Document of The World Bank

FOR OFFICIAL USE ONLY

Report No: 34484

IMPLEMENTATION COMPLETION REPORT(IDA-31910 TF-23689 TF-23576)

ON A

CREDIT

IN THE AMOUNT OF SDR 11.1 MILLION

TO

BOSNIA AND HERZEGOVINA

FOR A

LOCAL DEVELOPMENT PILOT PROJECT

November 30, 2005

Infrastructure/Energy Sector UnitEurope and Central Asia Region

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

(Exchange Rate Effective November 23, 2005)

Currency Unit = Convertible Mark 1 BAM = US$ 0.60

US$ = 1.66 BAM

FISCAL YEARJanuary 1 December 31

ABBREVIATIONS AND ACRONYMS

BiH Bosnia and HerzegovinaBNG Bank of Netherlands' MunicipalitiesCAS Country Assistance StrategyDEF Development and Employment FoundationEUR EuroFMS Financial Management SystemFSD Foundation for Sustainable DevelopmentICR Implementation Completion ReportIDA International Development AssociationLDF Local Development FundLDP Local Development PilotPAD Project Appraisal DocumentPCB Private Commercial BankPDO Project Development ObjectivePIU Project Implementation UnitRS Republika SrpskaTA Technical Assistance

Vice President: Shigeo KatsuCountry Director Orsalia KalantzopoulosSector Manager Sumter Lee Travers

Task Team Leader/Task Manager: Lawrence M. Hannah

BOSNIA-HERZEGOVINALocal Development Pilot Project

CONTENTS

Page No.1. Project Data 12. Principal Performance Ratings 13. Assessment of Development Objective and Design, and of Quality at Entry 24. Achievement of Objective and Outputs 45. Major Factors Affecting Implementation and Outcome 76. Sustainability 87. Bank and Borrower Performance 88. Lessons Learned 99. Partner Comments 1010. Additional Information 23Annex 1. Key Performance Indicators/Log Frame Matrix 24Annex 2. Project Costs and Financing 26Annex 3. Economic Costs and Benefits 28Annex 4. Bank Inputs 29Annex 5. Ratings for Achievement of Objectives/Outputs of Components 31Annex 6. Ratings of Bank and Borrower Performance 32Annex 7. List of Supporting Documents 33

Project ID: P056192 Project Name: Local Development Pilot ProjectTeam Leader: Lawrence M. Hannah TL Unit: ECSPEICR Type: Core ICR Report Date: November 30, 2005

1. Project DataName: Local Development Pilot Project L/C/TF Number: IDA-31910; TF-23689;

TF-23576Country/Department: BOSNIA AND HERZEGOVINA Region: Europe and Central Asia

Region

Sector/subsector: District heating and energy efficiency services (28%); General transportation sector (28%); General water, sanitation and flood protection sector (28%); Sub-national government administration (9%); Banking (7%)

Theme: Municipal finance (P); Municipal governance and institution building (P); Other urban development (S)

KEY DATES Original Revised/ActualPCD: 03/20/1998 Effective: 09/01/1999

Appraisal: 04/15/1998 MTR: 05/01/2003 03/15/2004Approval: 04/13/1999 Closing: 05/31/2003 05/31/2005

Borrower/Implementing Agency: GOVERNMENT OF BOSNIA & HERZEGOVINA/FEDERATION BH - FOUNDATION FOR SUSTAINABLE DEVELOPMENT - LOCAL DEVELOPMENT UNIT; GOVERNMENT OF BOSNIA & HERZEGOVINA/AND REPUBLIKA SRPSKA DEVELOPMENT AND EMPLOYMENT FOUNDATION - LOCAL DEVELOPMENT UNIT

Other Partners:

STAFF Current At AppraisalVice President: Shigeo Katsu Johannes LinnCountry Director: Orsalia Kalantzopoulos Christiaan PoortmannSector Manager: Sumter Lee Travers Margret ThalwitzTeam Leader at ICR: Lawrence M. Hannah Sarah J. ForsterICR Primary Author: Lawrence M. Hannah; Goran

Tinjic; Anita Correa

2. Principal Performance Ratings

(HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HL=Highly Likely, L=Likely, UN=Unlikely, HUN=Highly Unlikely, HU=Highly Unsatisfactory, H=High, SU=Substantial, M=Modest, N=Negligible)

Outcome: S

Sustainability: L

Institutional Development Impact: M

Bank Performance: S

Borrower Performance: S

QAG (if available) ICR

Quality at Entry: SProject at Risk at Any Time: No

3. Assessment of Development Objective and Design, and of Quality at Entry

3.1 Original Objective:The original and unchanged project development objectives were to: " Strengthen the institutional and financial capacity of selected local governments and utilities so as to enable them to provide improved municipal infrastructure and services in response to citizen demand, and to initiate, on a pilot basis, the development of a municipal credit market to provide a long-term source of financing for creditworthy municipalities for infrastructure investments."

By 1998, when the PDOs were established, it had become clear that the administrative structure in Bosnia and Herzegovina (BiH), (and in the Federation BiH entity, in particular), was not efficient and its financing arrangements were not sustainable. However, it was also clear that there was no chance to address this issue through constitutional change as there was no political consensus in this regard. It was therefore decided to strengthen capacity of the state government and centralize certain functions (army, police, treasury etc) as preconditions for European integration, while, at the same time, strengthening the capacity of local governments (i.e. municipalities as the level of government closest to citizens) to provide better services to their citizens. This project was among the first Bank-financed operations of the "new generation" in BiH. In other words, it was not a classic post-conflict reconstruction project but an operation that aimed at promoting sustainable development and introducing instruments that could facilitate such development. The immediate post-conflict reconstruction phase was characterized by emergency infrastructure rehabilitation, with little attention to building local institutional capacity and the financial sustainability of service delivery. Further, Bosnia’s reconstruction effort was mainly driven by donor aid flows that were diminishing over time leaving an infrastructure investment gap (both maintenance and new infrastructure) that totaled billions of dollars. On the supply side a strategy and policy was in place to replace the former system of state banks with international standard banks operating within a modern financial sector policy framework. Hence, there was a perceived need to support local governments to improve their revenue-generation capacity and to access sustainable (i.e. commercial) sources of financing (commercial banks) for their capital investments.

The PDOs fit very well together because they were really two parts of one story. Financing for improved services would be provided through the modernizing financial markets that would, in turn, require local governments (and their utilities) to strengthen the way they were managed their financial performance in order to be treated as creditworthy. This formulation of the problem and the solution was consistent with the strategy of both the government and the Bank at the time.

According to the then Country Assistance Strategy (CAS), local governments (cantons, cities and municipalities) were important economic players in BiH in respect to reconstruction activity and accommodating the return of refugees, with specific responsibility for the provision of basic services and infrastructure at the municipal level. Although local governments and their utility companies were institutionally and financially weak, they faced huge demands to meet the needs of existing and returning communities. Up to that time, post-conflict reconstruction had focused

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on emergency infrastructure rehabilitation with little attention to building local capacity and the institutional and financial systems to support long-term economic growth and development. This project supported the shift from emergency, post-conflict reconstruction to sustainable economic growth and development, which was the main strategic goal of the CAS.

Specifically, the PDOs were conceived to provide incentives to economic actors, municipal governments and banks, and to constructively address all three development themes of the CAS - strengthening public finance management, private sector development in support of the transition to a market economy, and deepening the sustainability of reconstruction. Initiating a market for financing local public services required better managed borrowers and more developed lenders with a reason to establish and maintain good working relations, all required by the type of commercial lending transactions envisaged in the PDOs.

3.2 Revised Objective:The objectives were not revised.

3.3 Original Components:The original and unchanged components were as follows:

Component 1: Local Government Capacity Building : Technical assistance and training were to be provided to local governments, (selected based on an eligibility criteria that included indicators such as creditworthiness, economic environment, capacity of the municipal management, availability of development/urban plans etc), to strengthen their financial management skills and ability to identify and prepare bankable projects. Activities under this component were also designed to ensure appropriate public participation in the capital budgeting process. The technical assistance and training program was to be focused on: capital planning and budgeting; financial management and accounting; project design; project preparation and appraisal; procurement and public participation in capital budgeting process.

Component 2: Banking Sector Capacity BuildingTechnical assistance and training was to be provided to selected private commercial banks to improve their municipal credit analysis and project appraisal skills. Selection of participating banks was to be on the basis of criteria such as: financial condition, managerial capacity, compliance with banking agency regulations, credit analysis and credit policies and their potential to strengthen/develop municipal lending.

Component 3: Local Development Fund (LDF)A loan fund was to be established and administered by the LDFs in two entities, for on-lending funds to participating commercial banks that they in turn would lend to municipalities and/or their utilities for eligible investments.

Component 4: Project ManagementProject implementation was to be the responsibility of the local development units, to be established as autonomous, nonprofit agencies by the respective entity governments. These units did not make decisions on loans (commercial banks did) and, therefore, did not control disbursement except for technical assistance and their own administrative expenses.

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The project components were designed to fit the PDOs precisely. Since the project was organized around the initiation of a market for credit to local governments, the largest component (79% of project costs) was understandably Component 3, the LDF, which contained the financing for on-lending through banks to municipalities. Although there had been an assessment of the Local Government Sector in Bosnia-Herzegovina and its Creditworthiness in 1998 it was (correctly) understood that targeted assistance and training to both parties, lenders and borrowers, would be necessary for the achievement of the PDOs. No fewer components would have addressed the PDOs and no additional ones were needed.

3.4 Revised Components:The components were not revised.

3.5 Quality at Entry:Although there was no formal “quality at entry” review it is possible to make some judgments about “quality at entry” from the implementation experience. Although the design has proven robust and appropriate, there is evidence that implementation progress would have been better had the credit for the project been processed somewhat later. In simple terms, the project was phased, first to train and provide technical assistance to banks and local governments, and second to then have the two parties conduct business. Each phase was assumed to require about two years of the planned four-year project period.

The framework for modernizing the financial system (including banks) was in place and a detailed assessment entitled Local Government Sector in Bosnia-Herzegovina and its Creditworthiness (October 1998) was carried out as part of project preparation. The major findings of this assessment were: (1) the economic and financial conditions for local government are gradually improving and stabilizing; (2) there are enough local governments (both cantons and municipalities) which have reached a "creditworthy" status to warrant proceeding with the Local Development Pilot Project; (3) there are a large number and variety of projects that are ready for financing; (4) utility project financing will be complicated by the "quasi-separate" legal status of utilities; and (5) there is significant unused debt capacity since local governments had virtually no borrowing to date.

Despite these positive assessments, the project took six rather than four years (two extensions) to complete. The TA phase got organized early but ran into quite different problems in the RS than in the Federation. In the RS, the slower than expected privatization of the state-owned banks resulted in delayed selection of participating banks which was a precondition for receiving TA from the project. With only one bank qualified in the RS more than two years into the project, there was no “market” for prospective borrowers to go to despite active interest. In the Federation the problem was instead on the borrowers’ side where political considerations played an important role in slowing the process of reaching agreements on loans. Lower-cost sources of financing (deeply subsidized donor funds) caused borrowers to hesitate to accept commercial terms and the overly complex three level structure of government in the federation diffused responsibility for local services also reducing the incentive to borrow. So while the first loan to a local government was made at the end of approximately the second year, the business did not really take off until the issues mentioned above were resolved late in the third year. Instead of the

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smooth climb in disbursement envisaged at appraisal, the project disbursed little, except funds for technical assistance and project administration, in the first three to four years. Once the banks starting lending to municipalities they were able to use the entire remaining credit proceeds (about 80%) in the final two years.

Had the factors mentioned above been fully appreciated and included in the calculation of project’s timetable the project might well have been processed later. In this sense the quality at entry might be considered marginally satisfactory but that category is not available in this ICR format so it is designated satisfactory.

4. Achievement of Objective and Outputs

4.1 Outcome/achievement of objective:The first key achievement of the project is an improved ability of the participating local governments to identify and design priority projects, and to make sound capital investments. In contrast with immediate post-conflict reconstruction phase, when massive investments in infrastructure were made with little attention to building capacity of local governments as promoters of local development, this project aimed at changing the mind-set of the local governments from bystanders to creators of preconditions for growth in their respective areas. This was achieved by providing effective technical assistance to local governments and by motivating them to improve the way the identified and implemented local service improvements. The prospect of obtaining a loan created an incentive for local governments to strengthen their institutional and financial capacity so as to meet the requirements of lenders in order to borrower for improved municipal infrastructure and services. The indirect evidence that local governments accomplished this is that private lenders (banks), assuming the full credit risk, took the decision to make twenty-nine loans to them. The specific elements of the TA to local governments are reviewed below (4.2 Component 1) and it is the judgment of both the lenders and various reviewers that those who received assistance made great progress in respect to their ability to manage their finances and undertake capital investments. Accomplishment of the first PDO can also be seen as the demand side of the market for credit to local governments. To accomplish the second part of the PDO, creation, on a pilot basis, of a market for municipal credit in BiH requires that the lenders have entered this business and they have. Not only have they made KM 22.3 million (USD 13.25 million versus PAD estimate of USD 12.5 million) worth of loans to municipalities but they have developed standard loan underwriting practices and a positive attitude toward this business based on their experience under this project. Although, in most cases, these loans are still early in their repayment schedule, all are being paid on time which is evidence of the high quality of the portfolio. The PDOs are thus deemed satisfactorily achieved.

4.2 Outputs by components:Component 1: Local Government Capacity Building: Satisfactory Technical assistance and training under this component were provided to some thirty local governments (selection based on an eligibility criteria that included indicators such as creditworthiness, economic environment, capacity of the municipal management, availability of development/urban plans etc), to strengthen their financial management skills and ability to identify and prepare bankable projects. Activities under this component were also designed to ensure appropriate public participation in the capital budgeting process. The technical assistance and training program was provided by qualified

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international consultants (BMB Arcadis & Cowater International were selected competitively – procurement method was QCBS) and was particularly focused on: capital planning and budgeting; financial management and accounting; project design; project preparation and appraisal; procurement and public participation in the capital budgeting process. Under this project the direct mechanism, by which local government capacity was translated into better public infrastructure and services, was that the capacitated obtained a commercial loan. In addition, both the consultants to local government and an independent review judged the results of this component as successful. The LDFs confirmed this finding in their review of project feasibility studies that included confirmation of the procedure used to consult with the community. All of these reports are included or listed as a reference for this ICR.

Component 2: Banking Sector Capacity Building: Satisfactory Technical assistance and training was provided by qualified international consultants (Luso LFS during the initial phase and by the Urban Institute during the later phase of the implementation) to three selected private commercial banks (UniCredit Zagrebacka Bank, Raiffeisen Bank and LHB Bank) to improve their municipal credit analysis and project appraisal skills. Selection of participating banks was subject to a due diligence assessment performed on the basis of a standard eligibility criteria for participating commercial banks that includes indicators such as: financial condition, managerial capacity, compliance with banking agency regulations, credit analysis and credit policies and their potential to strengthen/develop municipal lending. A dispute with the initial consultants delayed implementation of this component (along with some regulatory factors in the Federation BH mentioned earlier) but the fact that the banks all made loans to local governments indicates that they eventually became comfortable with these borrowers, undoubtedly, in part, due to the assistance rendered under this component. This component came in under cost estimates and the resources saved were applied to Component 3 to fund loans for local governments.

Component 3: Local Development Fund (LDF): Satisfactory This component was fully disbursed by the extended closing date. Commercial banks underwrote the credit aspects of all loans while safeguard and procurement compliance was reviewed by the LDFs. All loans made under the project are being paid in full and on time to the lending banks. Although the investments financed under this component are relatively modest in size, for a country with such enormous financing needs for reconstruction and improvement of existing infrastructure and the building of new infrastructure, the outcomes are significant. Among other service improvements, the project supported: reconstruction of street lighting in the second largest city in BiH; rehabilitation of the local road network in ten municipalities in length of 76.36 km; building and reconstruction of water supply systems in nine municipalities; reconstruction of sewage networks in four municipalities; construction of sewage systems in length of 3,8 km; construction of nine water basins; construction of three water pump stations and procurement of necessary equipment; reconstruction of five cross-roads in two municipalities; building of two sports hall and building of flower market. These investments are co-financed from other sources as well, including the required contribution from each municipal budget of a minimum 10% to approximately 50% of investment costs in some cases.

Component 4: Project Management: Satisfactory Project implementation was the responsibility of the local development units housed within the two entity foundations

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(Development and Employment Foundation in Republika Srpska and Foundation for Sustainable Development in the Federation BiH) whose performance as a whole has been satisfactory throughout project implementation. DEF and FSD managed the procurement and delivery of all technical assistance under components 1 and 2. They also established the FMS procedures for component 3 and successfully channeled funds to the participating banks. Although the project took two years longer to implement than originally envisaged there are only a few cases where the implementing units could have shortened the time, such as dealing with consultant problems more expeditiously. The cost overrun on this component is exactly proportional to the extra time required to implement the project.

4.3 Net Present Value/Economic rate of return:Since specific investments were not identified at appraisal no ex ante rates of return could be calculated. However, each sub-project submitted to a bank for financing was required to be supported by an appropriate feasibility study which, inter alia, was to include an analysis of least cost choice or economic viability. A sample of these studies was reviewed by Bank supervision missions and found to be satisfactory in respect to the estimated economic returns as well as other parameters. The LDFs reviewed and accepted feasibility studies for all subprojects. Reports on all individual projects financed are available. Since the project’s principal objective was to increase the availability of financial services to previously unserved clients - local governments - it would be desirable to estimate the economic value of achieving this objective. However, there is not a standard way of estimating the economic returns to improved intermediation and the PAD did not attempt such analysis.

4.4 Financial rate of return:No financial rate of return was applied to the overall project in the PAD but the financial condition of prospective local government borrowers was discussed as an integral part of the creditworthiness assessment. Guidelines for borrowers were drawn up and these became part of the materials used in delivering technical assistance to banks. In the case of investments designed to directly recover all or a portion of their costs additional instructions were available. The LDFs have confirmed that the credit decisions of banks did make reference to borrowers’ compliance with regulations (in respect to borrowing) as well as required financial criteria. Project finances, when relevant, were covered in feasibility studies for specific investments.

4.5 Institutional development impact:There is a visible positive impact on the two main groups of institutions involved in the project. In response to the opportunity to obtain a loan, many local governments have measurably strengthened their budget management processes and taken the necessary steps to make themselves attractive borrowers. Perhaps more profoundly, these municipalities have changed their thinking about how to finance priority local services. Instead of relying exclusively on political lobbying of senior level governments or donors, a goodly number of local governments in BiH have taken the decision to approach commercial lenders and have learned how to do so, successfully. The participating banks have undergone significant institutional development too as a result of the project. At the outset they were not familiar with public sector borrowers and generally not disposed to trust them with loans. The evidence of change is most dramatically demonstrated by the loans these banks have made to municipalities but it also evident in the strategy and enthusiasm for this business as discussed with Bank missions. The public institutions

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created to implement this project also developed quickly and clearly had a positive impact on the achievement of project objectives but are not permanent fixtures in the municipal credit market.

5. Major Factors Affecting Implementation and Outcome

5.1 Factors outside the control of government or implementing agency:There were no significant external shocks or events which specifically affected this project. The continuing poor macro economic performance and the strained public finance environment did not help implementation of the project but these are generally not considered factors outside the control of government.

5.2 Factors generally subject to government control:Looking more narrowly at factors that directly affecting project performance, as mentioned in previous sections, it is clear that the availability of grant financing for capital investments discouraged many creditworthy municipalities and their utility companies from actively exploring opportunities in the commercial market. At the same time, at a policy level there was little understanding or support for municipal borrowing under commercial terms. As a result, during the first two years of project implementation, municipal officials either thought that they were (or should be) eligible for subsidized financing and may have been reluctant to present themselves as strong potential clients to commercial banks in this environment. Entity Governments could have played a more prominent role in promoting development of a municipal credit market as a sustainable source of financing of municipal capital investments.

In addition to many reforms during the life of the project that helped implementation, such as reforms to the fiscal and banking systems, the project itself supported analytical and advocacy work on the legal and regulatory framework for municipal borrowing in BiH. Final enactment of this legislation has been delayed by a long-standing difference of opinion between officials of the government and the IMF. Nevertheless the general framework needed to make this project work is much improved from where matters stood six years ago.

5.3 Factors generally subject to implementing agency control:Project implementation units in both entities demonstrated high levels of commitment and professionalism which ultimately led to the achievement of project objectives. However, while in Republika Srpska Local Development Unit enjoyed full support from the DEF's management and executive board, Federation BiH counterparts did not always have the support from the FSD's management and executive board. This was mainly due to prevailing perceptions as described under 5.2.

5.4 Costs and financing:The project cost was estimated at US$ 17 million of which US$ 15 million in IDA credit (SDR 11.1 million equivalent). Total financing for the project reached US$ 16.94 million and comprised of Italian Grant for TA components in the amount of US$ 850,000 (5.1 % of total project cost), Dutch Grant for TA components in the amount of US$ 400,000 (2.3%) and IDA credit in the amount of US$ 15.69 million (92.6%).

As mentioned above project management costs were estimated at US$ 0.9 million but rose in proportion to the extended implementation period of six years. Savings from the technical

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assistance components were used to increase funding for loans to local governments.

6. Sustainability

6.1 Rationale for sustainability rating:Likely: Both the investments financed and the loans made are sustainable. The infrastructure financed is sustainable if it continues to provide the services for which it was intended which the case for all investments under the project to date. The loans are sustainable if they are being repaid on time and in full which is the case for all as of this date. In a broader sense, the pilot approach adopted under the project implies that the experience of local governments being able to borrow from the financial system will be generalized and grow. It is clear that the local governments who borrowed, and many who did not, have a considerable appetite for debt finance. Many have figured out how to make themselves creditworthy and that process is expected to continue. There are already cases of local governments who have borrower and repaid going back for a second loan and negotiating better terms which is evidence that they have learned something from their initial transaction (the project) and been able to apply it in subsequent negotiations with lenders. As discussed below in the transition section, the participating banks have certainly understood how to evaluate these borrowers and how good this line of business can be. The banks have expressed their intention to continue this business and are likely to do so, with, or without, refinancing such as was available under this project. Thus we fully expect the market which was effectively piloted under this project to be sustained in the future. One caveat, mentioned below, is the delay in final approval of new subnational borrowing legislation but given the nature of the debate (it is not about the desirability of municipal borrowing for capital investment) this should be thought of as a delay not a threat to sustainability of this process.

6.2 Transition arrangement to regular operations:The project provided substantial input to policy makers on the legal and regulatory issues to be addressed to facilitate development of a sound municipal credit market in Bosnia and Herzegovina. The Urban Institute was hired to carry out an assessment and to provide recommendations on principles to be incorporated into the new legislation on municipal borrowing. These recommendations were taken into consideration when the new law on internal debt was drafted. However, as of today, this law has not been adopted mainly due to absence of a consensus about the ceiling for annual debt service by municipal borrowers (borrowers financed under this project were authorized to borrow under a special exemption). While, both municipalities and commercial banks are demonstrating capacity to strengthen their partnership resulting in increased infrastructure investments, adoption of this law is a necessary precondition for the process begun under this project to continue as a normal business.

7. Bank and Borrower Performance

Bank7.1 Lending:The Bank's performance in preparing the project is rated satisfactory with the caveats mentioned under the section Quality at Entry.

7.2 Supervision:The Bank's supervision performance is rated satisfactory. During the initial phase of the project implementation there was an intensive supervision by the field-based Team Leader with the

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support of a local Operations Officer and Washington-based Public Finance Specialist. Although there was a change of the Team Leader after this initial phase, it did not affect the project implementation or Bank's overall performance. The new Bank team was committed to the original design of the operation seeing no (longer term) alternative than to use private savings for public investments. During project implementation this concept gradually received support from all stakeholders and even among those who were originally skeptical about commercial approaches to support infrastructure investment.

7.3 Overall Bank performance:Overall Bank performance is rated as satisfactory.

Borrower7.4 Preparation:The Borrower's performance throughout the project preparation and implementation is considered satisfactory. In spite of initial skepticism about commercial borrowing by municipalities for capital investment projects, the counterpart team was very much involved in project preparation and provided an important contribution to the project design. Entity Governments also made necessary implementation arrangements to ensure successful implementation of the project.

7.5 Government implementation performance:The Government's implementation performance is rated as satisfactory. There was no political interference in decision making. Through this project, Government has, for the first time in Bosnia and Herzegovina, created an environment for commercial relationship between local governments and private commercial banks.

7.6 Implementing Agency:Performance of implementation agencies was satisfactory throughout the project preparation and implementation. Local development funds were established as a separate unit within Development and Employment Foundation in Republika Srpska and as a separate legal entity in the Federation BiH. At the later stage it was agreed in the Federation BiH to consolidate implementation of the several Bank financed operations under the umbrella of a new Foundation for Sustainable Development. As expected, this transition presented a challenge for the counterpart team in the Federation BiH which had to spend more time on administrative issues and to make sure that there was sufficient understanding of the project concept among the new management and members of the Executive Board. However, despite these difficulties, this transition did not have an overall negative impact on Borrower's performance. It is thanks to continued efforts of the counterpart teams that the interest of commercial banks for this project was maintained despite the somewhat slow start. Project objectives would not have been achieved without strong performance and commitment of the implementation agencies in both entities.

7.7 Overall Borrower performance:Overall Borrower's performance is rated as satisfactory.

8. Lessons Learned

The most important lesson learned from this project is that the model works. It means that even relatively weak local governments, in a moderately ambiguous intergovernmental fiscal framework, can make themselves creditworthy for commercial lenders. This is testament to the

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effectiveness of the assistance municipalities received and to the incentives they faced. Similarly, the project teaches us that private banks will lend to the subnational public sector and take the full credit risk. Any project attempting to replicate this accomplishment needs to start out with a complete understanding of lenders concerns. A clear lesson is that the legal and regulatory framework, in all its dimensions, is the necessary foundation for this business to succeed.

From an internal point of view, if the Bank were to decide to replicate this model there would need to be some adjustments in current policy and practices. At a mechanical level, standardized disbursement schedules can not be applied to projects where private sector actors wholly control the spending decision. The present arrangements to disburse Bank loans on a predetermined schedule actually create pressures that undermine prudent credit decisions by private lenders. However, the most important policy issue revealed by this project is that any attempt to create a market-based system of financing public investment can not be in direct competition with non-market funding sources (including from the World Bank) if it is to succeed. This means that there needs to be an explicit policy on which public entities are entitled to receive subsidized loans and for what purposes.

9. Partner Comments

(a) Borrower/implementing agency:Submission of the Project Implementation Units

of the Republika Srpska Development and Employment Foundationand the Federation BiH Foundation for Sustainable Development

I. INTRODUCTION

OBJECTIVES AND DESCRIPTION OF THE PROJECT

The Project had two main development objectives:

(1) to strengthen the institutional and financial capacity of local governments in BiH so as to enable them to provide improved infrastructure and services in response to citizen demand; and

(2) to initiate, on a pilot basis, the development of a municipal credit market to provide a long-term source of financing for creditworthy municipalities for capital investments.

A description of the degree to which the Project met its objectives is given by components.

Component 1: Local Government Capacity Building

Technical assistance and training is provided to app. 40 municipal governments throughout BiH to strengthen their financial management skills, ability to prepare bankable projects and capacity to identify and prepare priority investments and ensure appropriate public participation in the capital budgeting process. Selection of participating local governments is carried out in accordance with proposed procedure and their performance against proposed eligibility criteria, such as financial

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condition, economic environment, municipal (management's capacity), urban plan, public participation and service delivery orientation. In other words, eligible municipalities are selected on the basis of their ability to demonstrate potential creditworthiness. As was anticipated, the technical assistance and training program was comprised of individual consulting of municipal officials from participating municipalities in several areas, like as: capital planning and budgeting, financial management, accounting, project design, preparation and appraisal, procurement and public participation in capital budgeting process. Besides, within this component it was held 6 seminars in financial management and 2 seminars in project preparation, as well as was organized the study tour to the Netherlands for representatives of 12 selected municipalities to familiarize them with functioning of the Dutch local governments and their municipal lending system via the Bank of Netherlands’ municipalities (BNG).

Component 2: Banking Sector Capacity Building Technical assistance and training is provided to 3 selected private commercial banks to improve their municipal credit analysis and project appraisal skills. Capacity building of participating banks is achieved through an introduction of participating banks with municipal budgets, sources of municipal revenues, and intergovernmental flows, analysis of debt service coverage and other financial ratios, and identification of key sources of credit risk in municipal lending. Selection of banks is performed on the basis of meeting criteria such as: financial condition, managerial capacity, compliance with banking agency regulations, credit analysis and credit policies and their potential to strengthen/develop municipal lending. At the end of the Project’s realization four banks are approved as participating banks: UniCredit Zagrebacka Bank, LHB Bank, Nova Bank and Raiffeisen Bank BiH (due to the merger of two banks included in the Project, Universal and Zagrebacka, that followed lately). Representatives of the partner banks had an opportunity to get acquainted directly with experiences of Czech Republic and Poland in building their municipal lending systems in the course of five-day study tour to Prague.

Component 3: Local Development Fund (LDF) The loan funds provided by IDA to the State of Bosnia and Herzegovina are, on a project by project basis, provided to PIUs for on lending to private commercial banks for the purpose of refinancing particular municipal project loans to municipalities. A revolving loan fund has been established from which funds are on-lent to selected banks for on-lending to municipalities and/or their utilities. The total loan portfolio of LDP earmarked for funding of municipal loans amounts USD 13 million according to the effective exchange rate (1 USD=0.60 KM). Eligible investments are mostly made in the following municipal infrastructure and services sectors: water supply, sewage and waste water treatment, local roads, street lighting, sport halls, markets, municipal building rehabilitation etc. The maximum amount of approved loans is KM 2 million with a term of up to 10 years. The loans amounts are from KM 140.000 to KM 2.000.000 (average KM 750,000) and they have financed up to 90 percent of the cost of eligible infrastructure projects.

The LDF funding is made available as loans to the partner banks who receive loan applications from local governments previously selected for participation in the Project. The banks are responsible for carrying out an assessment of creditworthiness of municipalities and credit risk of loan applications. Based on results of the evaluation, banks decide to grant loans to municipalities for municipal

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investment financing assuming all lending risk. The basic requirement of municipal lending within the LDP is that the banks take the credit risk of municipal loans extended by them. The lending banks assume full credit risk for repayment of loans granted to municipalities. Accordingly, they make their own credit analysis and are solely responsible for loan collection. For that purpose the loans to local governments are additionally secured by mortgage on municipal real property. The reliance on real property collateral connects municipal lending to other forms of lending with which the banks have already had experience. It also reflects the policy of banking regulatory authorities, which requires that banks maintain higher risk-weighted capital ratios for uncollateralized loans.

The interest rate on the LDF loans to banks is determined in the Framework Agreements on Co-operation and Financing concluded with banks at 4% p.a. However, for the municipal lending activities is more important so called “a price of loan”, that is expressed as an interest rate on bank loans to municipalities. There has been recorded a significant decrease of this interest rate from maximum 9% in the first years to 6.5% in the last two years of Project’s implementation. The average interest rate on bank loans to municipalities is somewhere about 7.50% p.a. A downward trend of the interest rate is continuing. Finally, as a valuable outcome of this component it needs to be emphasized that repayment rate on municipal loans achieved so far is 100%. This ratio indicates a high quality of the LDF loan portfolio which has exceeded the expected one (no more than 10% of LDF portfolio at risk).

Component 4: Project Management

The PIUs have operated under the authority of the RS Development and Employment Foundation (RS DEF) in Republika Srpska and the Foundation for Sustainable Development (FSD) in the Federation BiH. The Foundations are established as autonomous, non-profit financial institutions by the Governments of the RS and FBiH. Each Foundation has its managing board composed of the Entities’ Governments representatives (ministries of finance, local governance, civil-engineering and housing-communal services), and representatives of the associations of cities and municipalities as well as banking agencies. The Boards are responsible for approving regulations, policies, procedures and annual budgets for the Foundations.

II. REALIZATION OF THE PROJECT

A. MAIN CHARACTERISTICS OF THE PROJECT’S REALIZATION

The Local Development Pilot Project (LDP) is one of the first World Bank’s truly developmental projects in Bosnia and Herzegovina (BiH). The Project is designed for the purpose of establishing municipal credit market and improvement of management of local governments in BiH, as an inducement and a condition for lending from private commercial banks. In the course of its preparation, it was anticipated that the Project would be implemented during four year time period. Actually, for its realization and achievement of set goals it was needed two additional years. Having in mind generally unfavorable state in the Country’s economy and particularly in public and banking sector at the onset of the Project, where a relative lack of creditworthy municipalities and a weakness and under-capitalization of local banks prevailed, additional time for accomplishment of the objectives

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of Project seems quite reasonable.

The first municipal lending transactions have started two years after the Project’s start-up. Nevertheless, this was almost in accordance with the anticipated Project’s implementation plan. Namely, it was foreseen to carry out capacity building activities of municipalities and banks in the first two years in order to prepare them for participation in municipal lending. An intensive institution building program was necessary and fully justified, as was beforehand determined that neither municipalities had experience in borrowing from banks for financing their infrastructure investments nor banks had experience in long-term lending to local governments for these purposes.

However, there were some objective external obstacles that have caused a delay in the Project’s execution. In Republika Srpska these obstacles were mainly on the side of banks, so that a slower than expected privatization of state-owned banks has resulted in a slower selection of banks for participation in the Project. Finally, one bank has met established criteria and has been included as the Project’s partner bank. As a consequence of such a status, over almost two years, the pace of lending activities, as well as terms and conditions of loans, were determined by that bank. The situation has been significantly improved by the end of year 2003, when two another banks were included in municipal lending activities in the RS. An involvement of these banks has enabled dispersion of credit risk of the LDF loan portfolio, and has brought advantages of competition between banks in municipal credit market in nascent.

The lending operations in the Federation BiH were delayed for reasons on the local governments side. Political considerations at the local level originally played an important role in the slow movement to loan completion. Besides, an offer of lower–costs sources of financing (donor grants) caused indecisive attitude toward borrowing among the municipalities in Federation in early years of Project implementation. Lending operations become better after local governments have received appropriate technical assistance that helped them to present properly and to prove necessity of borrowing for realization of infrastructure project to their citizens and municipal councils.

Contrary to the mentioned obstacles, during the entire period of Project’s implementation a number of substantial economic reforms performing in the Country have positively effected its pace and outcomes (to mention some of them: reform of fiscal and banking system, reform of public accounting and financial reporting). Besides, the BiH banking sector has been significantly consolidated through introduction of regularity and governments’ and banking agencies’ monitoring and regulation procedures, which further improve an ambiance for lending to public sector institutions (municipalities and municipal enterprises).

In the same spirit it was designed technical assistance and training program for selected BiH municipalities. Twenty-eight months program provided by a pool of international and local consultants is positively assessed by municipalities participating in it, as well as by the PIUs staff responsible for coordinating the consultants’ activities. As a result of these activities financial management practices and creditworthiness of participating local governments has been considerably improved. Moreover, participating municipalities are now prepared to easier establish parameters of their creditworthiness (conduct a self-assessment of creditworthiness) and take measures for increasing it through improvement of their financial management practices, as well as establish relationships with lending

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banks and negotiate about loan terms and conditions. On the other hand, the LDP participating private commercial banks are now able to carry out credit analysis that is adequate for the types of loans that they grant to municipalities. Banks demonstrate ability to make long-term loans to municipalities and secure repayment of these loans, and thus include and carry out municipal lending and municipal account management as a profitable line of business in their banking operations.

Although the Project started very slowly and took much longer than expected to accomplish initial capacity building goals, the implementation of technical assistance and training was mainly assessed as satisfactory. However, there were some weaknesses as well in rendering the consultants’ services, especially those to banks, but they could not diminish more considerably generally positive performance of this component of the Project. On the other hand, an excellent and competent municipal and bank staff who participated in the LDP deserves also credit for achieved good results and efficient performance. Therefore, we would like to emphasize here that the municipal and bank officials and officers have given substantial contribution to the successful realization of Project and its objectives.

The most important component of LDP is the revolving loan fund available for on-lending to banks for lending to municipalities for financing infrastructure investments. These funds have served as an initial support to achievement of main development goal of the Project, creation of a small scaled municipal credit market. More significant progress in that regard is made in the course of the last three years of Project’s implementation. To May 31, 2005, 29 loans are granted and disbursed to municipalities by five participating banks, which indicates that an actual result of Project’s realization exceeded planned one for the IDA Credit funding period (15-20 municipal loans). An average size of these loans (app. KM 767,000) is somewhat above anticipated value (KM 700,000). Such an increase of lending volume is accomplished by an enlargement of the LDF credit funds of Republika Srpska for app. KM 965,000 due to a reallocation of the IDA Credit funds earmarked for financing “consultants’ services” to “sub-loans”. The total value of LDF loans is EUR 11 million (USD 13 million equivalent) which represents about 99.60% of the total loanable funds of the Project (due to the long procurement and contracting procedure a tiny amount of these funds of 0.40% remained unwithdrawn from the IDA Credit).

The main quality indicator of LDF loan portfolio is a repayment rate of municipal loans. Although the lending to municipalities has started just recently, and accordingly these loans are in early repayment stage, it is noted 100% repayment ratio of municipal loans so far, which is an evidence of a high quality of the loan portfolio. In the interest of further development and growth of municipal lending business, it is of essential importance to maintain such a repayment rate level (or close around it). With multiple review and approval procedures required by the Project, it has been built a reliable lending system whose participants are aware of their roles and responsibilities. Therefore, we believe there is enough grounds for expecting that the established credit system continue to realize good performance indicators all along. It is worth emphasizing a positive impact of competition among participating banks reflected through the terms and conditions of municipal loans, particularly expressed in the last two years of Project’s implementation. Banks became very active in their endeavors for attracting municipal clients by offering them long-term loans under more favorable conditions. This fact could be illustrated by a

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downward tendency of interest rates on loans to municipalities, so that they were about 6.9% in the Federation BiH and about 8% in the RS in the last year. The average interest rate on bank loans to municipalities for the entire IDA Credit implementation period is about 7.50% p.a. Further decrease of interest rates is noted down in the current year as well.

However, the effects of the Project are more impressive when they are presented in quantitative parameters of investments in infrastructure and services that are financed from loan funds. Although these investments are modest size from the funding aspect, for the Country with such enormous needs for financing reconstruction and improvement of existing infrastructure and building of new infrastructure facilities, the outcomes of investments are extremely significant. The fact that some of these investments are co-financed from other sources as well, including required contribution of municipal budget of minimum 10% to app. 50% of investment cost, does not diminish the Project’s effects at all. (More detailed overview of sub-projects financed by municipal loans within the Project is given in the Attachment I to this Report.)

The development of the Municipal Credit Market in BiH is thus initiated by the Project activities and although somewhat protracted because of earlier mentioned impediments has nevertheless exceeded expectations. Given the scope of the Project’s goal, the complexity of its components and the expediency with which implementation had to occur, especially in post-war and transitional conditions prevalent in BiH, the Project was successful.

As indicated earlier, the Project’s key requirement is that participating banks assume full credit risk of loans extended to municipalities. The other specifics of the LDP lending scheme is that credit line to lending banks is denominated in Euro (EUR), while credit line to borrowing municipalities is in domestic currency (KM), which means that such an arrangement involves a foreign currency risk. All of the loan agreements concluded between banks and municipalities have a provision that assign foreign currency risk to the municipality, i.e. the municipality is required to repay the loan in local currency adjusted for the value of Euro. Accordingly, the loan agreements shift the currency risk exposure that banks have in their loan agreements with the PIUs to the final beneficiaries, municipal borrowers.

As long as the Central Bank of BiH maintains monetary stability through the Currency Board arrangement which implies fixed exchange rate of domestic currency to EUR, there is no foreign currency risk. During Project’s implementation the BiH Presidency has adopted decree by which extended the Currency Board regime to August 2008. As the term of bank loans to municipalities may expand to 10 years, and even 5 year loans will begin to extend beyond August 2008, this issue might become critical in the future. Nevertheless, it seems that new Internal Debt Laws expected to be passed and put in force soon, as well as the Foreign Exchange Operations Laws, will contribute to resolution of foreign currency risk issue.

During the realization of Project, the PIUs have been included in a work on establishing appropriate legal and regulatory framework for municipal lending in BiH, as a pre-condition for sound and responsible municipal borrowing and the development of municipal credit market. Over the time, many laws relevant for performing municipal lending, especially long-term lending for capital investment financing, are adopted in the Country and its Entities, like laws on budget system, laws on

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self-governance and laws on banks, so that a basic legal framework is put in place. Moreover, the Project has financed the paper “BIH Local Development Project Legal and Regulatory Framework”, that has provided recommendations to the governments for drafting necessary legislation for municipal borrowing. These recommendations are contained in already mentioned laws on incurring debts by sub-national governments (Internal Debt Laws).

The allowed level of indebtedness, i.e. annual debt service limit on municipal borrowing is presently set at 10% of total recurring revenues from the previous fiscal year. The same debt limitation is also proposed in the Debt Laws which has caused objections by the IMF officials in BiH, who consider it high and potentially endangering for macroeconomic stability of the Country. A long lasting process of reconciliation of opinions between the IMF and BiH officials is still under way and that is a reason that these laws are still in adoption procedure. (It is expected that a newly formed working group will reach an accord on the Internal Debt laws soon and thus create conditions for their adoption and enforcement.)

B. FUTURE OF MUNICIPAL CREDIT MARKET IN BIH

The evidence of a successful realization of the Local Development Pilot Project in BiH is a municipal financial market in nascent, as a solution for the self-financing local governments’ investments. The Project has laid foundations for functioning and development of the long-term credit market for local infrastructure financing in the years to come. The municipal credit market in the near future is likely to be a modest scale operation, given the small size of municipalities as well as their financial capacity. Based on our experience gained in the course of the Project’s implementation, we do consider that it is extremely important to continue working with local governments and banks on further development of the existing capital market of infrastructure financing for the purpose of satisfying citizens needs and promoting local economic development. Alongside, the debt legislation, when finally is adopted, will remove present temporary “barriers” on municipal borrowing and thus enhance the prospects for further development of municipal lending market in the Country. The wise and appropriate use of credit is of vital importance for local development in the transition context and is a logical stepping stone for those municipalities, which can demonstrate creditworthiness to put forward innovative revenue generating projects. Certain municipal governments are increasingly becoming more professional in regards to financial management and planning and entrepreneurial in terms of fostering mobilization of resources necessary for development of domestic municipal credit market. That will additionally increase involvement of private commercial banks in lending to local governments for maintenance and reconstruction of municipal infrastructure.

There are several advantages on the side of municipalities that make them more attractive for the banks compared to other bank clients. First, they have stable sources of revenues, mostly from shared taxes and intergovernmental transfers, as well as their own revenues (taxes, fees, revenues from property). In the last few fiscal years the majority of municipalities has begun to stabilize their financial position and to record continuous growth of revenues. Municipalities are good clients of banks since they are public entities that can not go into bankruptcy. Besides, their management practices, budgeting (both operating and capital budgeting), accounting and reporting practices were significantly improved in the last years through implementation of economic reforms and application of

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international standards in these areas. And finally, the lending to municipalities for funding their infrastructure investments in practice is always linked to management of their bank accounts, as well as other banking transactions. This is also one aspect of diversification of banks’ activities, especially in the circumstances when banking sector is growing faster than economy, which is a specific feature of BiH development in the last years.

Recent communications with municipalities and banks in both BiH Entities about their borrowing/lending intents for the next construction season (2006) have confirmed existence of continuous needs of local governments’ for infrastructure investments as well as strong interest of commercial banks for having access to the credit line created by the Project. Right upon closure of the IDA Credit, first loan placement from the credit line/revolving credit funds have started in Republika Srpska under the same terms and conditions as for the Project’s lending. To the date of this Report, a loan application pipeline is made for the second phase of lending to municipalities that exceeds available funds from principal repayments collected so far. Following the expressed demand in this capital market segment, we should actively work on identifying additional financing for expanding the credit line for municipal lending. A completion of the pilot phase of Project’s implementation and start-up of next phase, the revolving fund transactions, is a crucial moment for operations of the revolving credit fund in the future, as well as a transformation of the existing PIUs. There are several conceptions of institutional arrangement for credit line transactions, but the decision regarding optimal solution for future operations will make our governments soon. Some initiatives in that direction are already taken. Namely, an adoption of a specific law on legal status of the Republika Srpska Development and Employment Foundation is under way. Since there are two other credit lines, beside the municipal lending credit line, that are created from the respective World Bank’s projects (Local Initiatives Project I and II, and Private Sector Credit I and II), the most appropriate solution is one that enables continuation of their operations within the existing Foundation. The Foundation will be legally institutionalized as a specialized non-banking financial institutions, that will provide specialized funding for domestic commercial banks involved in transactions of the mentioned credit lines.

In the context of planning of future operations of the Foundation and management of the credit lines funds, the staff responsible for their administering prepared adequate projections of cash-flows in the period 2005-2036, by when the respective IDA Credits will be repaid. The net result of financial projections clearly indicates that the revolving funds operations are self-financing and sustainable in the long run. The total funding at the Foundation’s disposal in year 2036 will remain at about the same level as in year 2005 and all IDA Credits will be repaid.

There are other options as well. The LDP credit funds have been established as revolving funds and there is possibility to extend this credit line with same approach and same procedures in the entire country. The new Fund should be transparent and open for cooperation with other investors and donors. The municipalities that are not “strong” enough yet through this enlarged, revolving credit line will be prepared to participate in commercial credit market in future and use other available resources also. The sustainability of municipal lending revolving fund operations is certainly more complex issue and

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depends on many different factors, whose effects are difficult to recognize now and almost impossible to predict in the future. Besides, the years to come will bring some new elements into the municipal financing system, e.g. introduction of VAT instead of sales tax from January 1, 2006, debt laws, etc. It seems however more likely that they will further improve the environment for local governments lending according to experience from the neighboring countries (Croatia and Serbia and Monte Negro). Over the last World Bank’s supervision missions, there was regularly on the agenda a consideration of possible directions for further development and growth of credit market for local governments in BiH. In order to maintain the existing market and eventually expand it for the purpose of satisfying funding needs of municipalities’ investments, it is inevitably to try to increase funds and volume of lending through: (1) enlargement of credit line by merging with other sources of financing (e.g. other financing institutions in the Country etc.); and (2) requirement for higher level of co-financing of municipal loans from lending banks. Concerning the first proposal, some international institutions and foreign-owned banks which have extensive experience in lending to municipal governments elsewhere in the region have already confirmed their interest for an entry into the emerging municipal credit market in BiH (e.g. USAID Municipal Credit Initiative and KfW Municipal Borrowing scheme). Despite their announcement of intents in BiH, they did not realize any significant outcome in the lending to municipalities so far, which opens an opportunity for collaboration in this field. It would be of essential importance for achieving the lasting success in municipal lending activities to establish mutual cooperation on the grounds of utilization of our funds and practical experience with their funds dedicated for lending to local governments in BiH.

III. EVALUATION OF PERFORMANCE OF THE DONORS

A. The World BankThe World Bank has played a main role in the initiation of the Local Development Pilot Project by developing the Project’s design, providing a major part of financing and by lobbying the governments of Italy and the Netherlands for providing additional funding for the Project (donations). Throughout the Project’s implementation, the World Bank has provided leadership in helping our management team to manage the Project adequately and towards accomplishment of its ambitious development objectives.

A lack of practical experience of the main stakeholders of the LDP, especially in early years of its realization, was overcoming by pragmatic approach of the World Bank’s task team staff. Their expertise and experience in building municipal financing systems for infrastructure financing was fundamental input in the realization of Project in BiH. Considering the great challenges we were facing in the beginning, we have to stress that without the involvement of Bank it would be very difficult (if not impossible) to avoid some general obstacles and risks, and to develop adequate solutions for responding to them. Its authority has enabled mitigating certain misunderstandings between international consultants and us and facilitated our collaboration with them. Lessons learnt in assisting the countries worldwide to establish appropriate sub-national governments capital markets, the World Bank has successfully applied in BiH as its contribution to efficient realization of the Project’s objectives. We would therefore like to emphasize once again that the World Bank’s leadership, an

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immense experience and permanent support provided to our team, was the key factor of achieving success in completion of the Project in BiH.

B. Government of Italy (Italian Trust Fund)Italian Trust Funds in the amount of USD 0.885 were available for co-financing the LDP through financing consultants services to municipalities and banks participating in the Project. As was mentioned above, the credit for providing this donation as well as the Dutch one deserves the World Bank staff. Thank to these donations for financing category “consultants services”, it was enabled increase of funds available for “sub-loans” funding in Republika Srpska.

C. Government of Netherlands (Dutch Trust Fund)Dutch Trust Funds in the amount of USD 0.4 million were limited to financing consultants services to participating local governments in Republika Srpska.

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OVERVIEW OF MUNICIPAL LOANS GRANTED TO MAY 31, 2005

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MUNICIPALITY PURPOSE OF LOAN / SUB-PROJECT TITLE

LOAN AMOUNT

LENDING BANK

LOAN TERM

INTEREST RATE

LAKTASI Reconstruction of Water Supply System – Phase I 500,000 LHB Bank 5 years 9%

BANJA LUKA I Rehabilitation of Street Lighting System in the City 1,500,000 LHB Bank 5 years 9%

BIJELJINA Reconstruction of Local Road Network 800,000 LHB Bank 4 years 9%

DOBOJ Reconstruction of Local Road Network 800,000 LHB Bank 4 years 9% PRNJAVOR Reconstruction of Water and Sewage Network 600,000 LHB Bank 5 years

9% GRADISKA Reconstruction of Water and Sewage Network – Protection of

Water Source Area 500,000 Nova Bank Bijeljina 7 years

9%

SRBAC Reconstruction of Local Road Network 400,000 Raiffeisen Bank BiH

5 years 8.5%

SAMAC Construction of Water Supply Well; Reconstruction of Sewage Network; and Rehabilitation of High School Building

350,000 Nova Bank Bijeljina 5 years 8%

KOZ. DUBICA Construction of Main Collector of Sewage System – Phase I 176,896 Raiffeisen Bank

BiH 5 years 8.5%

NOVI GRAD Reconstruction of Local Road Network 700,000 Raiffeisen Bank

BiH 7 years 8.5%

LJUBINJE Construction of Waste Water Treatment Device of Sewage

System 300,000 Nova Bank Bijeljina 5 years 8%

TREBINJE Construction of Collectors of Sewage Network – Phase II 262,621 Nova Bank Bijeljina 5 years 8%

BANJA LUKA II Reconstruction of Local Road Network in Rural Areas of the

City 1,301,920 Nova Bank Bijeljina 10 years 7.9%

ODZAK Reconstruction of Local Road Network

140,000 Zagrebacka Bank 7 years 9%

ODZAK Construction of Water Supply System 260,000 Zagrebacka Bank 7 years 9%

KISELJAK

Reconstruction of Local Road Network

400,000 Zagrebacka Bank 8 years 7.5%

BOSANSKA KRUPA Reconstruction of Local Road Network

300,000 Universal Bank 8 years 8%

NEUM

Construction of Water Supply System 500,000 Zagrebacka Bank 7 years 8%

TUZLA UTILITY Building of Flower Market 150,000 Zagrebacka Bank 5 years 9%

TUZLA Reconstruction of Local Road Network

1,120,000 UniCredit Zagrebacka Bank

7 years 6.5%

TUZLA Reconstruction of Local Road Network

190,000 UniCredit Zagrebacka Bank

7 years 6.5%

TUZLA Reconstruction of Water Supply System 1,369,511 UniCredit/ Zagrebacka Bank

7 years 6.5%

GRACANICA Reconstruction of Local Road Network; Control of River Channel; and Supply of Garbage Containers

700,000 Universal Bank 5.5 years 8%

TESANJ Construction of Sport Hall 750,000 Universal Bank 4.5 years 8%

SANSKI MOST Reconstruction of Sewage System 1,900,000 UniCredit Zagrebacka Bank

10 years 7.5%

GRUDE Construction of Water Supply System 2,000,000 UniCredit Zagrebacka Bank

10 years 6.5%

SIROKI BRIJEG Construction of Water Supply System 1,700,376 UniCredit Zagrebacka Bank

10 years 6.5%

LJUBUSKI Construction of Water Supply System 1,950,000 UniCredit Zagrebacka Bank

10 years 6.5%

ILIJAS Construction of Sport Hall 700,000 UniCredit Zagrebacka Bank

7 years 6.8%

TOTAL: 22,321,324

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(b) Cofinanciers:Bank-administered Trust Fund resources from the Governments of Italy and Holland were used for consultants services. Since there was no contact with the donors other standard financial reporting no attempt to solicit their opinion about this project was made.

(c) Other partners (NGOs/private sector):

10. Additional Information

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Annex 1. Key Performance Indicators/Log Frame Matrix

Outcome / Impact Indicators:

Indicator/Matrix

Projected in last PSR1

Actual/Latest Estimate

* participating municipalities demonstrate improved financial management capacities and improved citizen accountability

Technical assistance and training provided to 15 - 30 municipalities to build the institutional and financial capacity in preparation for commercial borrowing.

Technical assistance and training provided to 31 municipalities to build their institutional and financial capacity in preparation for commercial borrowing. Most receiving training were able to demonstrate to banks that the financial management capacities were sufficiently improved to warrant a loan. The LDFs independently reviewed feasibility studies which confirmed mechanism for consultations with citizens.

* pilot PCBs demonstrate improved municipal on-lending abilities -- no. of banks that implement high quality municipal lending practices -- no. and value of loans disbursed -- loans to values increase and/or negative covenants decrease

Training provided to 5 PCBs. 18 loans approved for a total amount of KM 13 million.

Training provided to 4 PCBs. 28 loans approved for a total amount of KM 22.3 million. Banks receiving training were able to underwrite loans to municipalities and loans have proven to be of high quality.

* measurable improvements in the quantity and quality of municipal infrastructure

Measurable improvements in the quantity and quality of municipal infrastructure, PCBs approve a total of 18 loans for capital investments by local governments and their utilities.

PCBs approved 28 loans to municipalities and their utility companies. The types of projects financed include: reconstruction of street lighting in Banja Luka; rehabilitation of local road network in ten municipalities; building and reconstruction of water supply systems in nine municipalities; reconstruction of sewage network in four municipalities; construction of nine water basins; construction of three water pump stations; reconstruction of five cross-roads in two municipalities; building of two sports hall and building of flower market.

* high loan repayment with no more than 10 percent of the LDF loan portfolio at risk (60 days past due)

High loan repayment rate with no more than 5 % of the LDF portfolio at risk (60 days past due).

As of November 18, 2005 there were no loans overdue. Repayment rate is 100% (0% PAR).

Output Indicators:

Indicator/Matrix

Projected in last PSR1

Actual/Latest Estimate

15-30 local government units (LGUs) trained in improved financial management and public participation in the capital budgeting process. Number of LGUs that meet the project financial management and public participation standards.

20 LGUs meet the project financial management and public participation standards.

31 local governments received training and technical assistance designed to improve their financial management performance, public consultation practices and strengthen their capacities in project identification and preparation. All borrowers met financial management and public participation standards.

3-5 PCBs trained in municipal lending and municipal loan portfolio management. a. no.of PCBs trained in municipal credit analysis and portfolio management. b. no.of PCBs implementing sound municipal lending policies and procedures

5 PCBs trained. 18 municipal loans approved by 5 PCBs

4 PCBs trained. 28 municipal loans approved by 4 PCBs. Please note that 5 PCBs have been approved as participating commercial banks under the project. However, two of those (Zagrebacka bank and Universal bank) merged into UniCredit Zagrebacka bank thus reducing number of PCBs to 4. This merger is a welcome step forward in strengthening the overall banking sector in Bosnia and Herzegovina.

10-20 LDF loans disbursed to LGUs for investment in municipal infrastructure and services. No.and value of loans disbursed

18 loans approved for a total amount of KM 13.09 million (US 7.6 million)

28 loans approved for a total of KM 22.3 million (US$ 13.3. million).

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1 End of project

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Annex 2. Project Costs and Financing

Project Cost by Component (in US$ million equivalent)AppraisalEstimate

Actual/Latest Estimate

Percentage of Appraisal

Component US$ million US$ millionLocal Government Capacity Building 2.60 1.44 55Banking Sector Capacity Building 1.00 0.85 85Local Development Fund 12.50 13.25 112LDF Management Support 0.90 1.40 155

Total Baseline Cost 17.00 16.94Total Project Costs 17.00 16.94

Total Financing Required 17.00 16.94

Project Costs by Procurement Arrangements (Appraisal Estimate) (US$ million equivalent)

Expenditure Category ICBProcurement

NCB Method

1

Other2 N.B.F. Total Cost

1. Works 0.00 0.00 0.00 0.00 0.00(0.00) (0.00) (0.00) (0.00) (0.00)

2. Goods 0.00 0.00 0.10 0.00 0.10(0.00) (0.00) (0.10) (0.00) (0.10)

3. Services 0.00 0.00 0.00 0.00 0.00(0.00) (0.00) (0.00) (0.00) (0.00)

4. Sub-Loans 2.50 8.70 1.30 0.00 12.50(2.50) (8.00) (1.30) (0.00) (11.80)

5. Consultant Services 0.00(0.00)

0.00(0.00)

3.60(2.30)

0.00(0.00)

3.60(2.30)

6. Operating Exepnditures 0.00(0.00)

0.00(0.00)

0.80(0.80)

0.00(0.00)

0.80(0.80)

Total 2.50 8.70 5.80 0.00 17.00(2.50) (8.00) (4.50) (0.00) (15.00)

Project Costs by Procurement Arrangements (Actual/Latest Estimate) (US$ million equivalent)

Expenditure Category ICBProcurement

NCB Method

1

Other2 N.B.F. Total Cost

1. Works 0.00 0.00 0.00 0.00 0.00(0.00) (0.00) (0.00) (0.00) (0.00)

2. Goods 0.00 0.00 0.19 0.00 0.19(0.00) (0.00) (0.19) (0.00) (0.19)

3. Services 0.00 0.00 0.00 0.00 0.00(0.00) (0.00) (0.00) (0.00) (0.00)

4. Sub-Loans 0.00 0.00 13.25 0.00 13.25(0.00) (0.00) (13.25) (0.00) (13.25)

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5. Consultant Services 0.00(0.00)

0.00(0.00)

2.29(1.04)

0.00(0.00)

2.29(1.04)

6. Operating Exepnditures 0.00(0.00)

0.00(0.00)

1.21(1.21)

0.00(0.00)

1.21(1.21)

Total 0.00 0.00 16.94 0.00 16.94(0.00) (0.00) (15.69) (0.00) (15.69)

1/ Figures in parenthesis are the amounts to be financed by the Bank Loan. All costs include contingencies.2/ Includes civil works and goods to be procured through national shopping, consulting services, services of contracted staff

of the project management office, training, technical assistance services, and incremental operating costs related to (i) managing the project, and (ii) re-lending project funds to local government units.

Project Financing by Component (in US$ million equivalent)

Component Appraisal Estimate Actual/Latest EstimatePercentage of Appraisal

Bank Govt. CoF. Bank Govt. CoF. Bank Govt. CoF.Local Government Capacity Building

1.30 0.00 1.30 0.44 0.00 1.00 33.8 0.0 76.9

Banking Sector Capacity Building

1.00 0.00 0.00 0.60 0.00 0.25 60.0 0.0 0.0

Local Development Fund 11.80 0.00 0.70 13.25 0.00 0.00 112.3 0.0 0.0LDF Management Support 0.90 0.00 0.00 1.40 0.00 0.00 155.6 0.0 0.0

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Annex 3. Economic Costs and Benefits

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Annex 4. Bank Inputs

(a) Missions:Stage of Project Cycle Performance Rating No. of Persons and Specialty

(e.g. 2 Economists, 1 FMS, etc.)Month/Year Count Specialty

ImplementationProgress

DevelopmentObjective

Identification/Preparation01/12/1998 8 TEAM LEADER (1)

FINANCIAL ANALYST (1)ECONOMIST (1)PROJECT OFFICER (1)CONSULTANTS (4)

S S

04/15/1998 8 TEAM LEADER (1)FINANCIAL ANALYST (1)CONSULTANTS (4)ECONOMIST (1)PROJECT OFFICER (1)

S S

Appraisal/Negotiation07/27/1998 9 TEAM LEADER (1)

FINANCIAL ANALYST (1)ECONOMIST (1)PROJECT OFFICER (1)CONSULTANTS (4)PROCUREMENT SPEICALIST (1)

S S

11/09/1998 7 TEAM LEADER (1)FINANCIAL ANALYST (1)ECONOMIST (1)CONSULTANTS (4)

S S

03/04/1999 8 TEAM LEADER (1)FINANCIAL ANALYST (1)PROJECT OFFICER (1)OPERATION ANALYST (1)CONSULTANT (4)

S S

Supervision

11/12/1999 3 TEAM LEADER (1); FINANCIAL ANALYST (1); PROJECT OFFICER (1)

S S

02/25/2000 3 TEAM LEADER (1); FINANCIAL ANALYST (1); OPERATIONS ANALYST (1)

S S

07/21/2000 3 TEAM LEADER (1); OPERATIONS ANALYST (1); FINANCIAL ANALYST (1)

S S

12/06/2000 3 TEAM LEADER (1); OPERATIONS ANALYST (1); LEAD ECONOMIST (1)

S S

07/03/2001 3 OUTGOING TEAM LEADER (1); NEW TEAM LEADER (1); TEAM MEMBER (1)

S S

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04/25/2002 2 TEAM LEADER (1); TEAM MEMBER (1)

S S

09/20/2002 2 TEAM LEADER (1); SUPERVISION (1)

S S

ICR

(b) Staff:

Stage of Project Cycle Actual/Latest EstimateNo. Staff weeks US$ ('000)

Identification/Preparation 33.50 138,075.99Appraisal/Negotiation 33.50 138,075.99Supervision 131.40 457,992.55

ICR 8.00 18,976.45Total 753,120.98

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Annex 5. Ratings for Achievement of Objectives/Outputs of Components(H=High, SU=Substantial, M=Modest, N=Negligible, NA=Not Applicable)

RatingMacro policies H SU M N NASector Policies H SU M N NAPhysical H SU M N NAFinancial H SU M N NAInstitutional Development H SU M N NAEnvironmental H SU M N NA

SocialPoverty Reduction H SU M N NAGender H SU M N NAOther (Please specify) H SU M N NA

Private sector development H SU M N NAPublic sector management H SU M N NAOther (Please specify) H SU M N NA

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Annex 6. Ratings of Bank and Borrower Performance

(HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HU=Highly Unsatisfactory)

6.1 Bank performance Rating

Lending HS S U HUSupervision HS S U HUOverall HS S U HU

6.2 Borrower performance Rating

Preparation HS S U HUGovernment implementation performance HS S U HUImplementation agency performance HS S U HUOverall HS S U HU

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Annex 7. List of Supporting Documents

1. Loan Application Form for Local Development Fund, Bosnia and Herzegovina, February 23, 2003

2. LDP Loan Pipeline and Closed Loans as of January 20033. BiH Local Development Fund (LDF) Loans for Municipal Infrastructure Projects,

February 23, 20034. Information Checklist for Banks, February 23, 20035. ARCADIS/BMB in Association with Cowater International, Local Development Pilot

Project, Local Government Capacity Building Component, Final Report, September 2002

6. ARCADIS/BMB in Association with Cowater International, Local Development Pilot Project, Progress covering planned activities and objectives inthe extension period, September 2002

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