PROJECT INFORMATION DOCUMENT (PID) CONCEPT STAGE Report No.: AB3897 Project Name. October 7, 2008

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1 PROJECT INFORMATION DOCUMENT (PID) CONCEPT STAGE Report No.: AB3897 Project Name Panama Access to Finance Region LATIN AMERICA AND CARIBBEAN Sector Micro- and SME finance (90%); General finance sector (10%) Project ID P Borrower(s) REPUBLIC OF PANAMA Implementing Agency Environment Category [ ] A [ ] B [ ] C [ ] FI [X] TBD (to be determined) Date PID Prepared May 14, 2008 Estimated Date of July 14, 2008 Appraisal Authorization Estimated Date of Board Approval October 7, Key development issues and rationale for Bank involvement While Panama is categorized as an upper middle-income country, it is also recognized as one of the countries in Latin America and the Caribbean (LAC) with the highest income inequality. On average, 37% of the population lives in poverty, but poverty reaches 65% of the population in the rural area (649,000 individuals), compared to 15% in the urban area (306,000 individuals). Similarly, Panama is one of the countries in the region with the highest levels of financial sector development, but there are large disparities in access to finance outside the capital and between rural and urban areas. The overall depth of the system does not translate well into the rural area or into the urban areas other than Panama City access to financial services is relatively high in the metropolitan area, but extremely low in the rest of the country. The sparse presence of regulated banks in non-metropolitan areas imposes large costs on individuals and organizations located in these areas to set up and sustain microenterprises, save money, use remittances services, pay for services, or receive transfers from the government. Overall, microfinance is particularly underdeveloped as compared to other countries in LAC, while rural finance is limited compared to the rest of the financial sector in Panama. In this context, the challenge in Panama is to extend the relatively broad access to financial services in Panama City to the underserved poor households, small and medium rural producers, and microenterprises. The major limitations to access to financial services for underserved clients include the following: (i) Potentially high unmet demand for financial services among the un-banked, linked to geographic constraints as well as educational limitations and cultural barriers; (ii) Banks are sparsely distributed outside the commercial metropolitan area due to significant costs to reach these areas through traditional means; (iii) The technology platform of institutions with greater proximity to the underserved population has major limitations; (iv) MFIs other than banks have little presence in the primary interbank network (Telered), whose entry rules may limit the geographical expansion of service points; (v) The lack

2 of information about the underserved population results in its exclusion from the formal financial system, although initiatives are currently in place that could help to overcome this limitation; (vi) The plethora and insufficient coordination between financial sector regulators and supervisors may be resulting in regulatory arbitrage, impeding the development and expansion of services for the low-income population; (vii) The level of transparency of prices, commissions and other variables related to the provision of financial services needs improvement. The promotion of private sector initiatives can help overcome some of these limitations, while others may require a stronger catalytic role by the government. This government role typically emerges in the provision of public goods, bearing initial costs of initiating some activities, analyzing feasibility of certain products, or simply enabling coordination around a common social goal. Likewise, there is a potential role for international financial institutions to help the government achieve this objective, to which we turn in the next sections. The government has expressed interest in receiving support from the World Bank for the development of rural finance and microfinance in line with the country s Concertación Nacional para el Desarrollo. A loan that promotes the development of microfinance and rural finance would be in line with the Country Partnership Strategy (CPS) in Panama approved in The CPS includes the expansion of access to rural finance as one of the main initiatives that the Bank will support in order to contribute to the broad objective of reducing poverty, especially among the rural poor. Moreover, the objectives of this loan are in line with those of other initiatives currently supported by the Bank in the areas of rural productivity (Pro-Rural), land titling, and conditional cash transfer programs (Red de Oportunidades). Indeed, this loan will be designed in order to cut across existing interventions supported by the Bank, in order to complement those interventions with a broader access to financial services and financial education. Focusing on access to financial services to micro and rural enterprises, the World Bank appears to have the following comparative advantages: (i) Expertise and best practice experiences from other regions, with a particular focus on aspects beyond credit as well as traditional strategies; (ii) Unique position to provide coordination among multiple parties. Under the integrated and innovative yet complex approach envisioned, coordination is key among financial institutions, regulators, government agencies and IFIs; (iii) Ability to serve as a catalyst to assist the authorities in the provision of public goods, such as the gathering of information about the underserved population s willingness and ability to repay their loans or the provision of financial education. In addition, the World Bank could bring significant experience in helping with regulatory reforms for the development of non-traditional products to address the needs of the rural population (e.g. e-factoring, branchless banking, etc). Importantly, the proposed loan will complement poverty reduction efforts made by the government and by IFIs, including efforts supported by the World Bank to reduce extreme poverty in Panama (i.e., Pro-rural, Land-titling and conditional cash transfer programs), one broad program supported by the IDB (Pro-competitividad, which seeks to enhance competitiveness and also includes support to farmers); and a program by FIDA that targets extreme poverty in rural areas.

3 2. Proposed objective(s) The overarching development objective of the proposed project is to expand access to financial services for the underserved in Panama towards poverty alleviation. The proposed project would help improve access to financial services (savings, credit and access to the payments system) to the underserved, including poor households and micro and small enterprises in urban and rural sectors. Such access can help increase the low-income population s income and contribute to the building of assets, making them less vulnerable to crises and assisting them towards finding their own way out of poverty. The improved financial intermediation would have positive, lasting effects on private investment, helping to create jobs and improving the social and economic environment. The project seeks to create assets and expand the opportunities to enter the formal financial system, including for those low-income individuals who are currently participating in ongoing programs that seek to reduce poverty. The loan would include efforts to expand financial education; help create an information about the underserved that could complement the existing credit bureau in order to facilitate their inclusion in the formal financial system; promote the creation of a non traditional distribution net of financial services for the underserved, using branchless banking technology (i.e., at shops, through either points of sale or cell phones) in order to broaden access to the payments system and promote an increase in the range of financial products available for the underserved, such as widespread small scale savings, rural leasing, factoring and index-based insurance for the agricultural sector. 3. Preliminary description The project is being designed to cut across and complement ongoing initiatives to reduce poverty, and to leverage the development of the financial sector (that concentrates on the higher income groups) to improve access for the underserved population. The authorities have shown great support for the proposed project s cross-cutting approach, which would seek to complement and link scattered efforts by providing financial support for goods, consultant services and training. In particular, the following components are being considered: a. Financial education. This component would support expanding and enhancing the supply of financial education for low-income individuals, families and businesses, exploring three complementary ways: (i) to incorporate financial issues within the existing trainings offered to Red de Oportunidades beneficiaries via INADEH, MIDA and AMPYME, which currently provide training and education on corporate governance, productive development, technology, and family issues; (ii) to develop and implement a program of financial education through one or several mass media that reach low-income segments; and (iii) to strengthen existing programs that seek to promote an entrepreneurial culture among high-schools students, by incorporating within these programs financial education issues. b. Information systems and compilation of alternative data about the underserved population. This component would create assets that would facilitate access to the financial sector. For instance, the conditional cash transfer program, Red de Oportunidades,

4 could be used to capture and monitor beneficiaries consumer behavior, thus creating information that could be otherwise too costly to gather by banks. Similarly, payments patterns of beneficiaries from Pro-Rural and other similar programs that include credit (e.g. Pro- Competitividad) could be tracked regularly thus creating credit history (an asset ) in order to facilitate their future entrance to the formal financial system (beyond the prevalence of the program, which in Pro-Rural lasts up to three years for beneficiaries). Furthermore, telecommunications companies could report the buying habits of prepaid cards and of customers who have shifted to a post-payment system, while, water and electricity companies could help track customers payment behavior. c. Branchless banking. As a first step, feasibility studies would be necessary to assess the potential success of creating a network of payments that works across popular stores (e.g., drugstores, shops or similar), such as the one developed with great success in Brazil, and those currently being developed in Peru and Colombia. In this model, stores act as an agent bank, and can receive deposits and payments for services, as well as allow clients to make withdrawals and transfers, substantially reducing the costs of access. For this model to work, stores require a direct connection with financial institutions (through point of sale terminals or mobile phones) so that transactions can be approved and registered by the relevant entity in real time. The reliability of transactions can be guaranteed by the technological platform and by the fact that all customer transactions in cash would be made against the agent s (the store) bank account. Ideally, this payments network would be shared, that is, it would be available to all financial institutions wishing to use it (and having an adequate IT infrastructure to connect to the technological platform e.g., for cooperatives), as well as to the government for the payment of wages, pensions and social benefits for people living in areas without a bank or postal service coverage. A shared network of these characteristics would be a first in the world, in line with the marked development of Panama s financial system. Pilots are likely to be a suitable mechanism to test the feasibility before launching these initiatives full scale, starting with one of two provinces and bringing in government s transactions (e.g. oportunidades) to enhance volume. d. Strengthening of the institutional setting. This would include efforts to: (i) Promote a wider range of financial products for the underserved. Emerging private-sector initiatives such as electronic factoring are facing regulatory obstacles, including the lack of a factoring law allowing the trading of accounts receivables. Furthermore, explore complements to the products currently provided by the Instituto de Seguros Agropecuarios (ISA) such as the introduction of index-based insurance. Also, micro-insurance is an unexplored instrument; (ii) Strengthen institutions such as the IPACOOP, including its legal and regulatory framework enabling it to provide access of cooperatives to platforms that would broaden financial services; (iii) Assist in regulatory arbitrage and gap reforms. This could include considerations for regulating and supervising the larger cooperatives under SBP, a monitoring institution for the payment systems, ensuring the promotion and development of the national payments system by encouraging its development in accord with the public policy objectives of efficiency and formal banking; (iv) Promote transparency of prices, commissions and other variables related to the provision of financial services. This would include strengthening the relevant institutions in the collection and dissemination of information.

5 The project will rely on early studies and pilots expected to be conducted during the preparation stage to form a selective approach towards areas to be financed. The studies could possibly lead to pilots under the proposed project for the financial education, underserved information system and branchless banking components. The studies and pilots will serve to further identify areas for assistance under the proposed project or beyond, based on a programmatic approach and thus assisting the authorities hand-by-hand throughout their efforts towards greater access to financial services. 4. Safeguard policies that might apply To the extent that OP4.10 is triggered, the Borrower would need to complete a Social Assessment of potential indigenous beneficiaries. This process would include a process of free, prior, and informed consultation with relevant indigenous representatives. The Social Assessment would allow the Borrower to identify any potential cultural barriers to indigenous peoples ability to access and participate in the expansion of financial services. Based on the findings of the Social Assessment and consultation process, an Indigenous Peoples Planning Framework (IPPF) would likely be the safeguard instrument prepared and disclosed prior to appraisal. The IPPF would outline measures to be taken under the project to ensure its design is culturally compatible with indigenous peoples. 5. Tentative financing Source: ($m.) Borrower 0 International Bank for Reconstruction and Development 25 Total Contact point Contact: Yira J. Mascaro Title: Sr Financial Economist Tel: (202) Fax: (202) Ymascaro@worldbank.org