FOR OFFICIAL USE ONLY Report No: PAD4190 INTERNATIONAL DEVELOPMENT ASSOCIATION PROJECT APPRAISAL DOCUMENT ON A PROPOSED CREDIT IN THE AMOUNT OF EUR 85.9 MILLION (US$100 MILLION EQUIVALENT) TO THE REPUBLIC OF KENYA FOR A SUPPORTING ACCESS TO FINANCE AND ENTERPRISE RECOVERY PROJECT November 24, 2021 Finance, Competitiveness and Innovation Global Practice Eastern and Southern Africa 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. CURRENCY EQUIVALENTS (Exchange Rate Effective October 31, 2021) Currency Unit = Kenya Shilling (KES) EUR 1 = KES 129.70 US$1 = EUR 0.86 GOVERNMENT OF KENYA FISCAL YEAR July 1 - June 30 Regional Vice President: Hafez M. H. Ghanem Country Director: Keith E. Hansen Regional Director: Asad Alam Practice Manager: Niraj Verma Task Team Leader(s): Neema Mwingu ABBREVIATIONS AND ACRONYMS AfDB African Development Bank ALM Asset and Liability Management AWPB Annual Work Plan and Budget BPS Business Pulse Survey CBK Central Bank of Kenya CE Citizen Engagement CGC Credit Guarantee Company CGS Credit Guarantee Scheme COVID-19 Coronavirus Disease 2019 CPS Country Partnership Strategy CSD Central Securities Depository DA Designated Account DFIs Development Finance Institutions DT Sacco Deposit Taking Savings and Credit Co-operative Society E&S Environmental and Social ESMS Environmental and Social Management System FI Financial Intermediary FIF Financial Intermediary Financing FM Financial Management FSD Financial Sector Deepening GDP Gross Domestic Product GoK Government of Kenya GRM Grievance Redress Mechanism IDP Institutional Development Plan IFC International Finance Corporation IFI International Financing Institution IFMIS Integrated Financial Management System IFR Interim Financial Report IP Indigenous People KfW Kreditanstalt für Wiederaufbau KPI Key Performance Indicator KIEP Kenya Industry and Entrepreneurship Project KYEOP Kenya Youth Employment and Opportunities Project LDR Loan to Deposit Ratio MFB Microfinance Bank MFI Microfinance Institution MNO Mobile Network Operator MoiTED Ministry of Industrialization, Trade and Enterprise Development MSME Micro, Small and Medium Enterprise NPL Non-performing loan NT National Treasury OAG Office of the Auditor General PBC Performance Based Condition PCC Project Coordination Committee PCGS Public Credit Guarantee Scheme PDO Project Development Objective PFM Public Financial Management PFI Project Financial Institution PIE Project Implementing Entity PIU Project Implementation Unit POM Project Operations Manual PPSD Project Procurement Strategy for Development Sacco Savings and Credit Co-operative Society SAFER Supporting Access to Finance and Enterprise Recovery SASRA Sacco Societies Regulatory Authority SEP Stakeholder Engagement Plan SME Small and Medium Enterprise TOR Terms of Reference WEF Women Entrepreneurship Fund WB World Bank WBG World Bank Group TABLE OF CONTENTS DATASHEET ........................................................................................................................................2 I. STRATEGIC CONTEXT ........................................................................................................ 8 A. Country Context ................................................................................................................ 8 B. Sectoral and Institutional Context ................................................................................... 11 C. Relevance to Higher Level Objectives .............................................................................. 17 II. PROJECT DESCRIPTION ................................................................................................... 18 A. Project Development Objective (PDO) ............................................................................ 18 B. Project Components ........................................................................................................ 19 C. Theory of Change............................................................................................................. 31 D. Project Beneficiaries ........................................................................................................ 33 E. Gender ............................................................................................................................. 33 F. Rationale for Bank Involvement and Role of Partners ..................................................... 36 G. Lessons Learned and Reflected in the Project Design ..................................................... 37 III. IMPLEMENTATION ARRANGEMENTS .............................................................................. 39 A. Institutional and Implementation Arrangements ............................................................ 39 B. Citizen Engagement ......................................................................................................... 41 C. Results Monitoring and Evaluation Arrangements .......................................................... 42 D. Sustainability ................................................................................................................... 42 IV. PROJECT APPRAISAL SUMMARY ..................................................................................... 43 A. Technical, Economic and Financial Analysis (if applicable) .............................................. 43 B. Fiduciary .......................................................................................................................... 44 C. Legal Operational Policies ................................................................................................ 45 D. Environmental and Social ................................................................................................ 45 V. GRIEVANCE REDRESS SERVICES ....................................................................................... 47 VI. KEY RISKS........................................................................................................................ 47 VII. RESULTS FRAMEWORK AND MONITORING..................................................................... 51 ANNEX 1: Indicative Eligibility Criteria for the Line of Credit and the CGS ................................. 65 ANNEX 2: Implementation Arrangements and Support Plan ...................................................... 69 ANNEX 3: Performance-based Conditions and Verification Protocols ........................................ 78 ANNEX 4: Economic and Financial Analysis................................................................................... 81 ANNEX 5: The COVID-19 pandemic, the liquidity problem and rationale for MSME liquidity support ............................................................................................................................................. 83 ANNEX 6: A Sample of Previous Lines of Credit to Commercial Banks ....................................... 88 ANNEX 7: Map of KENYA ....................................................................................................... 90 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) DATASHEET BASIC INFORMATION BASIC INFO TABLE Country(ies) Project Name Kenya Supporting Access to Finance and Enterprise Recovery (SAFER) Environmental and Social Risk Project ID Financing Instrument Process Classification Urgent Need or Investment Project P175017 Substantial Capacity Constraints Financing (FCC) Financing & Implementation Modalities [ ] Multiphase Programmatic Approach (MPA) [ ] Contingent Emergency Response Component (CERC) [ ] Series of Projects (SOP) [ ] Fragile State(s) [✓] Performance-Based Conditions (PBCs) [ ] Small State(s) [✓] Financial Intermediaries (FI) [ ] Fragile within a non-fragile Country [ ] Project-Based Guarantee [ ] Conflict [ ] Deferred Drawdown [✓] Responding to Natural or Man-made Disaster [ ] Alternate Procurement Arrangements (APA) [ ] Hands-on Enhanced Implementation Support (HEIS) Expected Approval Date Expected Closing Date 09-Dec-2021 31-Dec-2026 Bank/IFC Collaboration Joint Level Yes Complementary or Interdependent project requiring active coordination Proposed Development Objective(s) The objective of the Project is to increase access to financial services and support COVID-19 recovery of Micro, Small and Medium Enterprises (MSMEs) in Kenya. 2 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) Components Component Name Cost (US$, millions) Innovation and liquidity support to MSMEs 55.00 De-risking Lending to MSMEs 30.00 Technical Assistance and Project Management 15.00 Organizations Borrower: Republic of Kenya Implementing Agency: National Treasury and Planning PROJECT FINANCING DATA (US$, Millions) SUMMARY -NewFin1 Total Project Cost 250.00 Total Financing 250.00 of which IBRD/IDA 100.00 Financing Gap 0.00 DETAILS -NewFinEnh2 Private Sector Investors/Shareholders Equity Amount Debt Amount Non-Government Contributions 20.00 IFI Debt 120.00 Private Sector Equity 20.00 IDA (Credit/Grant) 100.00 Other IFIs 20.00 Commercial Debt 110.00 Guaranteed 80.00 Unguaranteed 30.00 Total 20.00 230.00 3 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) IDA Resources (in US$, Millions) Credit Amount Grant Amount Guarantee Amount Total Amount Kenya 100.00 0.00 0.00 100.00 National PBA 100.00 0.00 0.00 100.00 Total 100.00 0.00 0.00 100.00 Expected Disbursements (in US$, Millions) WB Fiscal Year 2022 2023 2024 2025 2026 2027 Annual 12.85 14.15 20.17 21.79 25.34 5.70 Cumulative 12.85 27.00 47.17 68.96 94.30 100.00 INSTITUTIONAL DATA Practice Area (Lead) Contributing Practice Areas Finance, Competitiveness and Innovation Social Protection & Jobs Climate Change and Disaster Screening This operation has been screened for short and long-term climate change and disaster risks SYSTEMATIC OPERATIONS RISK-RATING TOOL (SORT) Risk Category Rating 1. Political and Governance  Substantial 2. Macroeconomic  High 3. Sector Strategies and Policies  Moderate 4. Technical Design of Project or Program  Substantial 5. Institutional Capacity for Implementation and Sustainability  Substantial 6. Fiduciary  Substantial 7. Environment and Social  Substantial 4 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) 8. Stakeholders  Moderate 9. Other 10. Overall  Substantial COMPLIANCE Policy Does the project depart from the CPF in content or in other significant respects? [ ] Yes [✓] No Does the project require any waivers of Bank policies? [ ] Yes [✓] No Environmental and Social Standards Relevance Given its Context at the Time of Appraisal E & S Standards Relevance Assessment and Management of Environmental and Social Risks and Impacts Relevant Stakeholder Engagement and Information Disclosure Relevant Labor and Working Conditions Relevant Resource Efficiency and Pollution Prevention and Management Relevant Community Health and Safety Relevant Land Acquisition, Restrictions on Land Use and Involuntary Resettlement Relevant Biodiversity Conservation and Sustainable Management of Living Natural Relevant Resources Indigenous Peoples/Sub-Saharan African Historically Underserved Traditional Relevant Local Communities Cultural Heritage Relevant Financial Intermediaries Relevant 5 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) NOTE: For further information regarding the World Bank’s due diligence assessment of the Project’s potential environmental and social risks and impacts, please refer to the Project’s Appraisal Environmental and Social Review Summary (ESRS). Legal Covenants Sections and Description Section I.A. 3b of Schedule 2 to the Financing Agreement: The PCC shall meet at least every six months to, inter alia, review the Project results, discuss any key issues arising and agree on key milestones over the following six months. Sections and Description Section II.C.1 of Schedule 2 to the Financing Agreement: The Recipient shall within ninety (90) days after the Effective Date develop and implement throughout the Project, a monitoring and evaluation strategy (M&E Strategy), such M&E Strategy to be in form and substance satisfactory to the Association Sections and Description Section II.C.2 of Schedule 2 to the Financing Agreement: The Recipient shall within one hundred twenty (120) days after the Effective Date, hire and maintain throughout Project implementation, an independent monitoring agent holding such qualifications and under terms of reference acceptable to the Association, to monitor the flow and use of Project funds and perform such other functions as may be further stipulated in the POM. Sections and Description Section II.A.2 of Schedule 2 to the Financing Agreement: No later than thirty (30) months after the Effective Date, the Recipient shall, in conjunction with the Association, carry out a mid-term review of the Project (the “Mid-term Review”), covering the progress achieved in the implementation of the Project. Conditions Type Financing source Description Effectiveness IBRD/IDA Article V. 5.01of the Financing Agreement: The Recipient has adopted the Project Operations Manual (“POM”), in accordance with Section I, part B.1(a) and (b) of Schedule 2 to this Agreement, in form and substance satisfactory to the Association Type Financing source Description Disbursement IBRD/IDA Section III.B.1b of Schedule 2 of the Financing Agreement: under Category 1 No withdrawal shall be made unless and until the Recipient has (i) identified and selected an Apex PIE satisfactory to the Association, for the implementation of Part 1 of the Project; (ii) executed and submitted to the Association a Subsidiary Financing Agreement with the Apex PIE, such Subsidiary Financing 6 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) Agreement to be in form and substance satisfactory to the Association; (iii) prepared, adopted and published, (A) Gender-based Violence Action Plan, (B) MSMEs environmental and social training toolkit and training manuals, and (C) Labor Management Procedures, such instruments to be in form and substance satisfactory to the Association Type Financing source Description Disbursement IBRD/IDA Section III.B.1c of Schedule 2 of the Financing Agreement: Under Categories 1 and 2 No withdrawal shall be made unless and until the Recipient has: (i) prepared, adopted and published the NT ESMS, such NT ESMS to be satisfactory to the Association; (ii) prepared and conducted a Social Assessment to identify barriers to entry and access to finance particularly those related to discrimination, bias, literacy and numeracy for disadvantaged groups and incorporated the results of the Social Assessment in the NT ESMS, the Stakeholder Engagement Plan and the grievance redress mechanism Type Financing source Description Disbursement IBRD/IDA Section III.B.1d of Schedule 2 of the Financing Agreement: Under Category 3 No withdrawal shall be made unless and until the Recipient has furnished evidence satisfactory to the Association, including verification reports from the OAG, that the PBCs set forth in Schedule 4 for which payment is requested have been met and verified in accordance with the Verification Protocol 7 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) I. STRATEGIC CONTEXT A. Country Context 1. The Coronavirus Disease 2019 (COVID-19) pandemic has severely affected the entire world causing a global economic downturn in most countries. The global economy contracted by 3.5 percent in 2020 compared to growth of 2.8 percent in 2019. It is projected to grow by 5.5 percent in 2021 and 4.2 percent in 2022. 1 Sub-Saharan Africa’s economy contracted sharply by 2.6 percent in 2020 from a growth of 3.2 percent in 2019, the first recession in the region over the past 25 years. 2 Sub-Saharan Africa’s economic growth is projected to increase to 3.2 percent in 2021 and 3.9 percent in 2022. Governments across East Africa have provided relief measures to support businesses and households, but many economies, including Kenya continue to be severely affected. 2. Kenya was hit hard at the onset of the COVID-19 crisis, but growth has been recovering since mid- 2020. 3 Real GDP growth contracted by 1.1 percent year-on-year in quarter three of 2020, a significant improvement from quarter two which saw a contraction of 5.5 percent 4. Growth was supported by strong performance of agriculture, construction, real estate, information, and communications technology (ICT), and public administration sectors. However, activities have remained subdued in most service sectors. The external sector proved resilient against the backdrop of the shock, with horticultural exports and remittances performing well 5. The crisis increased fiscal pressures and led to a widening of the fiscal financing gap from 7.8 percent of GDP in 2019/2020 to 9 percent of GDP in the first half of 2020/2021. Nevertheless, to maintain a fiscal consolidation effort that pre-dates the crisis, the Government of Kenya (GoK) has since rolled back some of its immediate economic support measures. The earlier personal and corporate income tax cuts as well as the reduced value added tax rates were discontinued at the end of December 2020. 3. The pandemic has also created unprecedented supply and demand shocks that have resulted in a drop in economic activities globally. Kenya’s continued reliance on the export of primary commodities and inability to move up sufficiently the value chain across major economic and productive sectors has left the economy extremely vulnerable to the spillover effects of the pandemic. The COVID-19 pandemic has affected micro, small, and medium enterprises (MSMEs) 6 through a range of transmission channels and will need targeted support to facilitate their recovery, particularly for informal sector MSMEs. Around two thirds of firms reported decrease in demand, cash flow and available finance, while 56 percent of firms lament the unavailability of inputs. 7 The Word Bank COVID-19 Business Pulse Survey (BPS) in Kenya 1 IMF’s World Economic Outlook, January 2021. 2 World Bank’s Africa Pulse, April 2020. 3 IMF’s World Economic Outlook, January 2021. 4 World Bank Kenya Economic Update, June 2021. 5 Central Bank of Kenya (CBK) Monetary Policy Committee, November 2020 6 The 2012 MSME Act in Kenya defines Micro and Small Enterprises based on the number of employees, sector of operation, and annual revenues. A micro enterprise employs less than 10 employees while a small enterprise employs between 10 and 50, and medium enterprises employ between 50 and 99 employees. http://www.industrialization.go.ke/indec.php-micro-and-small- enterprises-act-2012 7 World Bank COVID-19 Business Pulse Survey, September 2020. 8 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) found that almost all firms experienced a decline in sales, with sales dropping by 51 percent on average, 93 percent of firms report a reduction of sales in the last 30 days compared to the same period in 2019, while only 2 percent report an increase. Large firms were most likely to remain open, whereas micro firms were more likely to have been closed. The industrial and other service sectors (other than retail/ wholesale, accommodation/ food, etc.) have been hit harder by a reduction in their cash flow from sales due to the pandemic, while the agriculture and accommodation/food sectors have been affected more by the decrease in demand. 4. Labor adjustments (e.g., layoffs, extended leave, reduced wages, reduced working hours, 8 etc.) have taken place, with serious impacts on incomes and livelihoods, due to decreased sales and cash flow. 9 More than one in five businesses in Kenya have let go some of their workforce. Overall, the unemployment rate nearly tripled from 5 percent in last quarter of 2019 to over 10 percent in the second quarter of 2020, before declining to below 7 percent in the first quarter of 2021. Those employed/self- employed in informal micro and small firms have also been seriously impacted. 10 Workers in informal enterprises face a higher risk of falling into poverty and might experience greater challenges in regaining sustainable livelihoods. 5. Women-owned businesses 11 are a vibrant part of Kenya’s MSME landscape but face specific challenges to productivity, growth, and profitability. Women form 61 percent of unlicensed MSMEs and 31 percent of licensed MSMEs in Kenya. 12 However, enterprises owned or run by female achieve much lower profits compared to those owned or run by their male counterparts. Specifically, average profits of male-run household enterprises are roughly two times higher than profits of female-owned enterprises. 13 Female-owned businesses rely more heavily on microfinance (24 percent) and Savings and credit co- operative societies (Saccos) 14 (14 percent) than male-owned businesses (15 and 10 percent respectively). 15 Gender inequalities in Kenya present significant constraints to women’s economic opportunities and productivity, with women: (a) spending more time on unpaid care in the household; (b) being much less likely than men to own property; (c) scoring lower on various indicators of financial inclusion; and (d) scoring lower in the usage of mobile internet and M-Pesa. 16 Additional key barriers faced 8 Working hours have reduced, with average hours decreasing from 45 to 30 hours per week. 9 Around two-thirds of firms also stated a decrease in demand. The decline of sales for example was heterogeneous – larger firms fared better than smaller firms, with no drop in sales reported at the 90th percentile of large firms, while sales declined by 90 percent for the bottom 10percent of firms. 10 According to the KIHBS 2015/2016 Kenya Social Protection and Job Programs Public Expenditure Review, it is estimated that out of the 16.8 million people employed in Kenya, 14 million work in the informal sector, corresponding to approximately 83 percent of total employment. 11 For this project, women-owned formal sector businesses are defined as businesses where one of the cofounders or the CEO is a woman. Women-owned informal sector businesses are defined as businesses where the primary owner/operator is a woman (sole proprietorship) and are interchangeably referenced as women borrowers. 12 KNBS (2016): MSME Survey. 13 World Bank (2018): Kenya Poverty and Gender Assessment. 14 A SACCO is a member owned financial cooperative whose primary objective is to mobilize savings and afford access to loans on competitive terms as a way of enhancing members’ socio-economic wellbeing. 15 Preliminary information from World Bank (2020) Kenya Women’s Economic Empowerment Scoping. These institutions offer lower level of finance compared to larger institutions. 16 GSMA (2020): The Mobile Gender Gap Report 2020; World Bank (2018): Kenya Poverty and Gender Assessment. The gender gap in the usage of mobile internet and M-pesa is 39 percent and 16 percent respectively. 9 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) by women in running their businesses include lack of business skills, limited value addition of products, low access to market information, and a lack of access to business networks. 17 6. The impacts of COVID-19 on women entrepreneurs are substantial. Global evidence from past disease outbreaks generally shows that health emergencies accentuate existing gender inequalities. This is mainly through adverse effects on their health and well-being, food security and nutrition, livelihoods, and protection from violence. Early assessments of informal settlements in Nairobi showed that women compared to men are more likely to: (a) have completely lost their income due to the pandemic; (b) have increased housework and face increased tensions at home; (c) forgo health services; and (d) skip meals. 18 A recent Facebook business survey in Sub-Saharan Africa, including Kenya, shows that female-owned firms have been more likely to report having to temporarily close their business during COVID-19. 19 Given their smaller size and lower access to credit, women-owned firms are less equipped to cope with shocks. With the school closures during March-December 2020 and March-May 2021 and limitations on movements, a greater burden was placed on women to care for children and the elderly. The extra burden of care further affected women’s ability to take on paid work or business activities. Women-owned enterprises also form the highest proportion of businesses engaged in the sale of fresh food commodities that was affected by the COVID-19 measures such as border closures and restrictions on movement. 20 7. Climate change is having and will continue to have a considerable negative impact on livelihoods and economic growth. Over the past 50 years, changes in temperature and rainfall patterns have resulted in more frequent weather-related disasters such as floods, droughts, and landslides with a profound impact on Kenya’s economy and people’s well-being. Each flood event affected 68,000 people on average, each drought event affected 4.8 million people on average, and 3.4 million Kenyans were classed as food insecure in 2017 due to ongoing droughts. The economic effects of climate change will be significant, with recent modeling for Kenya placing the reduction in gross domestic product (GDP) growth at approximately 2.3 percentage points under current warming conditions (at the upper end of the estimates), doubling to 4.7 percent at 2°C warming. 21 The most severe effects of these changes will be felt by the poor, women, and children, who depend most directly on ecosystem services. This project will be implemented across Kenya, with some regions heavily affected by climate change, hence it would be critical to ensure climate risks mitigation and adaptation are embedded during implementation. 17 SNV (2017). Gender Analysis of Women’s Economic Empowerment Kenya. Enhancing Opportunities for Women’s Enterprises Programme Knowledge Series. 18 Nairobi informal settlements: COVID-19 knowledge, attitudes, practices and needs. Population Council/Ministry of Health Kenya, April 2020. 19 Goldstein, Markus, Paula Ganzalez Martinez, Sreelakshmi Papineni and Joshua Wimpey (2020): Gender Inequalities in the Global State of Small Businesses during COVID-19. 20 https://dalberg.com/our-ideas/applying-a-gender-lens-to-post-covid-economic-recoveries-a-spotlight-on-women-led- businesses-in-africa/ 21 Source: World Bank Group. 2019. Kenya Country Environmental Analysis. Report No. AUS0001100. 10 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) B. Sectoral and Institutional Context 8. Despite a vibrant financial sector and the substantial contribution of MSMEs to the Kenyan economy, 22 lending to MSMEs has been declining for the past few years. 23 The introduction of the interest rate cap on loans and interest floor on deposits in 2016 led to significant credit misallocation, with commercial banks shifting from lending to the private sector, especially to MSMEs, to investing in government securities. This decline is further confirmed on the demand side by the World Bank Enterprise Survey 2018, with the proportion of small firms identifying access to finance as a major constraint jumped from 15.1 percent in 2013 to 32.3 percent in 2018. The cap was officially lifted in November 2019, but the impact of its elimination on MSME lending and lending rates is yet to be seen. Lack of collateral remains one of the key constraints to accessing finance by creditworthy MSMEs. The 2018 Enterprise Survey identified that banks in Kenya require collateral worth 240 percent of the loan amount for 88 percent of small borrowers, with women-owned businesses being more adversely affected 24 (see the Gender section for more details). With COVID-19, the situation has worsened while demand from viable MSMEs exists. 9. Similar to countries with comparable levels of development, Kenya’s financial sector is dominated by banks. The banking sector accounts for 65 percent of the total financial sector assets and about 50 percent of GDP 25. The Kenyan banking sector remains stable, well-capitalized and has posted growth in asset base and deposits for the past seven years (2014-2020). 26 Uncertainty and risks of increased default due to the impact of COVID-19 has increased financial sector stresses since 2020. In August 2020, non- performing loan (NPL) ratios among medium and small banks, which have a larger share of MSMEs customers, averaged 19.5 percent and 17.7 percent respectively. The Central Bank of Kenya (CBK) anticipated a spike in loan defaults and granted flexibility to banks on provisioning requirements for loans restructured due to the pandemic, extending flexibility to borrowers on loan terms based on individual circumstances arising from the crisis. This resulted in a total of 54.2 percent of loans benefitting from temporary debt relief agreements by the end of 2020. However, the average NPL ratio in the bank sector remains high at 13.9 percent in August 2021 compared to the same ratio in August 2020, and 10.5 percent in August 2019. The increase in NPLs is attributable to the economic slowdown following the pandemic and spans the agriculture, personal and household, manufacturing, real estate, and transport and communication sectors. Repayments and recoveries have recently been observed in the tourism, restaurants and hotels, and building and construction sectors following the lift of lockdown measures. 10. The stresses emanating from the pandemic have led to a slower growth of credit to the private sector and a higher level of liquidity in the banking system, as banks move their investments to safer asset classes. Growth of private sector credit decreased to 7 percent in August 2021 compared to 8.3 22 The 2016 MSME KNBS survey identified 1.6 million MSMEs, of which 92 percent were microenterprises (employing about 14.1 million people or 81 percent of MSME employment) and 8 percent were SMEs. MSMEs represent the backbone of the Kenyan economy, contribute 34 percent to GDP, and make up 75 percent of formal establishments in Kenya, creating 30 percent of jobs annually. 23 The proportion of bank lending to MSMEs declined rapidly from 23.4 percent of banks’ loan portfolios in 2013 to 15.8 percent in 2018. 24 Banks can leverage the existing moveable collateral registry to develop more innovative products for MSMEs. Some technical support to the industry and regulators to spur innovation will be needed. 25 Financial Sector Regulators. 2019. Kenya Financial Sector Stability Report 2018. Issue No. 10. 26 During the period, both assets and deposits grew at a CAGR of 8 percent. As of December 2020, the ratio of core and total regulatory capital to risk weighted assets stood at 16.8 percent and 19 percent respectively. 11 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) percent in August 2020 (which was a slight increase from 6.3 percent in August 2019). At the peak of the COVID-19 pandemic, between March and July 2020, the growth of private sector credit declined from about 9 percent to 7.9 percent. Consequently, the industry loan-to-deposit ratio was 74.9 percent in August 2020, which is a marginal increase from the average of 74 percent in 2019. 27 The ratio of liquid assets to total deposits significantly increased from an average of 41 percent in 2019 to 56.8 percent in August 2020. However, it is noteworthy that the aggregate liquidity data in the banking system and inter- bank rates masks liquidity concentration and distribution challenges across the different tiers of banks (see Box 1 and Annex 5). The distribution of liquidity is skewed toward large banks while some of the medium and smaller banks are likely to face liquidity challenges going forward, especially in the context of high and increasing NPLs. To address this problem, CBK is working alongside the World Bank and other partners and has begun to make critical investments in the central securities depository (CSD), a strategic financial market infrastructure, with long-term implications on inter-bank market structure, banking system liquidity concentration, and the functioning of the interbank market. 28 Among other objectives, the CSD initiative is aimed at streamlining inter-bank credit and liquidity risk management by rationalizing arrangements for pledging collateral and settlement of transaction involving government securities and “central bank money.” The CSD initiative will ultimately contribute to improved effectiveness of monetary policy operations and reliability of settlements. A well-functioning inter-bank market and efficient distribution of liquidity will address the funding spread and cost issues for different tiers of banks enabling them to affordably extend finance to MSMEs. 11. The non-bank financial institutions ecosystem in Kenya is characterized by the presence of both regulated institutions, such as Saccos, microfinance banks (MFBs), unregulated credit only microfinance financial institutions (MFIs), and digital lenders, mostly lending to underserved MSMEs. CBK is responsible for regulating and supervising MFBs, while deposit-taking (DT) Saccos 29 are supervised by the Sacco Societies Regulatory Authority (SASRA). DT-Saccos have a much higher share of the loan portfolio than MFBs, at 13 and 2 percent respectively as well as a higher share of deposits (9 percent) compared to 1 percent for MFBs. 30 A survey conducted by McKinsey in April 2020 across a sample of 422 MSMEs gave similar results. Twelve percent of the respondents were borrowing from Saccos and 4.6 percent from MFBs. 31 12. The quality of loan portfolios of MFBs is unsatisfactory with NPL ratio averaging 18 percent. The introduction of the interest rate caps in 2016, which applied to commercial banks but not MFBs had a significant impact on the deterioration of the loan portfolio quality for MFBs. More creditworthy SMEs, formerly clients of MFBs, could suddenly have access to better rates at commercial banks, while riskier SMEs were turned down by banks and had no other option but to apply for loans with MFBs, credit-only MFIs, and to a lesser extent, Saccos. This increased the risk-profile of MFB customers. The MFB industry 27 World Bank Kenya Monthly Economic Data Update. 28 Under the Kenya Financial Sector Support Project. (P151816). SAFER will provide additional support to CBK to build on the success of FSSP related to the CSD initiative. 29 DT-Saccos are Saccos that mobilize both withdrawable and non-withdrawable deposits from their members and are. The withdrawable savings accounts they offer are similar to those offered by commercial banks. DT-Saccos are supervised by SASRA while the non-deposit taking Saccos are supervised by the Commissioner for Cooperatives under the Ministry of Industrialization, Trade, and Enterprise Development. 30 SASRA, Annual Report 2018. 31 McKinsey 2020. Survey of 422 MSME owners around the country on financial situation and need (conducted on April 24-29). 12 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) has been loss-making, and the capital adequacy ratios are worsening, although they remain above the minimum regulatory requirements. 13. Saccos are affected by the COVID-19 pandemic differently based on their business models. Saccos that rely on the multiplier model (share-based lending) are more likely to sustain liquidity compared to Saccos that do not. Since there is no Sacco “inter-bank” market, Saccos that have severe asset-liability mismatch and must rely on accessing additional financing from commercial banks, face increased cost of funds. Saccos that do not rely on share-based lending tend to serve more MSMEs based on a set of eligibility criteria. SASRA and Saccos are also in advanced discussions on an initiative, the Central Liquidity and Shared Digital Services (the “Sacco Central” initiative), aimed at setting up a mechanism for a centralized liquidity facility to advance efficient and secure distribution of available liquidity within the Sacco sector thereby tackling the asset and liability management (ALM) constraints. 14. The effect of COVID-19 on MSMEs is triggering a knock-on impact on short-term liquidity of some of the small and medium commercial banks/financial institutions (Tier III and some Tier II banks). Consequently, the capacity of the financial system to support economic recovery to viable and productive SMEs will be substantially reduced. Microenterprises, which are largely informal and where most female workers and owners are concentrated, have suffered from market lockdowns and lack of demand, rendering financial institutions which mostly serve informal MSMEs increasingly vulnerable and liquidity- constrained to continue lending. Notably, there are MSMEs that, though struggling due to the impact of COVID-19, are viable, adaptable, and likely to survive if targeted and provided with timely support to safeguard social, institutional, and financial capital that will help them recover and build resilience in future crises. 15. The market for digital credit has expanded given the ubiquitous nature of mobile phone based financial services in Kenya, although most service providers remain unregulated. While MSMEs have access to informal sources of funds, these tend to be exorbitantly priced and lacking safeguards for responsible lending, including disclosure practices by service providers. Digital credit, though popular and has reached some MSMEs, it is offered at a very high cost as evidenced by effective cost of borrowing of above 100 percent per annum. The regulator is concerned about predatory lending practices targeting micro and small borrowers and is working to develop a regulatory framework to facilitate the effective regulation of the digital lending market. 16. Demand for financing by MSMEs remains unmet. The International Finance Corporation (IFC) estimates an SME finance gap of US$19.38 billion for Kenya, 32 representing 30 percent of GDP. As highlighted earlier, the COVID-19 pandemic has exacerbated the difficulty of accessing finance by some firms. Although liquidity has been freed up through monetary measures applied by CBK, the World Bank (WB) COVID-19 BPS shows that many potentially viable firms are still struggling. For example, 89.1 percent of the total financing of KES 35.2 billion that was released after the lowering of the cash reserve ratio by the CBK from 5.25 percent to 4.25 percent in March 2020, was used up within three months to support 32https://www.ifc.org/wps/wcm/connect/03522e90-a13d-4a02-87cd-9ee9a297b311/121264-WP-PUBLIC- MSMEReportFINAL.pdf?MOD=AJPERES&CVID=m5SwAQA. 13 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) lending, especially to the tourism, transport and communication, real estate, trade, and manufacturing sectors. Box 1: The liquidity problem and rationale for MSME liquidity support Interbank rates and aggregate liquidity data (with liquidity ratios of 54.5 percent in 2020 compared to the statutory minimum requirement of 20 percent and 45.5 percent in 2019) shows that there is adequate liquidity in the financial system, but they mask liquidity concentration and the uneven distribution amongst the different players (Annex 5). Banks generally rely on short-term customer deposits to fund their lending business. Due to large branch networks, large banks can attract cheap deposits, giving them a comparative advantage over small banks, which largely depend on more expensive wholesale deposits from large banks and other corporates/institutions and market borrowings. Consequently, in August 2020, Tier I and Tier II banks had liquidity ratio of 50.3 percent and 67.18 percent, respectively but the ratio for Tier III banks was well below the industry average in January 2019 (at 37.6 percent) and stood at 46.3 percent in August 2020. In addition, the cost of funds differs among banks, with smaller banks having higher cost (at almost 3 percent in 2019) than the industry average (2.44 percent in 2019). With corporates and individuals increasingly seeking extensions on their loan repayments, banks are now taking a cautious approach in extending credit anew, thus affecting MSME lending. At the same time, net credit to government accelerated to 39.6 percent in July 2020 from 12.8 percent in July 2019, as the government turned to domestic sources to fund its widening budget deficit (including COVID-19 related spending). However, this rate has reduced to about 23 percent in July 2021. Data from the World Bank COVID-19 BPS and information gathered from key sector informants during project preparation indicate that two thirds of firms in Kenya experienced decreases in demand, cashflow, and available finance with large variability in cash availability and access to credit among MSMEs. In the Sacco sector, liquidity ratio averaged 50.9 percent in 2019, which was higher than the statutory minimum requirement of 15 percent. However, the low Cash Ratio and high Loan-to-Deposit Ratio (LDR) (Annex 5) throughout 2020 show that Saccos are highly leveraged and do not have enough cash liquidity or LDR headroom to cover additional borrowing requirements from mobilized deposits or internally generated funds. Members of farmer based Saccos, forming part of the Private Sacco category, collect very limited savings and equally advance minimal amounts in credit facilities. At the core of the problem is the Sacco business model, linking loans to savings, with loan demand far exceeding the volume of deposits that Saccos can capture. Further, the introduction of the interest rate cap and closure of two commercial banks in 2016 devastated microfinance banks (MFBs), leading to the deterioration of MFB loan portfolios, affecting their ability to raise funds from international wholesale investment vehicles and finance MSMEs. These effects persist to date. There are several International Finance Institutions (IFIs) with a private mandate and Development Finance Institutions (DFIs) providing lines of credit in the market (Annex 6). However, most are available to larger banks and in foreign currency, which are more likely to target foreign currency earning businesses. An assessment done by the World Bank of the 17 lines of credit offered by different DFIs in the past 8-10 years shows that less than 5 percent were offered in local currency, mostly to large commercial banks. 14 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) The lack of mechanisms to pool and distribute liquidity in the interbank market caused commercial banks and Saccos to face ALM challenges. This challenge is further revealed in high and uneven spreads across different tiers of Financial Intermediaries (FIs) and high borrowing costs for MSMEs and informal sector borrowers. The WB under the Financial Sector Support Project (FSSP, P151816) is supporting investment in financial market infrastructure and structural reforms essential for a well-functioning wholesale inter-bank market and efficient distribution of liquidity. Investments in these reforms are being led by the CBK through the CSD initiative and SASRA through the Sacco Central initiative. These reforms will level the playing field, enhance broad-based access to common liquidity pools and ameliorate the funding spread issue. However, these benefits will be realized over the medium to long term as improvements in market functioning are consolidated over time impacting market conduct and practice. 17. In 2019, the GoK started the process of establishing a credit guarantee company with the objective of de-risking lending to MSMEs through a public credit guarantee scheme (PCGS). PCGSs are a widely used policy tool to facilitate access to finance by creditworthy MSMEs, which would have been denied credit in the absence of sufficient collateral. PCGSs are particularly relevant and effective when there is enough liquidity in the financial system (which is the case in Kenya within the large Tier I commercial bank system), yet it does not flow to some sectors or market segments (e.g., MSMEs) because of risk aversion from the credit providers. Further, most commercial banks consulted during project preparation indicated that a properly structured PCGS would compensate for collateral shortfalls and increase banks’ risk appetite, especially during the pandemic. A feasibility study conducted with the support of the Financial Sector Deepening (FSD) Kenya together with the National Treasury (NT) identified both demand for a guarantee scheme and a supply gap with regards to MSME financing given commercial banks’ preference to invest in lower risk sectors or market segments. NT decided to set up a credit guarantee company (CGC) that would adopt a sustainable public-private partnership model with a robust governance structure to facilitate the crowding in of larger amounts of capital, including from the private sector. Several IFIs, including the IFC and similar institutions have shown interest to participate, if the governance of the company is structured to allow private sector participation. 18. Given the impact of the COVID-19 pandemic, there was a consensus among stakeholders that an interim credit guarantee mechanism would be needed as an emergency response to the pandemic, since the setting up of the CGC would take time. 33 The GoK decided to set up an interim credit guarantee scheme (from hereinafter referred to as the “CGS”), which was launched in December 2020. The CGS is currently housed at the NT and is expected to later transition into the CGC once it is established. The CGS will provide banks with 50 percent cover of potential losses associated with MSME loans on pari-passu basis, with the GoK’s exposure limited to 25 percent of loan losses at both portfolio and individual loan level. The GoK has approved up to Ksh. 10 billion (approximately US$100 million) over two years as capital for the CGS and the initial capital of Ksh. 3 billion (approximately US$30 million) has been committed. 19. The WB and the IFC have been consulted during the development of the CGS regulations and manual and encouraged the adoption of principles for guarantee schemes. Some recommendations 33 This decision was based on a series of discussions between the GoK, financial institutions, and development partners. 15 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) were adopted while others are expected to be adopted during the setting up of the CGC, incorporating lessons learned from implementation of the CGS. The Project will work together with NT to gather feedback from seven financial institutions that are currently participating in the existing CGS 34 and in setting up the CGC in accordance with international best practices. The CGS will be accessed by all regulated financial institution if they qualify based on set qualification criteria. Given the demand, more capital (for both the CGS and the CGC) will be required. As a policy measure to mitigate the impact of the COVID-19 pandemic in the short-term, under the current scheme, financial institutions will not be required to pay a guarantee fee. However, this could be reviewed in the future, since charging a guarantee fee is critical for the sustainability of the scheme and for mitigating the fiscal risk on the government. Setting up of the CGC is viewed as a sustainable mechanism. The CGS’s legal framework for guaranteeing MSMEs is fully anchored in the Public Finance Management (PFM) law, which was amended in 2020 to allow the GoK to set up the CGS. 20. The NT has developed a CGS manual to guide the operations of the scheme and identifies the NT, CBK and PFIs as the main CGS stakeholders. The CGS manual further identifies registered MSMEs as the main target group of the scheme. The governance structure of the scheme is further provided for under the PFM (Credit Guarantee Scheme), Regulations, 2020. In line with these regulations, the NT has set up a dedicated Scheme Steering Committee as the governance structure of the CGS. The committee is chaired by the NT Principal Secretary and includes the CBK Governor and representatives of the Ministry of Industrialization, Trade, and Enterprise Development (MoITED), Office of the Auditor General (OAG), and three independent members who are professionals in the banking, insurance, and finance sector. Section 9 of the regulations stipulates the appointment of a scheme manager and relevant staff. NT is working on the organization structure for the scheme, which will be presented to the Public Service Commission for approval. 21. In response to the COVID-19 pandemic, more than one in five firms is starting to use or increasing their use of digital platforms. According to the Kenya COVID-19 BPS, 23 percent of survey firms increased investment in digital platforms. This, coupled with increased use of digital payment/lending platforms present a great potential for increasing access to finance by MSMEs, especially those in the micro and small end of the scale. Mobile Network Operators (MNOs) facilitate digital payments and lending to businesses through their platforms. With over 40 million active customers, a total value of US$78 billion was transferred by the M-Pesa system in 2019. 35 A wide ecosystem of services is offered on the M-Pesa platform, including: (a) basic person-to-person payments (e.g., sending and receiving payments); (b) business-to-person payments; (c) business-to-business payments; and (d) institutional payments, including government-to-person payments such as salary payments, government social payments, government fees and tax collection, and microlending solutions (in partnership with the NCBA Bank). 36 34 NT invited applications from 39 banks across all tiers and it received applications from 14 commercial banks. Only seven banks (consisting of only tier 1 and tier 3 banks) met the criteria. It is expected that more banks will join in the future. 35 World Bank. 2019. Kenya Digital Economy Assessment: Background Paper Series – Digital Financial Services. 36 NCBA Bank in partnership with Safaricom offering savings and short-term unsecured loan service, namely “M-Shwari”. The credit assessment is based on a credit-scoring algorithm, which leverages alternative data such as airtime usage and M-Pesa transactions. Loans are generally advanced to the M-Pesa account in under a minute. In 2016, a little over three years after its launch, M-Shwari had disbursed nearly US$1 billion in loans to 14 million customers. 16 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) 22. Kenya is possibly the only country in Africa where there is widespread merchant acceptance for mobile money payments for purchase of goods and services. There are now an estimated 109,000 shops across Kenya that accept ‘Lipa na M-Pesa’. 37 In-store purchases by mobile money were used by nearly one million customers per day in 2018. 38 Consequently, ‘Lipa na M-Pesa’ sales have grown by 50 percent year- on-year. Most banks support transfers between bank accounts and mobile wallets, and there is a widespread usage of ‘bank-to-wallet’ transfers to facilitate mobile money transactions or as a route to cash out, given the larger number of mobile money agents than ATMs. Scaling partnerships between players such as MNOs and financial institutions, who can leverage the rich data available on MNO platforms could spur innovation and increase access to finance, especially for micro and small businesses. Discussions with MNOs identify that MNO platforms have access to both informal sector MSME financial data (on payments, savings, and loans), and alternative data (such as call histories, social networks, and trend analysis of financial behavior over time). Collaborations between MNOs and financial institutions can leverage on big data analytics to target informal MSMEs better by developing alternative scoring models that enable evidence-based support to viable MSMEs in sectors that were hard-hit by the COVID pandemic. Data analytic processes would adhere to the Data Protection Act 2019 that outlines safeguards relating to maintaining anonymity of data subjects and processing of personal data. 23. While structural market failures in the financial system existed prior to COVID-19, the pandemic exacerbated an already bad situation and is already having an impact on the growth of private sector credit. The effect on MSMEs is triggering a knock-on impact on financial institutions, limiting their ability to provide finance, especially to micro and small enterprises. This operation is expected to support financial institutions, to enable them to adapt to better manage their liquidity (and restructure loans during the pandemic), shore up innovation, and increase lending to viable MSMEs, including extending loans with longer maturity, which is critical for MSMEs to adapt and build resilience. Preserving viable MSMEs will be crucial for a faster path to economic recovery and job retention. Industry-wide technical support to upgrade market standards, especially within the Saccos sub sector, will go a long way toward enhancing the capability of market players, help to create the market for private sector solutions and unlock more lending. C. Relevance to Higher Level Objectives 24. This Project is part of the World Bank program for COVID-19 response focusing on supporting businesses, accelerating recovery, and strengthening economic resilience. The proposed operation is consistent with the World Bank Group Country Partnership Strategy (CPS) for Kenya, FY 2014-2018 (Report No. 88940), extended under the Performance and Learning Review of the CPS (P161914) to FY2020 and the World Bank Group COVID-19 Crisis Response Approach Paper (“Approach Paper”, Report No.150916 The CPS has three strategic result areas: (i) competitiveness and sustainability, growth to eradicate poverty; (ii) protection and potential, delivering shared prosperity; and (iii) consistency and equity, delivering a devolution dividend. The Project’s objectives are fully aligned with the twin goals of the World Bank Group (WBG) and IDA19 themes of Jobs and Economic Transformation, Debt Sustainability, Governance and Institutions, Gender, and fostering a Digital Economy. In line with this, the Project is taking a comprehensive approach to addressing impediments to the sustainability of the financial sector as an engine of growth by deepening access to sustainable sources of finance and 37 Lipa na M-Pesa means ‘pay by M-Pesa’ in Swahili. 38 World Bank. 2019. Kenya Digital Economy Assessment: Background Paper Series – Digital Financial Services. 17 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) strengthening resilience of these sources of finance. Reform elements of this operation which are key to support an orderly recovery process closely complement the GoK’s Big 4 agenda and Vision 2030 development plan with regards to supporting MSME financing and capabilities. 25. The Kenya program is being adjusted in line with the selective WBG crisis response. The WBG COVID-19 Crisis Response Approach paper “Saving lives, Scaling-up Impact, and Getting back on Track” (June 2020) spells out four thematic areas into a phased approach in 3 stages (relief, restructuring, resilient recovery). As such the proposed project adopts this phased approach, which was also featured under the Finance, Competitiveness and Innovation note on private sector policy response under COVID- 19 and addresses the considerations to ensure the most context relevant approach is designed. The Project will support the recovery of MSMEs, including the harder to reach informal firms, through market- based solutions by leveraging the outreach of financial institutions and digital platforms. 26. Ensuring business activity and job creation is a core pillar of the World Bank Group COVID-19 Crisis Response Approach Paper (“Approach Paper”, Report No.150916). It recommends the following stages: economic emergency; firm restructuring and debt resolution; and green business growth and job creation. As such the proposed project addresses the need to support viable firms during the response phase so that they do not exit due to the pandemic, including with a view to support worker retention. This is consistent with GoK’s Vision 2030 and Big Four agenda that seeks to create 6.5 million new jobs and increase the ratio of formal employment from 13 percent in 2017 to 40 percent in 2022. 27. The Project also complements ongoing WBG activities in Kenya. The Project is informed by numerous consultations with the GoK, financial sector, and other actors in the MSME ecosystem, including during the implementation of the Enhancing Access to Finance for MSMEs (P171828). The Project also draws numerous synergies with the second Kenya Inclusive Growth and Fiscal Management Development Policy Operation (DPO) (P172321) that provides the GoK with additional fiscal space to support the economic downturn induced by the global pandemic and help fill the financing gap. The Kenya Financial Sector Support Project (FSSP) (P151816) and the Kenya Industry and Entrepreneurship Project (P161317) have laid the foundation for a lot of the work proposed under the SAFER Project, especially support to strengthen the legal, regulatory, and institutional environment for improved financial intermediation as well as assistance to MSMEs through business training and supplier development programs. The activities in this Project will also complement the Kenya Youth Employment and Opportunities Project (P151831), which aims to increase employment and earnings opportunities among vulnerable youth with no more than secondary education, including by providing small start-up grants and business development services. PROJECT DESCRIPTION A. Project Development Objective (PDO) PDO Statement The objective of the project is to increase access to financial services and support COVID-19 recovery of Micro, Small and Medium Enterprises (MSMEs) in Kenya. 18 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) PDO Level Indicators The progress towards the PDO will be measured by the following indicators: a) Volume of additional private capital mobilized (including through the credit guarantee scheme, and lines of credit, and additional DFI capital mobilized) (amount, US$ millions). b) Volume of MSME financing to enterprises affected by the COVID-19 (amount, US$ millions). c) Share of beneficiary MSMEs under the Project that survive the COVID-19 pandemic (percentage). d) Number of new financial products for MSMEs launched by participating financial institutions in response to the COVID-19 pandemic (number). B. Project Components 28. The Project seeks to address market failures in access to finance by MSMEs that have been exacerbated by the negative impact of the COVID-19 pandemic. The Project aims to achieve its objective through a mix of market instruments, leveraging existing financial channels. Activities under this project will be structured in three mutually reinforcing components, namely: (a) innovation and liquidity support to MSMEs through MFBs, Saccos and digital channels (including via exploring instruments that can leverage greater private capital); (b) de-risking lending to MSMEs; and (c) technical assistance (TA) and project management (Figure 1). The Project is expected to leverage private capital via de-risking and demonstration effects. It will also attract parallel financing from development partners that would leverage the Project’s implementation arrangements to mobilize additional private sector financing. While the Project responds to the COVID-19 emergency in the short term, it also seeks to address structural challenges affecting MSME financing in the medium to long term. The Project design under Component 3 embeds actions to sensitize project participants and beneficiaries to climate risks and climate change adaptation- and/or mitigation-focused MSMEs. Activities will be mainstreamed through the implementing agencies of Component 1 and 2 and will target all projection locations (i.e., all regions of Kenya). The project is sector agnostic, all MSMEs in all sector will be targeted with interventions. It is noteworthy that the majority of MSMEs are in the service sector, however, there will be a sizeable number of MSMEs in the agriculture and manufacturing sectors, which tend to have a significant negative impact on climate change. 19 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) Figure 1: Summary of project components 20 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) Table 1. Summary of Project Financing by Component Amount Allocated Percent of Total Component Amount (%) (expressed in US$) Component 1 – Innovation and Liquidity. 55 55 • Window 1 - Provision of lines of credit through the Apex Participating Implementing Entities (PIE) to Project 30 30 Financial institutions (PFI) operating digital channels for the provision of sub-loans to eligible MSMEs. • Window 2 - Provision of lines of credit through the Apex PIE to PFIs for the provision of Sub-Loans to Eligible 25 25 MSMEs. Component 2 – De-risking lending to MSMEs 30 30 • Capitalization of the existing CGS 10 10 • PBC 1: Establishment of the CGC 10 10 • PBC 2: Operational readiness of the CGC 10 10 Component 3 – Technical Assistance and Project 15 15 Management Total 100 100 Component 1: Innovation and liquidity support to MSMEs (US$55 million equivalent) 29. The objective of this component is to support the immediate response to the COVID-19 pandemic focused on resilient recovery of MSMEs, especially those in hard hit sectors. This intervention envisions support to firms through liquidity support to enable a resilient recovery from the effects of the COVID-19 pandemic and emphasizes innovation to deliver demonstration on how financial institutions can increase lending to under-served MSMEs. Liquidity support will be provided to MSMEs through regulated FIs, especially regulated retail lending financial institutions that have limited liquidity and focus on MSME banking, including those innovating with digital channels (hereinafter referred to as participating financial institutions (PFIs)). 39 In addition, support will target viable MSMEs that were previously financed but are now facing constraints and those that are considered bankable but have not been able to access credit. The Project will benefit both formal and informal MSMEs. 40 The use of digital channels will leverage alternative data analytic tools to identify viable micro and small borrowers. The indicative loan size to individual microenterprises will range between KES7,000 and KES150,000 and for small enterprises will range between KES150,001 and KES250,000. Tenor for microloans is expected to not exceed 18 months, and for small loans to not exceed three years, though depending on experience and needs, adjustments can be made during implementation. Maximum grace period of six months may apply for both micro and small loans. These aspects will be further defined in the Project operations 39 In the medium term, the expectation is that these financial channels would be leveraged by GoK to blend financial assistance providing relief support for the COVID-19 recovery with the promotion of greater savings by surviving micro enterprises. 40 Micro enterprises are defined as employing between one and nine employees. Despite this, most micro enterprises are operated by self-employed individuals with few to no employees. Small enterprises employ between 10 and 49 employees, while medium enterprises employ between 50 and 99 employees. 21 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) manual. In addition, support will be channeled to key sectors as evidenced by the current demand 41 including such as the trade, pharmaceutical, transport, and manufacturing sectors. This intervention will be coupled with the support initiated under the World Bank-funded FSSP project to develop the Sacco Central initiative and establish a unique national informal sector micro pensions scheme that can blend the GoK’s financial assistance to meet the diverse needs of the marginalized informal sector with the promotion of greater savings to secure resilience against future crises. This support, which was initiated under the FSSP and follow-on technical assistance is programmed under Component 3 of SAFER. 30. In accordance with the World Bank Policy on Investment Project Financing, 2018 (previously Operational Policy, OP 10.0), PFIs will be required to meet eligibility criteria encompassing regulatory compliance, corporate governance, financial soundness, operational capacity, and outreach. 42 The assessment of eligibility of PFIs will involve a holistic assessment of the institutions to credibly serve viable underfunded MSMEs and provide capacity to: (a) develop, design, and launch new products, including scaling up existing products targeting informal sector MSMEs in the face of the COVID-19 pandemic; (b) market and execute promotional campaigns to build awareness of new products and offerings, including, information or incentives for MSMEs to focus on business model adaptations in the COVID-19 pandemic and other crisis that include climate change adaptation; (c) connect with specific MSMEs through use of digital platforms to sell specific products and offerings responding to COVID-19; 43 (d) onboard MSMEs and set up accounts and products, managing relationships and potentially expanding services over time; (e) work across product families and MSME customer types; (f) manage assets and liabilities; and (g) effectively target MSME segments that are difficult to reach in the face of the COVID-19 pandemic, such as women and youth. On-lending rates between the Apex Institution and PFIs will be determined by the NT and the Apex institution considering several factors, including the cost of IDA funding, the cost of swapping foreign currencies to local currency, prevailing market conditions, and other relevant factors. 31. This component will have two windows: Window 1 (US$30 million equivalent) and Window 2 (US$25 million equivalent). Window 1 will help drive innovation targeting informal and formal micro and small enterprises by leveraging digital channels to extend offering by PFIs to micro and small firms (including women-owned businesses) that would otherwise not be easily reached through traditional channels. The aim is to help drive digital transformation and provide a demonstration effect on innovation in banking micro and small firms. These arrangements will need to be endorsed by the regulators (CBK and SASRA) with a view to ensure responsible lending practices, product designs and pricing. The partnerships between the PFIs and MNOs will enable financial institutions to use MNO data in line with the Data Protection Act of 2019 to evaluate micro and small businesses’ willingness and capacity to repay loans. The use of digital data would also facilitate the identification of struggling but viable firms that need 41 A total of KES 604.4 billion (29 percent of the total banking sector loan book of KES2.9 trillion) was restructured in July 2020 mainly to trade (22.9 percent), real estate (19.5 percent), transport and communication (16.3 percent) and manufacturing (14.0 percent). 42 WB Policy on Investment Project Financing requires lending to financial intermediaries (a) which are duly licensed with at least two years in operation, (b) with qualified and experienced management, adequate governance, and institutional capacity for its specific risk profile, (c) are in “good standing” with its supervisory authority (it meets all prudential and other applicable laws and regulations), and (d) has adequate management information systems, among others. 43 For example, MNOs are currently providing P2P and P2B payment services to over five million and 150,000+ MSMEs spanning the entire country, respectively. In addition, MNOs are leveraging ‘big data’ for alternative credit assessments. By PFIs teaming up with MNOs in structures approved by their supervisory authority digital platforms, PFIs can be responsibly leveraged under this component to extend liquidity support to COVID-19 hit MSMEs. 22 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) financing and distinguish those from zombie MSMEs. The PFIs will use digital channels through mobile phones to promote greater convenient access by the target micro and small businesses, offer quick approvals when businesses apply for loans and will ensure that they receive personalized communications when they seek advice or information on financial products. This window is designed as an immediate COVID-19 response measure that augments risk capital of PFIs to scale existing digital products targeting businesses. The World Bank will explore with NT the possibility of blending finance under this component with IFC, CDC Group (formerly the Commonwealth Development Corporation), 44 European Investment Bank, and other DFIs’ funding to unlock a larger volume of funding from the private sector to support innovation, which will continue beyond the life of this project. 32. Window 2 will provide traditional lines of credit to MSMEs through Saccos 45 and MFBs, which mostly target MSMEs, but lack adequate liquidity. The component will operate as a revolving line of credit offering advances to Saccos and MFBs on a first-come first-served basis. So far, six Saccos and one bank with a focus on MSMEs (including informal firms) have expressed interest. The PFIs selected for on- lending to MSMEs will be expected to have experience in offering products and services to this market segment. This component would be coupled with technical assistance to upgrade market standards and innovation, especially within the Sacco segment (see Component 3). The NT Project Implementation Unit (PIU) will track performance throughout the duration of the Project using data from financial statements published by PFIs and coordinate with the regulators to obtain on a quarterly basis, comprehensive prudential reports on the PFIs. The Apex institution in collaboration with the NT and regulatory authorities will draft a reporting template that the PFIs will use to provide information about the loan portfolio supported by the Project and on the MSME beneficiaries. 33. Both windows will be managed by one Apex institution that will wholesale the lines of credit (Annex 1). The Apex institution will be an entity, which may include an FI, identified by the NT, in line with government policies and regulations and in accordance with the eligibility criteria acceptable to the Association. The identification and assessment of the Apex institution to ensure that it meets the performance criteria in Annex 1 will be a disbursement condition under Component 1. The Apex institution will also be required to have an Environmental and Social Management System (ESMS) and will adopt the umbrella ESMS to be developed by the NT. The umbrella ESMS will be adequate in line with the level of environmental and social (E&S) risks of the Project and the NT will develop the necessary capacity and commitment to adequately manage the E&S risks of the PFI lending activities. This will be specifically reflected in the Subsidiary Financing Agreement between the NT and the Apex institution and further between the Apex institution and the PFIs that will on-lend to MSMEs. 34. The Project design aims to meaningfully integrate a gender lens and target a segment of the population that is vulnerable and has been hit harder during the pandemic. Given the digital divide, using digital platforms is likely to be a disadvantage for women entrepreneurs. 46 Complementing the Project design with low-tech alternatives could support women’s immediate access. Enabling women’s access to digital products and mobile money presents an important long-term potential for increasing 44 CDC Group is a DFI owned by the United Kingdom (UK) government. The UK’s Foreign, Commonwealth and Development Office is the sole shareholder of CDC Group. 45 Lending to Saccos through a wholesale financial institution is necessary given the high number of these institutions in Kenya. 46 Accelerating digital inclusion for women in Kenya, Adrine Muhura, GSMA, May 2019. 23 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) women’s economic access in Kenya. 47 Component 1 will seek to outreach to women in particular given women’s lower access to finance and digital/mobile services 48 and time constraints because of the burden of care. Targeted communication showcasing women borrowers 49 is expected to encourage women to apply. Lastly, the requirement for good credit rating based on credit history has led to more women being financially excluded from the formal financial system, so the Project’s intent to use alternative data scoring and psychometric testing to predict business success, is expected to have meaningful results for women’s participation. 35. This component will be implemented over an initial 18 months of the Project 50 and subject to review on an ongoing basis. This is because of the ongoing and evolving nature of the effects of the COVID-19 pandemic on the operating context and funding availability to MSMEs. Given the pandemic, most MSMEs will require grace periods. PFIs will be required to provide working capital and term-loans with longer maturities of up to 3 years compared to the typical 30-day working capital loans and little to no term loans currently offered in the market for this segment. Offering repayment grace periods will help viable but struggling firms to better manage their cash flows and retain employees to ensure a resilience recovery. Adaptation and flexibility considerations to the ongoing pandemic including whether to lengthen or shorten the initial 18-month operation of the two windows will be based on assessments of progress towards results and outcomes undertaken regularly by NT and the World Bank alongside other stakeholders on the following criteria: (i) relevance - Is the component focused on the right activities given changes in country and sector context?; and (ii) efficiency/effectiveness - Is the component doing these activities the right way or are there better ways of doing them given changes in the country/sector context? and (iii) sustainability - is the component making a significant difference/sustainable impact including early identification of risks to sustainability given changes in the country/sector context? 36. With mobile money penetration in Kenya at 119 percent, this component will provide support to PFIs to leverage mobile money/payments data to undertake adequate credit risk, identify viable firms, and hence minimize the credit risk. Liquidity support to informal sector firms will also provide patient capital to encourage innovation and adaptations to the COVID-19 pandemic and demonstrate the viability of this market segment. The liquidity support provided through this component will give the NT the flexibility to pass on minimum IDA concessional borrowing benefits, including moratorium periods, flexible terms for loan repayment, below market-based lending or a waiver of the administration costs. The NT in consultation with the World Bank will determine the benefit and document a clear economic rationale with development outcomes for passing on IDA concessional financing so as not to distort the market. Since the informal market is characterized by exorbitant fees and interest rates that are borne by 47 Researchers compared areas where mobile money agents opened rapidly to areas where spread was gradual; they found in areas of rapid spread, mobile money influenced business creation, enabling 185,000 women to shift from agricultural employment to jobs in business and retail. See Suri, Tavneet, and William Jack. 2016. “The long-run poverty and gender impacts of mobile money.” Science 354 (6317): 1288-1292 48 Accelerating digital inclusion for women in Kenya, Adrine Muhura, GSMA, May 2019. Researchers compared areas where mobile money agents opened rapidly to areas where spread was gradual; they found in areas of rapid spread, mobile money influenced business creation, enabling 185,000 women to shift from agricultural employment to jobs in business and retail. See Suri, Tavneet, and William Jack. 2016. “The long-run poverty and gender impacts of mobile money.” Science 354 (6317): 1288- 1292. 49 For this component, women-owned informal sector businesses are defined as businesses where the primary owner/ operator is a woman (sole proprietorship) and are interchangeably referenced as women borrowers. 50 The implementation period could be less or more than 18 months depending on findings of assessments undertaken alongside regular six-month implementation support missions for the Project. 24 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) MSMEs, this component will act as a demonstration for responsible lending by PFIs and reduce predatory lending practices in Kenya. In addition, this support will leverage co-financing from other DFIs who would be more willing to participate in scaling up initiatives that have overcome first-mover risks and costs under subordination loan terms. Component 2: De-risking lending to MSMEs (US$30 million equivalent) 37. The objective of this component is to unlock lending to MSMEs during the COVID-19 crisis and beyond to support recovery and growth of enterprises. This component would ramp up support to the existing CGS as an emergency COVID-19 response measure and support the establishment and the capitalization of the CGC. Up to US$10 million would be used to increase the capital of the CGS (Annex 1), thereby augmenting the KES3 billion (approximately US$30 million) made available by GoK, which is expected to increase to KES10 billion (approximately US$100 million) over the course of two years. The CGC with a corporate structure will be expected to mobilize a larger amount of capital, including from the private sector, which would not be possible with the CGS being housed as a project within the NT. The CGC will be established to operate according to the Principles for Public Credit Guarantee Schemes (laid out in Annex 1) as a sustainable mechanism of de-risking MSMEs. 38. Consequently, quickly moving the scheme to the CGC (set up as a private company with a risk capital from the public sector) would be critical. The remaining US$20 million will be used to facilitate the setting up and capitalization of the proposed CGC with the right governance structure based on Kenyan national laws and regulations. The disbursement of the US$20 million will be subject to NT meeting two main performance-based conditions (PBCs): 51 a. PBC 1 – Establishment of the CGC: (i) CGC has been duly incorporated and has received the relevant licenses, permits, and approvals required to start operation; (ii) the CGC Board has been duly constituted in accordance with Recipient’s relevant laws and policies and in a manner satisfactory to the Association; and (iii) the Chief Executive Officer, Chief Finance Officer and the Chief Operations Officer of the CGC have been duly hired by the CGC board in accordance with relevance laws and policies governing the CGC and in a manner satisfactory to the Association; and b. PBC 2 – Operational readiness of the CGC: (i) CGC has developed and adopted key operational policies, manuals and systems in form and substance satisfactory to the Association, including a CGC Manual, CGC operational procedures, an Environmental and Social Standards, and the CGC Management has hired key operational staff to include risk, credit, finance, and environmental and social officers, all in a manner satisfactory to the Association (see Table 2). This Project will support the CGC in identifying potential private investors and fundraising activities. The OAG will conduct verification of the achievement of the PBCs prior to disbursement. Section VII and Annex 3 contain detailed description of the PBCs, allocated amounts and verification protocols. 39. The design of the CGC and the operational policies and manuals will follow best practice but will also be informed by market feedback based on the performance of the existing CGS. This will help ensure that the scheme is able to encourage banks to: (a) lend to both existing and new MSMEs as firms transition 51 The PBCs are linked to the PDO indicators: (i) volume of additional private capital mobilized and (ii) the volume of MSME financing to enterprises affected by COVID-19, and to intermediate indicators: (i) CGS company established and (ii) the number of PFIs participating in the credit guarantee scheme. 25 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) out of COVID-19; (b) reach out to non-typical borrowers, such as women-owned businesses; and (c) provide favorable terms (longer tenors and grace periods), especially during the COVID-19 pandemic. In addition, the CGC management will monitor the pricing offered by PFIs to MSMEs to ascertain the application of risk-based pricing of credit and facilitate burden sharing between the CGC and PFIs. The CGC will also track performance of the PFIs designed to reflect the PFIs’ track-record of monitoring and controlling the risks associated with their MSME portfolios. 26 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) Table 2: Performance-based conditions PBC PBC Amount Total Total Amount Performance Amount Allocated Amount of of the Based Allocated US$ the Financing Financing Action to be Completed Equivalent) Allocated Allocated Condition (expressed in EUR) (expressed in (US$ EUR) equivalent) PBC #1 1.1 – CGC has been duly incorporated and has received the 4,000,000 3,436,000 10,000,000 8,590,000 Establishment relevant licenses, permits, and approvals required to start of the CGC operation. 1.2 – The CGC Board has been duly constituted in accordance 3,000,000 2,577,000 with Recipient’s relevant laws and policies and in a manner satisfactory to the Association. 1.3 – The Chief Executive Officer, Chief Finance Office, and the 3,000,000 2,577,000 Chief Operations Officer of the CGC have been duly hired by the CGC Board in accordance with the relevant laws and policies governing the CGC and in a manner satisfactory to the Association. PBC #2 CGC has developed and adopted key operational policies, 10,000,000 8,590,000 10,000,000 8,590,000 Operational manuals and systems in form and substance satisfactory to the readiness Association, including a CGC Manual, CGC operational procedures, and an Environmental and Social Management System and the CGC Management has hired key operational staff to include risk, credit, finance, and environmental and social, all in a manner satisfactory to the Association. Total 20,000,000 17,180,000 20,000,000 17,180,000 27 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) Component 3: Technical Assistance and Project Management (US$15 million equivalent) 40. This component will provide technical assistance to build resilient capacity of the MSME finance ecosystem beyond the lifecycle of SAFER. During the life of the Project, the component will support the NT, CBK, SASRA, and PFIs in the delivery of Components 1 and 2 and ensure overall growth of the MSME lending market. In addition, support will be provided to the NT to build on innovations for a stable, efficient, and globally competitive financial services sector needed to make Kenya a regional financial hub that will contribute to the overall economic growth of the country. The TA will cover both project implementation and monitoring and evaluation and will be bolstered with support from specialists on M&E and MSME subject matters. 41. Subcomponent 3a: TA to the NT to set up the CGC (US$5 million equivalent). Support to the CGC will include support to CBK to develop prudential regulations for the company. Once the CGC has been established, the Project will provide support to build its operational capacity to ensure it effectively delivers its mandate. Support to the company will include: (i) the development of operational policies and procedures (including on risk management, governance, compliance, loan underwriting, environment and social management framework, and climate finance); (ii) design of technical specifications for IT infrastructure and management information system; (iii) development of a detailed manual for the scheme with clear eligibility criteria for PFIs and MSMEs, assessment methodology, and preliminary assessment of PFIs; (iv) design, establishment and cascading to PFIs of an ESMS and a framework for screening climate and disaster risks, tracking and assessing climate mitigation impacts of its financing; (v) design and implementation of a monitoring, evaluation and learning system; and (vi) capacity building and staff training, including on assessing the creditworthiness of PFIs, monitoring, evaluation and learning, E&S risk assessment, investor relations and fundraising activities. 42. Both the existing emergency CGS and the Credit Guarantee Company will be open to all qualifying PFIs based on eligibility criteria (to be outlined in the Project Operations Manual (POM)). In the short run, the focus of both schemes would be to encourage the provision of working capital loans, with the opportunity to encourage innovation on product and market expansion in the long run. The schemes will target MSMEs, whose loans could be conditioned on worker retention and/or job creation (depending on the macroeconomic context at the time of effectiveness). Such conditions could be monitored through the firms’ contributions to the National Social Security Fund or the National Health Insurance Fund as well as through surveys (via phone and in-person). NT in collaboration with the CBK are also drafting a reporting template for the PFIs that will collect data points on the beneficiary MSMEs disaggregated by gender and sectors. The NT together with the World Bank will examine the data of both institutions and their suitability for monitoring. Added emphasis will be placed on targeting lending to women-owned enterprises 52 and addressing some of the barriers to securing women’s access to loans, as well as raising awareness or providing incentives for enterprises to focus on climate change adaptation and/or mitigation. 43. Subcomponent 3b: TA to Participating Financial Institutions (PFIs) (US$2 million equivalent). The support to PFIs will target strengthening of governance arrangements, risks management capacity, business models, and operational efficiency. The majority of Saccos and MFBs, especially the smaller ones, 52For this component, women-owned formal sector businesses are defined as businesses where one of the cofounders or the CEO is a woman. 28 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) face numerous challenges including limited staff capacity with limited funds required to invest in capacity building, weak management and decision-making capacity, liquidity constraints compounded by poor Management Information Systems (MIS), ICT skills, and limited budget available for upgrading. The Project will adopt a cost sharing mechanism with the PFIs, depending on their size, with the larger banks and larger Saccos absorbing a higher percentage of cost for their own Institutional Development Plans (IDPs) than smaller banks and SACCOs. The assessment of governance, risks management and compliance issues identified during the process of accrediting PFIs to participate under Component 1 will inform an IDP agreed on by the PFI with a clear roadmap to improvement – the IDP will form a schedule of participating agreements between PFIs and the Apex institution. Support under this component will track progress of key performance indicators (KPIs) focused on: (i) improving operations, governance, and performance of the PFIs by monitoring KPIs such as the NPL, return on assets, and return on equity); (ii) developing sustainable lending approaches for the target groups (e.g., cash flow-based lending and inclusive credit products (considering gender, age, regions/locations/persons living with disability, etc.); (iii) training of staff on relevant and innovative MSME finance practices; (iv) training staff on ESMS; and (iv) integrating knowledge sharing and trainings on climate change adaptation or mitigation. The POM will elaborate on the KPIs to be used to track the performance of PFIs and benefits to MSMEs. Technical assistance to PFIs will also integrate knowledge sharing or trainings on climate change adaptation and/or mitigation, or information on the impacts of climate risks in financial markets and PFIs will be encouraged to mainstream these practices in their lending practices. 44. Subcomponent 3c: TA to financial sector regulators to strengthen the regulatory environment and enhance and digitize the financial infrastructure (US$6 million equivalent). This subcomponent will support follow-on TA activities related to strategic initiatives started under the Kenya FSSP (P151816) that are tied to underlying structural weaknesses in financial intermediation, liquidity distribution and ALM in the Kenya financial system. These activities will include: (i) additional support for the operationalization of the CBK’s CSD initiative; (ii) the operationalization of the Kenya National Entrepreneurs Saving Trust 53 targeting informal sector micro pensions as stated in the GoK’s FY21/22 Budget Statement; (iii) the implementation of a shared digital services platform for Saccos (i.e., Sacco Central initiative by SASRA); and (iv) support towards the insurance sector. In addition, the NT will undertake analysis to understand the gap in MSME financing and come up with actions to facilitate further MSME product development. 45. In line with the gender-informed design of the Project, subcomponents 3a, 3b and 3c will support gender sensitization through roundtables to expose PFIs to women-owned MSMEs and their unique challenges, including an actionable focus on how to identify and target women-owned MSMEs. Through the support of the Project, PFIs could also develop products and services geared towards women owned MSMEs. The NT currently has a gender committee in place that oversees and reports on gender mainstreaming as per the requirement of the GoK. The NT has already appointed a gender focal person for the Project. 46. Subcomponent 3d: Project management by the NT (US$2 million equivalent). The objective of this subcomponent is to assist in the development and implementation of the different components and 53FSSP supported GoK establish the Kenyan National Entrepreneurs Savings Trust, an innovative low-cost and secure micro- pensions program promoting greater savings by the informal sector that could be relied upon to cushion economic shocks like the COVID-19 pandemic. Follow on TA support for K-NEST scale up is provided under this component. 29 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) conducting of M&E. M&E activities will focus on developing a framework with baseline measurement and annual targets through data collection and survey implementation and evaluating the economic impact of the Project through structured impact evaluation at the conclusion of the Project. This subcomponent will provide resources for: (i) workshops and outreach to facilitate diffusion and replication of lessons and promising innovations from the Project; (ii) M&E analyses to ensure the successful implementation and sustainability of the Project activities; (iii) development of an ESMS for the Project; (iv) the development of an environmental and social operational and training manuals for the Apex institution, PFIs and MSMEs; and (v) project implementation support through key functions forming part of the PIU. This subcomponent will also finance the design and implementation of an overall project communications plan, information disclosure and dissemination tools through the PIU to inform the Project Coordination Committee (PCC) and stakeholders on the progress of the Project and facilitate replicability of success stories. These will support the Project through a demonstration effect and contribute to mobilization of additional private capital and broader capacity. 47. Finally, this subcomponent will support the PIU in the day-to-day management of the Project and in its role as the secretariat to the PCC. The PIU would consist of the NT staff, credit guarantee experts, financial intermediary financing (FIF) specialists, and consultants/experts that would need to be hired to boost PIU capacity. The core PIU staff will include a Project Coordinator, a Procurement Specialist, a Project Accountant, and an M&E consultant. Since the social and environmental risks are deemed to be substantial, the PIU will also recruit a full-time E&S safeguards consultant. The E&S safeguards consultant will: (a) oversee the effective implementation of the safeguards instruments throughout the Project; (b) manage E&S issues arising from project implementation; (c) implement the stakeholder engagement strategy and plan; (d) oversee all community liaison related matters, including the gender-focused activities; (e) undertaking daily assurance monitoring and inspections; (f) oversee the development of the environment and social operational and training manuals; (g) train all the PFIs and MSMEs on the management of environment and social risks and impacts; and (h) track progress of implementation of mitigation measures. Financial management (FM) of the Project will be based on the existing performance monitoring and reporting mechanism, including internal reporting, internal audit system, and external audit, that has been set up by the NT and will be centralized at the office of the Accountant General. 48. To address the specific constraints faced by women-owned businesses, subcomponent 3c will have dedicated resources for outreach to, and monitoring of women entrepreneurs as well as mapping of community partners with deep networks that can support getting women involved from early on. Support will encompass training and advisory services that increase the readiness and likelihood of women owned MSMEs to access finance, including business practices around planning and financial management. It will also seek to facilitate the adoption of digital technologies in business functions (e.g., planning, marketing, payment, and sales) to help them adjust to the ‘new normal’ and increase their growth opportunities in the recovery phase. 54 The creation of networks for women entrepreneurs (countrywide and in sub-groups) will also be supported for exchange of information and communication, including on how to apply for loans. Project activities for capacity building targeting women would include: (i) coaching women on sector choices, which can be crucial to guide women who are crossing over to more 54 Given the restrictions to face-to-face interactions due to COVID-19 more firms globally are turning to digital technologies. However, data from the COVID-19 Business Pulse survey shows that the share of Kenyan formal firms starting to use or increase the use of digital technologies for business purposes (23 percent) is lower than the average for other countries where data is available (around 34 percent). 30 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) male-dominated activities and sectors during the recovery phase; (ii) providing women-owned firms with banking information sessions that can boost their access to financial services; (iii) delivering training, which teaches women entrepreneurs to be proactive and demonstrate perseverance, which can help them recover from the effects of the COVID-19 pandemic; and (iv) contribute to effectiveness of the gender-responsive approach of the Project e.g., by supporting women to ensure that financial resources provided to them are indeed invested in their businesses and not diverted to other household needs. 49. Subcomponent 3d and the Project at large will complement and leverage existing support to MSMEs under the WB-financed Kenya Industry and Entrepreneurship Project (KIEP, P161317), 55 the Kenya Youth Employment and Opportunities project (KYEOP, P151831), 56 and IFC advisory services. While KIEP and KYEOP focus on skilling SMEs and microenterprises, respectively, special attention will be given under SAFER to reach MSMEs not currently supported by these projects and address the specific constraints of women-owned businesses. Efforts will be coordinated among the three projects to direct MSMEs in need of technical assistance to KIEP and KYEOP and MSMEs in need of financing to SAFER. To maximize reach and cost-effectiveness, the Project will leverage existing intermediaries and mechanisms, including the use of digital platforms 57 and private sector providers of business development services. As in the case of PFIs, technical assistance to MSMEs will include training and/or knowledge sharing on climate risks, and adaptation and/or mitigation measures. C. Theory of Change 50. The Project is providing a range of support activities to the financial and private sector in Kenya. It targets direct support of formal and informal MSMEs to address COVID-19 related liquidity pressures. The results chain is driven by the development challenges, including: (a) a steady decline of MSME lending; (b) slow growth in private sector credit; and (c) a knock-on impact on financial institutions’ short-term liquidity, due to the COVID-19 shock (Figure 2). 55 The Kenya Industry and Entrepreneurship Project (P161317) is a US$50 million investment project financing which aims to increase innovation and productivity for select firms in Kenya, including dedicated funding to support capacity building for parastatals under the Ministry of Industrialization, Trade and Enterprise Development; and an SME upgrading program targeting SMEs with annual turnover of US$0.5 million to US$10 million. 56 The Kenya Youth Employment and Opportunities Project (P151831) is a US$150 million investment project financing which aims to increase employment and earnings opportunities for targeted youths, and includes a component focused on job creation, comprising of support for the self-employed, mostly informal micro enterprises and catalytic interventions for job creation through a business plan competition targeting formal, youth led MSMEs. 57 In July 2020, about 6,300 KYEOP youth have been invited to participate in digital BDS with high take up rates so far, at an average of 74 percent, as well as relatively high completion rates, at 34 percent of those invited completing the training. 31 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) Figure 2: Theory of Change 32 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) D. Project Beneficiaries 51. The primary project beneficiaries are MSMEs 58 in the formal and informal sector. The number of MSMEs to benefit from the lines of credit and credit guarantees will depend on firm size with the potential to support an upper bound of 500,000 micro enterprises and 20,000 MSMEs, and an average of 261,667 micro enterprises and 11,789 MSMEs. Other beneficiaries will be GoK institutions that will be key to delivering targeted financial support to MSMEs through institutional strengthening and capacity building to facilitate the provision of financial and non-financial services to MSMEs and by improving the necessary financial sector infrastructure. These include the NT, MoITED, CBK and SASRA, and the CGS. Banks, Saccos and MFBs participating in the provision of liquidity and de-risking support will also directly benefit from capacity strengthening under the Project. 52. The Project will also contribute to a more robust and inclusive financial ecosystem that will benefit the entire Kenyan population including the economic resilience of women owned MSMEs in informal sector market segments. This will be accomplished by helping the GoK to develop clear policies and specific strategies, plans, and roadmaps to launch the CGC, as well as to effectively respond to the demands of the domestic economy for robust liquidity and de-risking instruments, enabled by an efficient digital infrastructure and an enabling institutional, legal, and regulatory framework. E. Gender 53. Women-owned businesses are a vibrant part of Kenya’s MSME landscape but face more challenges compared to male-owned enterprises. While activities under all three Project components will benefit women, a gender-focus of the Project is designed to address two main gaps. The first gap is the greater difficulty that women face in accessing finance compared to men because: (a) men are more likely than women to have a bank account (48.2 percent of men used bank services compared to 33.7 percent of women in 2019); and (b) men are more likely to borrow and save through formal channels compared to women (22.5 percent of men used informal saving groups in 2019 compared to 37.4 percent of women). In addition, more women than men (61 percent versus 49 percent respectively) are involved in informal sector enterprises that have more difficulty in accessing finance and less women compared to men (10.3 percent versus 86.5 percent respectively) own property, hence unable to access finance due to overcollateralization of loans by financial institutions. The second gap is the lower level of financial literacy among women-owned enterprises –males have a higher average financial literacy score at 5.52 than females at 4.985 in Kenya). 54. In implementing digital lending solutions under Component 1, the Project will work with PFIs to use digital data (including alternative data such as airtime usage and M-Pesa transactions) to identify viable women-owned enterprises and support credit risk assessment hence minimize the need for collateral. FSD Kenya notes that the gender gap between men and women on mobile money usage is smaller (at 6.2 percent in 2019, a decrease from 8 percent in 2016) compared to the gap in bank account usage (14.5 percent in 2019 compared to 16.2 percent in 2016). This showcases the importance of leveraging digital channels to better target women and increase their financial inclusion. This information 58In Kenya, MSMEs have various definitions in different contexts. For the purposes of this Project, they are defined as enterprises that have 1-99 employees. Micro enterprises have fewer than 10 employees; small enterprises have 10-49 employees while medium sized enterprises have 50-99 employees. 33 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) will also be useful in helping PFIs to identify the specific financing needs of women-owned enterprises and design financial products suitable for them. The design of the CGC under Component 2 (De-risking lending to MSMEs) will ensure that the scheme is able to encourage banks to target women-owned businesses and provide favorable terms (longer tenors and grace periods) to women-led firms, especially in the face of the COVID-19 pandemic. Under Component 3, the Project will provide specific training to women- owned MSMEs to address their financial literacy levels by building in robust gender sensitization programs through roundtables to expose PFIs to women-owned MSMEs and their unique challenges, including an actionable communication strategy on how to identify and target women-owned MSMEs. During the preparation of this Project, it was noted that financial institutions do not have specific strategies to target women and do not track gender disaggregated data. Hence obtaining the baseline for the gender-focused indicators was difficult. Through the specific interventions mentioned above and tracking of specific gender indicators in Table 3, the Project will begin to mainstream within PFIs practices a focus on women- owned enterprises, which will also help provide a baseline for future projects. 34 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) Table 3: Gender-based Result Indicators Challenges Activities Indicator Name Definition Target Less women than men Targeted use of digital Number of informal business borrowers This indicator is designed to include all informal 109,382 have access to financing channels to provide financed by MFB/ SACCOs and digital women-owned MSMEs that receive financing from traditional financial financial products and platforms under the Project (cumulative, under the Project's Component 1. institutions. services to women. new, disaggregated by gender, location/ region, sectors) – of which, women borrowers. More women than men Use of alternative Gender sensitization programs to expose Gender sensitization programs to expose 40% are involved in informal data to better identify financial institutions to the needs of financial institutions to the needs of women-led enterprises that have and target viable women-led enterprises in addition to enterprises in addition to improved awareness more difficulty in women enterprises improved awareness strategies targeting strategies targeting women-led enterprises. accessing financing. that lack collateral and women-led enterprises. Less women compared are affected by Gender sensitization programs to expose Gender sensitization programs to expose 37,760 to men have property COVID-19 and in need financial institutions to the needs of financial institutions to the needs of women-led rights and therefore of financing. women-led enterprises in addition to enterprises in addition to improved awareness often lack collateral that improved awareness strategies targeting strategies targeting women-led enterprises. is required to access women-led enterprises. financing from formal financial institutions. Lower level of financial Gender sensitization Percentage of beneficiary firms reporting A mid-term beneficiary feedback survey will 70% literacy among women- sessions to expose project financing reflected their needs - measure the satisfaction of women-owned owned enterprises. financial institutions of which, women-owned. project beneficiaries. to the needs of Number of women-owned MSMEs that This indicator captures the number of eligible 88,285 women-owned participate in targeted sessions. women-owned MSMEs that participated in MSMEs in addition to targeted sessions as part of the Project. awareness sessions Percentage of women-owned MSMEs This indicator captures the satisfaction of eligible 70% targeting women- reporting satisfied or very satisfied by women-owned MSMEs that participated in owned MSMEs. targeted sessions. targeted sessions as part of the Project. 35 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) F. Rationale for Bank Involvement and Role of Partners 55. This Project comes at an unprecedented time for the country and its small businesses, which are being hit hard by the COVID-19 pandemic. The WBG brings important global experience and knowledge in financial and private sector development to Kenya and more specifically in MSME access to finance for productive purposes, having supported many similar initiatives in the region and around the world. The Kenya program is being adjusted in line with the selected WBG crisis response areas focused on saving lives, protecting the poor and the vulnerable, sustainable business growth and job creation, and strengthening policies and institutions. In the relief stage, a new COVID-19 Health Emergency Response Project (P156777) with the objective to help strengthen the health response and save lives has already been provided. To support key policy and institutional reforms, including on private sector credit, transparency in debt management and procurement, and targeting of agricultural subsidies, and address emerging fiscal financial gaps, the Bank increased program budget support to US$1 billion in June 2020, which along with IMF Rapid Credit Facility (US$739 million) and African Development Bank support (€188 million) helped to close the fiscal gap in the FY2019-20 fiscal year. The SAFER Project will build on these initiatives by providing support to MSMEs during the relief phase to aid accelerated recovery and strengthening of economic resilience of small businesses in underserved markets thereby protecting livelihoods. 56. The Project also complements ongoing WBG activities in Kenya. The Project draws numerous synergies with the second Kenya Inclusive Growth and Fiscal Management Development Policy Operation (DPO) (P172321) that provides the GoK with additional fiscal space to support the economic downturn induced by the global pandemic and help fill the financing gap. The Kenya FSSP (P151816) and the Kenya Industry and Entrepreneurship Project (P161317) have laid the foundation for a lot of the work proposed under the SAFER project, around support to strengthen the legal, regulatory, and institutional environment for efficient financial intermediation as well as assistance to MSMEs through business training and supplier development programs, respectively. In addition, the Project interventions seek to alleviate structural constraints that have been identified through numerous consultations with the GoK, financial sector, business organizations, and other players in the MSME eco-system during the implementation of the Enhancing Access to Finance for MSMEs (P171828) analytical study. Findings from the study laid a foundation for the new project by providing insights on how to address structural issues facing MSMEs in Kenya and support a resilient recovery during the post-crisis period. 57. The Project is also part of a package of coordinated financial assistance from development partners, including the Kreditanstalt für Wiederaufbau (KfW) and IFC. KfW is also processing a package of assistance (about EUR 18 million) to provide complementary resources to support all three components of the SAFER Project. IFC has also indicated interest to collaborate in this Project to potentially provide resources that could be blended with the line of credit under Component 1 and providing de-risking capital under Component 2, hence avail a bigger resource pool for the proposed interventions. For IFC and other similar institutions to participate in the de-risking intervention, it would be critical that a private sector- led model is adopted by the CGC. The World Bank will also collaborate with IFC during implementation of the Project to ensure there is complementarity of activities, including coordinating technical assistance activities and the selection of PFIs that could most benefit from this Project. 36 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) 58. GoK is running several initiatives to support access to finance for women-owned businesses. These include the Women Enterprise Fund (WEF), Uwezo 59 Fund and the National Government Affirmative Action Fund. The Government has also initiated the Access to Government Procurement Opportunities requiring that 30 percent of all government procurement opportunities are set aside specifically for enterprises owned by youth, women, and persons with disability. However, uptake of AGPO remains low. The effectiveness of the affirmative action funds requires further evaluation, but there are anecdotal reports of limitations related to a lack of coordination on the ground, limited support towards a graduation from subsistence to large-scale activities, and gaps in training and communication (i.e., training not targeting women’s specific needs and constraints). 59. In response to COVID-19, several development partners in Kenya have initiated programs in support of MSMEs with a focus on women-owned MSMEs. Examples include a collaboration between the United Nations Women, the Kenya Women’s Finance Trust, and Echo Network Africa to set up a scheme of micro and small enterprises owned by women to access low interest loans to support them to: (i) rebuild their stock; (ii) pivot to cope with the effects of the pandemic on their businesses; and (iii) cover their overheads. The Mastercard Foundation with the Kenya Private Sector Alliance, Women Work Network, Kenya National Chamber of Commerce & Industry, TechnoServe, Grassroots Business Fund, and 4G Capital are supporting a series of interventions to facilitate business continuity especially for those MSMEs led and owned by young women with less than 10 employees and a turnover below KES 500,000. G. Lessons Learned and Reflected in the Project Design 60. The proposed project has benefitted from WB global experience and knowledge and special considerations reflecting the country and sector context: a) The Project design reflects the need to implement short-term interventions to address immediate liquidity challenges confronting hard-hit MSMEs (i.e., “to keep the lights on”), reduce layoffs, and avoid firm closures and bankruptcies by ensuring liquidity and support adjustments for viable firms. In this way, the Project follows World Bank COVID-19 global guidance aimed at informing mitigation of the negative impacts on healthy firms and support firm resilience. The Project is designed to enable the availability of credit lines to hard-hit MSMEs channeled through FIs (Banks and Saccos and MFBs) in a manner that blends public and private capital, microfinance and digital solutions and strengthen the credit guarantee program. b) The CGS is supported because de-risking instruments are known to play an important countercyclical role, providing support to small businesses during a downward economic cycle. An assessment of Credit Guarantee Facilities27 noted the important role that these can play in countries with weak institutional environments. In addition to increasing the risk-appetite of banks and providing a substitute for collateral that SMEs may well not be able to provide, CGSs can play an important role in encouraging the improvement of information available on borrowers in coordination with credit registries and credit bureaus, and in building the credit origination and risk management capacity of participating lenders, for example through technical assistance to strengthen 59The Uwezo is a Swahili word for ‘Enabler’ Uwezo Fund is a flagship program by the GoK aimed at enabling women, youth, and persons with disability access finance to promote businesses and enterprises. 37 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) the capacity of lenders’ SME units. The WBG contributes to global expertise about CGSs, pioneering the use of the Key Principles for Public Credit Guarantee Schemes in Kenya, a set of good practices that represent a global reference for the design, execution, and evaluation of public CGSs. Along with this, the experience and lessons learned have been used to inform the intervention in Kenya in providing both technical assistances to support designing and implementing credit guarantee schemes, as well as financing towards CGS. Country examples include Madagascar Financial Services Project (P109607) and Morocco Leveraging Finance for Inclusive Growth (P153099). In addition, the Project incorporates good practices identified in the 2006 Independent Evaluation Group's (IEG) evaluation of World Bank Lending for Lines of Credit and 2009 IEG’s evaluation of WBG Support for SMEs. Overall, lessons learned point to: (i) simple and flexible design, allowing for operational adjustments, and avoiding sectoral or regional targets; (ii) inclusion of technical assistance components to strengthen the institutional capacity of the borrower; (iii) intensive monitoring of key indicators that measure the quality of the loan portfolio; (iv) use of quantified eligibility criteria for selecting PFIs; (v) availability and use of sound analysis and data on the financial performance of PFIs, and external audit for verification; and (vi) importance of leveraging lines of credit with other World Bank operations, such as Development Policy Finance. 61. The Project is also drawing heavily on lessons learned from implementing World Bank projects in the financial sector as well as the country sector context on the opportunities and challenges presented by fintech in Kenya. SAFER is designed to deliver sustainable outcomes and lessons learned from the Kenya Affordable Housing Finance Project (P165034). The setting up the Kenya Mortgage Refinancing Company as a public-private company enabling provision of long-term funding to financial institutions on a sustainable basis have informed interventions seeking to set up a CGC and support SASRA to establish the shared digital services platform with a centralized liquidity for Saccos. Lessons from the Kenya FSSP (P151816) shows that TA packages under the SAFER will need to be scrutinized for economy (competitiveness, effectiveness, and efficiency) to mitigate the risk of a slow start due to handling of numerous and small uneconomical procurement packages by the PIU or beneficiary institutions. This avoids a long inception phase of the Project as fewer, larger, and comprehensive packages are handled. In turn, this would fast track the completion of the ‘procurement’ phase of the Project and turns attention to contract management and performance in delivering outcomes. The use of digital channels will require digital platform providers/MNOs to collaborate with regulated FIs and ensure partnerships are sanctioned by supervisory authorities. In the recent past, digital lending activities in Kenya have been tagged with numerous consumer protection issues and irresponsible conduct that have involved non-disclosure of effective interest rates, fees, and unfair collection methods. Oversight by supervisory authorities of regulated FIs enables the pass through of consumer protection responsibilities on digital channels. The CBK is currently working on revising the CBK Act to include the regulation of digital lending further down the line. 62. Other special considerations with regards to project design relate to adaptive programming. SAFER will be a flexible and adaptive project incorporating strong evidence and technical feasibility feedback loops, adapting to new opportunities and risks as they emerge as well as continually responding to changes in the operating environment and economic risks presented by the COVID-19 pandemic. In terms of supporting women owned MSMEs, the Project intends to leverage lessons from innovative operations such as the Ethiopia Women Entrepreneurship Development Project (P174874) and analytical work such as ‘Profiting from Parity: Unlocking the Potential of Women's Businesses in Africa’ (Report No. 135420). A robust M&E function will underpin project elements related to learning or informing a phased and iterative implementation approach with regards to investment activities. 38 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) III. IMPLEMENTATION ARRANGEMENTS A. Institutional and Implementation Arrangements 63. To leverage implementation capacity within the government, the existing FSSP PIU at NT will also act as the Project PIU. The existing PIU has been successfully implementing the last two active financial sector projects in Kenya as a single PIU in accordance with the World Bank policies and procedures. To remain cost-efficient, avoid duplicating roles in different agencies, and use existing capacity, the PIU will implement the Project as it relates to procurement, FM, E&S safeguards, and M&E. The PIU will hire an E&S specialist for day-to-day management of E&S safeguards matters and enlist the support of an M&E firm as needed to support annual M&E reviews. In addition, the NT/CGC and the Apex institution identified under the Project will implement the credit guarantee scheme and the lines of credit respectively. For the implementation of the lines of credit, the NT will enter into a Subsidiary Financing Agreement with the eligible Apex institution to on-lend to PFIs who will on-lend to the eligible MSMEs. For the provision of partial credit guarantees, the NT will enter into Participation Agreements with the relevant eligible PFIs. The NT PIU will prepare and implement the POM. 64. The Project will be supervised by a PCC chaired by the NT’s Principal Secretary and the PIU will act as the secretariat to the PCC. The core members of the Committee will include the CBK, the NT, MoITED, SASRA, other ministries, departments and agencies, and other relevant institutions, and will work closely with the existing CGS Steering Committee. The PCC shall be responsible for, inter alia: (a) providing strategic and policy guidance for project implementation; and (b) resolving any project coordination and implementation bottlenecks that may arise. The PCC will host quarterly meetings to review the Project progress and results, discuss key issues, and agree on key milestones over the next 6 months. The meeting will review technical reports based on reviews conducted by the World Bank. The reports of the PCC meetings will be used in technical discussions during World Bank project implementation support missions. Figure 3 provides an organogram of the Project implementation structure. 39 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) Figure 3: Institutional Arrangements 40 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) B. Citizen Engagement 65. Outreach and Inclusion. Citizen engagement (CE) is embedded in the Project design through several proactive mechanisms and will continue throughout the lifecycle of the Project to ensure that beneficiaries can gain access and provide feedback to the design and rollout of the Project. Various citizen and stakeholder engagement tools will be used for outreach. To mitigate potential risks and address received grievances, a Grievance Redress Mechanism (GRM) will help address feedback, inquiries, complaints and/or concerns. For Component 1, outreach will be conducted through a public awareness campaign launched on social and broadcast media to inform beneficiaries about the MSME financing opportunities. This will be complemented by outreach at the MSME authority level, to ensure that those without access to internet are also informed of the opportunity to apply. For activities under Component 2, broad stakeholder consultations will be undertaken as part of the development of the CGS and CGC. The Stakeholder Engagement Plan (SEP) that has already been developed by NT includes the specific measures to be used for awareness and consultations. CE mechanisms will build on existing practices for outreach and engagement developed by NT, such as through information desks and officers within regional public service halls, staff of non-governmental organizations, web platforms, and social media. The Project design will place additional emphasis on transparency mechanisms in the use of funds and the inclusiveness of project beneficiaries. 66. Beneficiary feedback. During project implementation, SAFER will employ several CE mechanisms, including: (i) regular credit dialogues for participatory planning, for which small groups (if permitted) and virtual consultations will be organized and (potential) beneficiary firms invited at least twice a year to provide opportunities for beneficiaries to voice their needs and priorities regarding the loan program and enable feedback on its functionality (ease of access, transparency, quality). The dialogue will help better understand the firms' needs and obstacles regarding financing and will inform the planning and implementation of the project. Moreover, potential beneficiaries will be able to receive information on the loan program and if necessary, join working groups to improve the program. A mid-term beneficiary feedback survey will be followed by (face to face/ virtual) focus group discussions with beneficiary firms to obtain feedback on the effectiveness of the loan program and to discuss the survey results to inform implementation and a GRM will be established to address inquiries or concerns, mitigate potential risks and address received grievances. The Project will enable different channels for grievances such as email, direct, telephone, and social networks to ensure easy access to the service. The two beneficiary feedback indicators used for the project are: (i) a CE indicator at mid-term review to capture the percentage of beneficiaries (with gender disaggregation) reporting project financing reflected their needs (including ease of access, quality, process, disclosure, responsiveness of needs, etc.) and (ii) a report analyzing and assessing the results of the CE survey, which will contain actionable recommendations for project adjustments informed by citizen feedback. The result of these indicators will help the Project effectively close any feedback loops with beneficiaries with the aim of serving them better. Quarterly reporting will include information about the number of grievances received and resolved and will flag major concerns raised. The POM will detail the design and implementation processes/ procedures of all CE mechanisms, including the staffing and budget to implement them. 41 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) C. Results Monitoring and Evaluation Arrangements 67. The Project will build on significant advances already made by the GoK in supporting women entrepreneurs. Certain products will be developed that will cater to women entrepreneurs, such as those using digital platforms. The Project will rigorously measure any differential impacts on male and female owned MSMEs. Gender disaggregated data (in addition to the RF indicators) will be collected for all firm- level indicators, namely the number of MSMEs receiving loans and the number of MSMEs receiving technical assistance. In addition to monitoring the number and proportion of male-owned and female- owned MSMEs accessing services, a potential impact evaluation will focus on understanding any differences in business growth for male and female-owned enterprises that participate in the Project. 68. An M&E strategy will be developed within 90 days after project effectiveness and implemented throughout the Project to measure the results of interventions under the Project. This strategy will ensure that key information is regularly collected and tracked so that implementing agencies can measure the progress towards the Project objectives. The Project will also fund an independent monitoring agent (to be hired within 6 months after project effectiveness) to provide an added layer of physically monitoring the flow and use of project funds, including for Component 1 and 2. The Project will also include a set of additional indicators to monitor its advancement. The progress of these indicators will be measured periodically and reported as part of the semiannual progress reports. A midterm review will be conducted mid-way through the Project, and an Implementation Completion and Results Report will be prepared within six months of project completion. 69. The M&E strategy will be supported by a communication plan that will be implemented during the life of the Project. As part of the communication strategy, NT will be in continuous communication with MSMEs and PFIs during the implementation phase which will facilitate the monitoring and evaluation activities, promote the dialogue with key stakeholders, and increase the level of engagement. NT will be responsible for defining and implementing a broad communication strategy in two phases. In the first phase, the communication plan will be used to make information available to MSMEs and PFIs about the improved or newly developed financial products that will be available for their access. Communication material will be prepared and will be used to provide information about the characteristics of the products, how to apply, who is eligible to apply, what kind of activities can be financed, etc. In addition, under Component 3, education material on climate co-benefits, climate change mitigation and adaptation aspects, and the application of best practices on environmental and social risks management will be part of the strategy. In the second phase, site visits will be carried out to assess beneficiaries’ satisfaction with the financial products offered under the Project and evaluate and document the progress achieved by MSMEs after receiving access to finance. Finally, the strategy will be used to showcase how MSMEs got access to financial products and to disseminate the results achieved by those borrowers. D. Sustainability 70. The sustainability of this proposed project is enforced through its design, which mandates: (a) the provision of lines of credit to financial institutions and support innovation to build capabilities and deliver demonstration effect in the financing of MSMEs; (b) the creation of a sustainable and dedicated credit guarantee platform to encourage PFIs to deepen outreach to MSMEs and maximize the provision of private financing for development; and (c) the provision of technical assistance to PFIs to improve market 42 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) standards and to MSMEs to increase their capacity to access finance. The program design prioritizes the participation of the private sector and includes the integration of different financing mechanisms. The co- financing measures envisaged will allow the private sector to have ‘skin-in-the-game’ and thus be incentivized to ensure their selection of MSMEs and performance of their portfolios are sound. The training, networking, and business advisory services that MSMEs will receive will better prepare them for success constituting an important risk mitigation against potential default/failure which would in turn contribute to the sustainability of the lenders. All these factors will facilitate the strengthening of MSMEs’ ability to access finance and sustain the growth of their businesses beyond the life of the Project and thus contribute to the economy. IV. PROJECT APPRAISAL SUMMARY A. Technical, Economic and Financial Analysis (if applicable) 71. The Project will provide emergency relief and recovery support to the private sector. The Project is expected to have a significant impact on Kenya’s economy by supporting financial sector deepening, improving MSMEs’ access to finance, and supporting livelihoods. Gains are expected through contributions to economic development and poverty reduction, as demonstrated by several studies. Empirical evidence shows that financial sector development directly reduces poverty in developing countries. Jaluluan and Kirkpatick (2001) 60 find that a 1 percent change in financial development raises the income of the poor by almost 0.4 percent. Honohan (2004) 61 finds that head count poverty falls as the ratio of private sector credit to GDP increases. 72. The Project support will be systemic and provide significant benefits for the local private sector. Ultimately this will have a positive impact on worker retention and expanded output of MSMEs. Key benefits to the private sector include: (a) cheaper source of funding at a much longer maturity than currently available in the market 62; (b) increased supply of financing to informal sector MSMEs; 63 and (c) improved lending/financing terms through innovative products better tailored to MSME needs. While experience from other countries indicates that lines of credit will have an impact on MSMEs’ employment and output, there is very little evidence on the impact on micro enterprises that this Project is targeting. An evaluation of credit lines in Turkey indicated that credit lines helped firms undertake long-term investments, enabling them to expand output and employment. 64 For the CGS, the analysis shows that the financing can provide risk sharing for a sizeable share of MSME loans up to a reasonable threshold that is five times the median firm loan size for micro firms, lower than the median firm loan size of small and medium firms before the crisis. 60 Jalilian, Hossein, and Colin Kirkpatrick. 2001. “Financial Development and Poverty Reduction in Developing Countries.” Working Paper 30, IDPM, Manchester University. 61 Honohan, Patrick. 2004. Financial Development, Growth and Poverty: How Close are the Links. 62 Microenterprise loans in Kenya tend to be 30-day loans and loans to MSMEs from commercial banks tend to be working capital and short-term in nature. 63 While commercial banks in Kenya are generally liquid, supply of funds available to MSMEs has been limited, following the interest rate cap regime; banks invest a large portion of their assets in government securities, which are risk-averse asset classes 64 The study was based on a survey of 400 export finance intermediation loans (EFILs) and SME beneficiary firms and 200 control firms from credit lines during 1999–2010. 43 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) 73. The support from the lines of credit will depend on firm size with the potential to support an upper bound of 500,000 micro enterprises and 20,000 MSMEs, and an average of 261,667 micro enterprises and 11,789 MSMEs (detailed in Annex 4). The financing for the CGS will be sufficient to guarantee the majority of MSME loans up to a reasonable threshold that is equal to the loan size before the crisis. There are around US$120 million of total MSME loans to be guaranteed during the crisis across Component 2. With a guarantee coverage of 25 percent and a leverage of 4 (1 dollar of financing providing 4 dollars of guarantee), this will require US$30 million of financing, which will be covered by the Project funding for the CGS. 74. Given that the lines of credits ultimate beneficiaries are to be identified by PFIs and this is the first MSME credit line project in Kenya, at this stage it is difficult to precisely capture potential gains from MSME investments through traditional economic/financial analysis. Multiple scenarios are possible, which will depend on the number of PFIs under the Project, their specialization, sizes of loans/finance to be granted, and so on. The Project will track benefits through an impact evaluation process with the beneficiary wholesale and retail PFIs. B. Fiduciary (i) Financial Management 75. An FM assessment was carried out in accordance with the World Bank Directive: Financial Management Manual for World Bank Investment Project Financing Operations issued February 4, 2015; and the World Bank Guidance: Financial Management in World Bank Investment Project Financing Operations Issued and Effective February 24, 2015. 76. The FM assessment revealed that NT has adequate capacity and experience to effectively implement the proposed project. Capacity strengthening will be done of the PIU at NT that will manage the Project to enhance technical and fiduciary capacity. This will include NT designating a qualified project accountant to handle the FM activities. The PCC will provide monitoring and oversight of the Project based on TOR agreed with the World Bank and the NT and submit biannual reports of their assessment of the performance of the Project, submitted to the World Bank within 45 days after the calendar semester to which these relate. In addition, the Subsidiary Financing Agreement between the NT and the Apex institution, which will manage both Window 1 and Window 2, will require the Apex institution to provide monthly status reports, on the basis of the TOR agreed by the NT and the World Bank. Copies of these reports will be shared with the World Bank as part of the quarterly interim financial reports (IFRs). 77. The Project design is complex with multiple activities and subcomponents. This could result in disbursement delays in funds reaching the beneficiary MSMEs, as well as accountability challenges in ensuring that funds have been disbursed to the right beneficiaries or otherwise used for the intended purposes. Therefore, it is necessary to have proper coordination of fiduciary arrangements to facilitate efficient implementation of project activities. The NT has already developed an FM procedures manual defining the fiduciary arrangements during project implementation to ensure quick disbursement of funds and proper accountability. 44 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) 78. Robust fiduciary interventions have been put in place to respond to the identified risks. These include: (i) development and implementation of FM procedures manual as well as the CGS manual; (ii) designation of two project accountants – one for NT PIU and the other for the CGC; (iii) preparation and submission of quarterly IFRs by PIU which will incorporate status monthly reports by the Apex institutions and participating FIs; (iv) biannual assessment of the technical performance and fiduciary compliance of the Project by CBK; (v) annual risk-based fiduciary internal audit review by the NT ministry internal audit unit; (vi) annual external audit by the Kenya supreme audit institution OAG; and (vii) regular WB FM review. (ii) Procurement 79. Procurement under Component 3 of the Project that aims at providing technical assistance to the National Treasury, PFIs, and financial sector regulators will be carried out in accordance with “The World Bank Procurement Regulations for IPF Borrowers, dated July 2016 and revised in November 2017; August 2018; and November 2020”, hereafter referred to as ‘Procurement Regulations’. Procurement Regulations will not apply to procurement under Component 1 which is aimed at providing liquidity support to MSMEs in the informal sectors through loans made by eligible FIs and community based financial institutions. The Project will however be subject to the World Bank’s Anti-Corruption Guidelines, dated October 15, 2006 and January 2011 and July 1, 2016. The Government will prepare a Project Procurement Strategy for Development (PPSD) using the short form and the first 18 months Procurement Plan (PP) for Component 3. The PP has already been drafted and was discussed during Project Negotiations. The PPSD is a methodology that is used to determine the optimum procurement approach to deliver the right procurement result. . C. Legal Operational Policies . Triggered? Projects on International Waterways OP 7.50 No Projects in Disputed Areas OP 7.60 No . D. Environmental and Social 80. Project activities are not expected to have large-scale, significant, and/or irreversible environmental and social impacts. The Project environmental and social risks are assessed as substantial. The specific sub-projects are expected to be of moderate risks. However, the capacity of the NT has been assessed to be inadequate due to lack of an existing ESMS, qualified environmental and social risk management staff, and prior experience of implementing similar FI projects. The locations and details of the sub-project MSMEs, the Apex institution and the PFIs are currently not known, however, it is expected that the Project will provide support to MSMEs country wide. Sub-projects that are screened to be of substantial and/or high environmental and social risks, those requiring land acquisition and involuntary resettlement, and those with impacts on sensitive areas (for example, nationally and internationally protected areas) and cultural heritage will not be eligible for project financing. An Exclusion List for sub- projects that will be precluded from financing as part of Component 1 and 2 has been prepared. The 45 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) financing is expected to have minimal environmental and social impacts – major civil works are not expected, and any minor civil works will be within the existing MSMEs facilities. The main environmental and social risks are associated with labor and working conditions, occupational health, and safety, dust and noise emissions, energy use, waste generation, exclusion of disadvantaged groups (women, youth, persons living with disability, ethnic marginalized and minority groups), poor working conditions and child labor at the sub-project level. These overall risks and impacts are expected to be site specific, temporary, and easily managed with standard mitigation measures and compliance with national laws. 81. Environmental and Social Management System: The NT will develop the Project umbrella ESMS that will be adopted by all the Project PFIs. The development of NT’s ESMS will be a disbursement condition for Component 1. The NT’s ESMS will be cascaded to the respective Apex institution, PFIs, and the MSMEs. The ESMS will be commensurate with the E&S risks profile of the portfolio to be financed by the World Bank. The NT will be required to: (i) appoint a qualified and experienced E&S risk management officer; (ii) develop and implement an ESMS before disbursements to ensure that its lending activities comply with the identified applicable ESF and ESS9 requirements; (iii) ensure that suitable resources are provided for the implementation of the ESMS and that members of staff responsible for the implementation of the ESMS are adequately trained; (iv) comply with the requirements of ESS9 and ESS2 on labor and working conditions; and (v) provide monitoring reports on its environmental and social performance to the World Bank. 82. Component 2 of the Project will be implemented by the CGC, a company that will be established by the NT. The CGC will be required to develop an ESMS and appoint qualified and experienced environmental and social risk management officer as part of disbursement conditions for Component 2. 83. Environmental and Social Risks Management documents: The NT together with the World Bank held engagement and consultations sessions from February 10-24, 2021 with various stakeholders that included commercial banks, the Public-Private Partnership unit within the NT, Saccos, MNOs, the IFC, and other relevant government entities. These consultations were documented in the Aide Memoire. Further, the World Bank prepared the Appraisal Environmental and Social Review Summary which was disclosed on the external website on March 8, 2021. The Borrower has prepared the SEP, which includes the provisions of ESS10. The SEP was publicly disclosed on the website of the NT March 28, 2020 and on the Bank’s external website on March 8, 2020. Subcomponent 3c will finance the design and implementation of an overall Project communications strategy, information disclosure and dissemination tools to inform stakeholders on the progress of the Project. All PFIs will disclose information on the Project and on the E&S risks and impacts. The NT, the Apex institution, PFIs and MSMEs will respond to public enquiries and concerns in a timely manner, and workers GRM will be put in place. The Project GRM has been defined under the SEP and will be set up and managed by the NT. All the PFIs will put in place a GRM to receive and manage grievances. The NT has also prepared the Environmental and Social Commitment Plan, which was disclosed externally by the Bank on March 8, 2020 and in country by the NT on November 22, 2021. The borrower will also prepare an ESMS for both Component 1 and 2, Labor Management Procedures, Gender Based Violence action plan, and the Social Assessment as conditions of fund disbursement for respective project components, these requirements have been documented on the Environmental and Social Commitment Plan. The Project will carry out a Social Assessment to identify barriers to entry for MSMEs, particularly those related to discrimination, bias, literacy, numeracy, and access to credit disbursed to disadvantaged groups by MNOs. This will enable the Project to determine if there are 46 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) technically feasible measures that can be implemented to facilitate access by disadvantaged groups and eliminate discrimination. During implementation the participating MSMEs will be required (as applicable) to prepare simplified Environmental and Social Management Plans or Summary Project Reports as per the national law and consistent with the ESSs. 84. Climate and disaster risk screening was conducted for the project and the overall risk to the outcome of the project is considered to be Moderate. The project will support MSMEs with finance focused on resilient recovery from the impact of COVID-19. Precipitation is projected to increase in frequency and intensity in future decades, which means finance-related infrastructure may be subject to flooding with implications for information and communications systems in terms of potential losses in critical data and disruptions to client services. The potential risks of service disruption due to flooding is greatly reduced by the design of these systems, which takes flood risk into account. However, lack of emergency response systems to bring back connectivity and critical supplies for operations in case of extreme weather events, moderately increases such risk. In Kenya finance sector, there is institutional capacity to identify and respond to disruptions from climate and geophysical hazards. However, there is lack of resources to respond to climate and geophysical hazards. The Project includes capacity building and training to strengthen budgeting processes to account for additional maintenance costs to address increasing damages from hazards and increase flexibility in management protocols to allow for adaptation to changing hazards. Combined, these features will reduce the anticipated risk from climate and geophysical hazards. V. GRIEVANCE REDRESS SERVICES Communities and individuals who believe that they are adversely affected by a project supported by the WB may submit complaints to existing project-level grievance redress mechanisms or the World Bank Grievance Redress Service (GRS). The GRS ensures that complaints received are promptly reviewed to address project-related concerns. Project affected communities and individuals may submit their complaint to the WB independent Inspection Panel which determines whether harm occurred, or could occur, because of WB non-compliance with its policies and procedures. Complaints may be submitted at any time after concerns have been brought directly to the attention the World Bank, and Bank Management has been given an opportunity to respond. For information on how to submit complaints to the WB’s corporate Grievance Redress Service (GRS), please visit http://www.worldbank.org/en/projects-operations/products- and-services/grievance-redress-service. For information on how to submit complaints to the World Bank Inspection Panel, please visit www.inspectionpanel.org. VI. KEY RISKS . 85. The overall project risk is Substantial but considered manageable with the provision of technical assistance. The major risk to the Project’s ability to achieve its development objectives include political and governance risks as well as macroeconomic risks, which are considered high. In addition, other risks such as institutional capacity for implementation and sustainability risks, and fiduciary risks are judged to be substantial. 47 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) 86. Political and governance risks are assessed as Substantial. With general elections scheduled for 2022, pre-election politics have begun in 2021 and are likely to intensify throughout the year and into 2022. While this is not expected to directly impact the implementation of the Project, the pre-election environment is bound to impact on the implementation of COVID-related support to MSMEs. This risk is mitigated by leveraging market instruments such as the use of financial intermediary financing which will be less prone to political disruptions. In addition, having technical staff appointed at the NT will ensure continuity in project implementation. 87. Macroeconomic risks are assessed as High. Kenya’s economy was hit hard at the onset of the COVID-19 crisis, but growth has been recovering since mid-2020 and into 2021. The authorities’ forceful early actions cushioned the pandemic’s economic impact, and real GDP growth is projected to have contracted by just -0.1 percent in 2020. Inflation remained within the CBK’s target, reaching 5.7 percent in January 2021, while financial sector vulnerabilities have been contained. Fiscal consolidation efforts have had to be paused due to weaker revenues and increased spending needs (including for healthcare and providing more support to households and firms), and a large fiscal deficit of 8.9 percent of GDP was budgeted for FY2020/21. There is a high risk that the economic recovery is impeded by further adverse developments in the pandemic and its effects on the global and Kenyan economies, including prolonging fiscal pressures, decreasing the availability of private sector credit, and reducing business confidence and investment. Such developments would negatively impact MSMEs and make it more difficult to achieve the Project development objectives. Development partners’ support, including through this proposed operation, close supervision, and technical engagement provided through programs supported by IFIs, will help mitigate these risks. 88. The technical design risk of the Project is rated as Substantial. Under Component 1, some activities will be implemented by Saccos, with most having weaker capacity compared to larger financial institutions. Under Component 2, if the NT does not quickly transition from the existing CGS to the CGC, the achievement of the desired outcomes would be compromised. Mitigation measures include the implementation of capacity building activities as outlined in Component 3. The PBCs proposed under Component 2 will also help to incentivize progress towards the setting up of the CGC with the appropriate governance and design features that reflect best practice to attract other investors (including the private sector), to become more sustainable, and reach a larger pool of MSMEs in the long-term. 89. Institutional Capacity for Implementation and Sustainability risks are assessed as Substantial. Though the NT has experience in implementing World Bank financed projects, it does not have experience in implementing World Bank projects that involve FIs. The NT is committed to a wholesale business model based on second-tier lending, but it has limited experience with this approach. These risks will be mitigated by the technical assistance program that is a critical component of the Project and efforts that shore up high governance standards in the market, especially in the Sacco sector by demonstrating the value of investing in such high standards by eligible Saccos. The Project PIU will also be staffed with competent consultants and experienced resources on FIF. 90. Fiduciary risks are rated Substantial. 48 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) a) Financial Management: The nature and institutional arrangements of the Project are such that they involve decentralized implementation arrangements and significant participation of private financial institutions and MSMEs. For project purposes, the NT procedures and internal controls need to be strengthened to enhance follow up and monitoring of sub-loans provided by PFIs to assure loan proceeds are used for the purposes intended. Moreover, arrangements under the capitalization of the CGS are not yet finalized. On this basis, the financial management risk is substantial, and the fiduciary residual risks are also substantial. Some mitigation actions are described under the FM implementation arrangement section. b) Procurement: Procurement risk is assessed as Substantial. The PIU is fully staffed with procurement and other consultants with requisite qualifications and experience in World Bank- financed operations. However, the implementation of various projects has been slowed down by systemic institutional weaknesses, including lack of seamless integration of work-processes between the PIU and the Procurement function at the NT resulting in delays in internal approvals and award of contracts. Since the Project is being processed under the World Bank program for COVID-19 response, it requires that the procurement and delivery of critical goods and services be fast-tracked to provide rapid response and operational effectiveness. The institutional weaknesses highlighted would affect the effective delivery of goods and services under the Project, if not appropriately addressed. In addition, the procurement profile for the project comprises of relatively low value and non-complex consultancy services assignments and procurement of office equipment. 91. The E&S risk is considered Substantial. The Project seeks to address market failures in access to finance by MSMEs, which have been exacerbated by the negative impacts of COVID-19. This will be achieved through providing increased access to financial services and supporting the post COVID-19 recovery of MSMEs in Kenya. The Project funds will be channeled through FIs and will finance capital costs for financial institutions and in relation to MSMEs, expenses such as salaries for employees as well as rent expenses. In this case, the main E&S risks for the FIs are related to labor and working conditions to be covered under ESS 2 and ESS 9. The main environmental risks under Components 1 and 2 are related to occupational health and safety, dust and noise emissions, energy use and waste generation at the sub- project MSMEs level. These impacts are expected to be site-specific, temporary and can be readily addressed through standard mitigation measures and compliance with relevant national laws. At the MSME sub-project level, a simplified Environmental and Social Management Plans or Summary Project Reports and compliance with national laws can serve as underlying framework to address the E&S risks and impacts. 92. The social risks will mainly be related to discrimination, equitable access to finance, lack of participation by small Saccos and MSMEs in remote areas and marginalized areas. Sexual Exploitation and Abuse and Sexual Harassment (SEA/SH) risks will be assessed and addressed during implementation. The lack of access to clear and culturally appropriate information due to limited efforts by the Apex institution and PFIs regarding inclusive strategies/approaches could lead to a possible exclusion of some subgroups such as MSMEs owned or led by women, youth, indigenous people (IP) (vulnerable and marginalized groups), and persons with disability. No adverse impacts on IPs are expected. Since as an important part of the ESMS, the Project has adopted the exclusion list of activities, sub-projects that the 49 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) Project will refrain from financing as part of Components 1 and 2. Stakeholder engagement will be carried out in a manner proportionate to the risks and impacts of the Project and will be led by the NT. 50 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) VII. RESULTS FRAMEWORK AND MONITORING Results Framework COUNTRY: Kenya Supporting Access to Finance and Enterprise Recovery (SAFER) Project Development Objectives(s) The objective of the Project is to increase access to financial services and support COVID-19 recovery of Micro, Small and Medium Enterprises (MSMEs) in Kenya. Project Development Objective Indicators RESULT_FRAME_TBL_PDO Indicator Name PBC Baseline End Target PDO indicators Volume of additional private capital mobilized (Amount(USD)) 0.00 50,000,000.00 Volume of MSME financing to enterprises affected by COVID-19 0.00 80,000,000.00 (Amount(USD)) Share of beneficiary MSMEs under the project that survive 0.00 70.00 COVID-19 (Percentage) Share of beneficiary MSMEs that did not receive support from 0.00 30.00 the project that survive COVID-19 (Percentage) Number of new financial products for MSMEs launched by participating financial institutions in response to Covid-19 0.00 3.00 (Number) PDO Table SPACE 51 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) Intermediate Results Indicators by Components RESULT_FRAME_TBL_IO Indicator Name PBC Baseline End Target Liquidity Support to MSMEs Number of business borrowers financed by MFB/SACCOs and digital platforms under the Project (cumulative, new, 0.00 273,456.00 disaggregated by gender, location/region, sectors) (Number) Of which, women borrowers (Number) 0.00 109,382.00 Number of PFIs receiving the line of credit under the project 0.00 5.00 (Number) Number of subloans disbursed through digital channels under 0.00 261,666.00 the Project (Number) Percentage of MSME Loans extended to Women-Owned 0.00 40.00 Enterprises (Percentage) De-risking Lending to MSMEs Number of MSME borrowers financed by PFIs through the credit guarantee scheme under the Project (cumulative, new, 0.00 94,400.00 disaggregated by gender, location/region, sectors) (Number) Of which, women borrowers (Number) 0.00 37,706.00 PBC 1, CGS Company Established (Yes/No) 1.1, No Yes 1.3 Number of PFIs participating in the credit guarantee scheme PBC 2 0.00 7.00 (Number) Private Capital Mobilized (Amount(USD)) 0.00 10,000,000.00 Number of partial credit guarantees provided to PFIs under the 0.00 35,400.00 Project (Number) Technical Assistance PFIs develop institutional maturity (IM) (Percentage) 0.00 80.00 52 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) RESULT_FRAME_TBL_IO Indicator Name PBC Baseline End Target Number of PFIs that implemented institutional development 0.00 10.00 plans (Number) Citizen engagement: Percentage of beneficiary firms reporting 0.00 70.00 project financing reflected their needs (Percentage) Citizen engagement: Percentage of beneficiary firms reporting project financing reflected their needs - of which, women- 0.00 70.00 owned (Percentage) Citizen engagement: Report drafted on Citizen Engagement No Yes Survey (Yes/No) Number of women-owned MSMEs that participate in targeted 0.00 88,285.00 sessions (Number) Percentage of women-owned MSMEs reporting satisfied or very 0.00 70.00 satisfied by targeted sessions (Percentage) Share of volume of financial support under the Project channeled to investments in the green economy and climate financing 0.00 15.00 (Percentage) IO Table SPACE UL Table SPACE Monitoring & Evaluation Plan: PDO Indicators Methodology for Data Responsibility for Data Indicator Name Definition/Description Frequency Datasource Collection Collection This indicator includes Project reports Volume of additional private capital unguaranteed private Annual NT produced by PIU and Implementing Agency mobilized capital mobilized partners (cumulative, US$ millions) 53 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) Volume of bank financing provided to MSMEs affected Project reports by COVID-19 (cumulative, in Volume of MSME financing to enterprises Annual NT produced by PIU and Implementing Agency USD). Volume of financing is affected by COVID-19 partners the sum of: (i) lines of credit and (ii) volume of loans guaranteed by the Project. Share of MSMEs benefiting from the project that survive the COVID-19 crisis. With an estimate that 2/3rd firms were affected by the Project reports crisis in 2020 (based on Share of beneficiary MSMEs under the Annual NT produced by PIU and Implementing Agency estimates from the WB project that survive COVID-19 partners business pulse survey), the project estimates to target affected firms with a conservative estimate that 70% will survive the crisis based on support provided. Comparator indicator to PDO indicator #3 that measures the share of firms that did not receive SAFER financing and survived Share of beneficiary MSMEs that did Analysis of PFIs' COVID-19. According to the Annual PFIs Implementing Agency not receive support from the project portfolio data BPS, 2/3 of firms that survive COVID-19 experienced a decline in demand and cashflow (and more than half a lower availability of financing inputs) thus were affected 54 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) by COVID-19. This indicator will measure new financial products Project reports Number of new financial products for expected to be launched as Annual NT produced by PIU and Implementing Agency MSMEs launched by participating financial part of the project in partners institutions in response to Covid-19 response to MSME needs after Covid-19 ME PDO Table SPACE Monitoring & Evaluation Plan: Intermediate Results Indicators Methodology for Data Responsibility for Data Indicator Name Definition/Description Frequency Datasource Collection Collection This indicator is designed to include all MSMEs that receive financing under the project's Component 1. The indicator is calculated using the sample WB loan size Number of business borrowers financed under Component 1 to by MFB/SACCOs and digital platforms target beneficiaries through MFBs and Analysis of Annual Implementing Agency under the Project (cumulative, new, the digital channel (MNOs) SACCOs beneficiaries' data disaggregated by gender, location/region, and MFBs and Saccos. The sectors) average loan size of loans to micro and small enterprises through MNOs is ($70 - $1500) and the average loan size of loans to SMEs through MFBs is ($1,000 - $5,588). 55 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) This indicator is designed to include all women-owned MSMEs that receive MFBs and Analysis of financing under the project's Annual Implementing Agency Of which, women borrowers SACCOs beneficiaries' data Component 1 (with an assumption that 40% of borrowers are women based on MNO data) This indicator measures the Analysis of PFIs' Number of PFIs receiving the line of credit Annual PFIs Implementing Agency total number of eligible PFIs portfolio data under the project receiving the line of credit This indicator measures the total number of subloans PFIs and provided to MSMEs by PFIs Digital Analysis of PFIs' Number of subloans disbursed through with Project funds through Annual Implementing Agency channels portfolio data digital channels under the Project digital channels, working (MNOs) with an assumption that the average loan size is $70- $1500. The proportion of MSME MFB, Saccos, Analysis of Beneficiaries Percentage of MSME Loans extended to loans submitted to the Apex Annual PFIs, Digital Implementing Agency Data Women-Owned Enterprises institution that are Channels extended to women Number of MSME borrowers financed by This indicator is designed to PFIs through the credit guarantee scheme Analysis of include all MSMEs that Annual PFIs Implementing Agency under the Project (cumulative, new, beneficiaries' data receive financing under the disaggregated by gender, location/region, project's Component 2 sectors) This indicator is designed to Analysis of include all women-owned Annual PFIs Implementing Agency Of which, women borrowers beneficiaries' data MSMEs that receive financing under the project's 56 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) Component 2 National Project reports This indicator will receive a Annual Treasury and produced by PIU and Implementing Agency CGS Company Established ‘Yes’ once the company is Planning partners established National Project reports This indicator measures the Number of PFIs participating in the credit Annual Treasury and produced by PIU and Implementing Agency total number of eligible PFIs guarantee scheme Planning partners participating in the CGS This indicator measures Project reports total private sector finance Annual NT produced by PIU and Implementing Agency Private Capital Mobilized mobilized as part of equity partners in the CGS under Component 2 of the project. This indicator measures the National number of partial credit Annual Analysis of PFIs' Number of partial credit guarantees Treasury and Implementing Agency guarantees provided to portfolio data provided to PFIs under the Project Planning eligible PFIs with Project funds under Component 2 Apex institution reports PFIs using the institutional development plans (IDPs) to improve internal Project reports governance systems, credit Annual NT produced by PIU and Implementing Agency PFIs develop institutional maturity (IM) allocation systems, risk partners management, responsible market conduct (use of APR, disclosure standards, grievance redress, etc.) Number of PFIs that implemented This indicator measures the Annual National Analysis of PFIs' Implementing Agency institutional development plans total number of eligible PFIs Treasury and portfolio data 57 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) that implemented IDPs Planning A mid-term beneficiary At mid- Project Citizen engagement: Percentage of Survey of beneficiary feedback survey will term Implementati Implementing Agency beneficiary firms reporting project firms measure the satisfaction of review on Unit, PIU financing reflected their needs the project beneficiaries A mid-term beneficiary Citizen engagement: Percentage of At mid- feedback survey will Survey of beneficiary beneficiary firms reporting project term PIU Implementing Agency measure the satisfaction of firms financing reflected their needs - of review women-owned project which, women-owned beneficiaries A citizen engagement survey will be provided to a subset of beneficiaries and designed to assess overall satisfaction of services (including ease of access, quality, process, disclosure, At mid- Survey of beneficiary Citizen engagement: Report drafted on responsiveness of needs, term NT Implementing Agency firms Citizen Engagement Survey etc.) The results of the review survey will be analyzed and assessed in a report, which will also contain proposed recommendations for project adjustments informed by citizen feedback. This indicator captures the Project Project reports number of eligible women- Number of women-owned MSMEs that Annual Implementati produced by PIU and Implementing Agency owned MSMEs that participate in targeted sessions on Unit, PIU partners participated in targeted sessions as part of the 58 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) project (with conservative estimates based on other SME project examples) This indicator captures the satisfaction of eligible Percentage of women-owned MSMEs Satisfaction measured women-owned MSMEs that Annual PIU Implementing Agency reporting satisfied or very satisfied by after every session participated in targeted targeted sessions sessions as part of the project Share of volume of financial support under the Project Share of volume of financial support Project reports that is channeled to National under the Project channeled to Annual produced by PIU and Implementing Agency investments in the green Treasury, PIU investments in the green economy and partners economy and climate climate financing financing (mitigation and/or adaption measures) ME IO Table SPACE Performance-Based Conditions Matrix DLI_TBL_MATRIX PBC 1 Establishment of the CGC Type of PBC Scalability Unit of Measure Total Allocated Amount (USD) As % of Total Financing Amount Intermediate Outcome No Date 10,000,000.00 4.00 Period Value Allocated Amount (USD) Formula Baseline 30-Nov-2020 FY22 30-Jun-2022 10,000,000.00 None FY23 31-Dec-2022 0.00 None 59 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) DLI_TBL_MATRIX PBC 1.1 CGC has been duly incorporated and has received the relevant licenses, permits, and approvals required to start operation. Type of PBC Scalability Unit of Measure Total Allocated Amount (USD) As % of Total Financing Amount Intermediate Outcome No Date 4,000,000.00 1.60 Period Value Allocated Amount (USD) Formula Baseline 30-Nov-2020 FY22 30-Jun-2022 4,000,000.00 None FY23 31-Dec-2022 0.00 None DLI_TBL_MATRIX The CGC Board has been duly constituted in accordance with Recipient’s relevant laws and policies and in a manner PBC 1.2 satisfactory to the Association. Type of PBC Scalability Unit of Measure Total Allocated Amount (USD) As % of Total Financing Amount Intermediate Outcome No Date 3,000,000.00 1.20 Period Value Allocated Amount (USD) Formula Baseline 30-Nov-2020 FY22 30-Jun-2022 0.00 None FY23 31-Dec-2022 3,000,000.00 None 60 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) DLI_TBL_MATRIX The Chief Executive Officer, Chief Finance Office and the Chief Operations Officer of the CGC have been duly hired by the PBC 1.3 CGC Board in accordance with the relevant laws and policies governing the CGC Type of PBC Scalability Unit of Measure Total Allocated Amount (USD) As % of Total Financing Amount Intermediate Outcome No Date 3,000,000.00 1.20 Period Value Allocated Amount (USD) Formula Baseline 30-Nov-2020 FY22 30-Sep-2022 0.00 None FY23 31-Dec-2022 3,000,000.00 None DLI_TBL_MATRIX PBC 2 Operational readiness Type of PBC Scalability Unit of Measure Total Allocated Amount (USD) As % of Total Financing Amount Intermediate Outcome No Date 10,000,000.00 0.00 Period Value Allocated Amount (USD) Formula Baseline 30-Nov-2020 FY22 30-Jun-2021 0.00 None FY23 31-Dec-2022 10,000,000.00 None 61 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) Verification Protocol Table: Performance-Based Conditions PBC 1 Establishment of the CGC Description The Borrower has established the CGC Data source/ Agency National Treasury Verification Entity World Bank Procedure CGC has been duly incorporated and has received the relevant licenses, permits, and approvals required to start PBC 1.1 operation. Description CGC has been duly incorporated and has received the relevant licenses, permits, and approvals required to start operation. Data source/ Agency National Treasury Verification Entity Office of the Auditor General • A copy of the certificate of incorporation of the CGC and relevant licenses. • A copy of the signed Subsidiary Financing Agreement between the NT and the CGC. Procedure • A letter from the NT and/ or bank record confirming funding/capital provided by the NT to the incorporated company. The CGC Board has been duly constituted in accordance with Recipient’s relevant laws and policies and in a manner PBC 1.2 satisfactory to the Association. The CGC Board has been duly constituted in accordance with Recipient’s relevant laws and policies and in a manner Description satisfactory to the Association. Data source/ Agency National Treasury Verification Entity Office of the Auditor General Procedure • A letter from the NT confirming the appointment of the members of the CGC’s board of directors. 62 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) • The Board of the CGC has approved the CGC’s corporate governance charter acceptable to the Association. • A letter from NT and/ or bank record confirming additional funding/capital provided by the NT to the incorporated company. The Chief Executive Officer, Chief Finance Office and the Chief Operations Officer of the CGC have been duly hired by the PBC 1.3 CGC Board in accordance with the relevant laws and policies governing the CGC The Chief Executive Officer, Chief Finance Office and the Chief Operations Officer of the CGC have been duly hired by the Description CGC Board in accordance with the relevant laws and policies governing the CGC and in a manner satisfactory to the Association. Data source/ Agency National Treasury Verification Entity Office of the Auditor General • The executive management (including the Chief Executive Officer, Chief Finance Office and the Chief Operations Officer) have been hired. • Signed Board minutes evidencing the hiring/approval of the hiring based on clearly defined criteria acceptable to Procedure the Association. • A letter from the NT and/ or bank record confirming additional funding/capital provided by the NT to the incorporated company. PBC 2 Operational readiness CGC has developed and adopted key operational policies, manuals and systems in form and substance satisfactory to the Association, including a CGC Manual, CGC operational procedures, an Environmental and Social Management System - that Description is aligned with the Environmental and Social Standards, and the CGC Management has hired key operational staff to include risk, credit, finance, and environmental and social officers, all in a manner satisfactory to the Association. Data source/ Agency National Treasury Verification Entity Office of the Auditor General • Operational manuals, other procedural manuals, and the ESMS, with signed Board minutes verifying the approval of Procedure such policies/manuals. 63 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) • Key operational staff as outlined in the PBC have been hired. • The CGC has implemented an IT infrastructure/management information system for the management of the guarantee operations. • A letter from NT and/ or bank record confirming additional funding/capital provided by the NT to the incorporated company. 64 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) ANNEX 1: Indicative Eligibility Criteria for the Line of Credit and the CGS COUNTRY: Kenya Supporting Access to Finance and Enterprise Recovery (SAFER) 1. This Annex is indicative of selection criteria for the lines of credit, which will be further defined in the POM. The selection of the Apex institution and PFIs should meet the minimum eligibility criteria required by the World Bank under the World Bank Policy on Investment Project Financing 2018 (formerly OP 10.00). The NT will select the Apex institutions, with inputs from the supervisory authorities and in coordination with the World Bank. The Apex institution shall have the necessary capacity and knowledge to perform the assigned apex role, including the capacity to assess the competence and creditworthiness of the PFIs. The Apex institution will in turn select PFIs with inputs from the supervisory authorities consisting of a “certificate of good standing”. (a) License: financial institutions must be properly licensed. (b) Good governance – ‘fit and proper’ owners: adequate Board composition and practices; adequate organization and institutional capacity for its specific risk profile; existence and effectiveness of business and risk-related committees (such as Assets/Liability Management Committee, Risk Committees, Credit Committees, Audit Committee, and so on) operating with adequate policies and procedures; competent management with adequate managerial autonomy; business strategy aligned with the FI’s size and management experience. (c) Good standing with the supervisor: compliance with the supervisory authorities’ prudential regulations and other applicable laws and regulations. (d) Capital adequacy: good capital structure and compliance with risk-based capital adequacy requirements; positive trend adequate for the FI’s growth perspectives and risk characteristics of new business initiatives. (e) Adequate liquidity and effective asset/liability management: levels of liquidity that meet the supervisory authorities’ regulations and FI’s needs, with effective liquidity management practices. Good funding structure without high concentrations and capacity to mobilize domestic resources. Adequate contingency planning for funding to meet unanticipated events or periods of excess liquidity. (f) Adequate profitability: profitability with well diversified and stable earnings trend and acceptable risk profile. The value capital, and the level and growth trends of operating costs and expenses should be well managed. (g) Adequately managed financial and operational risks: financial and operational risk management functions should be well organized; have in place well-defined and prudent policies and written procedures for management of all types of financial risks (liquidity, credit, currency, interest rate and market risk, as well as risks associated with balance sheet and income statement structures) and operational risk; exposure to interest rate risk, currency risk, and market risk at the instrument, portfolio, and balance sheet levels within risk limits and well managed. (h) Good asset structure and portfolio quality: good asset structure including type, concentration, liquidity, and diversification; effectiveness of loan/finance underwriting and the related policies, procedures, and practices; lending to/financing connected parties; asset classification and 65 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) provisioning practices; 65 level, distribution, and severity of classified assets and timely identification and collection of problem assets. (i) Adequate internal audit function: including organization of internal audit and compliance functions; internal audit policies, procedures, and practices; annual audit planning and execution, ensuring that all risk areas are examined and that those areas of greatest risk receive priority; reporting requirements to senior management and Board; quality of reporting and responsiveness to audit suggestions, recommendations, or requirements; and follow up on any noted issues. (j) Adequate IT and Management Information Systems, and openness to experiment with technology- based credit assessment and distribution approaches. Eligibility Criteria for PFIs 2. The eligibility criteria for financial institution participation will involve a comprehensive assessment of the prospective PFIs’ capability to serve MSMEs, including those in the informal market segments that were hard-hit by the COVID-19 pandemic and a ‘certificate of good standing’ issued by their respective supervisory authorities. Capabilities assessed will include: (a) design of products and services targeting MSME market segments; (b) marketing and promotional campaigns building awareness of products and offering to MSMEs; (c) digital financial services capacity on onboarding customers, managing relationships and potentially expanding services over time; (d) ALM; (e) experience in targeting, reaching out to, and collecting data for segments of the population that are hard to reach, including women-owned businesses; and (f) ability to measure investments in the green economy and climate financing. Supervisory authorities providing oversight of PFIs on an ongoing basis will be required to certify each PFI’s adherence to prudential regulatory ratios, minimum capital requirements, and operational standards as may be set out in the operational manual such as fit and proper controllers and managers, adequate profitability and capital, strong management, and healthy portfolio quality (i.e., liquidity, loan loss provisioning, and NPLs at 10 percent or less). Further details on the PFI selection criteria will be provided in the POM. Governance and Flow of Funds 3. The NT will use simple management tools to mitigate excessive risk in the portfolio and facilitate efficient workflows. Supervisory authorities will provide oversight of PFIs on an ongoing basis and certify adherence to prudential regulatory ratios, sound governance arrangements and risk management covering credit policies on MSME loan appraisal process, loan granting, loan monitoring and recovery, and credit risk rating in accordance with World Bank Directive on Investment Policy Financing, Environmental and Social Framework (ESF) and application of World Bank Anti-Corruption Guidelines considering the specifics of the Project. The NT will employ an Apex institution as a fund manager, who will also undertake a third-party monitoring role of funded sub-loans and report to the NT, respective supervisory authorities, and the World Bank on individual subprojects and the portfolio. 4. The end of life of the liquidity support to MSMEs will not be determined. Liquidity support to MSMEs is intended to operate for as long as the COVID-19 induced crisis remains unresolved, thus rendering justifiable the service for financing of MSMEs recovery and resilience in Kenya. The operational 66 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) flexibility concerning the eligibility criteria and oversight by supervisory authorities would make it possible for the NT to consider emerging priorities for specific segments of the informal economy further down the line. Any changes to operational arrangements during the Project lifecycle will be made in consultation with the World Bank. At the end of the Project, sub-loans outstanding and funds on the collection account will be transferred by the Apex institutions to the company being set up by the NT to manage the partial credit guarantee scheme. Credit Guarantee Scheme – Component 2 5. The risk sharing structure is somewhat unique among guarantee schemes. The risk sharing will be on a 50:50 pari-passu basis; however, once the lender’s loss reaches 25 percent of the facility amount, the lender will bear the rest of the risk. The coverage ratio is much lower than those found in other COVID- 19 response programs. The World Bank conducted a meeting with representatives of the Kenya Bankers Association who indicated that they had been consulted about the proposal and that they supported it and felt it would be a good starting point. Key features of the facility are demonstrated in Table 1.1. Table 1.1 Key features of the CGS 6. Operational characteristics. The maximum loan amount is KES 5,000,000. The maximum loan tenor is 3 years with a 5-month grace period. There is no guarantee fee or commitment fee. However, the GoK will review this decision as well as the coverage ratio, when setting up the long-term guarantee company. The credit decision will be made by the lender. The lender may initiate the claims process 90 days after the date of default if the standard recovery procedures have not resulted in full payment of the loan. 7. The NT intends to review the structure of the program in one year. The situation with the pandemic is very fluid and it is very difficult to predict how long the economic impact will last. The goal is to provide some assistance quickly. 8. The NT will manage the scheme and appoint existing staff members to make the scheme operational and to show lenders how to use it. A staff that was part of the team managing the Program for Rural Outreach of Financial Innovations and Technologies, which was offering credit guarantee to agriculture and agribusiness firms has been brought to join the NT’s CGS team. NT will also hire international advisers/experts to provide support during implementation. These staff members will 67 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) operate the scheme manually at the start to get the program running as quickly as possible and to provide a substantial amount of flexibility. Lessons learned during the manual operation of the scheme will be incorporated into the final version of the permanent scheme, which will leverage technology. 9. The credit decision will be made by the lenders. The NT staff will provide each PFI with an allocation of the funds available that it can use to make guaranteed loans. Lenders will process loans and review those that are declined to determine if adding a guarantee will overcome the reason for decline. If the answer is yes, the PFIs will register the borrower with the guarantee scheme and identify it as part of the PFI’s guaranteed portfolio. 10. Because the credit decision is delegated to PFIs, operational experience is more important than credit experience. The main function of the NT staff will be to properly administer the paper submitted to them to register the guarantee and, if needed, to pay on the default. The NT staff will develop written procedures to handle registering loans and payment on defaults, including internal controls on both the payment decision and on the transfer of cash. 11. Additional staff and consultants will be hired to boost the operational capacity of the NT team. Initially, additional staff and consultants with process expertise will be hired to review proposed procedures and assist with the implementation of the scheme. 12. The CBK will provide oversight. Understanding the need for transparency in operations and for lenders to trust the scheme, the CBK has agreed to provide oversight. This will include process monitoring as well as portfolio monitoring. One of the main goals of the oversight will be to ensure there are adequate funds available to pay claims. 13. The PCC established under this operation will advise the scheme with policy and operational issues. The committee will consist of organizations that have contributed funding to the process along with the Kenya Bankers Association and a representative of SMEs. The committee will be able to provide input from users, beneficiaries, and donors. This input would be used to improve the program and ensure that it addresses the concerns of the marketplace. 14. The National Treasury has provided the initial funding of KSh. 3 billion for the CGS and entered a Risk Sharing Scheme Agreement with seven Participating Financial Institutions (PFIs), launching the CGS in December 2020. The PFIs were competitively selected through a set out criteria (prepared by the National Treasury and the CBK) to implement the Risk Sharing facility. The seven PFIs are KCB Bank, NCBA Bank, ABSA Bank, Co-operative Bank, Diamond Trust Bank, Stanbic Bank, and Credit Bank. The NT is keen to engage other stakeholders, including international DFIs and the private sector to mobilize additional capital for both the emergency CGS and the proposed CGC. 68 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) ANNEX 2: Implementation Arrangements and Support Plan COUNTRY: Kenya Supporting Access to Finance and Enterprise Recovery (SAFER) 1. Overall Program Implementation and Institutional Arrangements. The Project will be supervised by a PCC chaired by the National Treasury and the PIU will act as the secretariat to the PCC. The core members of the Committee will include the CBK, the NT, MoITED, SASRA, other ministries, departments and agencies, and other relevant institutions, and will work closely with the existing CGS Steering Committee (SCC) that is chaired by NT. Other Ministries/Associations may be invited to participate as needed by the PCC. The PCC shall be responsible for, inter alia: a) providing strategic and policy guidance for project implementation; and b) resolving any project coordination and implementation bottlenecks that may arise. The PCC will host quarterly project review meetings to review the Project results, discuss key issues, and agree on key milestones over the following six months. The PCC will review reports of technical reviews conducted by the World Bank. This report will also form the main technical outcome of the World Bank project implementation support missions. The quarterly project review meetings will be chaired by the Principal Secretary of the NT, while the PIU will act as the secretariat. The core members of the meeting will be the NT, CBK, MoITED and SASRA. The NT will invite additional organizations or agencies to the meeting as may be necessary. 2. The Project will be implemented by an Apex institution (which may be an FI), the NT, and a PIU. For implementation of the lines of credit, the NT will enter into a Subsidiary Financing Agreement with eligible apex and retail FIs to on-lend to eligible MSMEs. For the provision of partial credit guarantees, the NT will enter into participation agreements with the relevant eligible PFIs. The PIU has previous experience in the implementation of World Bank financed operations having been involved in the implementation of the Kenya Infrastructure Finance and Public Private Partnerships Project, the FSSP, and the Kenya Affordable Housing Finance Project. In the implementation of the three projects, the NT acts as the procurement function for the Project thus processing procurement activities up to the contract award stage while the beneficiary institutions and/or agencies manages the contracting and post-contract award phases of their respective contracts. A similar implementation arrangement is envisaged under this project. The PIU is fully staffed with procurement and other consultants with requisite qualifications and experience in World Bank financed operations. In addition, the PIU will act as a first stage grievance committee for all safeguard related complaints and act as the main focal point for interaction with FIs and other stakeholders on behalf of the Project. 3. Component 1: Liquidity Support to MSMEs (US$55 million equivalent). Under this component, the Project will finance the provision of lines of credit by the NT to eligible PFIs through an Apex institution. Eligible PFIs will then on-lend to eligible MSMEs. The Apex institution will assume the credit risk of the PFIs, and PFIs will assume credit risk of the MSMEs. The cost of on-lending financing through PFIs will include, at a minimum, the cost of IDA funds to NT plus an on-lending margin reflecting the apex administrative costs, a credit risk mark-up associate with the PFI, and expected profit. Pricing should be adequate to encourage lenders to compete in this market. 4. Component 2: De-risking lending to MSMEs (US$30 million equivalent). This component will finance two arms of the CGS: (a) the capitalization of the emergency CGS to respond to liquidity challenges of MSMEs posed by the COVID-19 crisis and (b) the capitalization of the CGC for standard guarantee 69 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) programs. The eligibility criteria for MSMEs under both components will be described in the operational manual. 5. For both Components 1 and 2, the institutions must meet criteria required by the World Bank Operational Policy on Investment Project Financing, 2018, including ensuring that PFIs are well managed, with an adequate corporate governance structure, sound financial performance indicators, and adequate technical and institutional capacity to operate at competitive market conditions. These criteria will be outlined in the TOR the NT will use to engage the Apex. The World Bank will be involved in reviewing the TOR, procurement process, and will issue a no objection to the apex identified. 6. Component 3: Technical Assistance and Project Management (US$15 million equivalent). This component will finance technical assistance to NT, PFIs and financial sector regulators. To implement this component, the PIU will: (a) coordinate the development of TOR for the TA activities with the technical staff within NT responsible for the areas to be strengthened – the World Bank team will provide guidance and support for the completion of the TOR; (b) coordinate the selection process; (c) supervise the implementation and completion of the contract with the firms or consultants selected; and (iv) coordinate with the technical team the review of all deliverables received. The PIU in coordination with the technical team will monitor the progress of the Project and will incorporate the findings and results in the Project progress report. Procurement 7. Procurement under Component 3 of the Project that aims at providing technical assistance to the NT, PFIs, financial sector regulators, and MSMEs will be carried out in accordance with the World Bank Procurement Regulations. Procurement Regulations will not apply to procurement under Component 1 which is aimed at providing liquidity support to MSMEs in the informal sectors through loans made by eligible FIs and community based financial institutions. The Project will however be subject to the World Bank Anti-Corruption Guidelines, dated October 15, 2006 and January 2011 and July 1, 2016. 8. The profile of procurement under Component 3 of the Project comprises of consultant contracts for risk assessment, claims processing, reforms and institutional strengthening and governance, management information/IT systems, strengthening and advancing effective credit infrastructure systems, change management, digital financial service innovation, implementation of supervisory and regulatory frameworks, shared service digital platforms, financial management, access to finance and digital business operations and services. Small contracts of low value may also be procured to support project management and administration. 9. The Project will be implemented by a PIU established under the NT. The PIU will comprise of the existing CGS unit and the existing PIU team to leverage on existing fiduciary and safeguards aspects. Although the PIU is fully staffed with procurement and other consultants with requisite qualifications and experience in World Bank financed operations, the implementation of these projects have been slowed down by systemic institutional weaknesses among them, lack of seamless integration of work-processes between the PIU and the Procurement Function at the NT resulting in delays in internal approvals and award of contracts, poor and disjointed contract administration and management processes, weak linkage between the NT and contracting authorities in post-contract award management 70 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) of contracts, poor coordination between the NT and contracting authorities in procurement processing, lack of external procurement oversight, and poor records keeping and management. Since the Project is being processed under the COVID-19 Umbrella, it requires that the procurement and delivery of critical goods and services is fast-tracked to provide rapid response and operational effectiveness. The institutional weaknesses highlighted above would affect the effective delivery of goods and services under the Project if not appropriately addressed. Based on the systemic weaknesses outlined above and considering that the procurement profile for the Project comprises of relatively low value and non- complex consultancy services assignments and procurement of office equipment, procurement risk rating is assessed as “Substantial”. 10. Preliminary risk mitigation measures include: (a) an additional procurement staff to manage the increased project portfolio; (b) development of streamlined approval processes for emergency procurement within the NT and beneficiary institutions; (c) institutional strengthening of the PIU and the procurement functions of the NT and beneficiary institutions to establish a seamless interface for internal processing and approval of contract awards; (d) use of simple, faster but fit-for-purpose approaches in the selection of consultants; (e) use of streamlined contract management activities; (f) enhanced records keeping and management; (g) effective use of Systematic Tracking of Exchanges in Procurement System for tracking and monitoring procurement implementation; (h) increased training and capacity building; and (j) enhanced procurement oversight through prior and post reviews. 11. The Project procurement does not involve procurements within the Operations Procurement Review Committee thresholds, hence beneficial ownership pilot will not be applicable. The World Bank’s oversight of procurement will be done through increased implementation support and procurement post review based on a 20 percent sample while the World Bank’s prior review will not apply. Financial Management 12. An assessment of the proposed FM arrangements for the NT was carried out to determine whether the implementing agency maintains adequate financial management arrangements capable of ensuring that: (a) funds channeled into the Project will be used for the purposes intended in an efficient and economical manner; (b) the Project’s financial reports will be prepared in an accurate, reliable and in a timely manner; and (c) the Project’s assets will be safeguarded from misuse or loss. The FM assessment was carried out in accordance with the World Bank Directive: Financial Management Manual for World Bank Investment Project Financing Operations issued February 4, 2015; and the World Bank Guidance: Financial Management in World Bank Investment Project Financing Operations Issued and Effective February 24, 2015. 13. The FM assessment revealed that NT has adequate capacity and experience to effectively implement the proposed project. Capacity strengthening will be needed for the PIU to enhance technical and fiduciary capacity. This will include NT designating a qualified project accountant to handle the FM activities. The PCC will provide monitoring and oversight of the Project based on TOR agreed with the World Bank and NT and submit biannual reports of their assessment of the performance of the Project, submitted to the World Bank within 45 days after the calendar semester to which these relate. In addition, the Subsidiary Financing Agreement by NT with the Apex institution will require it to provide monthly 71 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) status reports, on the basis of the TOR agreed by NT and the World Bank. Copies of these reports will be shared with the World Bank as part of the quarterly IFRs. 14. At portfolio level, material in-country disbursement delays were noted in transfer of funds from the Designated Account (DA) in the NT to the relevant project accounts (PAs) through the government exchequer systems and the ministry development accounts. There are also challenges of insufficient IDA budget allocation, arbitrary slashing of budgets regular, late approval of supplementary budgets, insufficient counterpart funds and delays in making payment to vendors. These are being addressed as part of the portfolio reform dialogue. 15. The Project design is complex with multiple activities and subcomponents. This could result in disbursement delays in funds reaching the beneficiary MSMEs, as well as accountability challenges in ensuring that funds have been disbursed to the right beneficiaries or otherwise used for the intended purposes. Therefore, it is necessary to have proper coordination of fiduciary arrangements to facilitate efficient implementation of project activities. NT will develop an FM procedures manual to define the fiduciary arrangements during project implementation to ensure quick disbursement of funds and proper accountability. The FM procedures manual was completed before negotiations. 16. Robust fiduciary interventions have been put in place to respond to the identified risks and these include: i) development and implementation of FM procedures manual as well as credit guarantee scheme (CGS) manual; ii) designation of two project accountants, one for PIU and the other for the CGC; iii) preparation and submission of quarterly IFRs by PIU, which will incorporate status monthly reports by the Apex institution and compliant FIs; iv) biannual assessment of the technical performance and fiduciary compliance of the Project by CBK; v) annual risk-based fiduciary internal audit review by NT’s internal audit unit; vi) annual external audit by the OAG; and vii) regular World Bank FM review. Eligibility of Expenditures and Disbursement Triggers for Sub-Components 17. A summary of the FM arrangements, the eligibility of the expenditures and the related disbursement triggers under each sub-component is as follows: a. Component 1 – Window 1: Liquidity support will be provided through an Apex institution to a compliant financial institutions bank (across the three tiers) that meets the eligibility criteria to on-lend to micro enterprises through an MNO platform. The assessment of qualifying institutions will be done by NT based on clearly defined criteria approved by the World Bank and cleared by the CBK’s banking supervision department. NT will enter into an agreement with the Apex institution and the agreement will define the applicable technical requirements as well as fiduciary arrangements (including the provision of monthly status reports). The mentioned agreement between NT and Apex institution will be reviewed and cleared by the World Bank before signing. b. Component 1 – Window 2: Liquidity support to the MSMEs would be provided through Saccos and regulated MFBs. The funds will flow from NT through an Apex institution pre-identified by NT to participating Saccos and MFBs selected based on eligibility criteria and thereafter to the beneficiary MSMEs. The Apex institution would need to have adequate technical and fiduciary capacity to oversee the Saccos and MFIs and provide monthly financial returns to NT on the use of the Project funds. NT 72 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) through the PIU would in turn provide quarterly financial and technical reports to the World Bank, with copy to CBK and the oversight Apex institution of the Saccos and MFIs. NT will enter into a Subsidiary Financing Agreement with the Apex institution which will include fiduciary arrangements (including monthly status reports). The agreement will be prior reviewed and cleared by the World Bank. c. Component 2: US$10 million would go towards capitalization of the CGS, which has been set up by NT, while the rest of the funds – US$ 20 million – would be utilized for the operationalization and capitalization of the CGC to be established by NT as part of the Project implementation. A CGS Manual is being developed, which will provide the operational and fiduciary framework for this component. The manual will also include PBCs that would be met before the tranches of funds are released by the Bank for capitalizations of the CGC scheme. The first tranche of US$10 million will be conditional to: (a) the company having been incorporated under the Companies Act of Kenya; (b) the governance framework and structure having been developed; (c) the company’s Board of Directors having been duly constituted; and (d) the Chief Executive Officer (CEO) of the company having been hired by the board through a competitive process; The second tranche of U$S10 million will be disbursed once the company’s readiness to operate has been established and a Subsidiary Financing Agreement between the government and the company has been signed. For the company to be deemed ready to operate, the following conditions would have to be satisfied: (a) the company’s Board has hired the executive management; (b) the executive management has hired key operational staff; (c) key operational policies and manuals have been developed, including the scheme operational manual; (d) the ESMS is in place; and (e) the company has procured an electronic system for the management of the day-to-day operations of the company and scheme. 18. Audit and Financial Reporting: The NT will prepare and submit to the World Bank quarterly IFRs within 45 days after the end of each calendar quarter. NT will also prepare and submit separate annual project-specific audited financial statements. The internal audit unit of NT will be required to conduct internal audit reviews of the Project activities as part of their annual internal audit plan. This risk-based internal audit fiduciary review (incorporating management comments and time-bound action plan) will be expected to be submitted to the World Bank by April 30 of every year. Any incremental cost of the internal audit review may be covered by the Project. The CBK will also conduct semi-annual assessment of the Project with respect to Component 1 and 2 and provide assessment reports to the World Bank within 30 days after each calendar semester. 19. Disbursement: The Project will adopt the Statement of Expenditure (SOE) method of disbursement. The disbursement methods will include advances, reimbursement, direct payment, and special commitment. The Project will have three DAs denominated in foreign currency, for Component 1, Component 2 and the TA (Figure 2.1). This will ensure that any material risks identified in one component does not affect disbursement to the other components. 20. Conclusion of FM Assessment: The results of the assessment indicate that the overall FM arrangements satisfies the World Bank’s minimum requirements under the World Bank Directive: Financial Management Manual for World Bank Investment Project Financing Operations issued February 4, 2015, and is adequate to provide, with reasonable assurance, accurate and timely information on the status of the project as required by the World Bank. The FM residual risk for the Project is Substantial. 73 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) 21. Budgeting: The Project funds will be factored in the national annual budget under the line ministry budget and captured in Integrated Financial Management System (IFMIS) based on the GoK Standard Chart of Accounts. The budget will be based on annual work plan and budget (AWPB) developed by NT and submitted to the World Bank for prior review and clearance. The PIU should ensure that the AWPB is prepared and cleared in good time so that it forms part of the in-country annual budget preparation process which commenced in September of the preceding year. If this is not done, there is risk of project failing to get sufficient budget allocation which could adversely affect project implementation. In addition, the Project will only receive funds from the World Bank into its DA only when the Project confirms that it has an allocation of budget as part of the annual approved budget. This is to manage the risk that most times World Bank funded projects are not allocated funds and funds released into the DA tend to stay in the DA for longer time than required. 22. Accounting arrangements: The NT is assessed as having adequate accounting capacity. The ministry uses IFMIS as the accounting platform. However, IFMIS is not configured to generate quarterly IFRs and annual project financial statements. Hence, the quarterly IFRs and the annual audit reports are done manually using Excel spreadsheets. In view of the relatively low volume of transactions expected in this project, this is deemed to be adequate for project accounting and financial reporting. 23. Funds flow arrangements: The disbursement would be done using the World Bank client connection system. Funds from the World Bank Credit Account will be disbursed to the three DAs denominated in foreign currency (EUR) opened at the CBK. From the DA, the funds will be transferred to the respective project accounts (PA) in NT. The CGC will open a sub-project account. The Project accounts (PA) and sub-project account will be denominated in local currency (KES) and will be opened at financial institutions acceptable to the World Bank. The funds flow arrangements are illustrated in Figure 2.1. 74 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) Figure 2.1: Funds Flow Arrangements 75 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) Table 2.1 Disbursement Categories PBC Amount PBC Amount Percentage of Allocated Allocated (US$ Expenditure to Be Category (expressed in Equivalent) Financed EUR) (Inclusive of Taxes) (1) Goods, non-consulting services, consulting services, training, and operating Costs under 12,885,000 15,000,000 100% Component 3 (2) Line of Credit under Component 1 47,245,000 55,000,000 100% (3) Public Credit Guarantee Scheme under 25,770,000 30,000,000 100% Component 2 a. Capitalization of the CGS 8,590,000 10,000,000 100% b. PBC 1.1: Cabinet approval to establish the CGC 3,436,000 4,000,000 100% c. PBC 1.2: Registration of the CGC 2,577,000 3,000,000 100% d. PBC 1.3: CGC’s CEO is hired 2,577,000 3,000,000 100% e. PBC 2: Operational readiness of the CGC 8,590,000 10,000,000 100% TOTAL 85,900,000 100,000,000 24. Internal controls: The NT has functioning internal audit unit with qualified internal auditors whose annual work-plans will be updated to include regular risk-based fiduciary review of the Project activities. The World Bank FM team will also conduct FM reviews at least once every year which will include on-site reviews to selected project sites at national and county level. The FM procedures manual and the CGS manual will also contain additional internal control procedures for the Project. 25. Financial Reporting: The NT has adequate financial reporting requirements capacity and will prepare and submit to the World Bank consolidated quarterly IFRs (including status reports from the Apex institutions) within 45 days after the end of each calendar quarter. It will also prepare and submit consolidated annual project-specific financial statements to the OAG by September 30, being three months after the year end. The CBK will prepare and submit to the World Bank biannual project assessment reports (within 30 days of each semester) covering Components 1 and 2. 26. Audit Arrangements: The Project audit will be carried out by the OAG. The scope of the audit will cover all the Project components and sub-components, including all the participating entities. The audit report and management letter would be submitted to the World Bank six months after the end of the financial year. The audit will be conducted based on audit TOR reviewed and cleared by the World Bank. 76 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) 27. Implementation Support Plan: Based on the risk assessment of the Project, the World Bank FM supervision review will be conducted twice a year for the first 2 years and thereafter at least once every year depending on the assessed FM risk. The missions’ objectives will include ensuring that strong financial management systems are maintained for the Project throughout its life. Reviews will be carried out regularly to ensure that expenditures incurred by the Project remain eligible for IDA funding. 28. The Project will have the flexibility of using retroactive financing for Component 3. No withdrawals shall be made for payments prior to the date of the Loan Agreement, except for withdrawals up to an aggregate amount not exceeding 20 percent of the total amount of the loan may be made for payments made for Eligible Expenditures of the Project as per the financing agreement. The eligible period for retroactive financing will be defined in the financing agreement. 77 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) ANNEX 3: Performance-based Conditions and Verification Protocols COUNTRY: Kenya Supporting Access to Finance and Enterprise Recovery (SAFER) 1. A CGC with the right governance structure, adequate capital, and capacity to implement the guarantee scheme is critical to the achievement of PDO-level results. The PBCs as presented in Table 2.1 have been designed to support the government to set up a sustainable mechanism for de-risking MSMEs in the form of a company that efficiently manages the scheme, mobilize additional capital from other sources, and build market capacity as necessary to unlock more lending. PBC 1 will ensure the company is set up and capitalized in line with best practice and has right corporate governance structure and quality management/leadership. PBC 2 will ensure the company has the adequate human resources capacity, policies, processes, and systems (including technology critical to efficiently manage the scheme). In this project, the PBCs provide the impetus and financial incentive to implement a sustainable mechanism critical to delivering results, while the specifically tailored TA activities under Component 3 will support the implementing agency and the CGC in achieving the targets of each of the PBCs. Table 2.1: PBCs, allocated amounts, and indicative time frame 66 Results PBCs June 2022 December 2022 PBC 1: PBC 1.1: PBC 1.2: Establishment of CGC has been duly The CGC Board has been duly constituted in the CGC incorporated and has accordance with Recipient’s relevant laws and policies received the relevant and in a manner satisfactory to the Association. licenses, permits, and approvals required to start PBC 1.3: operation. The Chief Executive Officer, Chief Finance Office, and the Chief Operations Officer of the CGC have been duly hired by the CGC Board in accordance with the relevant laws and policies governing the CGC and in a manner satisfactory to the Association. For PBC 1.2: US$3,000,000 Allocated amount US$4,000,000 For PBC1.3: US$3,000,000 PBC 2: CGC has developed and adopted key operational policies, manuals and systems in form and substance Operational satisfactory to the Association, including a CGC readiness Manual, CGC operational procedures, and an Environmental and Social Management System and the CGC Management has hired key operational staff to include risk, credit, finance, and environmental and social, all in a manner satisfactory to the Association. Allocated amount US$10,000,000 66 The time frames indicated in this table are indicative and the achievement of PBCs is not time bound. 78 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) PBCs verification mechanism and protocols. 2. The OAG will undertake the verification of the PBCs and related eligible expenditures based on which disbursements will be made. The OAG shall prepare a report that will cover PBC verification, eligible expenditures quality and sufficiency reviews, PBC and eligible expenditures supporting evidence, and key risks and challenges affecting the PBCs and eligible expenditures. Eligible expenditures will include: (a) capitalization cost; (b) expenses related to the setting up of the CGC, including obtaining relevant certification, licenses, permits; (c) cost of hiring key advisers for the developing key operational manuals and processes, systems (including the ESMS); (d) cost of salaries for staff since the CGC will be a new entity; 67 (e) capital cost of implementing an IT infrastructure; (f) costs related to staff training and training of PFIs as necessary. 3. The PIU at NT will compile the information on the status of achievement of results (as provided by the responsible implementing agencies/departments). The NT, as the implementing agency in charge of the PBCs, will provide evidence of eligible expenditure and achievement of their respective PBCs to the OAG using the prescribed reporting formats as shall be detailed in the POM. The report shall be submitted to the World Bank through the NT. As part of implementation support, the World Bank may, directly or through its appointed agents, undertake additional confirmation reviews. Where the eligible expenditures and achievement of a PBC cannot be verified, an amount equivalent to the price of that PBC will be withheld and may be paid later once such achievement has been verified and confirmed. Table 2.2 shows the verification protocols for the PBCs. The detailed verification mechanisms, protocols, roles and responsibilities will also be outlined in the POM. Table 2.2: Verification Protocols for PBCs PBCs Description or Definition of Achievement PBC 1: PBC 1.1: PBC 1.2: PBC 1.3: Establishment of the CGC • A copy of the certificate • A letter from the NT • The executive of incorporation of the confirming the management (including CGC and relevant appointment of the the Chief Executive licenses. members of the CGC’s Officer, Chief Finance board of directors. Office and the Chief • A copy of the signed Operations Officer) have Subsidiary Financing • The Board of the CGC has been hired. Agreement between the approved the CGC’s NT and the CGC. corporate governance • Signed Board minutes charter acceptable to the evidencing the • A letter from the NT Association. hiring/approval of the and/ or bank record hiring based on clearly confirming • A letter from NT and/ or defined criteria funding/capital bank record confirming 67 This is proposed since the WB is involved in the setting up of the new institution and building its capacity in the first two to three years of the operation would be critical. Eligible expenditure related to salaries will be for new staff rather than existing staff. This responsibility will be later transitioned to the GoK and the institution as it develops a robust revenue model, including from guarantee fees that would be charged to PFIs. 79 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) PBCs Description or Definition of Achievement provided by the NT to additional funding/capital acceptable to the the incorporated provided by the NT to the Association. company. incorporated company. • A letter from the NT and/ or bank record confirming additional funding/capital provided by the NT to the incorporated company. Protocol to evaluate achievement of the PBC and data/result Data source/agency: NT Verification entity: OAG Procedure: OAG to obtain documentation, undertake assessment, and verify data/results. PBC 2: • Operational manuals, other procedural manuals, and the ESMS, with signed Board minutes verifying the approval of such policies/manuals. Operational • Key operational staff as outlined in the PBC have been hired. readiness • The CGC has implemented an IT infrastructure/management information system for the management of the guarantee operations. • A letter from NT and/ or bank record confirming additional funding/capital provided by the NT to the incorporated company. Protocol to evaluate achievement of the PBC and data/result Data source/agency: NT Verification entity: OAG Procedure: OAG to obtain documentation, undertake assessment, and verify data/results. 80 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) ANNEX 4: Economic and Financial Analysis COUNTRY: Kenya Supporting Access to Finance and Enterprise Recovery (SAFER) Estimated coverage and allocation of Liquidity support to MSMEs (Component 1) 1. Table 4.1 shows the MSMEs that the lines of credit can cover subject to an eligibility criterion. The amount of support to MSMEs is also significant in a country with GDP per capita at US$4,329 in 2019, providing substantial support to MSMEs’ operational expenses during the crisis. Table 4.1: Estimated coverage of lines of credit (Component 1) Unlicensed Micro MSMEs entrepreneurs* Unlicensed MSMEs (Served Licensed MSMEs (Unbanked) by Saccos and MFBs) (Banked) Number of firms* 1,124,601 1,164,590 395,937 Share of firms that 83.5% 83.5% 81.7% apply** Active MSME Loan 1,700,000 ~703, 379 ~703, 379 Accounts*** Number of beneficiaries 23,333 - 500,000 3,579 – 20,000 118,781 Average size of funding $70 - $1500 - $1,000**** $1,000 - $5,588 per firm Total Amount of lines of $30 million $25 million credit *Note: Based on the MSME survey 2016 data **Note: This table includes demand for credit from MFIs, Saccos, Banks, Rotating Savings and Credit Associations, other formal/ Informal cooperatives, and mobile platforms (MSME Survey 2016). ***Note: Based on MNO 2020 data for unlicensed MSME loan accounts and CBK 2018 data for licensed MSME loan accounts ****Note: Assumption based on loan limit on unsecured loans by banks of US$1,000 Estimated coverage and allocation of CGS (Component 2) 2. The estimated scale of project support through the CGS is outlined in Table 4.2. The CGS could accommodate more resources from other donors and development partners such as the IFC by increasing the guarantee threshold. Currently the maximum loan limit under guarantee is capped at KES 5 million, which is below the median size of small and medium firms’ outstanding balance of credit from commercial banks 68. With more resources for the CGS, the guarantee loan limit could be increased to better support larger MSMEs. 68Bank financing of SMEs in Kenya, 2015 identifies thresholds of median size of firms’ loan sizes as KES 1 million for micro firms, KES 6.5 million for small firms, and KES 50 million for medium firms 81 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) Table 4.2: Estimated Coverage of the CGS (Component 2) MSMEs Number of Firms 395,937 Share of Firms with Access to Finance 30% Out of which, share receiving guarantee (based on expected utilization rates 75% Number of Firms with Access to Finance 118,781 Average Guarantee Amount (based on average MSME loan size by banks, CBK $5,000 2018) Guaranteed loans (US$) $1,000 - 5 million Guaranteed portion (25% of guaranteed loans) $30 million Leverage Multiple 4x $30 million in Y1; $70 Capital required million on Years 2 -3 *Source – National Treasury 82 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) ANNEX 5: The COVID-19 pandemic, the liquidity problem and rationale for MSME liquidity support COUNTRY: Kenya Supporting Access to Finance and Enterprise Recovery (SAFER) 1. COVID-19 and rationale for MSME liquidity support: Despite stable liquidity in the financial sector, it is unevenly distributed and not flowing to the MSMEs. Banks had started lending to the private sector at an increasing pace since the removal of interest rate caps in November 2019, but the momentum was slowed by the COVID-19 pandemic. Banks are now taking a cautious approach in extending fresh credit, in an environment where corporates and individuals are increasingly seeking extensions on their loan repayments, thus affecting MSME lending. Growth of private sector credit decreased to 7 percent in August 2021 compared to 8.3 percent in August 2020 (which was a slight increase from 6.3 percent in August 2019). At the peak of the COVID-19 pandemic, between March and July 2020, the growth of private sector credit declined from about 9.03 percent to 7.9 percent. At the same time, net credit to government has accelerated to 44.24 percent in August 2020 from 8.06 percent in March 2020, as the government switched to domestic sources to fund its widening budget deficit (including COVID-19 related spending). Segregated data from the World Bank COVID-19 Business Pulse Survey (2020) and information gathered by World Bank from key sector informants during project preparations indicates that two thirds of firms in Kenya experienced decreases in demand, cashflow and available finance with large variability in cash availability and access to credit amongst MSMEs and FIs. The lack of mechanisms to distribute and pool liquidity in the interbank money market has led to liquidity management problems for both commercial banks and Saccos. This challenge is further revealed in high and uneven spreads across different tiers of FIs across the board and high borrowing costs for MSMEs and informal sector borrowers. 2. Demand-side assessment of the liquidity problem: According to World Bank Business Pulse Survey (2020), the COVID-19 pandemic has affected firms through a range of transmission channels. Around two-thirds of MSMEs experienced decreases in demand, cash flow and available finance, while 62 percent of firms lament a decrease in hours worked and 54 percent of firms noted a decrease in the availability of inputs. The different transmission channels are affecting different types of firms in similar proportions, however medium-sized firms are the least often affected by any of the shock transmission channels. The survey also found that, on average a firm in Kenya can remain open for 18 weeks while the median firm can remain open for 20 weeks, indicating little variation between firms. Larger firms reported that they could remain open longer, given their larger reserves and better access to credit, which has made them more resistant than smaller firms. While Kenyan MSMEs can continue to cover costs for 47 days on average, the median MSME can cover costs only for 30 days. The large difference suggests a large variability in cash availability. This outturn places at risk livelihoods and wealth of households of ordinary Kenyans in hard-to-reach MSME market segments. According to the World Bank Enterprise Survey, access to finance was a challenge prior to the COVID-19 pandemic with the proportion of small firms that identified access to finance as a major constraint jumping from 15.1 percent in 2013 to 32.3 percent in 2018. The Project will target existing and new viable MSMEs that need liquidity support to tide over the downturn caused by the pandemic. In addition, the Project will use big data analytics to target these viable firms and to minimize the chances of funding zombie firms. 3. Supply-side assessment of the liquidity problem: Aggregate liquidity data in the commercial banking sector and interbank rates masks liquidity concentration and distribution challenges (Figure 5.1 83 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) and Figure 5.2). While the overall commercial banks liquidity levels meet the prudential levels 69, there remains a distribution challenge across the different tier banks. The large banks in tier 1 have maintained a liquidity ratio of 46.3 percent compared to an industry average of 49 percent in January 2019, this improved to 50.3 percent in August 2020 compared to an industry average of 53.25 percent. Medium banks in tier 2 have consistently maintained liquidity above the industry average from January 2019 (57.3 percent) to August 2020 (67.18 percent). In contrast, the small banks in tier 3 have been the worst hit by liquidity constraints although they are the most likely to lend to MSMEs. Tier 3 bank liquidity has remained below the industry average from January 2019 to August 2020 at 37.6 percent and 46.3 percent respectively. The interbank rate has been trending down for the most of 2017-19 consistent with increased liquidity availability in the money market, while the spreads between lending rates (Figure 5.3) remained high at 10 percent in 2019 and the cost of funds low at an average of 2.4 percent (Figure 5.4). While the cost of funds for large banks has remained consistently below the industry average throughout this review period, the cost for small banks has remained higher than the industry average, and that of medium banks has been in line with the industry average. These disparities in funding costs have affected the cost of borrowing to final borrowers and availability of funding to MSMEs. The average interbank rate decreased to 2.7 percent in October 2020, from about 5.1 percent in April 2020. In the quest to encourage more lending to the private sector, CBK reduced its key policy rate in January and March 2020 by a total of 100 basis points to 7.25 percent, followed by a 25 percent basis points cut in the policy rate cut in April to seven percent. The Cash Reserve Ratio (CRR) was reduced by 100 basis points to 4.25 percent in March 2020. These measures have contributed to the increase in aggregate liquidity in the system to 53.3 percent in August 2020, compared to 51.2 percent in April 2020. Figure 5.1: Industry liquidity Figure 5.2: Interbank and CBK rates Liquidity Ratio 91-day Treasury bill rate Interbank interest rate Minimum regulatory liquidity ratio 14% Average lending rate (Bank Loan & Advances) Loan-to-deposit ratio 12% CBR 100 10% 80 % 8% 60 6% 40 4% 20 2% 0 0% Aug-19 Sep-19 Oct-19 Nov-19 Dec-19 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20 Source: KBA, CBK. Source: KBA. 69 Statutory requirement of 20 percent 84 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) Figure 5.3: Spreads - average lending rates Figure 5.4: Cost of funds versus cost of funds Large banks Medium banks 6% 15.9% Small banks Industry average 15% 5% 14.1% 13.5% 4% 13.1% 13.1% 3% 10.5% 11.1% 2% 10% 1% 0% 2011 2012 2013 2014 2015 2016 2017 2018 2019 2011 2012 2013 2014 2015 2016 2017 2018 2019 Source: KBA. Source: KBA & CBK. 4. Regarding the Sacco sector, at 50.9 percent in 2019, aggregate liquidity in the Sacco sector was higher than the statutory minimum requirement of 15 percent. However, the low Cash Ratio (see Table 5.1 below) and high Loan-to-Deposit Ratio (LDR) (see Table 5.2 below) throughout 2020 shows that Saccos are highly leveraged and do not have enough cash liquidity or LDR headroom to cover additional borrowing requirements from mobilized deposits or internally generated funds to finance new requirements by MSMEs hard-hit by COVID-19. Members of farmer based Saccos, forming part of the Private Sacco Category, collect very limited savings and equally advance minimal amounts in credit facilities. At the core of the problem is the Sacco business model linking loans to savings and that loan demand far exceeds the volume of deposits that Saccos can capture. The deposit to total asset ratio has increased slightly from 68.1 percent in January 2020 to 69.3 percent in October 2020, while external borrowings has reduced slightly from 3.9 percent in January 2020 to 3.7 percent in October 2020. Table 5.1: 2020 Sacco Holdings of Cash and Cash Equivalents to Total Liabilities (Cash Ratio) Sacco Category Mar Jun Sep Community 19.5% 21.3% 19.9% Farmers 24.5% 29.8% 26.5% Government 12.3% 15.7% 13.7% Private 22.0% 25.9% 26.2% Teachers 10.9% 16.6% 14.4% Source: SASRA 5. The liquidity impacts of the COVID-19 pandemic on Saccos has been uneven depending on Sacco category and operating model. Government-based and Teacher-based Sacco members have continued to receive salaries from their employers and thus the severity of liquidity constraints has not been as that faced by Private-based and Farmer-based Saccos. All Sacco categories continue to rely heavily on deposits as a source of financing over external sources of financing which has also contributed to low levels of liquidity. 85 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) Table 5.2: 2020 Sacco Loan to Deposit Ratio (LDR) Sacco Category Mar Jun Sep Oct Community 121.2% 118.7% 123.4% 115.0% Farmers 109.5% 103.8% 109.2% 94.1% Government 106.7% 104.2% 106.5% 108.2% Private 93.9% 91.7% 95.9% 93.3% Teachers 120.2% 107.4% 111.6% 113.1% Source: SASRA 6. The Central Liquidity Facility (CLF) is one of the critical tools SASRA is working on under FSSP to help improve working capital management in the Sacco sector. By applying digital tools to centralize liquidity and other best practices such as pooling to gain improved visibility, Saccos will be able to substantially reduce financing costs and in turn enhance availability and affordability of finance to households and MSMEs. The envisioned digitalization and sharing of digital services under Sacco Central are expected to provide an added impetus to changing the underlying business model of Saccos and enhance their strategic positioning. 7. The introduction of the interest rate cap and closure of two commercial banks in 2016 disproportionately devastated micro-finance banks (MFBs) ability to raise funds and finance MSMEs. These effects persist to this day. MFBs experienced a significant deterioration in loan portfolio quality 70 due to the interest rate cap and “flight to safety” of deposits following the closure of two commercial banks in early 2016. This exacerbated the already weakening liquidity situation as NPLs and cost of funding correspondingly spiked. The impacts of these events have persisted – for example, one of the largest MFB is currently paying 13-14 percent for deposit placements of between three to six months and it’s cost of funding increased to 13 percent in 2019 from 11 percent in 2018. 71 Given the rapid deterioration of MFB loan portfolios, financing from international wholesale lenders also came to a halt. Capital investment when available (i.e., before the COVID-19 pandemic) from micro-finance investment vehicles (MIVs), i.e., arms of development finance institutions (DFIs) and private investment funds providing an efficient way of seeding capital to promising MFBs and bridging funding gaps, was priced at about 10 percent for investments longer than six months. The lack of access to medium to long-term capital investments has had a significant impact on the offering of loans to MSME by MFBs. 8. The Kenya FSSP is working on market infrastructure and structural reforms essential for the well-functioning of wholesale inter-bank mechanisms and efficient distribution of liquidity in Kenya. Investments in these reforms are being led by the CBK through the CSD initiative and SASRA through the Sacco Central initiative. These reforms will level the playing field, enhance broad-based access to common liquidity pools and ameliorate the funding spread issue. However, these benefits will be realized over the medium to long term as improvements in market functioning are consolidated over time impacting market conduct and practice. 70 More creditworthy SMEs, formerly clients of MFBs, could suddenly have access to better rates at commercial banks, while riskier SMEs were turned down by banks and had no other options than to apply for loans with entities like MFBs and credit-only MFIs. This increased the risk-profile of MFBs customers. 71 World Bank MFI/MFB Diagnostic Report, 2019 86 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) 9. Given the immediate risks/costs of the COVID-19 pandemic to life/health and livelihood/wealth, there is a possible role for an emergency government intervention in the short-term using market instruments to shore up cash and funding availability, and access to liquidity for MSMEs and FIs facing limited access to existing liquidity pools. At US$55 million, the proposed size for the facility is approximately 82.5 percent of the market demand as estimated by seven industry informants (six Saccos and one commercial bank). The proposed intervention is not a substitute for private capital or investment. It is designed to catalyze private capital mobilization by participating FIs through its “demonstration effects” as an added benefit layer thereby contributing to increased availability of funding to MSMEs on a sustainable basis. 87 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) ANNEX 6: A Sample of Previous Lines of Credit to Commercial Banks COUNTRY: Kenya Supporting Access to Finance and Enterprise Recovery (SAFER) Table 6.1: Summary of Commercial Bank borrowing rates Year-End Bank Loan Loan currency Lender Term Effective Rate Comments Currency (million) Not Equity US$ Not known AfDB 4-7 LIBOR +2.85% known years Not Equity US$ Not known IFC 4-7 LIBOR +3.15% known years Not Equity KES Not known KfW 4.00% This loan was known earmarked for the Smallholder Irrigation Program Mount Kenya Region 2011 Co-op Bank US$ 35.7 AFD 3.25% Original amount was not mentioned. The amount indicated is what has been withdrawn as of 2019 2012 Co-op Bank EUR 50 EIB 2.43% 2012 Co-op Bank US$ 60 IFC 5 years Not known but financing the small variable pegged and medium to LIBOR enterprises as well as the agribusiness sector - in December 2013 Co-op Bank US$ 52 DEG 5 years Not known but variable pegged to LIBOR 2015 Co-op Bank US$ 105 IFC 7 years Not known but Senior unsecured variable pegged loan to finance the to LIBOR growth of SMEs portfolio, WOEs portfolio and affordable housing - with 2-year grace period on principal repayment 2016 Co-op Bank US$ 50 AFD Not known but This was additional variable pegged finance for the 2011 to LIBOR loan 2019 Co-op Bank US$ 150 IFC 5.5 Not known but years variable pegged to LIBOR 2013 DTB US$ 20 IFC 7 years 2015 DTB US$ 20 IFC 8 years Subdebt 88 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) 2018 DTB US$ 25 AfDB 8 years Subdebt US$ Subdebt 2014 NCBA US$ IFC 7 Years Variable pegged to 6- month LIBOR 2014 NCBA US$ 35 IFC 7 Years 2016 NCBA US$ 54 EIB 7 Years Senior unsecured NCBA EUR 10 AFD NCBA US$ 66 AfDB 7 Years 2013 I&M US$ 50 IFC 7 Years 2014 I&M US$ 26 PROPAR 7 Years 2-year grace period CO 2014 I&M EUR 10 PROPAR 7 Years 1-Year grace period CO 2017 I&M US$ 7.4 Respons 3 Years 1-Year grace period ibility 2018 I&M US$ 15 FMO 4.5 Years 1-year grace period 2016 Family EUR EIB 5 Years 2016 Family US$ EIB 5 Years 2016 Family KES EIB 7 Years 8.85% Family KES OIKO 6 Years 10.00% Credit 89 The World Bank Supporting Access to Finance and Enterprise Recovery (SAFER) Project (P175017) ANNEX 7: Map of KENYA COUNTRY: Kenya Supporting Access to Finance and Enterprise Recovery (SAFER) 90