BY TAKAKO IWAKI
Takako Iwaki is a second-year International Development student at Johns Hopkins SAIS focusing on women’s economic empowerment and financial inclusion.
Why Financial Sector Development in Fragile and Conflict-Affected Countries?
Throughout the decades, international financial institutions (IFIs) have actively engaged in the Financial Sector Development (FSD). Although a well-functioning financial sector is required for all stages of economic growth, effective access to financial services is particularly important in fragile and conflict-affected situations as it can help people make their way out of poverty. The term “fragile and conflict-affected situations (FCAS)” evolved in the 2000s, when the World Bank began drawing attention to countries facing specific operational challenges pertaining to the situation. Although the significance of FSD in FCAS has become widely accepted today, given the issue’s nascent nature, institutions are still developing best practices around it.
Cambodia and Rwanda are example of countries that IFIs perceive as success stories of transitioning out of conflicts. For instance, in its FCAS operational plan, Asian Development Bank (ADB) states that “ADB helped Cambodia to transform itself after decades of war from a post-conflict developing member country to a market-oriented economy.”[1] Similarly, African Development Bank (AfDB) articulates that “the possibility of successful turnaround is clearly demonstrated by the experience of such countries as Rwanda” in its FCAS strategy publication.[2] Given both countries attained 4 to 7 percent of the average annual economic growth rate in the conflicts transition periods, it is worth examining how IFIs have engaged in developing market-oriented economy through FSD in these two countries, which would be the important lessons for the other conflict-prone countries. This article expects to draw lessons learned from IFI’s historical operations in two counties and conclude with recommendations for the role of IFIs in FCAS context.
Trend of FSD in FCAS
Although ADB, AfDB, and the World Bank have developed specific strategies to incorporate FCAS, the explicit FSD focus is still limited. Specifically, financial allocation for FSD has been historically low in FCAS and other low-income countries that are eligible for concessional loans comparing to the rest of the member states. In ADB, concessional lending committed to FSD was only at 3 to 5 percent over the last decade, while the share of FSD of the rest of ADB lending has been generally more than 10 percent.[3] Similarly, a significant gap exists in AfDB lending, where only 1 to 2 percent of concessional lending was spent in FSD, while a much higher proportion, ranging from 5 to 47 percent, of the non-concessional AfDB lending was allocated to this area.[4] On the other hand, the World Bank portfolio exhibits a relatively smaller gap for lending in FSD between the International Bank for Reconstruction and Development (IBRD, non-concessional) and the International Development Association (IDA, concessional). Still, the IDA has spent lower value for FSD throughout the years, ranging from 1.8 to 6.3 percent, while IBRD has spent approximately 10 percent on average.[5]
Overview of Cambodia and Rwanda
Cambodia and Rwanda both experienced conflicts before IFI’s turned their increasing attention to FCAS. Cambodia experienced civil war, genocide, and prolonged conflict from 1967 to 1998. It first joined ADB in 1966 but ceased to be a member during the war between 1975 and 1992.[6] Compared to the 30 year-long conflict in Cambodia, Rwanda engaged in a large-scale civil war and genocide for a relatively short period from 1990 to 1994. Rwanda joined AfDB in 1965 and has maintained its membership. Both countries are members of the World Bank, with Rwanda joining in 1963 after gaining independence, while Cambodia received its membership in 1970.
IFIs’ Supports in Cambodia
ADB: Financial Sector Program Loan Cluster
ADB has played a key role in bringing attention to SD in Cambodia. In 2000, ADB provided the technical assistance (TA) to support the government to develop the Financial Sector Development Strategy (FSDS) for 2001-2010, building on its comprehensive diagnostic review of the financial sector. Based on the FSDS, ADB launched the Financial Sector Program Loan Cluster (FSPL-I) with the National Bank of Cambodia as an executing agency in 2001. The FSPL-I served as a catalyst to establish a market-oriented financial system and private sector-led economy following the 30 year-long domestic turmoil and international isolation. Seven years after the program implementation, FSPL-I brought a number of desirable outcomes. For example, the relicensing program led to the growth of the banking sector in both number and outreach, including the establishment of 18 banks, seven specialized financial institutions, and 17 licensed and 26 registered microfinance institutions.[7]Building upon FSPL-I, ADB launched subsequent programs, including the second Financial Sector Program in 2006, the third Financial Sector Program in 2011, and the Inclusive Financial Sector Development Program in 2016.
World Bank: The Financial Sector Assessment Program and the Financial Sector Reform and Strengthening Initiative
The World Bank has supported the FSD by providing policy advice and TA. One of the main contributions of the Bank is the Financial Sector Assessment Program (FSAP), a joint program with International Monetary Fund (IMF). The FSAP is an in-depth diagnostic that specifies financial sector vulnerabilities and development needs, and its recommendation were incorporated into Cambodia’s FSDS for 2011-2020.[8] Furthermore, in 2003, the Bank established the Financial Sector Reform and Strengthening Initiative (FIRST), a multidoor grant facility, to provide TA for converting recommendations from FSAP into program implementations through a five-year funding cycle. The FIRST implemented three projects in Cambodia to date, with focus on banking, financial and information infrastructures, and financial safety net respectively.
IFIs’ Supports in Rwanda
AfDB: Line of Credit
AfDB has engaged in FSD in Rwanda through the Line of Credit (LoC), which is a non-project lending program. Since the 1990s, AfDB’s lending projects for FSD are LoC to support Micro, Small, and Medium Enterprises, which have been facing challenges in accessing capital markets. After the civil war, AfDB provided LoC to the Development Bank of Rwanda (BRD) in 2000, 2010, 2015, and 2017 and to the Bank of Kigali in 2010. Although AfDB’s country evaluation in 2014 points out that the bank’s support through LoC overall contributed to sustainable financing of SMEs,[9] the evaluation published by Independent Development Evaluation team at AfDB in 2021suggests a mixed result for the LoC with a couple of “unsatisfactory” ratings.[10] During the BDR LoC project in 2017, no TA was provided although BRD requested it during the due diligence, and AfDB provided no clear explanations.[11] The impact on gender was another indicator with an unsatisfactory rating. AfDB estimated that SMEs financing created at least 8,004 jobs, but only 17.6% of them went to women.[12]
The World Bank: The Financial Sector Assessment Program and the Financial Sector Reform and Strengthening Initiative
The World Bank significantly contributed to the FSD in Rwanda through TA and policy advice. Similarly to Cambodia, the Bank carried out FSAP and provided series of TA through FIRST in the country since 2007. The FIRST programs provided a holistic approach, covering seven areas: banking, financial and information infrastructures, financial sector strategy, insurance, financial safety net, and microfinance. One notable FIRST’s contribution is the Financial Sector Development Program, which developed a systematic plan based on FSAP recommendations. After developing the plan, the government presented it to its development partners and sought financial and technical assistance for implementation. Through the effort, the government successfully mobilized more than $30 million, including $6 million TA grant from the Bank.
The role of ADB, AfDB, and the World Bank in FSD
As discussed so far, the World Bank and the two regional banks have played different roles in FSD in Cambodia and Rwanda. The main contribution of the Bank is to provide analytical work, including policy advice and TA through FSAP and FIRST while ADB and AfDB mainly provide financial contributions through concessional lending programs. In terms of the share of the portfolio in FSD from 2000 to 2020, the Bank spent 15 and 42 percent for TA grants in Cambodia and Rwanda respectively, while ADB and AfDB’s contributions to TA were only 4 and 2 percent. On the other hand, concessional lending for FSD by ADB and AfDB comprises 93 and 98 percent of their total portfolios respectively. As such, each IFI has functionally played different role but closely collaborated each other, which contributed to the overall development of Cambodia and Rwanda. Although both countries are perceived as the countries that successfully transferred out from conflicts, the IFIs’ historical operations indicate a few policy implications in FSD. Therefore, I will suggest the following solutions for the future consideration.
Recommendations
· Strengthen the country’s ownership through capacity building. The FCAS strategy in each institution has identified capacity development as an overall focus area since the lack of ownership in reforms often causes unsatisfactory project ratings.[13] The importance of capacity building was demonstrated by both country cases. In Cambodia, during the first loan cluster program, ADB faced the challenges of limited enforcement due to the lack of institutional capacity. In contrast, Rwanda’s strong ownership of the project contributed to success of the World Bank’s FIRST programs and resulted in their rapid progress.
· Establish a systematic monitoring and evaluation mechanism. Specifically, weak monitoring capacity often undermined AfDB’s projects. For instance, during LoC programs, the BRD did not adequately capture and track indicators due to the lack of its capacity, which limited the ability to evaluate the project outcomes objectively.[14] Also, the World Bank FIRST projects do not include project-level evaluations. So far, FIRST has only conducted aggregate evaluations for each funding cycle phase, making project assessments difficult.
· Incorporate concrete FSD agenda and allocate around 10 percent funds to FSD in FCAS strategy. IFIs should provide key focus aspects in FSD under FCAS context. In addition, they need to allocate sufficient financial resources exclusively for FSD. As stated earlier, IFIs spend very limited funds to FSD in FCAS countries. To develop market-oriented economy, IFIs should spent around the same level of funding to FSD as the non-FCAS countries at the earlier stage of development. Although other sectors, such as governance reform and social policy, would be the highest priority for FCAS context, FSD is also important to establish the foundation for economic growth. As Cambodia example demonstrated, establishing a sound financial system at an early stage enables a country to transit away from FCAS. By incorporating explicit FSD agenda, FCAS countries will be able to accelerate their transitions from conflicts through establishing a well-functioning market-oriented economy.
PHOTO CREDIT: metamorworks from Istock collection.
References:
[1] Asian Development Bank. Operational Plan for Enhancing ADB’s Effectiveness in Fragile and Conflict-Affected Situations. Manila: Asian Development Bank, 2013. Pg.6.
[2] African Development Bank. Strategy for Enhanced Engagement in Fragile States. Tunisia: African Development Bank, 2008. Pg.1.
[3] Asian Development Bank Independent Evaluation. The Asian Development Fund Operations: A Decade of Supporting Poverty Reduction in the Asia and Pacific Region. Manila: Asian Development Bank, 2012; Asian Development Bank Independent Evaluation. Relevance and Results of Concessional Finance: Asian Development Fund XI and 12. Manila: Asian Development Bank, 2019.
[4] African Development Bank. Annual Report 2017. Tunisia: African Development Bank, 2018; African Development Bank. Annual Report 2020: African Development Bank, 2021.
[5] The World Bank. Annual Report 2021. Washington D.C: World Bank Group, 2021.
[6] Asian Development Bank. ADB and Cambodia 50 Years of Partnership. Manila: Asian Development Bank, 2016. Pg.2.
[7] ADB. Cambodia: First Financial Sector Program Cluster. Manila: Asian Development Bank, 2008. Pg.5.
[8] ADB. Proposed Programmatic Approach, Policy-Based Loan for Subprogram 1, and Technical Assistance Grant Kingdom of Cambodia: Third Financial Sector Program. Manila: Asian Development Bank, 2011. Pg.1.
[9] African Development Bank. Combined 2012-2016 Country Strategy Paper Mid-Term Review with Country Portfolio Performance Review. Abidjan: African Development Bank, 2014a. Pg.17.
[10] African Development Bank. Expanded Supervision Report Review Note: Line of Credit V - Development Bank of Rwanda. Tunisia: African Development Bank, 2021a. Pg.20.
[11] Ibid.
[12] Ibid. Pg.12.
[13] Asian Development Bank. Operational Plan for Enhancing ADB’s Effectiveness in Fragile and Conflict-Affected Situations. Manila: Asian Development Bank, 2013. Pg.26.
[14] African Development Bank. Expanded Supervision Report Review Note: Line of Credit V - Development Bank of Rwanda. Tunisia: African Development Bank, 2021. Pg.8.