beginning 2003. 0 Current account deficit contained within 5% o f GDP every year beginning 2004,

Outcome I Impact Indicators: 1. BB entered into MOUs with al l banks (both public and private) that failed to meet the minimum capital adequacy requirements, by December 3 1,2005, to enhance the soundness o f banking sector. 2. BB entered into MOU with al l banks (both public and private) that failed to make full bad debt provisions, by December 3 1,2005, to strengthen the financial position o f banks.

Data Collection Strategy

iectorl country reports: 'eriodic Review o f iational Accounts and 3angladesh Bank generated lata

'roject reports:

3angladesh Bank generated lata.

3angladesh Bank generatec lata.

From Goal to Bank Mission) Continued GOB

ommitment and capacity D implement banking ector reforms. 1 Stable nacro-economic and iolitical environment. 1 Positive response by usiness and industry to ianking sector reforms.

from Objective to Goal)

1 Strong GOB and 3angladesh Bank lwnership for the outputs )f the project.

1 Availability o f an nitial core group o f :ommitted central bankers vith integrity and jedication, willing to iccept the challenge o f mplementing the reforms.

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2omponent: 4mended legal framework BB Circulars to ensure the

(from Outputs to Objective)

0 Strong local "ownership", consensus and responsibility for effective implementation o f the project components.

0 Core group o f committed BB professionals available and willing to provide leadership.

0 Excess labor issues resolved in a timely manner and sufficient funds allocated to finance the VERS.

0 N o successful attempts by Trade Unions to resist or interfere with the implementation o f the reforms

rov id ing adequate iutonomy and ndependence to BB, Iperationalized.

rraining needs assessment md plan.

3B reorganized, fully iutomated, and staffed idequately wi th skilled ifficers.

Some broader financial sector reforms undertaken by GOB.

0 N o legal challenges block the proposed amendments or the BB decisions.

soundness and stability o f the banking system enforced effectively, by December 3 1,2005. BB staff trained to implement effectively AML/CFT provisions in the law, by December 3 1, 2004. Systems installed in BB to capture and share data on ML/FT, by June 30,2006. New BB Organogram showing three major wings according to i t s three core functions, adopted by June 30,2004. Functioning o f BB streamlined by reducing i t s hierarchy from nine to seven layers, by December 3 1,2006.

Key staff in computer department receive adequate training by December 3 1,2004. BB work processes fully automated by December 3 1, 2006. About ha l f o f a l l the commercial banks report to BB on-line by June 30, 2006.

Modem HR policies adopted by BB, by December 3 1,2004. BB's skill level enhanced through recruitment o f around 100 fresh graduates each year, f rom year 2004, under new recruitment policy.

Data Collection Strategy Critical Assumptions

Iroject reports:

iB and supervision nission reports. Jopies o f new BB Jirculars issued. )atabase on ML/FT.

Jew BB Organogram.

3B Office Orders.

Nork Stations at BB and upervision mission eports.

IR Policy Manuals.

Zecruitment data.

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3B's capacity enhanced in he areas of: research; rudential regulations and upervision; and .ccounting and auditing tandards.

Training needs assessment o f BB officials completed and training plan initiated, by June 30,2004. A modem performance management system in place by December 3 1, 2004.

Quality research reports on vital issues, such as inflation, interest rates and spreads, etc., prepared and disseminated by BB, by December 3 1,2005.

A l l private domestic banks comply wi th BB's capital adequacy requirements by March, 2005. Al l private domestic banks comply with BB's loan classification and provisioning standards by December 3 1,2004. Bank Supervisory Policy Manual upgraded by June 30, 2004. BB comply fully with Basle Committee's Core Principles o f Bank Supervision, by June 30, 2007. Supervisory staff training plan adopted and implemented b y December 31, 2005.

International central banking accounting and auditing standards adopted by June 30,2004. BB's Financial Statements for the year ended 2003, and onwards, prepared according to international standards.

3B research reports.

2uarterly BB reports.

Jpgraded Bank iupervisory Policy danual.

3B's Financial Statements.

3B and supervision nission reports.

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'Project Components I 1 Sub-components: l 1. Strengthening the 'Legal Framework. 2. Reorganization and Modernization of BB. 3. Capacity Building of BB.

14. Unallocated.

nputs: (budget for each :omponent) I. US$0.48 mill ion

US$28.83 mill ion

3 . US$4.40 mill ion

1. U S 3 . 2 9 mill ion

'roject reports:

. Quarterly BB reports.

!, Annual audit reports.

i. Disbursement reports.

from Components to )utputs) i) no delays in hiring onsultants; ii) no shortage o f BB unds; iii) supportive and close upervision and monitoring iy BB and Bank; iv) close co-operation ,etween MOF / BB and the knd v) IT systems installed roperly and functioning as )lanned. vi) Vested interests within 3B do not oppose changes.

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Annex 2: Detailed Project Description BANGLADESH: Central Bank Strengthening Project

The proposed project supports implementation of 66's strengthening program by providing assistance in three major areas: (1) Legal framework; (2) Reorganization and modernization; and (3) Capacity building. By Component:

Project Component I - US$O.SO million STRENGTHENING THE LEGAL FRAMEWORK -- The legislative changes to the existing legal framework to strengthen BB's authority and autonomy, and to streamline i t s internal operations have been passed by Parliament in the form o f amendments to the Bangladesh Bank Order (BBO), the Banking Companies Act (BCA), and the Bangladesh Banks (Nationalization) Order, thus ensuring the sustainability o f the changes. The amendments have enhanced the legal standing o f BB and i s adequate to support the changes proposed under this project. However, the three laws could be modernized further to incorporate international good practices and the recommendations o f the Financial Sector Assessment Program. Therefore, further strengthening o f the three laws would be carried out during the term o f this project. Moreover BB would be assisted by experts on AML/CFT to establish an effectively functioning AMLKFT regime. This component i s made up o f the following activities:

(i) Legal Counsels. The large number o f directives issued b y BB, pending court cases, and the long delays in litigation point, in part, to the need for competent and continuous legal advice within BB in the form o f a full-time, in-house legal experts. Central banks and bank supervisors with competent legal departments are better able to manage crisis, implement and enforce laws. The business o f regulating and supervising banks requires extensive legal interpretation and legal compliance. The central bank, as a quasi administrative and legal body exercising legal powers under the law, needs to ensure that i t s actions are valid and are within the law. I t is, therefore, necessary for BB to engage highly competent in-house counsels to provide legal advice on central banking and bank supervisions matters. The proposed Project would finance the engagement o f a legal firm which would provide two professional banking lawyers with drafting experience. These counsels would help to translate the goals and objectives o f the BBO, BCA, and the reorganization and reengineering o f BB into appropriate and workable directives. In addition, they would help update, at the specific request o f BB, both the B B O and the B C A to transform them into modem pieces o f legislature, thereby enabling BB to carry out i t s central banking and bank regulatory and supervisory roles more effectively. The consultant would also update the Financial Institutions Act, 1993, and review the need for a law to encourage mergers between banks as an exit mechanism. For purposes o f capacity building, BB would hire at least two junior lawyers as regular BB staff who would be trained by the professional lawyers and ultimately carry out the legal advisory work in BB. (Cost: US$0.30 million. Funding: IDA - US$0.24 million; BB - US$0.06 million)

(ii) Anti Money Laundering and Countering of Financing of Terrorism. Bangladesh did not have any specific AMLKFT measures in place until the enactment o f the Prevention o f Money Laundering Act 2002, which was passed on April 7,2002 ( AML Law). The Money Laundering Prevention Department in Bangladesh Bank issued Circular No. 2 to all commercial banks on July 17, 2002, for compliance with the AML Act. Since the law has j u s t been passed, the implementation and setting up o f the necessary mechanisms and training o f staff are crucial issues to be dealt with. Moreover, the limitations in the law have to be addressed so that the AMLKFT offences are clearly defined and al l relevant financial institutions are brought within the purview o f the AML law. The law has to also provide clear provisions on the powers and duties o f Financial Intelligence Unit (FIU), the enforcement powers and arrangements, international cooperation and reporting requirements. Apart from that, Circular No. 2 issued to the banks has to be greatly enhanced and issued to a l l the relevant entities.

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BB needs to ensure that all the financial institutions are implementing the AML/CFT requirement. Appropriate training will have to be intensified. Sufficient resources will be set aside for the FJU, training and enforcement efforts. Steps w i l l be taken to foster greater cooperation between the regulatory authorities and enforcement authorities. Systems w i l l be installed to capture and share data and statistics on ML/FT. Bangladesh has to s i g n and ratify the relevant conventions and draw up procedures for international cooperation. To assist in this regard, an international expert on AML/CFT will be hired under the Project, who w i l l also contribute towards the establishment and functioning o f an effective AML/CFT regime in Bangladesh. (Cost: US$0.30 million. Funding: IDA - US$0.24 million; BB - US$0.06 million)

Project Component 2 - US$36.79 million REORGANIZATION AND MODERNIZATION -- The legal amendments provide BB with sufficient legal authority to act as an independent central bank charged with the responsibility o f formulating a prudent monetary policy and ensuring the soundness and stability o f the banking system. To discharge this responsibility effectively and efficiently, BB would need to re-align i t s organizational structure, operational systems and business processes, and human resources to the new mandate. In this regard, BB has to address three major inter-linked tasks: one i s to reorganize i t s Departments around the three core functions; second i s automation o f the whole business transactions and work flows to improve efficiency; and the third i s to upgrade i t s human resources to operate the new systems in the new environment. This component i s made up o f the following sub-components:

A. Functional Reorganization. The BB Committee that reviewed the Study on Functional Re-organization and Human Resources Development, carried out by the PHRD funded consultants, endorsed a new organization structure which features a flatter organization with shorter l ines o f command and alignment o f departments with core functions. I t s new organogram wil l reflect this functional arrangement which wil l lead to closure and/or merger o f those Departments that are considered redundant and removal o f redundant layers in the l ines o f command so as to enable fast decision-making. This subcomponent wi l l have the following activities:

(i) Organization and Management Experts. The organization structure would be changed to realign Departments around the three core functions, which are: monetary policy; bank supervision and regulation; and reserve management and prevention o f money laundering. All the other Departments outside the core functions would be grouped together and phased out over time. Moreover, redundant layers in the hierarchy would be removed. Short term consultants experienced in organization and management would be hired by BB to assist in the implementation o f the new organization structure. Such consultants would be financed under this Project. (Cost: US$O. 15 million. Funding: IDA - US$0.12 million; BB - US$0.03 million)

(ii) Modernization Expert. BB i s about to embark on a long-term modernization program with the ultimate objective o f transforming itself into a modern, effective and efficient central bank. To this end, the Project would fund an internationally experienced change management professional, to be called the Modernization Expert, who wil l assist BB management to develop, implement and monitor an agreed change process in a conservative corporate environment. The Modernization Expert will be supported by national experts and this Team would be hired before Credit Effectiveness to act as the expert change management resource reporting to the Project Director. (Cost: US$l.05 million. Funding: IDA - US$0.84 million; BB - US$0.21 million)

B. Automation. To improve efficiency and effectiveness, BB intends to move from a manual mode for carrying out i t s core functions to an electronic mode. Such a move will streamline the delivery o f i t s services, strengthen the operational and administrative activities, and provide timely, comprehensive,

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accurate and relevant information to the top management o f BB. To help this process, an Information Systems Strategic Plan (ISSP) was formulated by BB with the help o f international consultants. The ISSP derived the hardware and software requirements from an analysis o f the fundamental business processes carried out by BB, and the information requirements and information flows associated wi th these business processes. I t then identified specific information systems that would need to be implemented to satisfy these requirements. I t also identified priority applications on the basis o f need and opportunity as determined by BB management. I t estimated the cost and time required for implementation o f the systems and the specific items o f hardware and software that would need to be acquired. I t included an implementation plan and suggested a phasing o f activities in accordance with management priorities and the absorptive capacity o f BB. I t identified the human resource requirements for implementing the plan and derived a training plan for existing staff to be augmented by additional recruitment. The proposed ISSP has the potential to transform BB and introduce modem banking and management practices, thereby strengthening the financial sector and providing a demonstration effect on the scheduled banks. The road map provided under ISSP would be implemented under the project which would finance the supply, installation, commissioning, training and operational support for the entire automation. The implementation o f this component would be monitored and supervised by an international IT Manager hired under this Project. (Cost: US$3 1.89 million. Funding: IDA - US$24.91 million; BB - US$6.98 million).

C. Human Resources Development Program. The proposed changes in the organization structure, business processes, and operational systems wil l have to be complemented by a strengthening o f the staff ski l ls to operate the new systems and processes. At the heart o f a l l organizational efficiency and effectiveness i s the quality o f the human resources. Reorganization will be meaningless if it i s not backed up by skilled staff that are motivated and eager to take up the challenge o f creating an excellent institution. This component will address the problems identified so far in the area o f human resources. With the help o f HR experts, new HR policies will be prepared and implemented with the objective o f upgrading the sk i l ls at BB, bringing in new ski l ls , and maintaining the s k i l l level. To provide for staff that do not meet the required level o f sk i l ls in the restructured central bank, a voluntary early retirment scheme (VERS), financed completely by BB from i t s own resources, would be announced for an orderly exit. The proposed project would support the adoption o f sound policies and best practices wi th regard to: human resource planning; recruitment o f new skil ls; promotion and rotation; compensation; development o f specialist career streams and a “fast-tracking’’ policy; and performance management to attract, motivate and retain qualified staff.. Moreover, job functions and descriptions w i l l be developed for the core departments. This subcomponent will have the following activities:

(i) HR Advisors. At present, there i s no professional HR staff at BB. Given the major changes envisaged in the HR area, a Resident HR Advisor will be needed for a period o f three years to advise and develop new HR policies and assist in their implementation. The Resident HR Advisor w i l l be assisted by a national HR expert and both will work closely with the Modernization expert to ensure that the new policies are in l ine with the change program. Furthermore, two junior officers have been selected to j o i n the Personnel Department and are being trained on HR management to carry out the HR functions at BB. The cost o f the HR Advisors, wi l l be supported under the proposed Project. (Cost: US$0.65 million. Funding: IDA - US$0.52 million; BB - US$0.13 million)

(ii) Counseling and Tracking Cell. In order to provide counseling to those staff that opt for the VERS, and to track the progress of a small sample, over a number o f years, a Counseling and Tracking Cell will be set up at BB. The Cell would be staffed by professionals on a contract basis, who would counsel departing staff on demand, and keep track o f retirees’ status and record the experience for future reform programs. The financing o f the contract would be provided under this Project. (Cost: US$0.05

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million. Funding: IDA - US$0.04 million; BB - US$O.Ol million)

(iii) Training and Management Development Program. One o f the f i r s t tasks o f the HR Advisors would be to carry out a comprehensive training needs analysis (TNA), which would include behavioral as well as technical training priorities. N o behavioral training exists at all for staff or managers. The TNA w i l l include a s k i l l s audit to prepare an inventory o f existing sk i l ls in BB. The gap between the existing and required ski l ls wi l l also be filled by fresh recruitment and training, where needed. As new HR policies are rolled out, there will need to a be a large communications and training effort (including behavioral training), to assist with the comprehension and application o f the policies. Once basic key competencies are agreed, as the basis for a l l future HR policies, extensive training wil l need to begin. Both local and international training in the core areas o f central banking would be needed to upgrade the sk i l l s that the new organization would demand and expect f rom all staff. Specially tailored management development programs would be arranged through local and international training institutes for the middle management at BB. The cost o f the training identified by the TNA would be financed under this Project. (Cost: US$3.0 million. Funding: IDA - US$2.4 million; BB - US$0.6 million).

Project Component 3 - US$ 5.45 million CAPACITY BUILDING -- Among the specific areas that have been identified for strengthening under this Project are: (i) the Research Department o f BB; (ii) the prudential regulations and supervision functions; and (iii) the accounting and auditing functions. This component i s made up o f the following sub-components:

A. Strengthening the Research Department. An important department in most central banks around the world i s the Research Department. The Department assists the bank in i t s role as an advisor to the Government on economic and fiscal policy issues. Although BB has a Research Department, the quality o f analysis and research done at present i s an area o f concern for senior management. The reasons for the low quality o f output include: inadequate sk i l ls and analytical capacity; lack o f access to modem information technology; and inadequate integration within and outside BB. The World Bank Institute (WBI) has agreed to provide assistance to BB in strengthening the Research Department. Such assistance wil l include a diagnostic review o f the Department with a view to developing a plan for upgrading i t s capacity in research and policy analysis o f direct relevance to BB operations. Such a plan wil l not only include the recruitment o f required experts but also a training plan for upgrading sk i l ls and improving product lines, the cost o f which will be funded under this project. (Cost: US$2.15 million. Funding: IDA - US$1.74 million; BB - US$0.41 million)

B. Strengthening the Prudential Regulations and Supervision. The Base1 Committee recognizes that effective banking supervision requires a number o f preconditions. These include sound, credible and sustainable macroeconomic policies, well developed commercial and securities laws and judicial systems, mechanisms to encourage sound corporate governance, well developed and enforced accounting and auditing standards and practices, structures to facilitate market discipline in the banking and corporate sectors and procedures for resolving bank distress and failure events. Although Bangladesh has made some progress within the last few years in a number o f the above areas, the country s t i l l has a long way to go towards achieving the goal o f meeting the general preconditions for effective banking supervision. According to the recent FSAP report, the on-site examination process o f BB i s weak since it fails to assess banks’ systems for monitoring and managing i t s operations and to address the risks that a bank incurs in the normal course o f i t s business. The off-site examination process i s not adequate since i t lacks the necessary information to perform an adequate analysis o f a banking institution’s financial position. Moreover, BB has not fully commenced the evaluation o f banks’ systems for combating money laundering. At present, a bank supervision expert financed by the US Treasury i s assisting BB in

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upgrading i t s off-site supervision capacity. Lastly, the training o f the examiners has not kept pace wi th the rapid changes in the global banking industry. The necessary support to further strengthen the supervisory and regulatory role o f BB w i l l be provided under this subcomponent which wil l have the following activities:

(i) Bank Supervision Experts. To assist BB in developing i t s supervisory and regulatory role, two resident bank supervision experts w i l l be recruited for a period o f two years. One expert would provide guidance and support in designing a strategy for financial sector regulation and to advise on new bank regulation policy. This consultant would assist in defining a new set o f prudential regulations as well as in designing the reporting and enforcement sanctions. The other expert would be responsible for bank examinatiodsupervision, and would be expected to review the existing methods and tools for on-site supervision and suggest improvements and provide general on-the-job training. (Cost: US$0.40 million. Funding: IDA - US$0.32 million; BB - US$O.OS million)

(ii) New Management Team for one NCB. The amendments to the Banking Companies Act w i l l bring the four NCBs under the full supervisory authority o f BB for the f i rs t time in their history. Given the poor condition o f the NCBs, it i s expected that BB wil l have to place them in the category o f “problem banks” and enter into Memorandum o f Understanding (MoU) with them to monitor their performance on a regular basis. Furthermore, the Ministry o f Finance, as the owner o f these banks, has agreed to hire an experienced CEO and a management team for one o f the NCBs to restructure i t for possible privatization. The cost o f the CEO and management team for the N C B w i l l be financed under this Project. (Cost: US$2.0 million. Funding: IDA - US$1.6 million; BB - US$0.4 million)

C. Strengthening the Accounting and Auditing Standards. A recent IMF mission on Safeguards Assessment reviewed the accounting, auditing and control systems at BB and made recommendations to ensure the transparency and accountability o f BB’s operations and to mitigate risks. Furthermore, IMF has agreed to provide assistance to BB in adopting International Accounting Standards (IAS) as BB’s accounting framework beginning with the financial statements for the end o f FY03, and International Standards on Auditing (ISA) as the auditing standard. To complement the Fund’s assistance, BB would hire Chartered Accountants (CAS) for i t s accounting and audit functions. An internal audit cell w i l l be set up to carry out internal audit on a regular basis. The Cell wi l l report directly to the Governor. As the existing salary scale i s not sufficient to attract experienced CAS, they would be hired on contract wi th funds from this Project. BB has agreed to hire a reputable local auditor with international affiliation to audit their FY03 accounts -- their first financial statements after adopting I A S . The cost o f this ISA audit, certified by the international associate, would be financed under this Project. Subsequent annual audits would be carried out by local auditors financed by BB from i t s own resources. (Cost: US$0.90 million. Funding: IDA - US$0.74 million; BB - US$O. 16 million).

Project Component 4 - US$3.29 million Unallocated -- As a follow-up to the FSAP recommendations, the Bank and the Fund are continuing the dialogue wi th BB/GOB on their implementation. The two key areas where discussion i s continuing relate to: (i) securing professional management and international experts for the remaining two NCBs; and (ii) assisting in the privatization o f Rupali Bank Ltd., the smallest NCB. As and when agreement i s reached in these two areas, the financing o f these activities may be made from the unallocated funds at the request o f BB. More generally, the unallocated funds would finance any shortfall in implementing the above activities.

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Annex 3: Estimated Project Costs BANGLADESH: Central Bank Strengthening Project

Total Project Costs Total Financing Required

Project Cost By Component

14.17 31.96 46.13

I. STRENGTHENING THE LEGAL FRAMEWORK 11. REORGANIZATION AND MODERNIZATION

A. Functional Reorganization B. Automation C. Human Resources Development

A. Strengthening Research Department B. Strengthening Prudential Regulations and Supervision C. Strengthening the Accounting and Auditing Standards

111. CAPACITY BUILDING

IV. UNALLOCATED Total Baseline Cost

Physical Contingencies Price Contingencies

Local US $million Project Cost By Category

0.12

0.24 10.88 1.40

0.40 0.88 0.25 0.00

14.17 0.00 0.00

Foreign Total US $million US $million

Foreign 1 Total

Unallocated Total Proiect Cost:

0.48

0.96 21.01 2.30

1.75 1.52 0.65 3.29

31.96 0.00 0.00

0.00 3.29 3.29 14.17 3 1.96 46.13

0.60 0.00 1.20

31.89 3.70 0.00 2.15 2.40 0.90 3.29

46.13 0.00 0.00

Goods Works Consultant Services including Local Training Foreign Training Incremental Operating Costs

3.54 0.00 3.63 0.00 7.00

20.05 0.00 7.12 1.50 0.00

23.59 0.00

10.75 1 S O 7.00

Total Financing Required 1 14.17 I 31.96 I 46.13 1 I

Identifiable taxes and duties are 0 (US%m) and the total project cost, net o f taxes, is 46.13 (US$m). Therefore, the project cost sharing ratio is 80.21% o f total project cost net o f taxes.

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Annex 4: Business Benefits Review BANGLADESH: Central Bank Strengthening Project

enefits for compliance, :gulatory and control ,amework Improved regulatory framework supported by automated information systems Improved and timely statutory reporting and ad hoc analysis for better decision making and compliance Management o f fiduciary risks Support for anti-money launderinp. efforts

The biggest component in this Project i s the Automation component (USS3 1.89 million) which w i l l finance the supply, installation, commissioning and maintenance o f the information systems at BB. The investment in computerization o f BB i s expected to enhance efficiency and effectiveness o f BB. I t w i l l streamline the delivery o f i t s services thus reducing the cost o f the financial institutions dealing with BB. I t wi l l also streamline i t s own operational and administrative activities and provide timely, comprehensive, accurate and relevant information to the top management o f BB. As i s the practice with al l IT investments, the team carried out a "business benefits" review with BB management, the details o f which are provided below:

W o r k process and manpower efficiency

Automated information systems w i l l have a significant impact on BB work processes and manpower rationalization o f between 10-25%.

lusiness Functional Area md IT Enabler

Financial statements as per Intemational accounting standards as agreed with IMF Better classification o f

hera l l ISSP Project

ipplication software suite or Banking, Treasury, kcounting, Budgeting, luman Resources, Data varehouse and Clearing louse

Manpower and work processes w i l l be adjusted downward and redeployed to higher value work

kcounting -

:inancia1 statements and ieneral ledger, Purchasing Ind goods receipt, iccounts Payable, iccounts Receivable and itaff loans, purchasing and :xpenditure mgt and Fixed isset register

hterprise Resource 'lanning (ERP) such as IAP, Oracle Financials or 'eoplesoft

hdgeting

Cost center hierarchy for budget Budget distribution and controls

ISSP nternal Process lfficiency

'ransforming Bangladesh - - lank into a modem centra ank with management an usiness practices that are ased on best practice

mproved image o f the langladesh Bank

Abil ity to produce BB financial statements as per Intemational Accounting standards and foster transparency Daily closing o f accounting ledgers instead o f 6 days to 1 month behind schedule Consolidated chart o f accounts with easy ability to restate accounts Abil ity to process workload o f 1000 paymentsiday and reduce cycle time from : days to 1 Reduce time taken to prepare transactions anc voucher entry

Ability to distribute udgets at l ine item level y cost centers Ex-ante controls on ever) xpenditure Better budget

usiness Benefits enefits to internal and iternal clients

nproved services to angladesh citizens and to cheduled banks

nproved financial sector xformance and reduced ansaction costs

Transparency o f accounts Timely payments as per service standards Facilitate reporting to donors by project Better relationships wit1 scheduled and foreign banks Reduce reputational risk due to inconsistent reporting o f financial risk Faster payments to vendors and staff

Managers w i l l have :tter and early iformation on budget ssition

Jdget No risk o f exceeding

Better budget ianagement

Risk management anc nproved controls

Review o f value ided services based on

lanpower may need to e redeployed

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. Monitoring against available budget

ERP solution with Budget management Human Resources . HR administration . Benefit administration . Payroll . Recruitment . Training

ERP Solution with HRMSPayroll

BB management wi l l receive accurate HR data for decision making Better strategic staff planning Abil ity to use HR data for workflow process and approvals Integrated HR data for budget Daily statements to Govt except for Sonali Provision for budget for bond payments, minting

Banking I Treasury Operations . Current & Govt accounts . Chequesiteller . Trade finance . Cash&vault . Term deposit . Loan accounts

Bankingmreasury packages such as Globus Temenos, I-Flex Flexcube and Profile

Manpower rationalization in HR with 10-20% redeployment

Possible manpower rationalization after implementation o f new systems

Banking Supervision and Credit Information Bureau

Foreign Exchange policy

Statistics and Econometric Modeling

Data Warehouse with modeling tools

ianagement

Timely processing o f HR actions Better HR information for decision making Accurate and timely payroll payments Reduce administrative costs for leave and medical reimbursement Availability o f training data Daily closing o f receiptsipayments o f Govt d c Reduce cycle time for updating debt mgt position Improved management o f treasury bills/bonds reducing errors in manual processes Analysis and projections o f remittance clearance & credit Integration w i l l reduce voucher processing Reduce 40-day cycle time for banking inspection through ready availability o f data and analysis Abil ity to ensure completeness o f Bank return submissions and timely update Abil ity to accurately analyze data and ‘slice & dice’ using latest data for supervision rather than last fiscal year Better and easy access tc individual credit data Reduce backlog o f 3-6 months for offsite inspection to make timely decisions Automate classification o f loans and improve targeting for inspection Collection, validation and reparatory work for deposits and advances, monetary data, macro financial data, balance 0:

payments and surveys Improved license reques’

Ability to cost services

BB staff w i l l benefit with timely processing o f HR actions and accurate payroll payments Targeted training as part o f individual learning plan Payroll statements and leave status

Improved communicatior with Correspondent banks

Reduced reporting burden for scheduled Banks Banks can review BB analysis o f scheduled bank Reduce cycle time to respond to credit request! and exceed service standards For some cases, provide for online access to credi rating Improved monitoring anc adherence to norms, projection for balance o f payments

Accurate information to management for actionable items Support to anti-money laundering task Improve controls to prevent frauds and forgery Follow up on complaints against banks Better decision making with a strong statistical system Improved management o f BOP Analytical reports for Ministry o f Finance, Ministry o f Commerce

.dditional workload in be managed with risting staff

ieed for better Jmputer ski l ls

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I processing and monitoring o f non-compliance on foreign exchange Reduced cycle time for clearing in-station cheques from 3 days to 1 day Outstation cheques clearance cycle time will be reduced from 30 days to about 3 days Calculation o f interest for National Savings

Package solutions and MICR technology

I Customers benefit with improved check collection

participating banks . Efficient operations for

Ready provision o f data to Comptroller General Statement to MMTU and BB management

Improved work processes

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Annex 5: Financial Summary BANGLADESH: Central Bank Strengthening Project

Years Ending June 30

5.6 10.7 6.0 3.7 1 .o 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

I IMPLEMENTATION PERIOD [ Year1 I Year2 [ Year3 I Year4 I Year5 I Year6 I Year 7

Total Financing Required Project Costs Investment Costs 16.2 11.7 7.0 3.2 1 .o 0.0 0.0 Recurrent Costs 0.0 0.0 1 .o 3.0 3 .O 0.0 0.0

Total Project Costs 16.2 11.7 8.0 6.2 4.0 0.0 0.0 Total Financing 16.2 11.7 8.0 6.2 4.0 0.0 0.0

IBRDIIDA Government

Central Provincial

Co-financiers Jser FeeslBeneficiaries I Other -- Bangladesh Bank

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Annex 6: Procurement and Disbursement Arrangements BANGLADESH: Central Bank Strengthening Project

Procurement

General Description

1. “Guidelines for Procurement under IBRD Loans and I D A Credits”, published in January 1995, and revised in January and August 1996, September 1997, and January 1999. Consulting services and training w i l l be procured in accordance with the Bank’s “Guidelines: Selection and Employment of Consultants by World Bank Borrowers, ” published in January 1997, and revised in September 1997, January 1999, and M a y 2002.

All IDA-financed procurement o f goods and works w i l l follow procedures outlined in the Bank’s

Goods (US%24.09 million)

2. Operational Support: This w i l l be a single responsibility goods-contract-package for automating the BB information systems and i t s business operations. The procurement w i l l be carried out following the ICB method. The scope o f this contract package w i l l include supply & installation o f hardware [computers, servers, printers, furniture etc.] for ISSP and A C H , networking, software [system software, application development tools, data management software, business application software, payment and clearing software, anti virus software etc.], integration & commissioning o f the automated system, training o f BB staff and operational support to the automated system for a period o f three years. The estimated cost o f this contract package i s US$23.59 mil l ion and this procurement w i l l be subject to IDA’S prior review.

Supply, Installation & Commissioning of Information System, and its Maintenance and

3 . Other Goods: During implementation o f the project, some small valued office equipment, furniture and other miscellaneous items may be procured as per the needs o f individual consultants. These are estimated to cost US$500,000 and would be procured following the NCB or Shopping procurement methods, depending on the estimated cost for each contract package and as per provisions under Table B.

Consultants’ Services including Training (USH2.25 million)

4. Consultants’ services under the Project w i l l involve selection o f both f i r m s and individual consultants. The individual consultants are likely to include - AML/CFT Experts, International HR Advisor, National HR Expert, Professionals for the Counseling and Tracking Cell, Program Manager for supervision o f implementation o f the BB Information Systems, Local IT Experts for the Program Management Team, Procurement Consultant, Experts for HRD Training courses, experts for BB’s Research Department, and Accounts and Audit Specialists. The selection o f individual consultants wil l be made in accordance with Section V o f the Consultants Guidelines.

5. legal firm for legal counsels, different institutes/organizations for training o f BB staff, Organization & Management Experts, Bank Regulation and Supervision Experts, a consulting firm for strengthening BB’s research department, and a CEO plus a team o f experts for new management o f one NCB. The f i r m s w i l l be selected following the QCBS method.

Selection o f f i r m s wi l l include - Modernization Experts, an international audit firm for BB, a

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6. at different instituteslorganizations abroad i s around $1,500,000. The selection o f training instituteslorganizations w i l l be on Single-Source basis.

The aggregated estimated cost for the staff training progradmanagement development program

Operating Cost [Recurring Costs Associated wi th the Information System] (US%7.0 million)

7. The operating costs that the IDA credit w i l l finance are the costs o f supplies, consumables, rent for VSAT circuit/WAN Link, fees for software upgrading, and post-warranty costs which Bangladesh Bank will incur for the operation and maintenance o f the new IT system. The Project wi l l finance 70% o f the operating costs incurred in FY04 and FY05, and 50% thereafter.

Procurement and Selection Planning

8. The Procurement Plan for goods and works and the Selection Plan for services have been prepared. The Procurement Plan will need to be updated annually. The revised Plan shall be submitted to IDA every year for i t s review and approval. Procurement o f goods and selection o f a l l consultants w i l l be undertaken in accordance with Plans approved by IDA and with the provisions o f said paragraph 1 o f Appendix 1 o f the respective Guidelines.

Use of Standard Documents

9. For procurement o f information systems, the use o f IDA’s Standard Bidding Documents for Supply and Installation o f Information Systems i s mandatory. For selection o f consulting f i rms, the Bank’s Standard Request for Proposals (RFP) including standard contract form w i l l be used. The Bank’s Standard Bid Evaluation Form for goods and Sample Form o f Evaluation for Selection o f Consultants will be followed for submission o f evaluation reports to IDA.

Pr ior Review Thresholds

10. or more irrespective o f procedures. All other contracts w i l l be subject to post review by IDA.

Goods: IDA will carry out prior review o f a l l contracts estimated to cost US$200,000 equivalent

11. estimated to cost US$lOO,OOO equivalent or more for f i r m s and US$50,000 equivalent or more for individuals. Training activities on single source basis w i l l be with IDA’S prior agreement.

Consultants’ Services: IDA’s prior review w i l l be required for consultants’ services contracts

Post Review

12. For compliance with the Bank’s procurement procedures, IDA w i l l carry out sample post review o f contracts that are below i t s prior review threshold. Such post review o f contracts below the thresholds wi l l be carried out for approximately up to twenty percent o f the contracts awarded, using a three-pronged approach: (a) desk reviews o f selected contracts forwarded by the borrower to IDA at i t s request; (b) on-site reviews during the supervision missions; and (c) reviews by external consultants.

Acceptability of NCB

13. provisions o f Section I o f the Procurement Guidelines:

In order to ensure economy, efficiency, transparency and broad consistency with the

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standard bidding documents approved by the Association shall be used;

invitations to bids shall be advertised in at least one widely circulated national daily newspaper and bidding documents shall be made available to prospective bidders, at least 28 days prior to the deadline for the submission o f bids;

bids shall not be invited on the basis o f percentage premium or discount over the estimated cost;

bidding documents shall be made available, by mai l or in person, to a l l who are willing to pay the required fee;

foreign bidders shall not be precluded from bidding and no preference o f any kind shall be given to national bidders;

qualification criteria (in case pre-qualifications were not carried out) shall be stated in the bidding documents, and if a registration process i s required, a foreign firm determined to be the lowest evaluated bidder shall be given reasonable opportunity o f registering, without any let or hindrance;

bidders may deliver bids, at their option, either in person or by courier service or by mail;

al l bidders shall provide bid security as indicated in the bidding documents. A bidder’s bid security shall apply only to a specific bid;

bids shall be opened in public in one place immediately, but n o later than one hour, after the deadline for submission o f bids;

evaluation o f bids shall be made in strict adherence to the criteria disclosed in the bidding documents, in a format and specified period agreed with the Association;

bid shall not be rejected merely on the basis o f a comparison with an official estimate without the prior concurrence o f the Association;

split award or lottery in award o f contracts shall not be carried out. When two or more bidders quote the same lowest price, an investigation shall be made to determine any evidence o f collusion, following which (A) if collusion i s determined, the parties involved shall be disqualified and the award shall then be made to the next lowest evaluated and qualified bidder and (B) if no evidence o f collusion can be confirmed, then fresh bids shall be invited after receiving the concurrence o f the Association;

contracts shall be awarded to the lowest evaluated bidders within the init ial period o f bid validity so that extensions are not necessary. Extension o f bid validity may be

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sought only under exceptional circumstances;

(xiv) extension o f bid validity shall not be allowed without the prior concurrence o f the Association (A) for the f i rst request for extension if it i s longer than eight weeks and (B) for a l l subsequent requests for extensions irrespective o f the period;

(xv) negotiations shall not be allowed with the lowest evaluated or any other bidders;

(xvi) re-bidding shall not be carried out without the Association’s prior concurrence; and

(xvii) a l l contractors or suppliers shall provide performance security as indicated in the contract documents. A contractor’s o r a supplier’s performance security shall apply to a specific contract under which it was furnished.

Procurement Status Reporting

14. submit them on a six monthly basis to IDA for i t s review.

BB wil l prepare procurement status reports as per specific formats agreed with BBiGOB and

Procurement Capacity Review

15. capacity to execute procurement activities following the World Bank procurement guidelines and procedures. The assessment included organizational aspects, skd ls o f staff, and suitability o f ru les and regulations applicable to the agency. For assessment, the team used the Bank‘s Procurement Capacity Assessment questionnaire and discussions with various personnel at BB.

The team reviewed the procurement management capacity o f BB with a view to assess their

16. assessment i t was revealed that BB has adequate capacity to execute procurement activities following the Bank’s procedures. As such, there i s only a normal risk associated with procurement under the Project.

Prior to this Project, BB has executed several IDA financed projects. As such, based on the

17. decided, in agreement with IDA, to hire, prior to Credit effectiveness, an individual procurement consultant who will provide technical assistance on a retainer basis to the Project Director in carrying out procurement activities under the project. The consultant would be familiar with IDA procurement guidelines and procedures, and would have experience in carrying out procurement activities under IDA financed projects, which would include preparation o f request for proposals following IDA’S standard documents.

Strengthening Procurement Capacity: To mitigate the procurement associated risks, BB has

18. Advanced Procurement Arrangements: Carrying out o f procurement in a timely and efficient manner i s the essence o f prudent project implementation. I t has been agreed with the BB that for at least the f i rs t year’s procurement program, the bidding documents for goods will be issued, and the consultants’ selection process sufficiently advanced so as to permit contract signature immediately after Credit Effectiveness. BB hired an IT and a procurement consultant, using i t s own funds, for the preparation o f the bidding documents for supply and installation o f the information system.

19. Action Plan: In addition to the above, the following time-bound action plan for strengthening management capacity and for completing tasks in readiness for implementation o f the project has been agreed with IDA:

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Time Bound Action Plan Actions Time Bound

5. Operating Cost

6. Unallocated

Total

(a) Procurement Capacity Improvement: 1. Appoint Procurement Consultant

0.00 0.00 7.00 0.00 7.00 (0.00) (0.00) (5.00) (0.00) (5.00) 0.00 0.00 2.79 0.00 2.79

(0.00) (0.00) (2.79) (0.00) (2.79) 23.59 0.00 22.54 0.00 46.13

(18.87) (0.00) (18.13) (0.00) (37.00)

June 15,2003

(b) Goods: Supply & Installation o f Information Systems 1. Publication o f Invitation for Bids 2. Send bid evaluation reports to IDA 2. IDA clears bid evaluation reports 3. Contract award and signing

May 30,2003 September 15,2003 September 30,2003 November 30,2003

(c) Consultants Service (First Year - individual consultants) 1. Finalize selection o f individuals 2. Obtain clearance o f IDA (if US$50,000 or more) 3. Sign contracts with individual consultants

July 7,2003 July 15,2003 July 30, 2003

20. Publication of General Procurement Notice: A General Procurement Notice has been published on February 16,2003 in the issue no. 600 o f the UN Development Business hard copy.

Procurement methods (Table A)

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Table A I : Consultant Selection Arrangements (optional) (US$ million equivalent)

Selection Method Consultant Services

Expenditure Category QCBS QBS SFB LCS CQ Other N.B.F. Total cost! A. Firms I 7.20 I 0.00 I 0.00 I 0.00 I 0.00 I 1.00 I 0.00 I 8.20

6. Individuals (5.64) (0.00) (0.00) (0.00) (0.00) (1.00) (0.00) (6.64) 0.00 0.00 0.00 0.00 0.00 4.05 0.00 4.05

Total

Note: QCBS = Quality- and Cost-Based Selection QBS = Quality-based Selection SFB = Selection under a Fixed Budget LCS = Least-Cost Selection CQ = Selection Based on Consultants' Qualifications Other = Selection of individual consultants (per Section V of Consultants Guidelines), and Selection on Single-Source basis. N.B.F. = Not Bank-financed Figures in parentheses are the amounts to be financed by the Bank Credit.

(0.00) (0.00) (0.00) (0.00) (0.00) (3.30) (0.00) (3.30) 7.20 0.00 0.00 0.00 0.00 5.05 0.00 12.25

(5.64) (0.00) (0.00) (0.00) (0.00) (4.30) (0.00) (9.94)

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Prior review thresholds (Table 6) As per Table A, procurement o f goods under the project w i l l only be through ICB. However, it i s possible that, during implementation o f the project, some small valued office equipment, furniture and other miscellaneous items may be procured as per the needs o f individual consultants. Therefore, N C B and Shopping procurement methods are also stated under Table B along with their thresholds and prior review requirements.

Table B: Thresholds for Procurement Methods and Prior Review '

I . Works

!. Goods

1. Servicesand Training

x => 200,000 ICB All contracts equivalent to 20,000<=x=>200,000 N C B $200,000 or more and the

x<20,000 N S first contract through NCB, irrespective o f value,

x=>100,000 QCBS All contracts for f i r m s

Total value of contracts subject to prior review: About 20 contracts, worth $33.3 million,

will be subject to IDA'S prior review.

Overall Procurement Risk Assessment

Average

Frequency of procurement supervision missions proposed: One every 6 months (includes special procurement supervision for post-reviewlaudits) __ ~ ____ 'Thresholds generally differ by country and project. Consult OD I I .04 "Review of Procurement Documentation" and contact the Regional Procurement Adviser for guidance.

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Disbursement

Goods

maintenance o f IT system. (a) Supply, installation and

(b) Other goods Consultant Services including Local Training

Allocation of credit proceeds (Table C) Disbursement under proposed Credit w i l l be made as indicated in Table C, which indicates the percentage o f financing for different categories o f expenditures o f the project. I t i s expected that IDA funds will be disbursed over a period o f four and a hal f years. The fiscal year disbursement estimate i s provided on page 2 o f the PAD. The Closing Date o f the Credit i s December 3 1,2007.

Table C: Allocation of Credit Proceeds

18.87 (a) 100 percent o f foreign expenditures and 70 percent o f local expenditures.

0.50 70 % 8.34 80 Yo

I Expenditure Category I Amount in US$million I Financing Percentage I

Operating Costs

Unallocated

Total Project Costs

Total

5.00

2.79

37.00

37.00

70 % in FY04 and FY05, 50% thereafter.

]Foreign Training I 1.50 I 100% I

Use of statements of expenditures (SOEs):

The transaction-based disbursement procedures wil l be applicable for withdrawal o f funds from IDA Credit. IDA w i l l require full documentation for a l l prior review cases where contracts exceed the equivalent o f : (a) US$200,000 for goods; (b) US$lOO,OOO for services contracts wi th f i rms; and (c) US$50,000 for individuals. Expenditures below the above threshold and al l expenditures under Operating Costs and training would be claimed on SOEs. During the initial supervision by IDA, the mission w i l l closely review the SOE claims to ensure that the funds are utilized for the intended purposes. Any deviations noticed during such reviews would be noted for remedy and improvements.

Special account: For utilization o f IDA'S share o f project expenditures, Bangladesh Bank may open and maintain a Special Deposit Account in US dollars under terms and conditions acceptable to IDA. The authorized allocation to the Special Deposit Account wi l l be limited to 3-4 months estimated expenditures o f IDA'S share o f the proposed project. The authorized allocation wi l l be limited to US$1.75 million. Accounts and Budget Department o f Bangladesh Bank will be responsible for preparation and submission o f withdrawal applications to IDA.

Most o f the experienced and trained BB staff involed in earlier IDA Credits have moved to other departments o f BB. The current staff in the Accounts and Budget Department will require comprehensive training with respect to withdrawal o f funds from IDA Credit. This training w i l l be completed by August 3 1,2003. However, at start o f the project the relevant BB staff w i l l be provided hands-on training on IDA disbursement policy and procedures in general and withdrawal o f funds from the proposed project in particular.

- 4 3 -

Retroactive Financing:

In order to expedite project implementation, BB has budgeted USS600,OOO as start-up funds for hiring the IT Program Manager, the National HR Expert, the Modernization Expert, the Bank Supervision Expert, and the Accounts and Audit Specialists, and for small value goods procurement. GOB/BB has requested retroactive financing, Le., Bank's reimbursement from the proceeds o f the IDA Credit, not exceeding US$0.60 mi l l ion equivalent in respect of: (a) procurement o f goods (US$125,000); consultants services (US$375,000); and (c) Operating Costs (US$lOO,OOO). In order to be eligible for retroactive financing, procedures for procurement, the use o f consultants, processing and clearance are subject to Bank's Procurement and Consultants Guidelines. In addition, documentation requirement for expenditures claimed under retroactive financing are the same as those for disbursements against payments made after the Credit Agreement i s signed and effective.

Financial ManaPement

Country Issues 0 There i s no significant country issue that may affect the smooth implementation o f the project. The generic problem o f lengthy procedures in releasing government counterpart funds, as commonly experienced in IDA financed projects, w i l l not be experienced in this project because there w i l l be no government counterpart funding. BB, as an autonomous body will finance project activities from i t s own resources as per agreed terms and conditions between BB/GOB and IDA. 0 A recent IMF mission on Safeguards Assessment has already identified the institutional weaknesses in the area o f financial management and has been working with BB for improvement in FM through an agreed action plan. The proposed IDA project wi l l further strengthen F M capacity in line with the agreed actions. The plan for reorganization and modernization o f key departments o f BB, developing the human resources, hiring new professional staff in the relevant departments, adopting I A S and ISA, strengthening internal audit functions, and setting up a Monitoring & Evaluation (M&E) system w i l l greatly contribute towards overcoming the existing FM weaknesses.

Summary o f Project Description: 0

regulatory and supervisory system for Bangladesh's banking sector and improve overall governance. The project activities are grouped under three major components. The details o f the components and their sub-components are described in annex 1 o f the PAD.

The U S $37.0 mi l l ion Credit through the project i s expected to achieve a strong and effective

Risk Analysis: 0

because a large portion o f the proceeds would be utilized under a few consultancy packages. BB's appointment o f a full time Procurement Specialist would greatly contribute towards avoiding any potential risk involved with the procurement o f consultancy services and performing the ex-ante audit functions efficiently and effectively.

From the financial management perspective, there i s low risk affecting the project. This i s

Strengths and Weaknesses: 0 The project wi l l have the following strengths in the area o f financial management: (i) The Forex Reserves and Treasury Management Department has extensive experience in managing DOSA accounts for Bank financed projects and has staff having previous experience in IDA projects; (ii) The sound project FM system in FIDP implemented by another department o f BB has allowed IDA fund disbursement based on Project Management Reports (PMRs); (iii) The project w i l l not experience

- 4 4 -

delays in the release o f government funds, which i s the major hindrance in timely project implementation, as the counterpart funds w i l l be provided by BB from i t s own sources, and i t s annual budget wil l include project cost; (iv) The high level commitment o f BB’s top management and the Finance Division in implementing various reform activities would be o f great help in addressing any potential weaknesses during project implementation.

Weaknesses and Resolution:

Accounts and Budget Department. This i s required to maintain liaision with various departments responsible for implementing project activities, to ensure timely f low o f financial information, to facilitate monitoring o f funding status and to make periodic cash forecast for the project. I t has been agreed that the Accounts and Budget Department would develop formats for financial data or information to be submitted at month end and would clearly indicate the input needed from different departments. This data would be part o f the project M I S system being set up in CBSP Cell. This would help in the timely delivery of outputs, consisting o f the monthly and yearly financial statements and quarterly Financial Monitoring Reports (FMRs).

0

The potential weakness i s the absence o f a wel l coordinated management approach in the ‘

Lack o f experienced accounting staff and capacity in BB will be resolved by hiring a Chartered Accountant on a contract basis. The project has started a process to develop an M I S system which w i l l store, process and analyze

project information for timely decision making. Since this M I S has no link to project financial information o f the Accounts and Budget Department, it has been agreed that the M I S w i l l integrate the financial data with the monitoring data so that there i s no discrepancy in project financial information. The system i s expected to be fully operational by December 3 1,2003.

Implementation Arrangements:

coordination and supervision of various project activities that will be implemented by different departments o f the BB. The Cell will be headed by a Project Director (PD) who i s the Deputy Govemor in charge of Bank Supervision. The P D w i l l be assisted by a Modemization Expert and a core team consisting o f Executive Directors o f five Departments and General Managers and Deputy General Managers. The consultants w i l l report to the respective Deputy Govemors for their day to day activities.

representative f rom the Finance Division o f the Ministry o f Finance will provide policy guidance to the Cell and wil l periodically review project progress.

The Central Bank Strengthening Project Cell will be responsible for overall implementation,

A high powered Steering Committee consisting o f the Govemor, three Deputy Govemors, and a

Funds Flow:

under terms and conditions acceptable to IDA. The PD, and in hidher absence Deputy Governor, Banking Policy and Regulation, wi l l be the authorized persons for issuing checks and payment requests to banks. There should be at least two authorized signatories o f BB for withdrawal o f funds from IDA Credit.

Transaction based disbursement procedures w i l l be applicable for withdrawal o f funds from the Credit.

Project funds w i l l be used in accordance with BB’s existing procedures outlined in the Expenditure Management Manual.

For utilization o f IDA’s share o f eligible expenditures, BB may open a Special Deposit Account

Accounting and Internal Controls: The accounting policies and procedures o f the project will be govemed by the existing Project

- 4 5 -

Accounting Manual o f the Ministry o f Finance and Expenditure Regulation Manual o f BB. These Manuals would serve as a reference document for all project staff. 0

BB). BB’s annual approved budget for the project and disbursement categories o f the Development Credit Agreement (DCA) would form the basis o f the accounts for expenditure. 0

basis. Separate books/records (cash and bank-book, General Ledger, Receipt Register, Payment Register, Inventory and Fixed Assets Register, Bank Reconciliation, etc.) for the project would be maintained by the Accounts and Budget Department. 0

are: (i) Budget preparation and monitoring; (ii) Payments for eligible project expenditure; (iii) Maintenance o f books and bank accounts; (iv) Cash flow and working capital management; (v) Financial Reporting to GOB, World Bank and other stakeholders; (vi) Preparation o f Withdrawal Application to claim funds from the Bank; and (vii) Assist internal and external auditors and ensure appropriate follow up action. 0 The accounts w i l l be maintained manually until computerization i s complete, which should be adequate to keep track o f project financial transactions. 0 The duties and responsibilities o f CBSP Cell and staff in Accounts and Budget Department are properly segregated and well defined. The reporting relationship i s clearly indicated in the project implementation arrangements.

Accounting Manual of the M O F and BB’s Expenditure Regulation Manual.

The financial management would cover al l project related transactions i.e. a l l sources (IDA and

Books of accounts wi l l be maintained using double-entry bookkeeping principles and on accrual

The key accounting functions for which the Accounts and Budget Division w i l l be responsible

Approval authority and the procedures to process financial transactions are laid down in Project

Financial Reporting and Monitoring: 0

transactions, maintaining supporting papers and preparing timely consolidated Financial Statements on a monthly basis. 0 The Accounts and Budget Department would also be responsible for preparing monthly, quarterly and annual Financial Statements after scrutiny o f financial information received within and outside BB, monitoring actual expenditure against forecast, and coordinating with other departments to reconcile timely financial information. A set o f customized formats for project Financial Monitoring Reports (FMRs) were agreed during project preparation. 0

Financial Statements (Sources and Uses o f Funds, Uses o f funds by project activity, Special Account statement); (ii) Output monitoring reports (projects/Units) and Procurement Monitoring Reports (goods, works and consultants). Quarterly Financial Monitoring Reports (FMRs) w i l l be prepared by project components, sub-components and disbursement category, and would be submitted to IDA within 45 days o f the end o f each quarter. The f i rs t such report should cover the expenditures from inception to September 30,2003, and be submitted to IDA by November 15,2003.

The Accounts and Budget Department will be responsible for consolidating financial

The Accounts and Budget Department would prepare Quarterly FMRs which w i l l include: (i)

Staffing : 0 The Accounts and Budget Department under the direction and supervision o f the Executive Director (ED) will be responsible for project financial management system. The ED who wil l be part o f the core team w i l l report to the P D o f the Project Cell. 0 The Department has adequate and experienced staff having previous experience in IDA projects. 0 The Accounts and Budget Department has designated two staff to be solely responsible for project specific financial management activities. These staff wi l l have necessary training and will be the focal points for all FM related issues. If these staff are transferred, the Accounts and Budget Department will ensure replacement o f new staff well ahead o f the transfer o f the incumbent staff so

- 46 -

that FM activities continue without interruption.

Implementing Agency BB

BB

External Audit: 0 The annual financial statements o f the project would be audited by the Comptroller and Auditor General (C&AG) and would be submitted to the Bank within six months o f the end o f each fiscal year The audit report will include a separate opinion on Project Financial Statements, Special Account and SOE.

under an extended TOR. A copy o f the audit report w i l l be submitted to IDA within 3 months o f the close o f each fiscal year.

In addition, BB's statutory auditor w i l l carry out annual financial audit o f the project accounts

Audit Auditors Project AccountBOE BB's statutory auditors

Special Account BB's statutory auditors (private sector auditors)

(private sector auditors)

Supervision Plan:

The initial supervision focus will be on the progress o f implementation o f agreed actions, and facilitating training on Disbursement and Financial Management arrangements.

Action Plan:

Actions Responsibility

1. Comprehensive training on Disbursement 2. Linking of project financial data with monitoring

3. FM training of designated staff in Accounts and

IDAJBB BB

BB data in MIS.

Budget Department.

Completion Date

August 3 1,2003. December 3 1,2003

August 31,2003.

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Annex 7: Project Processing Schedule BANGLADESH: Central Bank Strengthening Project

Project Schedule Planned Actual Time taken to prepare the project (months)

First Bank mission (identification)

Negotiations

Planned Date of Effectiveness

/Appraisal mission departure , I 02/02/2003 I 02/02/2003 I 04/28/2003 04/28/2003 0713 112003

Prepared by: Bangladesh Bank, Dhaka

Preparation assistance: BB, PHRD and Bank funds.

Bank staff who worked on the project Name

Joseph del mar Pernia Shamsuddin Ahmad Rakesh Asthana Ann E. Rennie Nagavalli Annamalai Kishor Uprety Kiatchai Sophastienphong Ismail Radwan Nilufar Ahmad Suraiya Zannath Subrata S. Dhar Q u a m 1 Hasan Debabrata Chakraborti Mohammad Sayeed Shah Nur Quayyum Margaret Murray Ziaun Nahar Joya S.A.K.M. Abdul Hye

ncluded:

Lead Financial Sector Specialist Senior Financial Economist Information Systems Specialist Human Resources Specialist Lead Counsel Legal Counsel Senior Financial Sector Specialist VRS Specialist Senior Social Scientist Senior Financial Management Specialist Senior Communications Officer Procurement Specialist Procurement Specialist Disbursement Specialist Junior Professional Associate Administrative Assistant Team Assistant Program Assistant

Speciality

- 4 8 -

Annex 8: Documents in the Project File* BANGLADESH: Central Bank Strengthening Project

A. Project Implementation Plan Borrower's Project Implementation Plan prepared by Bangladesh Bank.

B. Bank Staff Assessments CBSP: Pre-appraisal Mission Aide Memoire, August 29,2002. CBSP: Back-to-Office Report* o f Pre-appraisal Mission. CBSP: Appraisal Mission Aide Memoire, March 16,2003. CBSP: Back-to-Office Report* o f Appraisal Mission dated March 17,2003. CBSP: Voluntary Early Retirement Scheme Appraisal, February 14,2003. CBSP: Financial Management o f BB -- An Assessment, April 2003

C. Other

Monetary Fund. December 2002.

Private Sector Unit, South Asia Region.

Bangladesh: Financial Sector Assessment Program. Main Report. The World Bank and International

Bangladesh: Strategy for Establishing a Sound and Competitive Banking Sector. Vol. 1,2,3. Finance &

May 15,1998 Information Systems Strategy Plan for Bangladesh Bank. Final Project Report. Glendale Consulting

Study on Functional Re-Organisation and Human Resources Development. Final Report. Maxwell

Report of the BB Review Committee, Bangladesh Bank.

Limited, England. May 2002.

Stamp, plc. July 2002.

*Including electronic files

- 4 9 -

Annex 9: Statement of Loans and Credits BANGLADESH: Central Bank Strengthening Project

16-Apr-2003 Difference between expected

and actual disbursement; Original Amount in US$ Millions

Project ID FY Purpose IBRD IDA GEF Cancel. Undisb. Orig Frm Rev'd PO53578 2003 Social Investment Program Project 0.00 18.24 0.00 0.00

PO44876 PO71794 PO74040 PO74731 PO75016 PO57833 PO44810 PO50752 PO69933 PO59143 PO4481 1 PO49587 PO50751 PO09468 PO37294 PO41887 PO09524 PO50745 PO49790 PO09550 PO44789 PO40713 PO37857

2002 Female Secondary School Assis. II 2002 Rural Elect. Renewable Energy Dev. 2002 Renewable Energy Development 2002 Financial Services for the Poorest 2002 Public Procurement Reform Project 2001 Air Quality Management Project 2001 Legal 8 Judicial Capacity Building 2001 Post-Literacy 8 Continuing Education 2001 HIWAIDS Prevention 2001 Microfinance I1 2000 Financial Institutions Development 2000 Aquatic Biodiversity Conservation 2000 National Nutrition Program 2000 Fourth Fisheries 1999 Third Road Rehabilitation 8 Maintenance 1999 Municipal Services 1999 Dhaka Urban Transpolt 1999 Arsenic Mitigation Water Supply 1999 ~xpor t Diversification 1998 Primary Education Deveiopment 1998 Private Sector infrastructure Dev 1998 Silk Development Pilot Project 1998 Health and Population Program

0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

120.90 190.98

0.00 5.00 4.50 4.71

30.60 53.30 40.00

151.00 46.90

0.00 92.00 28.00

273.00 138.60 177.00 32.40 32.00

150.00 235.00

11.40 250.00

0.00 0.00 8.20 0.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00 5.00 0.00 5.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00 0.00

0.00 0.04 0.00

0.00 0.00 0.00 1.25 0.00

8.25 0.00 0.00

64.89 4.35 0.00

25.63 0.00 3.53 0.78

18.50 103.79 200.92

8.68 4.69 4.02 3.86

27.76 51.16 38.54 64.25 14.22 2.70

87.24 12.92

143.19 90.87 62.85 19.45 7.27

41.95 140.82

2.26 58.33

0.00 0.00 2.74 0.00

31.52 0.00 0.19 0.00

-0.04 0.00 0.65 0.00 3.60 0.00 7.46 0.00 3.90 0.00

17.65 0.00 6.03 0.00

18.14 0.00 3.84 1.03

41.00 0.00 18.81 0.64

141.91 13.98 6.47 0.00

122.00 9.14 23.63 0.00

7.98 0.00 57.63 22.48

146.33 0.00 6.18 0.64

50.53 0.00

Total: 0.00 2085.53 18.20 108.72 1210.25 718.16 47.92

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Bangladesh Statement of IFC's Held and Disbursed Portfolio

(In US'Dollars Millions) As of 2/28/03

Held Disbursed FY Approval Company Loan Equity Quasi Partic Loan Equity Q uasi Partic 1997 DBH 2.35 0.65 0.00 0.00 2.35 0.65 0.00 0.00 1991 Dynamic Textile 1998 Grameen Phone 1985/95 IDLC 1980/98 IPDC 1998/99 Khulna 1998/2000 Lafarge Surma 2003 RAK Ceramics 1997/2000 Scancem

1.86 0.00 0.00 1.48 1.86 0.00 0.00 1.48 11.67 1.58 0.00 0.00 11.67 1.58 0.00 0.00 0.00 0.15 0.00 0.00 0.00 0.15 0.00 0.00 7.50 1.05 0.00 0.00 7.50 1.05 0.00 0.00

16.47 0.00 0.00 20.39 16.47 0.00 0.00 20.39 35.00 0.00 0.00 15.00 0.00 0.00 0.00 0.00 12.00 0.00 0.00 0.00 5.00 0.00 0.00 0.00 10.00 0.00 0.00 0.00 10.00 0.00 0.00 0.00

Total Portfolio: 96.85 3.43 0.00 36.87 54.85 3.43 0.00 21.87

Approvals Pending Commitment Loan Equity Quasi Partic

1999 Khulna Swap 0.00 3.30 0.00 0.00 2000 USPCL 0.00 3.00 0.00 0.00 2000 ULC - Banglade5 5.00 0.00 0.00 0.00 2001 Dhaka Westin 8.75 0.00 0.00 0.00 2001 BRACBank 0.00 3.00 0.00 0.00

Total Pending Commitment 13.75 9.30 0.00 0.00

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Annex 10: Country at a Glance 5/2 1 /03

BANGLADESH: Central Bank Strengthening Project

POVERTY and SOCIAL Bangladesh

2001 Population, mid-year (millions) GNI per capita (Atlas method, US$) GNI (Atlas method, US$ billions)

Average annual growth, 1995-01

Population (%) Labor force (%)

Most recent estimate (latest year available, 199541) Poverty (% of population below national poverfy line) Urban population (% of total population) Life expectancy at birth (years) Infant mortality (per 1,000 live births) Child malnutrition (% of children under 5) Access to an improved water source (% ofpopulation) Illiteracy (% ofpopulation age 15+) Gross primary enrollment (% of school-age population)

Male Female

KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1981

GDP (US$ billions) 19.8 Gross domestic investmenffGDP 17.6 Exports of goods and services/GDP 5.3 Gross domestic savingslGDP 12.5 Gross national savingdGDP 17.8

Current account balancelGDP -4.3 Interest payments/GDP 0.3 Total debffGDP 21.9 Total debt servicelexports 2.6 Present value of debffGDP Present value of debffexports

1981-91 1991-01 (average annual growth) GDP 3.7 5.0 GDP per capita 1.1 3.2 Exports of goods and services 5.0 13.2

133.4 380 50.7

1.7 2.9

34 26 61 60 48 97 58

106 108 105

1991

31 .O 16.9 6.7

14.6 19.7

-3.1 0.5

42.4 20.7

2000

5.9 4.1 8.6

South Asia

1,355 460 617

1.9 2.4

28 63 74 47 87 45

100 110 90

2000

47.2 23.0 14.0 17.9 23.1

-0.6 0.4 0.0 9.1

20.3 110.6

2001

5.3 3.4

22.8

Low- income

2,459 420

1,030

1.9 2.4

32 59 77

76 38 96

102 86

2001

47.0 23.1 15.4 18.0 22.4

-2.2 0.3 0.0 7.4

2001-05

5.3 3.7

-2.2

Development diamond‘

Life expectancy

7

GNI

capita per

1

Access to improved water source

Bangladesh Low-income group

__p

Economic ratios’

Trade

I Indebtedness

- Bangladesh Low-income group

STRUCTURE of the ECONOMY

(% of GDP) Agriculture Industry

Services

Private consumption General government consumption Imports of goods and services

Manufacturing

(average annual growth) Agriculture Industry

Services

Private consumption General government consumption Gross domestic investment Imports of goods and services

Manufacturing

1 1981 1991 2000 2o01 1 Growth of investment and GDP (%)

30.9 29.5 24.6 23.3 ~

20.3 21.1 24.4 25.1 10 13.4 13.0 14.7 15.1 48.8 49.4 51.0 51.6 1 87.1 84.5 77.7 78.5 1 O $6 97 98 99 00 d, I

GDI *GDP - 4.5 4.1 4.6 4.5 1 14.5 12.2 19.2 21.5 j I

1981-91

2.1 6.0 5.4 3.8

3.0 2.5 6.7 2.9

199141 2000 2001

3.3 7.4 3.1 7.3 6.2 7.4 6.9 4.8 6.7 4.8 5.2 5.3

3.9 5.3 6.2 4.4 0.9 4.5 9.6 7.3 5.8

10.8 5.7 23.5

I Growth of exports and imports (“YO) 60 50 40 30 20 10 0

-10

I -Exports +Imports

Note: 2001 data are preliminary estimates. *The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond will

be incomplete.

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Bangladesh

PRICES and GOVERNMENT FINANCE

Domestic prices (% change) Consumer prices Implicit GDP deflator

Government finance (% of GDP, includes current grants) Current revenue Current budget balance Overall suroiuddeficit

TRADE

(US$ mil/ions) Total exports (fob)

Raw jute Leather and leather products Manufactures

Total imports (cif) Food Fuel and energy Capital goods

Export price index (1995=100) Import price index (1995=100) Terms of trade (1995=100)

BALANCE of PAYMENTS

(US$ millions) Exports of goods and services Imports of goods and services Resource balance

Net income Net current transfers

Current account balance

Financing items (net) Changes in net reserves

Memo: Reserves including gold (US$ millions) Conversion rate (DEC, local/US$)

EXTERNAL DEBT and RESOURCE FLOWS

(US$ millions) Total debt outstanding and disbursed

IBRD IDA

Total debt service IBRD IDA

Composition of net resource flows Official grants Ofticial creditors Private creditors Foreign direct investment Pottfolio equity

World Bank program Commitments Disbursements Principal repayments Net flows Interest payments Net transfers

I981

10.5

1981

1981

933 2,718

-1,785

-23 963

-844

445 399

16.3

1981

4,326 55

1,085

36 4 7

543 10 -4 0 0

21 2 159

0 159 11

149

I991

8.3 6.6

7.2 0.7

-5.4

1991

1,698 120 138

1,278 3,510

297 204

1,231

85 89 96

1991

2,113 3,829

-1,717

-102 846

-973

1,354 -381

880 35.7

1991

13,141 65

4,360

610 5

47

1,153 485 34

1 0

45 1 255

18 238 34

203

2000

3.5 1.9

8.5 0.7

-6.2

2000

5,752 72

195 5,123 8,403

381 684

2,133

127 136 94

2000

6,611 9,060

-2,449

-221 2,392

-278

357 -79

1,599 50.3

2000

15,613 24

6,431

789 7

129

561 336

13 194

3

233 357 87

270 49

221

2001

1.6 1.6

9.0 0.7

-5.1

2001

6,467 67

254 5,761 9,363

349 905

2,515

118 134 88

2001

7,178 10,103 -2,925

-264 2,171

-1,018

716 302

1,307 54.0

2001

15,294 17

6,439

678 7

143

432 401 270 174

0

280 312 99

21 3 50

163

1 inflation (%) I

1 -GDPdeflator *CPI I

Export and import levels (US$ mill.) i 10,000 T

8,000

6,000

4,000

2.000

0 95 98 97 98 99 00 01

Exports Imports

I Current account balance to GDP (%)

Composition of 2001 debt (US$ mill.)

A: 17 F: 446;: 294

A - IBRD E . Bilateral B - IDA D -Other multilateral F . Private C - IMF G - Short-term

Development Economics 5/21/03

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MAP SECTION