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									Public Disclosure Authorized

                                                                          Document o f

                                                                       The World Bank

                                                               FOR OFFICIAL USE ONLY

                                                                                                         Report No: 47963-IN
Public Disclosure Authorized

                                                                       PROJECT PAPER

                                                          FOR A PROPOSED ADDITIONAL L O A N

                                                          IN THE AMOUNT OF US$400 MILLION
Public Disclosure Authorized

                                                                            TO THE

                                                 SMALL INDUSTRIES DEVELOPMENT BANK OF INDIA

                                                 WITH THE GUARANTEE OF THE REPUBLIC OF INDIA

                                                                             FOR A


Public Disclosure Authorized

                                                                        March 30,2009

                                   Finance and Private Sector Development Unit
                                   South Asia Region

                                   This document has a restricted distribution and may be used by recipients only in the
                                   performance o f their official duties. I t s contents may not otherwise be disclosed without
                                   Bank authorization.

                                  CURRENCY EQUIVALENTS

                              (Exchange rate effective M a r c h 30,2009)

                                   Currency Unit = Indian Rupees
                                         Rs 5 1.08 = U S $ l

                                           F I S C A L YEAR
                                          April 1 - March3 1

                                    ABBREVIATIONS AND ACRONYMS
BDS         Busin ss Development Services                   MIS    Management Information System
CART        Credit Appraisal and Rating Tool                MoF    Ministry o f Finance
CF          Credit Facility                                 NPLS   Non-Performing Loans
C G T M S E Credit Guarantee Fund Trust for M i c r o Small PAD    Project Appraisal Document
            and M e d i u m Enterprises
CBIL        Credit Information Bureau o f India Ltd.        PDO    Project Development Objectives
DflD        Department for International Development, UK    PFIs   Participating Financial Institutions
DIR         Detailed Investigation Report                   PMD    Project Management Division
DO          Development Objectives                          PRC    Project Review Committee
E&S         Environmental and Social                        RAM    Rating Appraisal M o d e l
FIL         Financial Intermediary Loan                     RoA    Return o f Assets
FM          Financial Management                            RBI    Reserve Bank o f India
FMR         Financial Monitoring Report                     RSF    Risk-Sharing Facility
FX          Foreign Exchange                                RSGC   Risk-Sharing Guarantee Company
ICB         International Competitive Bidding               RTI    Right to Information
ISR         Implementation Supervision Report               SAR    South Asia Region
IUFR        Interim Unaudited Financial Reports             SMEs   Small and Medium Enterprises
GAAP        Governance and Accountability Action Plan       SMEFDP Small and Medium Enterprises
                                                                   Financing and Development Project
Go1         Government o f India                            SMERA  S M E Rating Agency
IBRD        International Bank for Reconstruction and       SIDBI  Small Industries Development Bank o f
            Development                                            India
IFC         International Finance Corporation               TA     Technical Assistance
IP          Implementation Progress                         TOR    Terms o f Reference
M&E         Monitoring & Evaluation                         WTO    W o r l d Trade Organization

                                 Vice President:          Isabel M. Guerrero
                               Country Director:          N. Roberto Zagha
                                 Sector Director:         Ernest0 M a y
                                Sector Manager:           Simon B e l l
                             Task Team Leader:            Niraj Verma
                          Co-Task Team Leader:            Gabi Afiam

I INTRODUCTION..........................................................................................................
.                                                                                                                                 1

I11 PROPOSED CHANGES ..............................................................................................
   .                                                                                                                              6


V . APPRAISAL OF SCALED-UP PROJECT ACTIVITIES ...........................................                                         8

V I. EXPECTED OUTCOMES .........................................................................................                 17

VI1. BENEFITS AND R I S K S ..........................................................................................           17

FINANCING.....................................................................................................................   21

ANNEX 1: RESULTS FRAMEWORK AND MONITORING.......................................                                                 23

                                 PROJECT PAPER DATA SHEET

Project Name: S M E Financing and                        Country Director: N. Roberto Zagha
Development Project-Additional                           Environmental Category: FI

Responsible agency: Small Industries Development Bank o f India (SIDBI)

Current closing date: June 30, 2009

Revised project development objectives/outcomes
There are no changes to the development objectives/outcomes indicators, but scope has
been scaled-un

                       Source                                 Local       I    Foreim        I      Total

* Includes US$120 million under the SME Financing and Development Project and US$400 million o f additional

1.     This Project Paper seeks the approval o f the Executive Directors to provide an
additional loan for US$400 million to the Small Industries Development Bank o f India
(SIDBI), with the guarantee o f the Republic o f India, for the S M E Financing and
Development Project (SMEFDP, PO865 18, LN 7263-IN).

2.       The proposed additional financing would scale up the project by facilitating an
increased flow o f working capital and term lending to the S M E sector. Term lending; in
particular, has become increasingly difficult to access as a result o f the recent global
financial crisis’s impact on the Indian financial system. The additional financing would
scale up the parent project and facilitate an: (i)increase in the geographical coverage o f
the project; (ii) expansion o f innovative SME loan products, including possibly loans to
smaller SMEs (‘downscaling’), and receivables financing; ( i )i iexpansion o f SME lending
through other participating financial institutions (PFIs), subject to demand; (iv)
exploration o f the possibility o f providing loans to promote investments in energy-
efficiency improvement technologies, subject to adequate demand from SMEs at the
Small Industries Development Bank o f India (SIDBI) for such funding; and (v) expansion
o f the coverage o f the innovative Risk-Sharing Facility (RSF) that was initiated under the
parent project. The additional financing project will substantially increase the
development outcomes from this project. The parent project has consistently performed
well and project supervision ratings are Satisfactory for both Project Development
Objectives and Implementation Progress.

3.     The ongoing technical assistance (TA) component o f the parent project, which i s
financed through parallel donor fbnding (from the United Kingdom’s Department for
International Development, DflD), will continue in parallel with the additional financing.



4.      The parent SMEFDP project entailed Bank funding o f US$120 million to S I D B I
for S M E financing and development. SIDBI is an apex development finance institution
with a mandate to support the S M E sector. The project was approved o n November 30,
2004; became effective o n April 4, 2005; and i s currently scheduled to close on June 30,
2009. The project objective i s to improve S M E access to finance (including term finance)
and business development services, thereby fostering S M E growth, competitiveness, and
employment. The two Bank-financed components o f the project are a credit facility (CF),
which is financed by US$115.0 million o f Bank funds, and an RSF, which i s financed by
US$5.0 million o f Bank funds. Both have been fully disbursed. In addition, there is
parallel financing by DflD o f US$37.0 million for TA related to policy and institutional
development. The TA component has provided assistance to help banks improve their
credit appraisal processes. Amongst other activities, the component has also supported
the creation o f a commercial credit bureau and an S M E rating agency. The SMEFDP
project was the Bank’s first engagement in India’s financial sector after a considerable

hiatus. Through policy dialogue and collaboration on positive implementation results, the
project has contributed to a growing relationship between the Bank and India’s financial

                         Loan No.                                  7263 IN

                         Loan closing date                        30-Jun-09
                       I Disbursement              I ~ ~ $ 1 million (100%) I
                                                             2 0

Project Implementation Record and Project Performance

5.      Throughout the project implementation period, the parent project has consistently
performed well, and project supervision ratings are Satisfactory with respect to both
Project Development Objectives (PDOs) and Implementation Progress (IP) (see also table
2). In terms o f disbursements, the project was fully disbursed by June 30, 2008, the
original closing date. Performance on the PDO indicators-growth in the volumes o f
lending to SMEs, growth in the volume o f term loans to SMEs, and reduction in
nonperforming loans (NPLs)-has been impressive (see table 3). W h i l e targeted portfolio
growth o f 37 percent and 26 percent was projected, respectively, for total S M E lending
and term lending, actual growth by the original closing date was 98 percent for both. On-
lending to SMEs has covered 927 SMEs spread across 10 Indian states. In line with its
mandate as a development finance institution, SIDBI channeled long-term loans to SMEs
under the project. The average tenor o f loans provided under the project was five years,
which i s not easily available from the banking sector. Recovery performance has been
strong, and asset quality o f the branches involved in the CF has improved steadily and i s
beyond targeted levels. The NPL ratio o f participating branches decreased from 12
percent in December 2004 to 1.9 percent in March 2008-a dramatic improvement that
resulted in part from improved lending practices supported through the project’s TA
component. Another factor influencing the improvement in the rate o f N P L s i s the
participating branches’ increased focus and efforts to monitor and improve asset quality.

  World B a n k ISRs; S=Satisfactory and HS=Highly Satisfactory


                        PDO Indicators                      Targets from       Actuals from
                                                           project start to   project start to
                                                          end-March 2008     end-March 2008
         1. Participating financial institutions (PFIs)         37%                 98%
         increase lending to SMEs
         2. PFIs increase term-lending (loans with a           26%                  98%
         maturity o f 3 to 15 years) to SMEs
         3, PFIs reduce nonperforming loan ratios on           <9%                 1.90%
         their SME loan portfolios.

    6.     The strong project performance results are also captured in the findings o f a
    baseline survey and draft impact evaluation report prepared o n SIDBI’s behalf. The
    impact evaluation reports an 18 percent growth in sales and a 17 percent growth in profits
    among the 300 beneficiary SMEs that were surveyed after they received long-term
    financing from S I D B I (further details o n the survey are provided in Section V below).

    7.      Despite the RSF’s delayed start when the Swiss Economic Secretariat was unable
    to proceed with expected co-financing, the component was successfully restructured in
    late FY2008 and has been implemented through the Credit Guarantee Fund Trust for
    Micro and Small Enterprises (CGTMSE). Since restructuring, the RSF component was
    fully disbursed to create the guarantee reserves. In this way, a new product, designed in
    line with good international practices for guarantee products, has been offered to the
    Indian financial sector by CGTMSE. Specifically, the first six initial agreements between
    CGTMSE and PFIs for guarantees worth Rs 475 million (US$9.3 million) have been
    issued. Thus, this component is now on track, and within a span o f three months from the
    RSF’s launch the guarantees issued have enabled “additionality” by leveraging Bank
    funding to promote financing to SMEs.

    8.      After a slow start, the TA component (funded by parallel donor financing) has
    picked up momentum and resulted in positive synergies with the Bank-financed
    components. Good progress has led to commitments/disbursements o f around U S $ l O
    million on the TA components with significant additional commitments expected in
    2009. S I D B I has benefited from i t s initial experience with the TA provided by the
    project. To avoid delays S I D B I has built a substantial pipeline o f additional activities that
    will be supported.

    9.      Activities initiated under the TA component are as follows.

           i) The project has supported the establishment and operations o f India’s first
           credit bureau, the Credit Information Bureau o f India Limited (CIBIL), and
           India’s first dedicated S M E rating agency, the S M E Credit Rating Agency

       (SMERA). Both institutions help improve financial infrastructure for SME
       financing. C I B I L has a database comprising over 123 million consumer accounts
       and over 1.98 million commercial accounts, o f which an estimated 83 percent
       pertain to SMEs. SMERA has rated over 2,000 SMEs so far and completed risk-
       profiling reports for over 24 S M E clusters.

       i ) The project has supported capacity building for financial institutions,
       including the Andhra Pradesh State Finance Corporation, to enhance their
       appraisal techniques and lending practices for S M E lending. Support to SIDBI has
       been provided to improve and implement i t s S M E loan appraisal system, which
       now operates o n a software-driven platform and has increased its focus on
       assessing qualitative but critical factors such as the S M E promoter’s background,
       financial disclosure practices, management quality, etc. A s a result, branch staffs
       focus much more on these aspects than had previously been the case. In addition,
       the TA component supports a recently initiated “down-scaling” initiative.

       i i Business development services (BDS) for SMEs have been initiated with
       work ongoing in three clusters (Kanpur, Alleppy, and Pune), with plans for
       expansion to additional clusters in coming months.

       iv) Research and advocacy on policy issues has been supported through the TA
       component. Activities include a study o n corporatization o f SMEs and the impact
       o f World Trade Organization (WTO) agreements o n SMEs. Policy workshops
       have been conducted on insolvency, bankruptcy, and risk capital. Going forward,
       S I D B I is considering establishing a cadre o f S M E business advisors who would
       provide counseling to SMEs.

       v) Implementation support to SIDBI has helped support the SIDBI Project
       Management Division (PMD)-a     dedicated team o f professionals overseeing
       overall project implementation.

Rationale for Additional Financing

 10.    Sustaining growth while making growth more inclusive remains a key challenge
facing India’s policymakers. This i s reflected in the Government o f India’s (GoI’s) llth
Five Year Plan (2007-12), which aims to put the economy o n a sustainable growth
trajectory during the plan’s period while reducing economic disparities. Achieving and
sustaining such growth and higher employment will require a sharp step up in industrial
and services growth, spurred by small and medium enterprises, which have the greatest
potential to provide employment for the two-thirds o f the labor force that is still working
in agriculture. For this reason, vibrant SMEs are regarded widely in India as being a key
engine o f economic growth, j o b creation, and greater prosperity. However, several factors
constrain the growth and competitiveness o f Indian SMEs. Key among these constraints
are the problems that SMEs face in accessing adequate and timely financing on
competitive terms, particularly longer tenure loans, but also, in the context o f the
financial crisis, working capital loans.

 11.     The proposed additional financing activities would help scale up the development
impact o f the parent project to a larger geographical area and base o f SMEs while using
the same implementation arrangements o f the parent project. The expanded CF would
contribute to improved access to term loans for more SMEs through S I D B I and other
PFIs, while the RSF would expand coverage to support banks and financial institutions,
including potential clients o f the International Finance Corporation (IFC). The TA
activities will contribute to better outcomes. For example, TA to select financial
institutions to improve appraisal systems for S M E lending could be complemented by
SIDBI refinancing o f such PFIs through the CF. TA could also provide capacity-building
support to CGTMSE to fine tune i t s product, expand i t s coverage, and improve its
monitoring capacity. Overall, a substantial portion o f the TA will be available and would
go hand in hand with the additional financing project to support project implementation
and monitoring (for example, supporting SIDBI’s monitoring o f project implementation
and ensuring compliance with the project’s safeguards framework).

12.     The additional financing will be especially important in the context o f the recent
global financial crisis and i t s impact o n liquidity tightening in India’s financial sector.
Foreign portfolio and debt financing i s drying up, and in recent months there have been
periods o f serious domestic liquidity pressures. Despite several measures by the Reserve
Bank o f India (RBI)-including      a proposed new line o f credit for S M E lending-tight
liquidity in overnight markets had pushed up call rates. Credit default swap spreads for
some major Indianbanks and corporations have increased, and domestic spreads between
corporate and government papers have also increased. A key concern i s that allocation o f
credit to different sectors might undergo a change, including a decline in SME financing.

 13.    India has 13 million SMEs in the manufacturing and services sector. Including
the S M E retail sector brings the count to around 30 million SMEs. These SMEs are
feeling the effects o f the credit crunch in two ways. First, until recently, large f i r m s have
had access to financing through both the capital markets and the banks. As the capital
market has witnessed a severe downturn and lost liquidity (losing over 50 percent o f i t s
value since the beginning o f 2008), large f i r m s have resorted relatively more to bank
lending-thereby      offering banks a new line o f business that is more lucrative than
lending to SMEs. Second, SMEs in India are typically o f three types: (i)      firms supplying
larger f i r m s as part o f the supply chain (business to business, or B2B), (ii)i r m s    f
producing goods and services for final consumption (business to consumer, or B2C), and
(iii)start-up entrepreneurs. Although the second group o f SMEs, for the most part, have
not yet witnessed a significant slow down (as India’s growth has slowed but i s still
respectable), the first group has been facing problems o f reduced orders, increased
inventories, and thus higher working capital requirements as a result o f the global
downturn. These SMEs have not yet experienced big decreases in profits (since the prices
o f many o f their inputs have gone down with lower worldwide commodity prices).
Nevertheless, their access to funding has been constrained, which i s affecting their ability
to invest in capital goods, environmentally friendly technologies, and j o b creation.

14.     The additional financing project i s part o f a larger program o f support in response
to the Go1 request for assistance in light o f the financial crisis. I t i s targeted particularly at
SME, to help address the credit crunch that has resulted from the financial crisis. The

latest RBI statistics show that the year-on-year growth rate o f bank credit to SMEs fell
from 35.6 percent in 2007 to 7.4 percent in 2008, even while the overall year-on-year
growth rate o f bank credit to industry (including large corporations) increased from 24.9
percent to 30.2 percent over the same period. The CF would contribute to the
improvement o f access to finance for SMEs by making funding available to SIDBI-and
to PFIs via SIDBI-for on-lending to SMEs. The funding would include otherwise scarce
long-term funds. This would enable the project to reach out to 2,000 to 3,000 SMEs and
increase the impact o f the ongoing TA component o f the parent project and the
demonstration impact o f good lending practices and products for SME financing.

15.     Consistent with South Asia Region’s Operational Guidelines, using the additional
financing instrument i s more appropriate than a repeater project because the components
remain the same as before and the proposed activities represent additions to and an
expansion o f the parent project’s current activities. Moreover, the additional financing
instrument enables a faster response to the client’s request to scale up the parent project
and provide additional liquidity to the financial system for lending to SMEs. This ability
to respond rapidly is particularly important in light o f the reduced liquidity and increased
risk aversion that has resulted from the global financial crisis’s impact on India’s
financial system. Additional financing also involves lower transaction costs both for the
client and the Bank. Further, S I D B I has been a competent implementing agency, and the
parent project, as described above, has a proven satisfactory track record. S I D B I has
demonstrated i t s commitment to the project, and the Go1 strongly supports the additional
financing project. The proposed additional financing would also enable the Bank to
deepen i t s role and contribution to the financial sector in India.


 16.    The objectives and the Bank components o f the parent project will not be
changed. The proposed additional financing o f US$400 million i s to be allocated to scale
up the two Bank funded components o f the parent project, namely Component A: the
Credit Facility (CF) and Component B: the Risk-Sharing Facility (RSF). The additional
financing will provide both working capital and term loans under the CF and will expand
the coverage o f the RSF, thereby helping to scale up the development impact o f the
parent project as follows.

17.    With regard to Component A, the Credit Facility:

       i) Channeling o long-term loans for SMEs in geographical areas beyond those
       covered in the parent project: The expanded geographical coverage would
       include lagging states, thereby not just facilitating the expansion o f credit but also
       channeling that expansion to new areas that have high potential S M E clusters. In
       addition, the C F could be directed to those clusters where the BDS component
       under the DflD TA is being implemented, thereby maximizing the synergies
       between TA and the CF.

       i )Increased focus on developing new SME loan products to channel loans to
       more smaller SMEs than were covered in the parent project: This would entail


           using techniques that are appropriate for smaller scale lending and would
           incorporate lessons from similar Bank or other donor supported “down-scaling”
           projects in other parts o f the world. Financing for smaller SME loans could be
           explored for those PFIs that have the interest and/or are being provided capacity-
           building support under the TA component o f the parent project for developing
           their “downscaling” techniques. The latter would involve TA interventions
           targeted at helping PFIs to develop new and appropriate financial products for
           smaller SMEs; new lending and delivery techniques, including the (re)design o f
           lending procedures; the development o f product promotion tools; and the training
           o f staff in marketing, financial service product delivery, and client servicing.

           i i Channeling a greater volume o loans through eligible PFIs, possibly those
           that have now been covered through the parent project’s TA component, subject
           to adequate demand for refinancing: The use o f refinancing support from SIDBI
           to other PFIs would facilitate C F project coverage beyond SIDBI, thereby
           increasing the project’s demonstration effect. I t i s noted that refinancing by SIDBI
           o f other eligible financial institutions did not happen in the parent project partly
           because market factors were not favorable when most o f the CF funds were
           utilized. Specifically, the interest rate o f the IBRD-sourced loan was not as
           attractive as it would be now relative to domestic interest rates. With the current
           market scenario and given that prevailing domestic interest rates have increased
           significantly, there is likely to be demand for refinancing from SIDBI. The
           refinancing will be o f loans through eligible PFIs that meet the eligibility criteria
           (in line with the provisions o f Operational Policy/OP 8.30) defined and captured
           in the Operational Manual. Such loans would typically entail an eligible PFI
           identifying a set o f eligible loans, conducting i t s due diligence, providing the
           required financing, and then getting refinanced through the C F by SIDBI.

           iv) Exploring the possibility o providing loans for investments to improve energy
           efficiency, subject to adequate demand at SIDBIfor such funding from SMEs: In
           this respect, the project would seek to coordinate with the proposed parallel
           Global Environment Facility technical assistance project that is being prepared.

    18.    With regard to Component Bythe Risk-Sharing Fund:

           i) While the RSF component will, as before, fund the creation o f guarantee
           reserves, i t would aim to expand the coverage o f the recently introduced RSF
           product to a larger number o f banks and/or SMEs. Based o n the lessons from the
           scaling up o f the RSF, the implementing entity for this component, CGTMSE,
           could initiate the process o f shifting emphasis from i t s current main product to the
           more innovative product launched under the RSF.

    19.    The implementation arrangements under the proposed additional financing would
    remain the same as for the parent project. SIDBI would be the implementing agency and
    Borrower and would be responsible for implementing both o f the Bank-financed
    components. Component B (the RSF) would continue to be channeled through SIDBI to
    CGTMSE, which i s the arrangement currently used. The Department o f Financial

Services, Ministry o f Finance (GoI) will b e the nodal department for the overall project.
To coordinate project implementation, monitoring, and supervision, S I D B I will use i t s
Project Management Division (PMD), which has been coordinating the parent project. A
committee comprising all the partners in the project (the Project Review Committee, o f
which IBRD i s a key member) has been established to oversee the project. Overall
financial management arrangements and the safeguards framework would be broadly
similar to those found in the parent project.

20.     O f the total additional financing, US$380 m i l l i o n would be allocated to the CF
and US$10 million to the RSF. The remaining amount would be unallocated. The time
frame for the project is expected to be three years from the closing date o f the parent
project, with an expected closing date o f June 30,2012.


21.     The proposed activities described above, under the additional financing project,
are consistent with the India Country Assistance Strategy (CAS) 2004-2008, which
emphasized private-sector-led growth. The project, by facilitating increased access by
SMEs to long-term finds, also supports the pillar o f rapid and inclusive growth that is
reflected in the new Country Strategy (2009-2012). By improving S M E access to finance
and business development services (through continued implementation o f the DfID-
financed TA component), the project would foster S M E growth and employment
creation, which are key to achieving rapid growth and making it more inclusive. The
additional financing, like the parent project, will complement existing I F C activities.
Synergies will exist, particularly on account o f the RSF’s coverage to PFIs that could be
IFC’s clients.


22.    I t i s confirmed that all scaled-up activities to be financed under the additional
financing meet normal appraisal standards for a Financial Intermediary Loan, as they are
economically and financially viable and comply with the Bank’s fiduciary,
environmental, and social safeguards. There are n o outstanding or unresolved fiduciary,
environmental, or social issues. An OP 8.30 review o f the proposed additional financing
found that the proposed additional financing was in compliance with Bank guidelines.

Economic and Financial Analysis

23.     Significant economic and financial benefits have already accrued from the parent
project, as can be seen from the findings o f the impact evaluation report prepared on
behalf o f SIDBI. As mentioned above, this report shows that the nearly 300 beneficiary
SMEs surveyed reported 18 percent growth in sales and 17 percent growth in profits after
receiving long-term financing from SIDBI. Further, nearly two-thirds o f the SMEs that
were financed upgraded their technology, which, in turn, helped increase productivity
(from Rs 0.27 million in sales per employee to Rs 0.41 million). Surveyed SMEs also
reported impressive compliance with environmental clearances and practices under the
project. The TA under the parent project and the additional financing will continue to

improve credit market efficiency with respect to SMEs, develop the ability o f banks to
appraise and manage S M E loans, enhance profitable lending to viable SMEs, reduce
banks’ SME-related NPLs, and develop select S M E clusters, with positive impacts o n
growth and employment creation.

24.       SIDBI’s financial performance on criteria such as profitability, capital adequacy,
asset quality, and liquidity, as reviewed under OP 8.30, continues to be very strong. A
stress-testing analysis o f S I D B I showed considerable resilience to a potential downturn in
i t s business and increased NPLs. This ability to withstand shocks is derived largely from
the excellent strength o f SIDBI’s balance sheet, in particular the very high risk-weighted
capital adequacy ratio. The analysis showed that even if gross N P L s were to increase by
60 percent over the end-March 2008 levels, S I D B I would remain marginally profitable
and maintain i t s high capital adequacy. Even with a tenfold increase in gross NPLs, while
earnings would be severely impacted, capital adequacy would s t i l l be more than twice the
regulatory requirement (20 percent); only with a 14-fold increase in gross N P L s would
the capital adequacy be reduced to near regulatory minimum levels.

25.     Initial analysis indicates that the scale o f the additional financing could be
absorbed and implemented by SIDBI. In the parent project, SIDBI demonstrated ample
capacity to implement the project well. Disbursements were ahead o f schedule and in
accordance with the implementation arrangements, over 900 SMEs across 10 states were
supported, and the project development outcome indicators were exceeded. SIDBI, which
manages an S M E portfolio o f over US$5.0 billion, has managed to sustain continued
good financial performance while growing i t s business. I t s overall disbursements grew by
50 percent in FY2008, totaling Rsl50,870 million (US$2.95 billion), while maintaining a
net NPL ratio o f 0.25 percent. I t s capital adequacy ratio i s nearly 42 percent. From April
to September 2008, SIDBI approved more than US$650.0 million in loans for more than
1,000 firms, while NPL levels remain within control. Furthermore, increased financing
by S I D B I will help it diversify i t s risk by expanding to other industries, regions,
promoters, and sizes. Going forward, while there could be pressure o n SIDBI’s business,
its strong capital base bodes well for the institution in the changed global financial

26.      In addition, SIDBI’s r i s k management framework is robust. SIDBI’s appraisal
system i s rigorous and utilizes an internal rating system-the Credit Appraisal and Rating
Tool (CART) for smaller SME loans and the Rating Appraisal Model (RAM) for larger
S M E loans. These appraisal tools were supported under the D f D TA program. Going
beyond just a financial appraisal, these tools emphasize a qualitative assessment o f the
promoters’ credentials and background and the quality o f management. SIDBI ensures
that monitoring o f loans i s undertaken with a view to risk mitigation, and annual reviews
o f ratings are conducted for each borrower. Monitoring includes post-approval, onsite
monitoring (for all loans, particularly those that are stressed or are expected to come
under stress), post disbursement verification o f asset purchase, filing o f credit
information with the credit bureau (CIBIL), assessing the role o f nominee directors,
reviewing financial statements, etc. To mitigate asset concentration risks, SIDBI’s board
sets limits on sectoral exposures, which are reviewed every six months. S I D B I also
proposes to undertake sensitivity analysis (with the high capital levels, the buffer

available will be substantial) and more detailed segmented analysis o f its portfolio.
SIDBI’s foreign exchange (FX) exposure i s fully hedged, either by using FX resources
for loans to exporters or by purchasing hedging products.

27.     The reliability o f financial information reports i s high and the overall quality and
independence o f potential PFIs and SIDBI’s management is good-including              internal
control systems and lending practices. The quality o f audited statements i s good.
Financial reporting under the parent project has been adequate, especially in terms o f
project monitoring indicators. SIDBI’s credit risk appraisal system i s robust with i t s use
o f internal rating systems, adherence to portfolio concentration norms, and use o f
appropriate project-specific r i s k mitigation measures (including postapproval assessment,
cross-checking o f credit histories with the credit bureau, clear systems for monitoring
stressed assets, etc).

28.     With respect to the reliability o f financial information at the S M E level, S I D B I
collects this information and conducts due diligence through i t s loan appraisal, approval,
and post-approval cycle, as envisaged in SIDBI’s Operational Manual. Adherence to the
provisions o f the manual was reviewed during project supervision and found to be
compliant. In addition, under the parent project, some SMEs and industry associations
have received training and capacity building, which included, among other areas,
preparation o f financial statements that PFIs would accept.


29.     SIDBI’s corporate governance, as appraised during the parent project preparation
and reviewed during supervision, was found to be satisfactory and in conformance with
the standards specified by the RBI for financial institutions. SIDBI’s shares are held by
public sector financial institutions, insurance companies, and commercial banks. SIDBI’s
overall management vests with the Board o f Directors, which has a current strength o f 15
members. This includes eight directors appointed by GoI: the chairman and two full-time
directors, two Go1 officers, and three experts. O f the remaining directors, three are
nominated by the three largest shareholding institutions, while four can be elected by the
public shareholders or coopted by the Board.

30.     SIDBI has constituted five committees o f the Board including the Executive
Committee, the Audit Committee, the Risk Management Committee, the Committee for
Supervision o f State Finance Corporations, and an Empowered Committee on
Microfinance. Amongst other things, the Executive Committee, which meets regularly,
considers approvals of credit proposals above a certain threshold limit. The Audit
Committee (which typically meets every other month) provides guidance on matters
related to finalization o f accounts, observations f i o m RBI inspections, etc. The Audit
Committee also oversees the audit department’s fimctioning and reviews its major

31.    At the operational level S I D B I also adopts a committee system for the exercise o f
delegated powers by executives to approve credit lines, settle impaired assets, and carry
out other promotional and developmental activities at head office, zonal office, and

branch levels. SLDBI also has a post approval reporting system to the next higher level.
The Executive Committee handles approval o f credit lines above the delegated powers o f
the Central Credit Committee (headed by the chairman and managing director). There
are also delegations o f approval limits at various levels.

32.     In terms of the governance o f SMEs, these are mostly family-owned businesses;
most decisions are taken by the owners. SIDBI’s appraisal standards ensure that
adherence to the laws covering SMEs are in order prior to loan approval. Further, given
that these owners are often personally liable for loan repayment (unlike larger f i r m s
where managers and not owners are involved in running the business) and since S M E
owners place a premium on the time value o f money, activities finded by the loans are
typically implemented o n time. Loans are used either for working capital or the purchase
o f goods. Given the SMEs’ obligation to repay the loans, there i s an inbuilt incentive to
manage the costs and optimize the loans’ value and the purchases made using these loans.

Financial Management

33.     A financial management (FM) assessment o f S I D B I was conducted by an
independent consultant in June 2004. The assessment covered financial and credit risk
management, strategic and operational issues, and operational and management audits.
The overall FM arrangements as reflected in the parent project’s Project Appraisal
Document (PAD), and the FM arrangements for the parent project were reviewed in light
o f experience during implementation, Areas that required strengthening were identified
and agreements are being reached with SIDBI. Overall, the FM performance during the
project was satisfactory, and audit reports did not identify significant issues. Some
changes and improvements have also been agreed with a view to further strengthening
project fiduciary assurance mechanisms.

34.      Fundflows: The Loan Agreement i s between the Bank and SIDBI, and hence
IBRD finds would flow directly to a bank account designated by S I D B I for receiving
disbursement from the World Bank-without routing the finds through the Controller o f
Aids Accounts and Audit in the Department o f Economic Affairs. S I D B I will request
reimbursement in U S dollars, equivalent to the actual expenditure incurred in Indian
rupees. A request for reimbursement for the World Bank project will come through the
withdrawal application. S I D B I will request reimbursement to their existing account in
N e w York. Funds flow in the original project was on the basis o f quarterly forecasts o f
expenditure, as projected by SIDBI. In the additional financing project i t has been agreed
that S I D B I will finance both components through i t s own budget and seek reimbursement
for “actual expenditures” incurred.

35.       Accounting/disbursement/financial reporting: All project costs and expenditures,
including those related to the TA component, will be paid for and recorded in the books
o f S I D B I in accordance with existing accounting policies and procedures. Each credit
line o f S I D B I is allocated a separate account code within the books o f accounts. This
helps in tracking progress under each credit line o f resources raised from various sources
(liabilities) and assets (sub-borrowers, loans, and advances) created there-under. The
Credit Facility under the proposed project would be allocated separate account codes to

help distinguish transactions under this l i n e from those under other existing credit lines.
S I D B I will open or identify separate account codes in i t s accounting system for the
purpose o f reporting on fund flows against the two components, the Credit Facility (CF)
and the Risk-Sharing Facility (RSF). Under the CF, S I D B I will have account codes for
the three modes o f lending under the Bank l i n e o f credit: (i)
                                                                 Direct Finance Term Loan,
(ii) Direct Finance Working Capital Loan, and (iii)       Refinance Account. Expenditures
booked against these codes will be consolidated to identify the routing o f Bank funds to
their final utilization, both to the intermediate banks and to individual SME beneficiaries.
A similar account code will be identified for the RSF transfers.

36.       Disbursement will be on the basis o f reimbursement o f actual expenditure, as
evidenced by the quarterly Interim Unaudited Financial reports, (IUFRs). For the CF, the
“actual expenditures” will be defined as the actual amount o f loans advanced by S I D B I
directly to the SMEs or through the PFIs. For the RSF, the actual expenditure i s defined
as the “amounts transferred by S I D B I to the CGTSME in respect o f creating the
guarantee reserves o f the RSF.” N o cash-forecast-based advances will be given to SIDBI
from Bank funds. The IUFRs will also have an annex listing the names o f the SME
beneficiaries who were recipients o f the subloans, the amounts advanced, and the purpose
o f the loan as per the agreement. Retroactive financing as per Bank guidelines would be
allowed to the extent o f 20 percent o f the loan amount and will be based o n separate,
stand-alone, audited IUFRs, which will report details o f expenditures for which
reimbursement i s sought. This will include loans made to the SMEs (direct and through
PFIs) and direct payments by S I D B I to suppliers during the period o f retroactive

37.       Refinancing under the CF: Assessment o Intermediate Banks / PFIs: In the
parent project, 60 percent o f the total funds allocated to the CF were to be utilized by
S I D B I for on-lending to eligible commercial banks (PFIs) as refinancing o f their loans.
Subject to demand, S I D B I will strive to channel loans by way o f refinancing through
eligible PFIs, as per defined eligibility criteria. The eligibility criteria for banks / PFIs to
participate in the CF, as defined in the Operational Manual, require that they have
acceptable financial management arrangements in place. S I D B I will ensure that the sub-
borrowers (PFIs) have accounting and internal controls (and, where required, auditing
arrangements) adequate to provide financial information o n implementation performance
required by the agreements between the intermediary and the sub-borrowers.

38.     The refinancing option and the eligibility criteria are documented in detail in the
2004 Operational Manual and the legal documentation o f the parent project. However,
refinancing by S I D B I o f other eligible financial institutions did not happen in the parent
project on account o f market factors not being favorable when most o f the C F finds were
utilized. Before advancing loans to sub-borrowers under the CF, S I D B I will assess
existing and new PFIs against the basic eligibility criteria and in accordance with
parameters laid out in the Operational Manual.

39.    Recycling o Loans: The issue o f recycling term and working capital loans
advanced by S I D B I (out o f repayments o f loans disbursed) during the period o f the IBRD
loan has been reviewed. Given that S I D B I has other lines o f business like microfinance,

venture capital, direct-retail credit, and treasury operations, there is a possibility that the
recycled funds could be used for purposes other than SME lending. S I D B I has provided
an assurance that the funds would be relent to SMEs and not diverted for any other
purpose. I t was agreed that this aspect would be monitored as part o f the monitoring and
evaluation process by watching the growth o f the overall portfolio o f SME loans
advanced by SIDBI during the project period. I t would also be ensured that the
outstanding amount o f S M E loans at any moment i s higher than the amounts disbursed
from the IBRD loan during the project’s life. This will also be tracked through SIDBI’s
financial statements as defined in the Results Framework.

40.       Statutory Audit: The terms o f reference (TORs) for statutory audit have been
updated to strengthen the audit process and coverage and are acceptable to the Bank. The
TORs also include procurement-related requirements and a detailed procurement
checklist. In particular, the TORs require the statutory auditors’ to verify the end use o f
funds for specific goods, works, and services by undertaking a detailed review o f a
sample o f loans advanced to S M E beneficiaries, either directly or through PFIs. The
auditors are also required to provide an opinion o n the working o f internal controls in
S I D B I and an assurance that these have been effectively applied to the Bank project. The
audit TORs have been discussed with and agreed to by SIDBI. Given that this i s likely to
be a fast-disbursing project with potentially substantial amounts o f upfront disbursement
by way o f retroactive financing, six-monthly statutory audit reports are being proposed to
provide timely assurance on the usage o f Bank funds (for the first two years, with annual
reports thereafter). This will assist in monitoring the usage o f the loan proceeds and
provide an opportunity for mid-course correction, if necessary. The following audit
reports will be monitored in the Audit Report Compliance System:

Agency            Audit Report                                  Audited by               Due date
SIDBI             Annual entity audit report                    SIDBI’s statutory        30 September
SIDBI             Six monthly audit o f project                 Statutory                30 June and
                  financial statements                          auditors                 31 December
CGTMSE            Annual audit report o f CGTMSE                Statutory                30 September
                  with a statement on expenditure               auditors
                  against the RSF funding

41.    Internal Audit:      SIDBI’s internal auditors would retain responsibility for
conducting an internal audit o f the Bank-funded project, as part o f their audit o f the
Credit Department and individual branch offices. They will review a sample o f loans
advanced by S I D B I to the SME beneficiaries under the CF (either directly by SIDBI or
through PFIs), and verify that the funds have been used as per the relevant agreements
between S I D B I and the beneficiary and for the purposes for which they have been
advanced. The internal audit reports will be shared with the Bank during supervision

’The Bank has reviewed the profile o f the current statutory auditor, Ws AJ Shah & Co., and they are
acceptable to the Bank for the project audit for the period o f their appointment. As and when a new
statutory auditor i s appointed for SIDBI, the latter w i l l share the profile o f the auditor with the Bank for the
purpose o f the project audit.

42.     Disclosure: The amount and type o f assets created in the project will be shown in
a table under the “Resources Management” section in the Annual Report o f SIDBI. The
project statutory audit report will also have a separate statement or schedule listing and
certifying all the assets created out o f the Bank loans, and an assurance that these assets
have been financed exclusively through the Bank funds and that no other funds have been
received by SIDBI for creating all or part o f these assets. I addition, it has been agreed
that the project statutory audit report (and the “Management Letter”) will be posted on
the external Web site o f SIDBI, along with SIDBI’s Annual Report.

43.    FM Risk Assessment: Taking into account the high number o f beneficiary entities
that will be covered-and the fact that SIDBI i s expected to channel a large percentage o f
loans via the CF by way o f refinancing through PFIs, which in effect then become
implementing entities that will first need to be appraised by S I D B I for their eligibility-
there are substantial FM risks. This risk assessment will be reviewed during the
supervision missions after examining a sample o f SIDBI’s appraisal reports o f the PFIs.


44.    Procurement under the project will be as per the World Bank Procurement
Guidelines o f M a y 2004, revised October 2006.

45.     Procurement under the CF Component: Under the C F component, the Bank loan
will provide funds to SIDBI, to be reloaned to SMEs for the partial financing o f sub-
loans. As per Section 3.12 o f Bank Procurement Guidelines, procurement will be
undertaken by the respective beneficiaries in accordance with established commercial
practices, acceptable to the Bank. Such commercial practices o f the beneficiary shall be
compatible with the Procurement Principles for the project as agreed with the Bank and
detailed in the Operational Manual. Procurement under this component will comprise
capital investments in equipment and machinery for expansion or technology upgrading.
N o procurements o f works or services are envisaged under the project. Under this
component, Bank funds can also be used by S I D B I for refinancing other PFIs. In such a
case, SIDBI’s agreement with the PFI will contain provisions governing procurement as
mentioned in Bank Procurement Guidelines GL Section 3.16, that is, indicating that due
attention to economy and efficiency would be undertaken and in accordance with
procedures which meet requirements o f paragraph 1.5.

46.    Procurement under RSF Component: Under the RSF component, pursuant to
section 3.16 o f the Bank Procurement Guidelines, the goods and works financed by the
loans guaranteed shall be procured with due attention to economy and efficiency and in
accordance with procedures which meet the requirements o f Paragraph 1.5 o f the Bank
Procurement Guidelines.

47.     SIDBI’s Role and Capacity: SIDBI’s appraisal process involves technical,
commercial, and management aspects o f subloan proposals from SMEs. S I D B I requires
that its borrowers justify all their purchases and adopt transparent and competitive
procurement procedures. To ensure value for money, assumptions on project outlay are
examined by inviting market inquiries on supplier credentials, comparative assessments

    are made with earlier financing, and risk-rating models are used (detailed in SIDBI Credit
    Manual). The PMD is in charge o f implementing the Bank project. The PMD i s
    adequately staffed, has a full-time procurement consultant, and works with the credit
    department to ensure that supervision and oversight are undertaken in accordance with
    the Operational Manual.

    48.       Procurement Methods: Procurement under the project will follow established
    commercial practices that have been reviewed and found acceptable. These shall be
    compatible with the Procurement Principles for the project, as agreed to by the Bank and
    detailed in the Operational Manual. However, for contracts estimated to be greater than
    U S $ l ,000,000, procurement will be done using the International Competitive Bidding
    (ICB) method (as described in Bank procurement guidelines and using Bank I C B
    documents). The threshold for I C B may be reviewed during project implementation
    based o n results o f Bank supervision, review o f such contracts, or any other feedback on
    performance. In cases where direct contracting (sole source) i s used (irrespective o f the
    value o f the contract), provision 3.6 o f the Bank Procurement Guidelines will apply.
    Further details are provided in the Operational Manual. Retroactive financing under the
    project will be as per the provisions o f the Bank’s Procurement Guidelines.

    49.    Bunk Review: All procurement transactions under the project that are greater than
    US$1 million will be subject to Bank prior no objection before these are financed under
    the project. All other contracts under this project will be subject to postreview by the
    Bank andor its nominated consultants. The prior review threshold will be reviewed
    during Bank supervision missions and may be changed depending on the performance o f
    procurements funded under the project and the number o f such contracts that are funded.
    Requirements o f Bank review are defined in appendix 1 o f the Bank Procurement

    50.      Review by SIDBI: S I D B I will ensure that procurement complies with the above
    requirements. As part o f i t s appraisal processes, S I D B I would require SMEs to include
    procurement plan information which provides: (i) l i s t o f proposed procurements and
    estimated value, (ii) proposed procurement methods (competitive or sole source), and
      i i the
    ( i ) agreed thresholds for contracts subject to prior versus post review. The final
    procurement plan for each, as agreed with SIDBI, should be maintained in S I D B I records
    for review by the Bank or auditors. As part o f S I D B I oversight arrangements, it will
    obtain all data related to awarded contracts under subloans, including the actual contract
    dates, names o f contractors, contract amounts, progress, and disbursements to date and
    will confirm that the procurement i s as per the agreed arrangements as defined in the
    Operational Manual. The procurement provisions mentioned in this note are based on the
    current versions o f documents shared by S I D B I that is, the Operational Manual and the
    Credit Manual (if there are further relevant or applicable changes to these, the Bank
    would be informed).

      5 1. Procurement Audit: All procurements under the project are subject to audit by the
    project auditor based on the TORS agreed with the Bank. The audit report will be made
    available to the Bank once in six months during the first two years and annually
    thereafter. The auditor report will be discussed with S I D B I during supervision missions.

    52.     Procurement Risk: Procurement risk in this project has been rated as moderate.
    This rating takes into account the internal controls o f SIDBI while appraising and
    approving a loan for any procurement. In addition, the SMEs are mostly family-owned
    businesses where the procurement decisions are taken by the owners who have to repay
    the loans and who are often personally liable. The owner therefore carries out extensive
    research and negotiations to ensure that the best value i s derived in such deals. Under the
    earlier Bank project there were no complaints, and disbursements were satisfactory.
    During implementation, the Bank’s focus will be to discuss and take feedback o n the
    functioning o f systems put in place by SIDBI, including but not limited to subproject
    appraisal, costing, evaluation o f SMEs by SIDBI, and risks identified by S I D B I while
    considering SME financing.

    Environmental and Social Safeguards

    53.     There are no outstanding safeguards issues. In terms o f social safeguards, no
    safeguards have been triggered. The parent project has been categorized as “FI” and will
    continue as such during the period o f the proposed additional finance. In terms o f
    environmental safeguards, OP 4.0 1 has been triggered. A detailed Environmental and
    Social (E&S) safeguards framework was developed for the project and has been adhered
    to by S I D B I in the course o f parent project implementation. The framework and the
    existing institutional arrangements within SIDBI’s PMD have been reviewed and
    validated in the context o f the additional financing project. The current institutional
    arrangements include (a) screening by the loan officer at branch level o f the loans to
    SMEs and proposed activities being funded; (b) review o f safeguards framework
    compliance at Central Loan Processing Cell; (c) internal audit review, including at
    various stages o f loan disbursement; and (d) use o f a management information system
    (MIS) system to track loan performance, including any specific flags o n safeguards.

    54. T o further strengthen monitoring o f compliance with the safeguards framework, the
    PMD will strengthen the current M I S system to reflect periodic monitoring reports for all
    the loans to SMEs under the project and to prepare additional monitoring and reporting
    formats. In addition to branch-level regular monitoring o f all SMEs loans financed under
    the project, the PMD will conduct periodic supervision o f at least 50 percent o f E-I
    category SMEs and a sample of E-I1category SMEs. W h i l e the periodicity o f supervision
    will be determined by the nature o f activities funded under the loans to SMEs and their
    impact, supervision for the sample o f E-I S M E loans will be conducted by PMD at least
    once annually. The PMD would proactively engage i t s e l f in monitoring and assessing the
    social impact o f loans to SMEs through periodic supervision and commissioning o f
    studiedimpact assessment on a case-to-case basis. The PMD would make efforts to
    allocate resources for impact assessment and documentation o f innovative and good
    practices o f the SME loans in area o f social development. The PMD would also sensitize
    and train i t s staff on empowerment, social development, and the Right to Information


55.     The project’s outcome indicators are similar to those o f the parent project.
However, the target values have been set at levels that recognize the impact o f the
prevailing macro-environment climate resulting from the global financing crisis (see
discussion on risks below). The framework for results monitoring for the scaled-up
project activities i s presented in annex 1. SIDBI will provide the Bank with interim
financial progress reports, information o n progress on key entity performance indicators,
audited financial statements (within six months o f the end o f each financial year), and
such other information as the Bank may reasonably require. These arrangements are
working in a satisfactory manner under the ongoing parent project and will continue
under the proposed additional financing.


56.     Benefits: As mentioned above, the parent project financed 927 SMEs spread
across 10 states. The additional financing o f US$400 million i s expected to more than
double these benefits, expanding the coverage to two to three times as many SMEs,
thereby creating additional jobs. Further, the project will (i)     increase the geographical
coverage; (ii)    provide new, innovative S M E loan products, including loans to smaller
SMEs (“downscaling”) and loans through other PFIs; ( i )        i i explore the possibility o f
providing energy efficiency loans; and (iv) support the expanded coverage o f the
innovative Risk-Sharing Facility. This will help improve S M E credit market efficiency,
develop the ability o f banks to appraise and manage S M E loans, enhance profitable
lending to viable SMEs, reduce banks’ SME-related NPLs, and develop select SME
clusters. I t i s expected that these benefits from the project will result in positive impacts
on growth, development, and employment creation for beneficiary SMEs. Ultimately,
through i t s economy-wide demonstration effect, the project i s likely to generate benefits
for a much larger number o f banks and SMEs, with wider implications for growth and
poverty reduction.

57.    Risks: The risks surrounding the project vary in scope and nature, from
implementation and sustainability risks to fiduciary and safeguards risks and finally to
external risks from the macro-environment-especially the potential impact o f the global
financial crisis. Table 4 summarizes the main risks and existing or suggested mitigation

58.    However, given the parent project’s successful implementation record, i t i s safe to
say that the biggest risk to the project’s ability to achieve its objectives and make
disbursements on time lies in the effect that the global financial crisis and the ensuing
worldwide recession could have on India’s SME sector. This effect could translate i t s e l f
into two different ways.

59.     First, lower disbursements under the project could. i t s e l f be the result o f two
factors. First would be lower levels o f business activity for SMEs and lower demand for
loans from S I D B I or PFIs. This risk could materialize for SMEs in a certain sectors such
as automotive components and textiles, which have been hardest hit by the crisis.


    However, not all sectors are affected to the same extent, and there exists a sizeable pool
    o f SMEs that continues to have vibrant businesses and growing needs for credit. Second,
    there could be risk aversion on the part o f the PFIs to lend to SMEs. SIDBI’s assessment
    is that there i s sufficient demand from SMEs that are viable and that are not seriously
    affected by the global financial crisis.

    60.     Second, the asset quality o f the PFIs, including SIDBI, could deteriorate as a
    result o f the slowdown, resulting in higher N P L s . (The excellent current asset quality o f
    SIDBI’s portfolio and i t s high capital adequacy and long years o f specialization in S M E
    financing should, however, allow it to absorb any deterioration.) During project
    implementation, these risks will be closely monitored, and the impact o f the slowdown
    and the financial crisis will be reviewed, and corrective action will be undertaken
    whenever needed.

    61.    Some o f the governance risks that might arise during project implementation
    include the following:

    62.     Lack o f transparency in the loan approval process by S I D B I and the PFIs: this
    might result in loan approval to ineligible SMEs as a result o f improper/fraudulent
    assessment by loan officers. This risk i s mitigated by an elaborate set o f lending standard
    and, loan appraisal and loan approval processes, which are described in detail in the
    project’s Operational Manual (and Credit Manual o f SIDBI) and which must be complied
    with. They involve appraisal o f technical, commercial, and management aspects o f S M E
    loan proposals and stipulate that borrowers should report on the use o f h n d s and ensure
    quality in procurement. The loan approval process also involves a series o f thresholds and
    committees so that the loan approval i s vetted according to i t s size by either executives or
    committees (in such a way that individual decisions are always checked and scope for
    improper approval i s eliminated). In addition, significant emphasis i s placed on post-
    disbursement checks, direct payment to suppliers, and post-disbursement onsite visits.
    Finally, the TA component o f the project continues to provide assistance to improve these
    processes for S I D B I and PFIs;

    63.     Insufficient checks and balances in the disbursement policies and practices: these
    could result in disbursements to fraudulent purposes. T o mitigate this risk, disbursements
    to SMEs are not made except through trackable accounts, and payments to suppliers are
    made directly once the invoices are presented. Centralized loan disbursements through
    checks are made. Annex 2 summarizes some o f the potential governance issues related to
    the project, and in consultation with SIDBI, identifies time-bound mitigation measures,
    included in the Governance and Accountability Action Plan (GAAP).

               Table 4: Critical Project Risks and Mitigation Measures

Risk                                   Existing or Proposed Mitigation Measures

Risk o f moral
hazard (the risk            (provided throuih parallel financing by‘DfID) has minimized the
that through                risk o f moral hazard. A key condition for SIDBI and PFIs to access
providing credit            project funds under the CF has been an upfi-ont commitment to a
support the quality         time-bound action plan to implement improvements in SME credit
o f lending actually        appraisal and r i s k management /monitoring, and also to upgrade
deteriorates)               credit information and share the information with CIBIL. In turn,
                            this has been supported by the TA program. Periodic progress
                            reports on this front and on NPLs would help detect any
                            deterioration o f credit quality.
Risk o f adverse       -    The RSF has been designed incorporating best practices on
selection (that the         controlling adverse selection risks. The criteria for determining
banks pass the              eligibility o f banks andor loardportfolios would ensure that the
risk for poorer             RSF does not create opportunities for adverse selection-selection
loans on to the             o f portfolios i s based on random selection o f loan accounts from
Risk-Sharing                various rated categories o f a portfolio. The TA being provided under
Facility while              the project also helps participating banks improve their portfolio
keeping better              quality so as to be able to meet the eligibility criteria for
accounts to                 participation in the RSF. Pricing must be seen to be “fair,” based on
themselves)                 rigorous risk-assessment. Portfolio selection will be based on
                            statistical principles aimed at avoiding adverse selection and PFIs
                            would have to retain at least 50% o f the exposure at all times to
                            minimize moral hazard risks.
Implementation ri3     +J
FX, credit, and             SIDBI will enter into hedging arrangements to mitigate the FX risk.
investment risks            SIDBI’s credit risk under the CF financed through IBRD and
                            SIDBI’s own counterpart funds will be mitigated through SIDBI’s
                            use o f the appropriate SME loan appraisal and bank
                            eligibility/appraisal criteria and procedures. In the context o f the
                            global financial crisis, in addition to other risk-mitigation measures,
                            SIDBI has indicated that it would undertake a detailed stress testing
                            o f i t s portfolio to assess i t s resilience to potential, future adverse
                            SIDBI’s investment risk in the RSF will be mitigated through the
                            fact that the CGTMSE i s operated on a commercial basis, with a
                            strong focus on bank and SME loan portfolio selection for partial
                            guarantee cover, controlling costs, charging appropriate fees, and
                            maintaining prudent treasury management, including investments in
                            safe securities.
                            The risk management function for the RSF will be dealt with
                            through ensuring a reasonable equity base in terms o f i t s capital
                            structure, sound investment policies, and a lean but control-and-
                            audit-focused staffing.

    Risk                                    Existing or Proposed Mitigation Measures
    Slow                    -   Initial analysis indicates that an increase in scale o f the additional
    disbursement risk           financing could be absorbed and implemented by SIDBI, through
                                scaling up both components o f the project. In the parent project,
                                S I D B I demonstrated ample capacity t o implement the project well.
                                Disbursements were ahead o f schedule and in accordance with
                                agreed implementation arrangements. Over 900 SMEs across 10
                                states were supported, and project outcome indicators were
                                exceeded. SIDBI, which manages an S M E portfolio o f over US$5.0
                                billion, has managed to sustain continued good financial
                                performance while growing i t s business: i t s overall disbursements
                                grew by 50 percent in FY2008 totaling Rs150,870 m i l l i o n (US$2.95
                                billion), while maintaining a net NPL ratio o f 0.25%.
    Safeguards risks
    Inadequate              -   An external consulting firm developed the E&S safeguards
    environmental and           framework that S I D B I has been implementing, t a h n g into account
    social ( E M )              the W o r l d Bank requirements.
    safeguards              -   A nodal person in the PMD i s responsible for oversight, for
    capacity at S I D B I       coordinating implementation o f the framework, and for compliance
                                with the monitoring and reporting requirements agreed with the
    Lack o f                -   Periodic review, supervision, and annual audit o f at least 50% o f E-I
    compliance with             category SMEs and a sample o f E-I1category SMEs will be
    the E&S                     undertaken by the PMD every six months.
    safeguards at           -   The PMD and the Bank will monitor and assess the social impact o f
    subproject level            subprojects during supervision.
                            -   The PMD i s committed to undertake periodic sensitization and
                                training o f i t s staff o n specific social issues and o n the Right t o
                                Information Act.
                            -   The impact assessment will cover specific social and environmental

    Mis-procurement             S I D B I encourages i t s borrowers t o justify the purchases and adopt
    by SMEs                     transparent and competitive procurement procedures.
                                While disbursing to suppliers, S I D B I examines the sales agreement,
                                warranties, rights, and obligations o f contracting parties as well as
                                remedies in case o f disputes and nonperformance.
                                Periodic visits before and during the implementation o f the project
                                (at least twice a year) and, subsequently, o n i t s operations are
                                undertaken. These include visits to the office/factory o f the assisted
                                unit, physical verification o f equipment purchases, discussion with
                                promoters, and informal discussions with the main purchasers o f and
                                suppliers to the assisted units.
                                SIDBI’s internal control measures are carried out by i t s Internal
                                Audit Department and supervised by the Audit Committee o f the
                                SIDBI’s oversight arrangements include: postdisbursement checks
                                o n the assets purchased and reviews to determine if there was any
                                kind o f misappropriatioddiversiono f funds by the end-user from
                                the intended use.



          Risk                             Existing o r Proposed Mitigation Measures
                               -All procurements under the project are subject to audit by the
                                project auditor based o n the TOR agreed with the Bank.
                            - During implementation, the Bank will discuss and take feedback o n
                                the functioning o f systems put in place by S I D B I including, but not
                                limited to, subproject appraisal, costing, evaluation o f SMEs by
                                SIDBI, and risks identified by S I D B I while considering S M E
                            - Procurement transactions will be subject to Bank review in l i n e with
                                the agreed procurement arrangements.
          Misuse o f funds  - The original project did not have a mechanism for appropriate
                                reporting and disclosure o n the assets created out o f the Bank-
                                funded loans. This issue was discussed with S I D B I and the Bank
                                team, which requested that S I D B I disclose the assets financed
                                (loans) out o f the Bank CF through the following measures: (i)     the
                                project statutory audit report will have a separate statement
                                certifying the assets financed and an assurance that these assets have
                                been financed through the W o r l d Bank funds and not through any
                                other sources; (ii) relevant information could be uploaded to the
                                external Web site o f the project; and (iii) same information will
                                be captured in the account that i t i s agreed would be maintained. I n
                                addition, S I D B I will disclose the information o n assets financed
                                through the Bank CF in i t s future annual reports over the project
          External and Maci -environment risks
          Deterioration in      Some o f the success o f the parent project has been helped by India’s
          the asset quality     strong growth in recent years. However, the global fin-ancial crisis
          and risks t o the     unfolding in recent months, and a slower forecasted growth for
          PDOs due to the       India, might negatively impact SMEs and their ability to repay.
          changing macro-                              P
                                SIDBI’s very l o w N L ratio (0.25%) and high capital adequacy
          economic              ratio (nearly 42%) would allow it to absorb any such downtrends.
          environment           Going forward, while there could be pressure o n i t s business, the
                                strong capital base bodes well for S I D B I in the changed global
                                financial environment. In addition, SIDBI’s robust risk assessment
                                framework includes undertaking periodic rating assessments o f i t s
                                loan accounts. This i s being strengthened to factor in the changing
                                macro-economic environment with careful reviews o f
                                sectorhndustry wise exposures and lending practices.
                                Duringproject supervision, the impact o f the external environment,
                                especially the global financial crisis, o n the performance o f SMEs as
                                well as the uptake o f project funds will be keenly monitored and
                                corrective action willbe-taken as and when needed.


        64.    The loan would be denominated in U S dollars with a variable spread, a 15-year
        maturity including a five-year grace period, and annuity repayments.

65.    The financial conditions for the additional financing mirror those under SMEFDP
and include the following:

       i) SIDBI shall continue to maintain the PMD and the Internal Audit Department
       with adequate powers, functions, staff, and resources.

       i ) Under the CF, S I D B I will make subloans directly to SMEs and/or also lend
       through PFIs and will carry out appraisal, supervision, monitoring, and reporting
       in respect o f these activities.

       i i SIDBI shall take such steps as necessary to protect itself against risk o f loss
       resulting from changes in the rates o f exchange between the currencies used in i t s
       operations, and shall assume the credit risk associated with lending to the PFIs
       and its direct SME financing.

      iv) The E&S safeguards framework and its compliance requirements prepared as
      part o f the project documents for S M E Financing and Development Project will
      continue to be mandatory for the additional financing project.


               PDO                                                           Use of Outcome Information
The objective o f this project i s to      30% increase in lending                 Yrs 1-2 gauge whether PFIs
improve SME access to finance              (including t e r m lending) to          manage to expand lending to
(including t e r m finance) and            SMEs by PFIs branches and               SMEs while managing NPLs
business development services,             overall increase in SME                 and improving the
thereby fostering SME growth,              portfolio                               profitability o f their SME
competitiveness, and                     0 Controlled net NPL ratio o n            business.
employment creation.                       the SME loan portfolios o f all     0   Yr 3 use the outcome
                                           PFIs (at 3% or less)                    information for project
                                           Improved profitability o f              evaluation o n SME’s.
                                           SME business i all PFIs as
                                           measured by Return o f Assets
                                           (RoA) o f 1% or more
                                         0 Scale-up benefiting SME’s

                                           operations (as measured by a
                                           15% increase i turnover)
                                                                              U s e o f Output Monitoring
Component One: The Credit               Component One: Evidence o f          Component One:
Facility: PFIs have better access       timely and satisfactory progress     Information on outputs from t h i s
to t e r m financing and are able to    toward the delivery o f              component w i l l be used to track
increase longer term (3 year+)          Component I   outputs, as planned,   progress toward provision and
lending to SMEs.                        including the following specific     availability o f long-term
                                        measures:                            financing to SME’s through PFIs
                                            Percentage growth in number      and to make changes in the
                                            o f SMEs that receive the CF,    project, if necessary, during
                                            and                              implementation.
                                          0 Value (and %) o f the CF to

                                            PFIs disbursed to eligible
Component Two: The Risk-                Component Two: Evidence o f          Component Two: Information
Sharing Facility (RSF): PFIs            timely and satisfactory progress     o n outputs from t h s component
lending to SMEs (including term         toward the delivery o f              w i l l be used to track progress
lending) i s expanded, whde             Component T w o outputs, as          toward provision and availability
ensuring moderate NPLs.                 planned, including the               o f long-term financing to SME’s
                                        value (and %) o f the RSF            through PFIs and to make
                                        guarantees issued.                   changes in the project if necessary
                                                                             during implementation.



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