FOR OFFICIAL USE ONLY Report No: PADHI00668 INTERNATIONAL DEVELOPMENT ASSOCIATION PROJECT APPRAISAL DOCUMENT ON A PROPOSED CREDIT IN THE AMOUNT OF US$120 MILLION TO THE KYRGYZ REPUBLIC FOR A KYRGYZ REPUBLIC DEVELOPING A SUSTAINABLE FINANCE MARKET FOR MICRO-, SMALL-, OR MEDIUM ENTERPRISES (MSMES) PROJECT (P505643) MARCH 28, 2025 Finance, Competitiveness and Innovation Europe And Central Asia This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Exchange Rate Effective January 31, 2025 Currency Unit = US$ KGS 87.48 = US$1 FISCAL YEAR January 1 - December 31 Regional Vice President: Antonella Bassani Regional Director: Asad Alam Country Director: Tatiana A. Proskuryakova Practice Manager: Cecile Thioro Niang Task Team Leader(s): Emiko Todoroki, Tatiana Segal ABBREVIATIONS AND ACRONYMS AIIB Asian Infrastructure Investment Bank CLA Co-Lenders Agreement CLMU Credit Line Management Unit at the Ministry of Finance CPF Country Partnership Framework DA Designated Account DFIL Disbursement and Financial Information Letter F4D Finance for Development ESMS Environmental and Social Management System ES4MSMEs Emergency Support for MSMEs project FA Financing agreement FM Financial Management GDP Gross Domestic Product GF Open Joint Stock Company Guarantee Fund GFF Green Finance Fund GHG Greenhouse Gas GRS Grievance Redress Service IDA International Development Association IFC International Finance Corporation IFR Interim Unaudited Financial Report IMF International Monetary Fund IPF Investment Project Financing KGS Kyrgyzstani Som M&E Monitoring and Evaluation MOF Ministry of Finance MOEC Ministry of Economy and Commerce MSMEs Micro, Small, and Medium Enterprises NBKR National Bank of the Kyrgyz Republic NDC Nationally Determined Contribution NDFIs National Development Financial Institutions PDO Project Development Objective PFIs Participating Financial Institutions PPL Procurement Procedures Law POM Project Operational Manual PP Procurement Plan PPSD Project Procurement Strategy Document PRSF Portfolio Risk-Sharing Facility SDB State Development Bank SEP Stakeholder Engagement Plan SML Shorter Maturity Loan SUW Scale-Up Window WB World Bank WBES World Bank Enterprise Survey The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) TABLE OF CONTENTS DATASHEET ........................................................................................................................... i I. STRATEGIC CONTEXT ..................................................................................................... 1 A. Project Strategic Context .................................................................................................................1 B. Sectoral and Institutional Context ...................................................................................................1 II. PROJECT DESCRIPTION .................................................................................................. 6 A. Project Development Objective .......................................................................................................6 B. Theory of Change and PDO Indicators .............................................................................................6 C. Project Beneficiaries ........................................................................................................................7 D. Project Components ........................................................................................................................8 E. Role of Partners ..............................................................................................................................13 F. Lessons Learned and Reflected in the Project Design....................................................................14 III. PROJECT IMPLEMENTATION ........................................................................................ 15 A. Institutional and Implementation Arrangements ..........................................................................15 B. Results Monitoring, Evaluation, and Verification Arrangements ..................................................16 C. Disbursement Arrangements .........................................................................................................17 IV. PROJECT APPRAISAL SUMMARY .................................................................................. 17 A. Technical, Economic and Financial Analysis (if applicable)............................................................17 B. Fiduciary .........................................................................................................................................18 C. Environmental, Social and Legal Operational Policies ...................................................................20 V. KEY RISKS .................................................................................................................... 21 ANNEX 1. RESULTS FRAMEWORK ........................................................................................ 23 ANNEX 2: National Development Financial Institutions and Financial Intermediary Financing Due Diligence .......................................................................................................... 28 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) @#&OPS~Doctype~OPS^dynamics@padbasicinformation#doctemplate DATASHEET BASIC INFORMATION Project Operation Name Beneficiary(ies) Kyrgyz Republic Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs Environmental and Social Risk Operation ID Financing Instrument Classification Investment Project P505643 Moderate Financing (IPF) @#&OPS~Doctype~OPS^dynamics@padprocessing#doctemplate 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 [ ] Alternative Procurement Arrangements (APA) [ ] Hands-on Expanded Implementation Support (HEIS) Expected Approval Date Expected Closing Date 15-May-2025 31-Dec-2030 Bank/IFC Collaboration No Proposed Development Objective(s) To support the development of a sustainable finance market for MSMEs by mobilizing green and other sustainable private finance and building the capacity of financial institutions. Components i The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) Component Name Cost (US$) Green and Sustainable Finance 110,000,000.00 Green Guarantees 59,000,000.00 Project Implementation and Sustainable Finance Capacity Building 1,000,000.00 @#&OPS~Doctype~OPS^dynamics@padborrower#doctemplate Organizations Borrower: The Kyrgyz Republic Contact Title Telephone No. Email Almaz Baketaev Minister of Finance +996 (312) 664036 minfin@minfin.kg Malik Abakirov Chairman of the Guarantee +996 (312) 625379 abakirov@gf.kg Fund Meder Temirbekov CEO +996 (312) 998080 mtemirbekov@sdb.kg Implementing Agency: The Ministry of Finance Contact Title Telephone No. Email Bermet Musakozhoeva Director of the CLMU +996 (312) 666001 b.muzakozhoeva@piu.kg @#&OPS~Doctype~OPS^dynamics@padfinancingsummary#doctemplate PROJECT FINANCING DATA (US$, Millions) Maximizing Finance for Development Is this an MFD-Enabling Project (MFD-EP)? Yes Is this project Private Capital Enabling (PCE)? Yes SUMMARY Total Operation Cost 170.00 Total Financing 170.00 of which IBRD/IDA 120.00 Financing Gap 0.00 DETAILS ii The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) World Bank Group Financing International Development Association (IDA) 120.00 IDA Shorter Maturity Loan (SML) 120.00 Non-World Bank Group Financing Other Sources 50.00 Asian Infrastructure Investment Bank 50.00 IDA Resources (US$, Millions) Guarantee Credit Amount Grant Amount SML Amount Total Amount Amount Scale-Up Window 0.00 0.00 120.00 0.00 120.00 (SUW) Total 0.00 0.00 120.00 0.00 120.00 @#&OPS~Doctype~OPS^dynamics@paddisbursementprojection#doctemplate Expected Disbursements (US$, Millions) WB Fiscal Year 2025 2026 2027 2028 2029 2030 2031 Annual 0.20 15.00 30.00 30.00 16.00 18.00 10.80 Cumulative 0.20 15.20 45.20 75.20 91.20 109.20 120.00 @#&OPS~Doctype~OPS^dynamics@padclimatechange#doctemplate PRACTICE AREA(S) Practice Area (Lead) Contributing Practice Areas Finance, Competitiveness and Innovation Climate Change CLIMATE Climate Change and Disaster Screening Yes, it has been screened and the results are discussed in the Operation Document iii The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) @#&OPS~Doctype~OPS^dynamics@padrisk#doctemplate SYSTEMATIC OPERATIONS RISK- RATING TOOL (SORT) Risk Category Rating 1. Political and Governance ⚫ Moderate 2. Macroeconomic ⚫ Moderate 3. Sector Strategies and Policies ⚫ Substantial 4. Technical Design of Project or Program ⚫ Substantial 5. Institutional Capacity for Implementation and Sustainability ⚫ Substantial 6. Fiduciary ⚫ Moderate 7. Environment and Social ⚫ Moderate 8. Stakeholders ⚫ Moderate 9. Overall ⚫ Moderate @#&OPS~Doctype~OPS^dynamics@padcompliance#doctemplate POLICY 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 Environmental and Social Standards Relevance Given its Context at the Time of Appraisal E & S Standards Relevance ESS 1: Assessment and Management of Environmental and Social Risks and Relevant Impacts ESS 10: Stakeholder Engagement and Information Disclosure Relevant ESS 2: Labor and Working Conditions Relevant iv The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) ESS 3: Resource Efficiency and Pollution Prevention and Management Relevant ESS 4: Community Health and Safety Relevant ESS 5: Land Acquisition, Restrictions on Land Use and Involuntary Resettlement Not Currently Relevant ESS 6: Biodiversity Conservation and Sustainable Management of Living Natural Relevant Resources ESS 7: Indigenous Peoples/Sub-Saharan African Historically Underserved Not Currently Relevant Traditional Local Communities ESS 8: Cultural Heritage Relevant ESS 9: Financial Intermediaries Relevant 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). @#&OPS~Doctype~OPS^dynamics@padlegalcovenants#doctemplate LEGAL Legal Covenants Sections and Description Financing Agreement, Schedule 2, Section I.A.1. The Recipient shall establish, not later than sixty (60) days from the Effective Date and thereafter maintain during Project implementation, a Steering Committee with composition, qualifications and terms of reference satisfactory to the Association, to serve as the oversight and approval body, which shall be responsible for strategic guidance, coordination, and implementation support, as further detailed in the Project Operations Manual. Financing Agreement, Schedule 2, Section I.A.2. The Recipient shall maintain, at all times during Project implementation, the CLMU, with composition, functions, qualified staffing and resources satisfactory to the Association and set out in the Project Operations Manual, and which shall be responsible for, inter alia: (i) preparing annual work plans; (ii) processing procurement, financial management, environmental and social impact management; and (iii) monitoring and evaluation of the Project. Financing Agreement, Schedule 2, Sections I.A.3, I.B.1(b) and I.C.2. The Recipient shall adopt, and thereafter maintain, throughout the period of Project implementation, the Project Operations Manual. The Recipient shall (i) cause SDB to adopt, and thereafter, maintain and carry out the Project in accordance with the Sustainable Finance Procedural Manual; (ii) cause GF to adopt, and thereafter, maintain and carry out the Project in accordance with the Green Guarantee Procedural Manual; and (iii) ensure that SDB cause GFF to adopt, and thereafter, maintain and carry out the Project in accordance with the Green Finance Fund Manual; all as acceptable to the Association. Financing Agreement, Schedule 2, Section I.B.1. The Recipient shall make the proceeds of the Credit available to SDB and GF in accordance with the Subsidiary Loan Agreements under terms and conditions acceptable to the Association, including specifically those set forth in this Section. Financing Agreement, Schedule 2, Section I.B.4. The Recipient shall cause SDB and GF to make the proceeds of the Credit available only to PFIs selected in accordance with the eligibility criteria as set forth in this Section and the Project Manual. v The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) Financing Agreement, Schedule 2, Sections I.B.5 and I.B.6. The Recipient shall cause SDB and GF to make the proceeds of the Credit available to PFIs in accordance with the agreements between SDB and PFIs and between GF and PFIs under terms and conditions acceptable to the Association including specifically those set forth in these Sections. Financing Agreement, Schedule 2, Section I.B.7. The Recipient shall cause SDB and GF to ensure that PFIs shall make the proceeds of the Credit available only to MSMEs selected in accordance with the eligibility criteria as set forth in this Section and the Project Manuals. Financing Agreement, Schedule 2, Section I.B.7. The Recipient shall cause SDB and GF to ensure that PFIs shall make the proceeds of the Credit available only to MSMEs selected in accordance with the eligibility criteria as set forth in this Section and the Project Manuals. Financing Agreement, Schedule 2, Section I.B.8. The Recipient shall cause SDB and GF to ensure that PFIs shall make the proceeds of the Credit available to MSMEs in accordance with the agreements between PFIs and MSMEs under terms and conditions acceptable to the Association including specifically those set forth in this Section. Financing Agreement, Schedule 2, Section I.C. The Recipient shall cause SDB to: (i) make the proceeds of the Credit available to GFF in accordance with the agreement between SDB and GFF under terms and conditions acceptable to the Association, including specifically those set forth in Section I.C.4 of this Schedule 2; and (ii) ensure that the establishment and implementation of the GFF in accordance with the terms and conditions acceptable to the Association, including specifically those set forth in this Section. Financing Agreement, Schedule 2, Section I.F. The Recipient shall ensure that the Project is carried out in accordance with the ESSs and the ESCP, in a manner acceptable to the Association. @#&OPS~Doctype~OPS^dynamics@padconditions#doctemplate Conditions Type Citation Description Financing Source The Recipient, through MOF, has adopted the Project Operations Manual Effectiveness Article V. 5.01 IBRD/IDA (“POM”) in form and substance satisfactory to the Association. Under Category (1), no withdrawal shall be made unless and until the Association has received satisfactory evidence that: (i) the Sustainable Finance Schedule 2. Section III. B.1 Disbursement Procedural Manual has IBRD/IDA (b) been adopted by the SDB in form and substance satisfactory to the Association; and (ii) the Subsidiary Loan Agreement for Part 1.1 of the Project vi The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) has been duly executed by the Recipient and the SDB Under Category (2), no withdrawal shall be made unless and until the Association has received satisfactory evidence that: (i) GFF has been established in accordance with Section I.C.1 of Schedule 2 of the Financing Agreement; (ii) a fund manager has been selected Schedule 2. Section III. B.1 in accordance with Section Disbursement IBRD/IDA (c) I.C.3 of Schedule 2 of the Financing Agreement; and (iii) the GFF Manual has been adopted by GFF in accordance with Section I.C.2 of Schedule 2 of the Financing Agreement; (iv) the Subsidiary Loan Agreement for Part 1.2 of the Project has been duly executed by the Recipient and the SDB. Under Category (3), no withdrawal shall be made unless and until the Association has received satisfactory evidence that: (i) the Green Guarantee Procedural Manual has Schedule 2. Section III. B.1 Disbursement been adopted by the IBRD/IDA (d) Guarantee Fund in form and substance satisfactory to the Association; and (ii) the Subsidiary Loan Agreement has been duly executed by the Recipient and the Guarantee Fund. vii The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) viii The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) I. STRATEGIC CONTEXT A. Project Strategic Context 1. The Kyrgyz Republic is highly vulnerable to climate change and natural disasters, driving vulnerable populations in rural areas that depend on natural resources for their livelihoods to face increasing risks. The Kyrgyz Republic has identified climate change impacts as a significant challenge to its development goals and has identified its water, energy, agriculture, and infrastructure sectors as the most vulnerable to climate change1. While the Kyrgyz Republic’s contribution to global GHG emissions is small, heavy use of coal for heating contributes to the country having one of the world's highest winter air pollution rates, severely impacting local health. Strengthening climate change mitigation and adaptation mechanisms, including more efficient management of natural resources, investments in adaptation, and reducing emissions in energy and agriculture, are needed to strengthen the resilience of livelihoods and ecosystems and present an opportunity to support a more diversified, greener growth path. 2. The Kyrgyz Republic, a land-locked, lower-middle-income country in Central Asia, was hit hard by the pandemic in 2020. The real GDP fell by 7.1% in 2020. The economy began recovering with real GDP growth of 5.5% in 2021 and then 9% during 2022-24, exhibiting high resilience to internal and external shocks, including Russia’s invasion of Ukraine. However, the real GDP growth is projected to decelerate to 6% in 2025 and normalize at around 5.5 percent - the new potential growth rate of the Kyrgyz economy. 3. Poverty in the country increased during the COVID-19 pandemic, and it remains elevated despite the strong growth. The COVID-19 pandemic increased the poverty rate (measured at US$ 3.65/ day) from 9.7% in 2019 to 15% in 2020. The poverty rate decreased slightly in the following years but remained relatively high, lingering around 12.5% in 2021 and around 13% in 20222. Poverty in the Kyrgyz Republic has strong gender and spatial dimensions, being particularly high in female-headed households, rural populations, and “lagging” regions. Inequality has steadily fallen. The Gini coefficient closely followed the poverty trends; in 2022, it stood at around 26.4%.3 Moreover, the World Bank's shared prosperity indicator shows that growth was fairly inclusive, with consumption growth for the bottom 40% of the income distribution exceeding that of the average across the whole income distribution B. Sectoral and Institutional Context 4. A robust and sustainable economic growth and development in the Kyrgyz Republic requires addressing rising climate and environmental risks and taking advantage of opportunities for green growth4. The Kyrgyz Republic is not a major emitter of GHGs. However, the country commits to reducing GHG emissions by 36.61% by 2025 and 43.62% by 2030 (the conditional emissions reduction targets), and to 16.63% by 2025 and by 15.97% by 2030 (unconditional emissions reduction targets), compared to business as usual, as outlined in its NDC. The NDC also includes ambitious adaptation measures, given the country’s vulnerability to physical risks, including those induced and exacerbated by climate change, such as floods, landslides, and droughts. Given the Kyrgyz Republic's significant vulnerability to natural disasters and the economy's dependence on high-emission sectors, sustainable finance can serve as a critical instrument in facilitating the 1 https://climateknowledgeportal.worldbank.org/country/kyrgyz-republic 2 Ibid. 3 https://data.worldbank.org/indicator/SI.POV.GINI?locations=KG 4 Here green growth refers to an economic strategy that prioritizes sustainable development, where natural resources are used responsibly, carbon emissions are reduced, and ecosystems are protected, while balancing social equity and governance standards. Page 1 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) green transition and enhancing resilience, particularly against extreme events exacerbated by climate change.5 The primary challenge in adopting sustainable finance practices is the limited expertise and awareness of sustainable finance opportunities among enterprises in the real sector and financial institutions, which leads to an inadequate supply of relevant financial products. This issue is further exacerbated by the high costs associated with green certifications and compliance. Additionally, the Government spending on climate-related actions has been low and falls short of financing commitments stipulated in the Nationally Determined Contribution (NDC). Meeting climate commitments under the updated NDC would be costly, with estimated financing required in the range of US$10 billion, of which 37% would come from domestic resources6. 5. Efforts are underway to create an enabling environment for sustainable finance. The National Bank of the Kyrgyz Republic (NBKR) issued guidelines on Environment, Social, and Governance (ESG) risks assessment in the banking sector in October 20237. It is currently developing a sustainable finance roadmap for the financial sector with the World Bank's assistance. The Kyrgyz Stock Exchange has joined the Sustainable Stock Exchange Initiative and issued Sustainable Reporting Guidelines for listed companies in 2023. The market has seen one green bond and one gender bond issued in the Kyrgyz Republic in 2022 and 2023, respectively, by two local commercial banks and listed on the Kyrgyz Stock Exchange (KSE) 8. The KSE has also selected domestic and international service providers to ensure proper verifications for future issuances. 6. The Government is also in the process of finalizing the national green taxonomy, green budgeting, and the regulation for a GFF. The Ministry of Economy and Commerce (MoEC) is leading the national green taxonomy development effort, supported by the World Bank and other donors9. The taxonomy is crucial in the context of the Kyrgyz Republic due to the benefits associated with greater standardization, improved risk management, streamlined regulatory compliance, and enhanced transparency and disclosure.10 However, the taxonomy is expected to be rolled out in phases, with the initial phase covering Energy, Transport, Energy Efficiency, Waste Management, Water Management, and Agriculture. The Ministry of Finance is leading green budgeting and issued Green Budget Tagging Guidelines in September 2024 with the World Bank's technical assistance. The GFF, the Kyrgyz Republic government’s special purpose vehicle under development to mobilize funding for green and sustainable projects, is also expected to provide important contributions, utilizing alternative finance instruments such as equity investment and long-term lending. The MoEC is finalizing the regulation for the GFF for approval by the Cabinet of Ministers. The Climate Finance Center, a government organization under the Cabinet of Ministers, coordinates the activities/projects funded by global climate funds with EBRD technical support. Several line ministries also lead sector-specific green finance programs (e.g., Green Energy Fund, sustainable agriculture program) supported by donors. 5 Sustainable finance, as defined here, encompasses a broad scope, including funding allocated to projects that take into account environmental, social and governance (ESG) considerations, including but not limited to adopting climate adaptation or mitigation measures, enhancing social and governance standards, and promoting sustainable economic activities towards achievement of the Sustainable Development Goals (SDGs). More details relevant to the context of the project are in paragraph 9. 6 Updated Nationally Determined Contribution 2021 (pages 6-7), incorporating both mitigation and adaptation measures. 7 The Guidelines specify minimum standards that banks should meet for the sound management of ESG risks within the current prudential framework and recommend how banks can integrate ESG into their business planning and environment, organizational structures, internal governance, and risk- management frameworks. The Guidelines are based on international best practices and have also considered standards issued by other central banks. 8 https://www.kse.kg/en/Sustainable 9 The World Bank provided technical support in the first phase and is also providing a review of the document and sharing best practices with the Government. 10 The green taxonomy outlined herein encompasses a systematic framework for categorizing economic activities as environmentally sustainable, based on well-defined objectives, technical criteria, and adherence to international standards. Page 2 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) 7. Kyrgyz National Development Financial Institutions (NDFIs) can play an instrumental role in kick-starting sustainable finance markets in the country. Kyrgyz NDFIs should benchmark themselves against the global practice, where NFDIs provide close to 20% of the total climate finance.11 In this regard, the SDB and the Open Joint Stock Company (OJSC) GF have a critical role in facilitating the establishment of a sustainable finance market by narrowing the large financing gap that exists in the Kyrgyz Republic.12 8. The SDB and the GF are working towards becoming green financial institutions. SDB finalized and approved its policy on green financing and sustainable development in April 2024. It has subsequently developed operational policies and guidelines for green finance products, including financial instruments and services designed to support environmentally sustainable projects, promote low-carbon initiatives, and align with global sustainability standards. In addition, SDB adopted an internal green taxonomy and launched a direct green investment facility and a wholesale green loan program with commercial banks in August 202413. The GF has also introduced a green credit guarantee product for individual entrepreneurs14 and is building up its internal capacity for implementation. This is timely as Kyrgyz financial institutions are building up sustainable finance capacity and offering some green financing products. The Union of Banks, as an association of banks and as a member of the IFC-led Sustainable Banking and Finance Network (SBFN), has developed knowledge-sharing and capacity-building programs for member banks on ESG risks assessment, sustainable finance, disclosure and reporting with international partners and donors since 2017. It has recently established the ESG Academy as a training center for financial institutions in April 2024, supported by IFC. 9. The SDB and the GF must serve as catalysts in fostering a sustainable finance market closely aligned with the Sustainable Development Goals (SDGs). Sustainable finance in this project context encompasses a broader concept, including climate finance and green finance (Chart 1). Sustainable finance projects consider environmental, social, and governance (ESG) considerations, including but not limited to adopting climate adaptation or mitigation measures, enhancing social and governance standards, and promoting sustainable economic activities toward achieving the Sustainable Development Goals (SDGs). Chart 1: Definition of Sustainable Finance Source: World Bank Staff and UNFCCC 11The World Bank, Finance and Prosperity. https://www.worldbank.org/en/publication/finance-and-prosperity-2024 12GF is currently owned but at the same time supervised by NBKR, creating conflict of interest. Therefore, preliminary agreement was reached with the authorities under the DPO discussions to transfer the ownership function to MoF. 13. SDB Targeted financing program with green criteria through partner banks and other FIs: https://sdb.kg/en/for-clients/targeted-financing- program-for-projects-in-accordance-with-green-criteria-through-partner-banks-and-other-fis/ 14 GF Guarantee Product: Passport Green https://gf.kg/en/pasport-green/ Page 3 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) 10. The project’s focus on MSMEs is also motivated by the firm clustering and labor concentration in the most polluting sectors, such as agriculture and industry. About 40% of the country's labor force is employed in the agriculture businesses. Both SDB and GF are given clear mandates by the government to provide financing to MSMEs. MSMEs contribute to 90% of job creation and 43% of GDP in the Kyrgyz Republic, according to national statistics in 2022. However, access to credit for growth and investment has been a major challenge for MSMEs in the country. The World Bank Business Enterprise Survey 2023 indicates that while 97.4% of firms have an account at a financial institution, only 13.3% of firms use banks to finance investments. This figure is much worse for small businesses at a mere 1%.15 Further, the green module undertaken in the World Bank Business Enterprise Survey 2019 exhibits that the Kyrgyz Republic firms are prone to losses due to extreme weather events, much more so than other European and Central Asian countries. About 13% of the Kyrgyz Republic firms experienced monetary losses due to extreme weather events compared with 3 or 4% of firms in less affected countries (see Figure 1). In 2023, firms reported that extreme weather events amounted to 17% of sales. 11. Alternative financial instruments and investment schemes to support MSMEs, especially innovative start-ups, are under development in the Kyrgyz Republic. Financial support channeled and intermediated by NDFIs will reach MSMEs and firms mainly through local banks, given their dominance in the financial markets in the Kyrgyz Republic. However, the recent development of non-bank financial institutions shows that their role in sustainable finance market development, especially in mobilizing private investment through alternative investment schemes such as private equity and other capital market instruments can be further nurtured. The MoEC and Kyrgyz Stock Exchange are developing a legal framework for alternative investment schemes. Several donor-sponsored private equity investment funds target start-ups and SMEs active in the market. For example, Highland Private Equity and Mezzanine Fund16, which was set up in 2018 with IFC and EBRD as co-investors and with US$15 million in capital commitments, was the first institutional private equity fund in the country. The Fund provided critical growth capital of US$800,000 to US$5 million to local SMEs in services, agricultural processing, health, education, telecommunications, media, and technology. USAID and the Russian- Kyrgyz Development Fund have also set up private equity or venture capital funds for start-ups or SMEs as pilot operations, some targeting specifically for green technologies. 15The World Bank, Enterprise Survey (2023). https://www.enterprisesurveys.org/content/dam/enterprisesurveys/documents/country/Kyrgyz- Republic-2023.pdf 16 IFC Partners with Highland Capital to Support Small and Medium Enterprises in the Kyrgyz Republic, 2018 https://www.worldbank.org/en/news/press-release/2018/09/18/ifc-partners-with-highland-capital-to-support-small-and-medium-enterprises-in-the-kyrgyz-republic Page 4 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) Figure 1: Environmental impact on firms % of firms experienced monetary losses due to extreme weather events 17 12. A particular focus on social and gender issues is also important, given it is a priority for the government and the World Bank Group. Women-led MSMEs (WMSMEs) in the Kyrgyz Republic face significant barriers in accessing finance, with only 14.8% of WMSMEs holding a bank loan or line of credit, compared to 37.5% in ECA.18 91% of loans require collateral, disproportionately affecting women, who own only 29% of registered property.19 Loan rejection rates are more than double for women-led firms (10.2% vs. 4.2% for male-led firms), and 34.3% of WMSMEs are fully credit constrained (WBES 2023). Limited financial literacy, discriminatory lending practices, and sectoral concentration in low-margin industries like trade and textiles further restrict their access to finance.20 Access to green finance is even more limited, with few tailored products for WMSMEs, high interest rates, and a lack of awareness and technical expertise to develop bankable green projects.21 13. Providing targeted financing to MSMEs and individual entrepreneurs for their green transition and improving their resilience to climate change are aligned with the National Green Economy Strategy. MSMEs need to transition to low-carbon and climate-resilient businesses and adopt green technologies, including eco-design, additive manufacturing, material substitution, remanufacturing, and reducing yield loss. However, the negative effects of this process on certain sectors and regions, such as job and income losses that can lead to broader economic and social disruptions, should be considered to ensure the 'just' transition.22 MSMEs should focus on environmental compliances to boost export 17 Enterprise surveys, green module (2019). 18 WBES 2023 19 WBES 2023; FCI Market Research 2022 20 OSCE Academy 2024; UN Factsheet 21 Household Survey on Green Finance; UNDP 2023 22 In this context, a just transition refers to the process of shifting towards a sustainable, low-carbon economy in a manner that is equitable and inclusive, ensuring that the social and economic impacts on individuals, communities, and industries are mitigated and that opportunities for fair employment, social protection, and economic diversification are provided. Page 5 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) competitiveness. The sustainable finance ecosystem is still at a very nascent stage, and the provision of sustainable finance is extremely limited, although efforts are underway to expand sustainable finance in the financial sector. In early 2024, only two or three banks had green products that emerged in the last few years. While liquidity in the banking system is high, the maturity profile of liabilities, predominantly composed of demand deposits, restricts long-term lending, with 70% of loans having tenors of three years or less. Consequently, there is a misalignment between demand and supply, as the return periods of green investments tend to be longer than the average maturity of these loans. In addition, the green finance portfolio is almost non-existent, with only US$ 10 million or 0.038% of the banking sector’s credit portfolio, as per NBKR data at the end of February 202423. 14. The market readiness for creating and developing a sustainable finance market has significantly improved quickly, as observed by the increasing number of banks and MFIs considering offering sustainable finance services. As of June 2024, an additional 5-6 commercial banks and several MFIs are already at an advanced stage of product design or actively seeking to offer sustainable finance products. Nonetheless, concerted efforts are needed to scale the market and support MSMEs so that they are not left out but become competitive in the local, regional, and global markets. 15. This is the first lending operation using an Apex financial institution for an IDA operation in the country. The project's main policy objective is to establish a sustainable finance market that can foster the country’s transition to a more green, resilient, and inclusive development pathway. Main support measures include the provision of long-term wholesale funding, introducing green guarantees, and building capacity for major stakeholders such as SDB and GF. By leveraging the skills, knowledge and competency of these development financial institutions, the project will introduce a degree of innovation and a market-based line of credit operation reflecting risk-based pricing. The project will build on an ongoing highly satisfactory ES4MSMEs Project24, providing access to finance to cope with and recover from ongoing crises, as well as the Enhancing Financial Stability and Promoting Innovative Finance and Inclusion in the Kyrgyz Republic (P501279), which includes a component for the provision of Technical Assistance to SDB and GF to build their institutional capacity. II. PROJECT DESCRIPTION A. Project Development Objective To support the development of a sustainable finance market for MSMEs by mobilizing green and other sustainable private finance and building the capacity of financial institutions. B. Theory of Change and PDO Indicators 23 In the absence of national green taxonomy, a few banks have moved ahead by classifying green finance products accredited by global organizations like the Green Climate Fund (https://www.greenclimate.fund). Further, following the issuance of the ESG guidelines by NBKR in October 2023, more banks are also designing green finance products. The World Bank team assisted the NBKR in developing this guideline, using international standards, including the Basel Committee’s Banking Supervision Principles for the effective management and supervision of climate- related financial risks. 24 P174028 Emergency Support for MSMEs Project approved by the WBG Board of Executive Directors on July 30, 2020. Page 6 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) Challenges Activities Outputs Immediate outcomes Medium term Long term outcomes outcomes Limited expertise and awareness of Finance MSME sustainable finance Green Finance Fund Window of the Green opportunities in both became operational Finance Fund Provision of real and financial sectors sustainable finance products increased Provide wholesale Wholesale co- Inadequate supply of funding and help PFIs financing on green and sustainable develop sustainable sustainable and green finance products Market for climate Kyrgyz’s transition to a finance products finance Private capital and sustainable more green, resilient, mobilized through finance for MSMEs and inclusive Participating Financial and start-ups well development pathway Support Guarantee Green Guarantee Institutions established. is fostered High costs of green Fund (GF) to establish Products introduced certifications and green guarantee in the Kyrgyz financial compliance products market MSMEs become More banks and bankable from the Limited government Support to MSMEs formed perspective of support and government agencies, linkages with financial institutions incentives to promote PFIs, and financial prominent local and the sustainable markets participants multinational finance market corporations PDO Level Indicators (i) an increased share of sustainable finance in the financial sector; and (ii) the number of financial institutions that offer new sustainable finance products to MSMEs. C. Project Beneficiaries 16. The project beneficiaries are MSMEs and Financial Institutions. MSMEs are direct beneficiaries of the Project. They will have better access to sustainable finance to transition to a green economy, including adjusting their products and services. Financial institutions are also direct beneficiaries of the Project, as their capacity to design sustainable finance operations and products will be built. Overall, the Kyrgyz financial sector will also benefit from the project as the market for sustainable finance is further developed. 17. For the purpose of the Project, MSMEs are defined as follows based on the definition used in the ES4MSMEs project (P174028); however, the threshold may change if the applicable legislations change or the project requires such a change. Micro-entrepreneurs are individual entrepreneurs who conduct entrepreneurial activities without forming a legal entity. Micro-entrepreneurs may operate under a nominal taxation sachem. They may operate under a document certifying the conducting of business activities in accordance with the tax legislation of the Kyrgyz Republic. As per the current definition in the Tax Code, the annual turnover of micro-entrepreneurs may not exceed KGS 8 million. Micro- entrepreneurs may only pursue certain types of activities in accordance with the Procedural Manual and legislation of the Kyrgyz Republic. Small enterprises are better structured and may operate under various taxation schemes (simplified taxation, general taxation schemes, tax contracts, or other methods, according to tax legislation). They include all other types of individual entrepreneurs with annual turnover from KGS 8 million to KGS 30 million who must maintain accounting record-keeping, as well as legal entities, the turnover of which may not exceed KGS 30 million as per the current definition in the Tax Code. Women-led MSMEs are defined as those where women own at least 51% of the business or Page 7 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) women own at least 20% and hold a senior executive role (e.g., CEO or COO), and the company’s board is at least 30% women (if a board exists). D. Project Components 18. The proposed project of US$170 million includes co-financing by AIIB and consists of three components. The WB will provide an IDA credit in the amount of US$120 million. The AIIB will provide a joint co-financing loan in the amount of US$50 million, entering into a CLA with the WB. The AIIB co-financing is expected to be available by January 30, 2026, to finance Component 1 of the Project jointly. The WB will carry out all services under the CLA, including inter alia Environmental and Social Services, Procurement Services, Financial Management (FM), and Disbursement Services in accordance with its policies and procedures. Table 1. Summary of Project Components and Costs (US$ millions) Project Component WB AIIB Total Component 1: Green and Sustainable Finance 60 50 110 Subcomponent 1.1: Wholesale Co-financing to 55 45 100 Participating Financial Institutions Subcomponent 1.2: Financing for the GFF 5 5 10 Component 2: Green Guarantees 59 0 59 Subcomponent 2.1: Green PRSF for eligible MSMEs 20 0 20 Subcomponent 2.2: Green Partial Credit Guarantees for 39 0 39 individual loans for eligible MSMEs Component 3: Project Implementation and Sustainable 1 0 1 Finance Capacity Building Total 120 50 170 19. The proposed project will contribute to creating a market for sustainable finance for new and existing MSMEs by leveraging the NDFIs. The SDB and the GF will play a catalytic role in narrowing the large green and other sustainable financing gap by mobilizing private capital. At the same time, the project will build the capacity of Participating Financial Institutions (PFIs) to develop an Environment and Social Management System (ESMS) aligned with national standards and the World Bank framework. The NBKR issued ESG Guidelines for the banking sector in October 2023. Integrating sustainability into banks’ credit risk management is vital, as most financial intermediation in the Kyrgyz Republic occurs through banks. Therefore, banks will be required to perform self-assessments and prepare action plans per the NBKR’s guidelines. When the national green taxonomy (NGT) is finalized, banks must also align with NGT. 20. Ultimately, the project will support the social and economic development of the Kyrgyz Republic in a sustainable manner by financing MSMEs to adopt environmentally sustainable practices and enhance climate resilience. This includes promoting renewable energy, improving energy efficiency, supporting sustainable agriculture, constructing climate-resilient buildings, restoring ecosystems to preserve biodiversity, and implementing water conservation measures. These initiatives aim to address the immediate climate challenges while fostering long-term environmental sustainability and economic prosperity. Moreover, NDFIs will ensure that women and vulnerable populations are not left out in adapting to climate change and transitioning to a green economy. Page 8 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) 21. Given that only 13.3% of firms with an account at a financial institution use banks to finance investments, the project will contribute to enabling more women entrepreneurs to access finance. Sustainable finance includes elements of social and gender-based financing. Financial institutions that focus on and prioritize social and gender-based financing will have access to project financing on a priority basis. A few banks in the Kyrgyz Republic already provide specialized products for women. As part of outreach to PFIs, the project will encourage SDB and GF, as implementing agencies of Components 1 and 2, respectively, to reach out to potential PFIs to develop products that target women entrepreneurs or expand if such products are already offered. In addition, the project will leverage parallel TA provided through the F4D partnership and Women Entrepreneurs Finance Initiative (We-Fi), in close coordination with other development partners, to build the capacity of more financial institutions to provide financial products suitable for women entrepreneurs. Planned activities under the We-FI initiative also include collaboration with NBKR to establish gender-disaggregated regulatory reporting standards. These efforts aim to catalyze the sustainable finance market, mobilize private investments25 by supporting product development, diversifying funding sources, and strengthening climate risk management. Component 3 of the project will include complementary capacity building for PFIs to improve WMSMEs’ awareness and capacity to use financial instruments offered by the project. 22. To effectively implement the credit line and guarantee facilities, especially targeting MSMEs owned and/or managed by women, the project will leverage the Women-in-Finance (We-Fi curriculum), customizing it for the Kyrgyz Republic context and be reflected in the Project Procedural Manuals for Components 1 and 2. This project will build on the approach towards MSMEs owned and/or managed by women taken by the ongoing ES4MSMEs project, which overachieved the 50% target of the indicator monitoring the percentage of women benefitting from the financial services provided under the project. The ES4MSMEs project designed and implemented a targeted outreach to many WMSMEs to raise awareness and explain the application process to access finances offered under that project. At the same time, the requirements for accessing financing were tailored for WMSMEs represented by predominantly individual and micro entrepreneurs. The PIU developed a WMSMEs’-focused monitoring system to track WMSMEs’ participation and collect their ongoing feedback for any targeted adjustments. 23. Component 1 will be implemented by the SDB, Component 2 by the GF, and Component 3 by the MOF CLMU. The funding is expected to come from the IDA Scale-Up Window Shorter Maturity Loan in the case of IDA financing. Participating Financial Institutions (PFIs) will be commercial banks and, in some cases, microfinance institutions and credit unions if they meet the PFI criteria, which will be detailed in the Project’s procedural manual. PFIs may participate in both Components 1 and 2 or only one component. 24. Component 1: Green and Sustainable Finance (US$110 million, out of which the WB co-finances US$60 million and the AIIB co-finances US$ 50 million). This component will provide i) wholesale sustainable finance to mobilize private capital and ii) a financial contribution to the GFF. 25. Subcomponent 1.1: Wholesale Co-financing to Participating Financial Institutions (PFIs) ($100 million , out of which the WB co-finances US$ 55 million and the AIIB co-finances US$ 45 million): The provision of green and sustainable 25 The market gap for green finance is estimated at US$150.6 million (demand-side) and US$415 million (supply-side capacity) in the next 5 years (the UNDP study on “Results of the Research: an Assessment of the Green Finance Market in the Kyrgyz Republic” (2023). The upcoming World Bank Country Climate and Development Report for the Kyrgyz Republic is expected to undertake its own climate finance needs assessment. Page 9 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) finance is still limited in the Kyrgyz Republic, with only two or three banks having green finance products. The project will provide eligible PFIs with access to a wholesale facility operated by the SDB to develop new sustainable finance products. Based on preliminary analysis, the target group will encompass MSMEs within polluting sectors such as agriculture and manufacturing, as well as firms operating along the value chains of major mining and energy companies. It is anticipated that the primary financial product offered by PFIs will be loans to MSMEs intending to adopt renewable energy and energy efficiency technologies, while others will focus on adaptation. PFIs will be expected to provide 20-50% co-financing. The interest rates to the PFIs will reflect the cost of IDA financing, a risk margin that includes exchange rate risk transfer from MOF to SDB, and operational and other costs and a risk margin by SDB. The interest rate to borrowers will be priced based on the cost and risks involved. It will consider full coverage of the costs of loans, such as cost of funds, operating expenses, and regulatory costs, including provisioning. The reference rate, its formula, and actual margins charged by PFIs shall be reviewed jointly with the World Bank, the MoF, SDB, and PFIs and may be revised occasionally, as necessary. 26. Given its mandate, vision, and strategic directions, the SDB is the best candidate to act as the Apex for this component. The SDB is the only institution with a development mandate for the overall economy through investment activities in “…commercially reasonable terms” as per the Law on SDB. SDB is a new institution created in 2022, and started its operations in 2023. The SDB has a Board of Directors with a majority of independent members, twelve departments reporting directly to the management, plus another three that are part of the Internal Control System, reporting to its Board of Directors. The management and the Board approved about 100 key internal policy documents and procedures to function as a development bank. The SDB started its lending operations by extending loans on an on- lending basis to commercial banks for KGS 805.8 million (US$ 9.3 million) and to large corporations for KGS 2.34 billion (US$ 26.7 million) by early 2025. While the SDB’s acquisition of Alfa Telecom from the Ministry of Digital Development (the regulator of the telecom industry) in the Fall of 2023 was an unusual move for a development bank and created a single exposure equal to 88.1% of capital, both SDB and the government have shown a commitment to reduce the exposure down to 55% of the capital by the end of 2025, and further down thereafter. As per the Law on SDB, risk, audit, and compliance units report directly to the Board of Directors. While SDB is currently under the oversight of the Cabinet of Ministers, it is actively seeking to be regulated and supervised by NBKR, counting on WB technical assistance to do so. Additionally, the SDB Law mandates that all costs must be incorporated in loan pricing, promoting a risk-based approach. A separate Financial Intermediary Financing (FIF) confidential institutional due diligence was also conducted for this project’s purpose (see Annex 2 for a summary of the FIF assessment). 27. Subcomponent 1.2: Financing for the GFF (US$10 million, out of which the WB co-finances US$ 5 million and the AIIB co-finances US$ 5 million): The GFF is under establishment by the government. The GFF will stimulate the sustainable economic development of the Kyrgyz Republic in a sustainable manner. It is expected to be owned by the Government and managed by the SDB. The regulatory framework governing the GFF is under development. The Government envisions the GFF as a vehicle to attract other domestic and external financing, including from development partners and international investors, to provide both debt and equity financing for green projects. It will likely have the following windows: i) MSMEs (both existing and startups) and ii) infrastructure projects. This subcomponent will support the first window. It also aims to focus on building private equity, mezzanine financing as well, and long-term financing for sustainable finance on a pilot basis. Private equity and mezzanine financing in the Kyrgyz Republic is almost non-existent, with only a few companies being active with Highland capital,26 which is the largest private equity, with US$23 million in capital commitments since 2014. Because the GFF is still under establishment, this subcomponent will be financed only 26 IFC, EBRD and USAID are among the investors of Highland Capital. Page 10 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) when the disbursement conditions are met. Namely, it is duly established, a manual for its operation is duly adopted, and a fund manager is appointed in a manner satisfactory to the WB. 28. Component 2: Green Guarantees (US$59 million). This component will help the GF introduce green guarantee products through i) the PRSF and ii) individual guarantee products through a partial credit guarantee facility. For Component 2, the focus will be placed on guaranteeing green loans, not broader sustainable credits; however, if the market for sustainable finance develops during the project implementation and there is a sizable loan portfolio for social and governance purposes, the GF could expand beyond green guarantees beyond this project. 29. The GF has been an implementing agency for the ES4MSMEs project, which aims to support MSMEs in response to and during the recovery from the COVID-19 crisis. The GF was selected to implement a PRSF, a new portfolio-based scheme launched under the Project with the allocation of US$32 million, of which US$19.5 million from IDA and US$12.5 million from AIIB. Since its inception in January 2022, the PRSF has grown steadily. As of January 31, 2025, 6,901 MSMEs received guaranteed credits under the PRSF. Females headed more than a third of these borrowers (2,359). The total cumulative volume of credits registered under the PRSF was US$61 million equivalent, of which US$27 million equivalent is covered by guarantee. In addition, the GF launched its own derivative PRSF products27, building on the success of the PRSF launched by the ongoing project. The GF committed US$26.7 million equivalent of its own capital to guarantee US$55 million equivalent credits, supporting an additional 5,852 MSMEs as of May 31, 2024. Mobilizing its own funds allowed the GF to meet the increasing demand for guarantees for loans outside the IDA-financed PRSF parameters. More information about the GF is in Annex 2. A separate FIF confidential institutional due diligence was also conducted for this project’s purpose (See Annex 2 for a summary of the FIF assessment). 30. Subcomponent 2.1: Green PRSF for eligible MSMEs (~US$20 million): A green guarantee window will be created under GF leveraging GF’s own green guarantee program, either as part of the existing PRSF, which was created under the ES4MSMEs project 28 or as a stand-alone PRSF. Given the nature of the portfolio-based partial credit guarantee facility, all eligible green MSME loans from PFIs will be automatically included in the green PRSF facility. This key feature will reduce the likelihood of selecting riskier projects. The maximum risk-sharing ratio is 50%, as stipulated in the Law "On GFs in the Kyrgyz Republic.” The Green Guarantee Procedural Manual will specify eligibility criteria, including pricing and the maximum value (threshold) of green loans eligible for the green PRSF. Currently, loans only up to US$40,000 are eligible for the PRSF.29 However, a higher threshold will likely be required as this component will focus on investment needs rather than liquidity needs, as was the initial case for the ongoing project. 31. Subcomponent 2.2: Green Partial Credit Guarantees for individual loans for eligible MSMEs (~US$39 million): This will cater for guarantees outside PRSF’s set parameters, i.e., aimed at MSME individual green guarantees that may be 27 The derivative PRSFs (following the model of the IDA-AIIB-financed PRSF) offered by the GF are: • Portfolio Guarantees Registration System (PGRS) which focuses on the loans above US$ 40,000 but below US$ 125,000 (note: PRSF ceiling is US$ 40,000); • The system for providing mortgage guarantee» (MGS); and • Micro-guarantee registration system (MGRS) «Microkepildik Kattoo Sistemasy» targeting microentrepreneurs. 28 The ongoing ES4MSMEs (P174028) created the first PRSF in the Kyrgyz Republic, managed by the GF. 29 The project may consider inclusion of loans up to US$100,000 or a threshold that would support MSMEs’ necessary transition to green economy. Page 11 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) too big for the PRSF.30 The current PRSF threshold is for loans up to US$40,000; however, loans up to US$100,000 or higher could be made eligible. A market assessment for MSME loans will be undertaken to better understand the needs of MSMEs. In addition, given that green guarantees are new to many commercial banks, many of whom have not yet started a sustainable finance portfolio, some commercial banks may prefer to start with individual green guarantees. The subcomponent will play a role in the demonstration of green guarantee transactions. 32. Component 3: Project Implementation and Sustainable Finance Capacity Building (US$1 million). The MOF CLMU will implement this component, which will focus on the overall management of the project and capacity building required in the sustainable finance ecosystem, including implementing agencies and PFIs. However, the capacity building will be complemented by the World Bank, IFC, and other multilateral organizations, MDBs, bilateral institutions, and donors that are currently providing technical assistance or plan to do so31. 33. Project implementation, coordination, and management. This is a core function of the CLMU. It will mainly finance expenses for (i) incremental implementation costs for staff and operating expenses (including office equipment, travel, communication, audit, printing, translation, and transportation) in the CLMU at the MOF that, inter alia, manages the roll-out of the project, performs fiduciary functions, ensures compliance with environmental and social safeguards, conducts awareness-raising activities related to the operations of the project, and monitors and evaluates project activities, and (ii) management of a Beneficiary Feedback Mechanism, including a Grievance Redress Mechanism. 34. The Government’s IDA borrowing is expected to be 99% repaid by the implementing agencies. The current discussion with the Government indicates that the implementing agencies have the potential to repay the MoF the principal amount of the IDA sub-loan provided for Component 1 and Component 2. The project aims to establish innovative financial instruments and catalyze the market by mobilizing private capital. In the medium to long term, it aims to create a self-sustainable market with the financial instruments introduced by the project that will continue to see demand after the project’s closure. See the schematic on the flow of funds. Chart 2: Project’s Flow of Funds 30The expected threshold will likely be around US$100,000; however, this will need to be further analyzed and discussed. 31Among several tasks, the capacity building part continues to support the governance strengthening of SDB and GFF seeking to support the plans to transfer the ownership Page 12 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) 35. The project brings a strong element of Maximizing Finance for Development (MFD) for Private Capital Mobilization (PCM). The project is currently tagged as MFD-enabled and PCE and includes an indicator related to PCM. The project is expected to generate PCM of US$148 million as follows: • Component 1: This component will provide PFIs with access to a wholesale financing facility through which they can on-lend to MSMEs. PFIs will be expected to provide 20-50% co-financing for each loan in Subcomponent 1.1. This is MFD-enabling as the project aims to address binding constraints to a private sector solution in relation to access to sustainable finance (including capacity building and access to finance). In addition, this component can also be considered PCM based on the co-financing amount provided by PFIs under each loan. Based on the current estimate of 20-50% co-financing by PFIs for Subcomponent 1.1, about US$30 million of PCM is expected to be generated in 5 years (based on the allocation of $100 million for 1.1). For Subcomponent 1.2, while the GFF is expected to mobilize private capital, it is too early to provide an estimate. • Component 2: This component will provide financing to support a green guarantee mechanism, with a maximum risk-sharing of 50%. This is MFD-e, as it addresses binding constraints to a private sector solution in relation to access to sustainable finance. In addition, this component can also be considered PCM based on the guarantee enabling PFI commercial financing/lending. The PFI loan amount for each loan under both the PSRF and the individual guarantees should be counted as PCM. Based on the current estimate of US$58 million allocation to Component 2, about US$118 million of PCM is expected to be generated in 5 years. • Component 3: This component will provide a range of capacity-building support to the CLMU, implementing agencies, PFIs, and financial market participants. This is MFD-e and PCE as it addresses a binding constraint to private sector solutions by building the capacity of financial institutions to offer sustainable finance. E. Role of Partners Name of Partner Nature of Involvement /Description Page 13 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) AIIB Will co-finance US$50 million to provide sustainable finance focused on climate mitigation and adaptation, including renewable energy and energy efficiency, and greening the financial sector IFC Provides support to the Union of Banks to establish the Sustainable Finance Academy to improve the capacities of local banks on sustainable finance EBRD EBRD’s Kyrgyz Sustainable Energy Financing Facility provides up to US$ 50 million to qualifying PFIs, focusing on green investments in the commercial and residential sectors UNDP Advises the MoEC with creating the GFF by the Cabinet of Ministers Deutsche Will launch a project on the Green Climate Fund (GCF) readiness program, which Gesellschaft für aims to support the Kyrgyz Republic’s institutions to be certified by the Seoul- Internationale based GCF Zusammenarbeit (GIZ) The UK Will provide technical assistance in developing a legal and regulatory framework Government for alternative investment schemes (PE, VC equivalent) that aim to diversify funding sources for start-ups and innovative companies ADB Advises the MoEC on the National Green Taxonomy F. Lessons Learned and Reflected in the Project Design 36. The project will build upon the ongoing World Bank support to the Government of the Kyrgyz Republic and the NBKR on greening the financial sector. Lessons learned from implementing the active lending operation and technical assistance projects are reflected in the project design, especially from the ongoing ES4MSMEs project. These include agency agreements with clearly defined roles, responsibilities, and accountability mechanisms for all stakeholders, contributing to a strong CLMU in MOF and higher-than-expected results/outcomes. The World Bank team advises the NBKR on integrating ESG into banking sector policies, guidelines, and supervision. The World Bank is supporting the SDB in integrating ESG risks management into its operations through technical assistance (P501279). The World Bank also supports private sector development, especially focused on entrepreneurs and MSMEs. The World Bank supports the implementation of the Air Quality Project (P177467), which has a component to provide loans through local banks in the Kyrgyz Republic to eligible projects aiming at air pollution reduction. Finally, the World Bank team also provided comments to the Ministry of Economy on the draft of the National Green Taxonomy documents and the draft of the regulation for the GFF. 37. The project will draw lessons learned from World Bank interventions for scaling up the sustainable finance market through Lines of Credit, green investment funds, and national development banks in other countries. Relevant engagements reviewed include Brazil (P178888), Kenya (P179381), Rwanda (179999), Tunisia (P167380), Egypt (P162835), Jordan (P161905), Morocco (P150928). It is noted from these ongoing operations that strong leadership of partnering financing institutions on green finance, enabling investment and financial sector policies and regulations to attract private sector investment, time-bound strategy and work-plan for national green transition, enhanced capacity of local financial professionals and service providers on ESG risks management, good collaboration among government agencies and Page 14 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) financial sector regulators on green finance policies and program development are among the key success factors to build and scale up sustainable finance markets. 38. The project will build on a successful implementation scheme developed under the ongoing ES4MSMEs project. This includes arrangements that allow the CLMU, implementing agencies, and the World Bank to respond quickly to the changing needs of MSMEs and adjust the project eligibility criteria and other terms and conditions as required. This required multiple revisions; however, such continuous efforts to adapt and adjust led to overcoming slow uptake and interest by MSMEs in the initial year or two. The Project is currently rated Highly Satisfactory and is expected to close in 2025, two years ahead of the scheduled closing in 2027 III. PROJECT IMPLEMENTATION A. Institutional and Implementation Arrangements 39. The SDB will implement Component 1 of the project, the GF will implement Component 2, and the CLMU at the MoF will implement Component 3 while performing as an implementing agency for the whole project, including fiduciary, M&E, E&S, and overall coordination functions. The implementation arrangements for the project are based on the successful approach applied to the ES4MSMEs project. The MoF CLMU has extensive experience in implementing World Bank-funded projects spanning the past two decades. The GF has proven to be a successful entity in implementing the ES4MSMEs project. The SDB is a new development bank established in December 2022, and the World Bank is currently providing technical assistance to operationalize the bank (See Annex 2 for more info on SDB). 40. Page 15 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) 41. To effectively implement the credit line and guarantee facilities, especially targeting MSMEs owned and/or managed by women, the project will leverage the Women-in-Finance (We-Fi curriculum), customizing it for the Kyrgyz context.32 This project will follow the same approach towards MSMEs owned and/or managed by women as the ongoing ES4MSMEs project, which overachieved the 50% target of the indicator monitoring the percentage of women benefitting from the financial services provided under the project. Through a series of workshops organized for the PFIs under the project, the PFIs will increase their knowledge and practices on supporting WMSMEs’ capacity to use the financial instruments offered under the project. The project will also encourage NBKR, Union of Banks, GF, SDB, and PFIs to support improving WMSMEs' creditworthiness by improving financial management practices, including budgeting, accounting, bookkeeping, and auditing, and facilitating linkages to financial institutions through credit application workshops. The project will also support identifying growth investment opportunities, such as new technology adoption and greening production processes, thereby strategically targeting the increased finances accessible to WMSMEs. PFIs with a relatively lower proportion of women borrowers will be supported in scaling up their supply of services to viable women-led firms, including technical assistance to reach women customers effectively. 42. The proposed project will use mechanisms, including Citizen Engagement arrangements, established under the ES4MSMEs project. The January 2024 Mid-Term Review rated ES4MSMEP Highly Satisfactory. The ES4MSMEP owes its success to a large extent to an excellent feedback mechanism established by the CLMU to constantly engage the project’s beneficiaries in the project’s activities. The same Project Implementation Unit at the Ministry of Finance (MoF CLMU) will implement the proposed project. The MoF CLMU will employ the same well-established mechanisms to ensure the utilization of various communication channels, including telephone and popular web applications such as Facebook, WhatsApp, and Viber. Moreover, the MoF CLMU will replicate its approach to disseminating the project information, which includes providing contact phone numbers, third-party websites, and a Quick Response (QR) code displayed at all PFIs. The project activities will be identified through a participatory process that will engage all relevant public and private stakeholders, including the MOF, Ministry of Economy, NBKR, SDB, GF, state-owned and private financial intermediaries, and MSMEs. The MoF CLMU will be encouraged to utilize existing online citizen engagement platforms to collect feedback from the project’s beneficiaries and adapt them to the specific needs of this project. The Results Framework will include an intermediate indicator to track the adaptation of an online citizen engagement platform, particularly (a) its revision and enhancement, (b) launch, and (c) provision of a two-way channel of feedback and response B. Results Monitoring, Evaluation, and Verification Arrangements 43. The proposed project will use the same monitoring and evaluation mechanisms that are now being used for the ES4MSMEs project. An agreement to be signed by the MoF CLMU with implementing agencies will also include the division of responsibilities for collecting data on relevant intermediate results indicators. The MoF CLMU's responsible staff will consolidate the data for monitoring and evaluation purposes for each sub-component and the whole project. The proposed mechanism proved successful for the ES4MSMEs project. 32The World Bank Board of Directors approved the Women Entrepreneurs Finance Initiative (We-Fi)--to specifically address the barriers that prevent women from starting and growing businesses. Main activities aim to support women entrepreneurs by scaling up access to financial products and services, building capacity, expanding networks, offering mentors, and providing opportunities to link with domestic and global markets (https://we-fi.org/). Page 16 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) C. Disbursement Arrangements 44. The transaction-based disbursement method will be used for the project. A Designated Account (DA) in the Loan currency (US$) will be opened in a commercial bank acceptable to the Bank. Project funds will flow from the World Bank—as an advance to the DA, which will be replenished by direct payment based on direct payment withdrawal applications. 45. The DA ceiling was indicated in the DFIL during the negotiations. Applications for replenishment of the DA will be submitted at least quarterly or when one-third of the amount has been withdrawn, whichever occurs earlier. Documentation requirements for replenishment would follow standard Bank procedures as described in the Disbursement Handbook. Bank statements of the DA, which have been reconciled, would accompany all replenishment requests. IV. PROJECT APPRAISAL SUMMARY A. Technical, Economic and Financial Analysis (if applicable) 46. The project supports climate change adaptation and mitigation by facilitating sustainable finance in the Kyrgyz Republic. It will cultivate a “low carbon footprint mindset” by educating MSME beneficiaries about business practices that promote using energy-efficient materials and ‘green’ technologies. Moreover, the project will bolster climate resilience and reduce GHG emissions by supporting the adoption of renewable energy and energy efficiency technologies. Furthermore, MSMEs will also become more competitive in the export markets as they adapt to the green standards that are accepted in the destination markets. 47. The Kyrgyz Republic financial sector, through the implementing agencies and PFIs, will increase the provision of sustainable finance. The financial institutions will learn what it entails to be a sustainable finance entity by implementing ESG guidelines and developing and offering sustainable finance products. 48. The operation is aligned with the goals of the Paris Agreement on both mitigation and adaptation. Assessment and reduction of mitigation risks: The Funding Contribution to the GFF and Wholesale Co-financing to PFIs (Component 1) promote investments in low-carbon technologies and sustainable practices by providing financing to MSMEs and infrastructure projects supporting GHG emission reduction and sustainable economic development. These initiatives build a private equity and mezzanine financing market for sustainable finance, ensuring resources are directed to projects with significant mitigation potential. Component 2 adds a Green PRSF for MSMEs, directing finance towards sustainable projects and promoting adopting low-carbon technologies, contributing to GHG emission reductions. The automatic inclusion of green loans in the PRSF facility incentivizes PFIs to support projects aligned with climate goals. At the same time, Individual Green Guarantees target larger projects, encouraging wider adoption of low-carbon technologies. Component 3 enhances sustainable finance capacity through training and technical assistance, promoting long-term GHG emission mitigation by embedding sustainable practices within the financial sector. 49. Assessment and reduction of adaptation and mitigation risks: Component 1 addresses adaptation risks by enhancing resilience against climate variability and extreme weather conditions through the establishment of the GFF and Page 17 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) wholesale climate finance, strengthening the financial system’s ability to support resilient infrastructure projects. Capacity building within PFIs ensures financial institutions can manage climate risks effectively, promoting long-term sustainability. Additionally, introducing green guarantee products and the PRSF mechanism (Component 2) helps MSMEs adopt resilient practices, enabling businesses to adapt to climate variability. Component 3 further enhances resilience by supporting the development of the national green taxonomy to support investments in climate resilience, helping stakeholders prioritize adaptation activities. Policy coordination among government agencies and financial sector regulatory authorities ensures a comprehensive approach, while capacity-building efforts equip financial market participants to implement resilience measures effectively. On mitigation, the operation has a low risk of preventing the country’s transition to low -carbon development pathways, given its contribution to the reduction of greenhouse gas emissions through the implementation of energy-efficient technologies, sustainable finance practices, and green guarantees. These initiatives enhance resource efficiency and support sustainable environmental practices across sectors. 50. On adaptation, the operation adequately reduces the physical climate risks to the project outcomes. The project’s climate resilience and adaptation design considerations limit the exposure to a low level of residual risk by incorporating robust financial mechanisms capable of withstanding climate-induced variability and extreme weather conditions. The project also enhances the capacity of financial institutions and stakeholders to adaptively manage resources amidst changing climatic conditions. 51. The IDA credit is anticipated to yield a positive economic impact. The economic and financial analysis encompasses three dimensions: (a) the financial intermediation process of the SDB providing sustainable financing directly to GFF and through financial intermediaries, (b) the mobilization of private sector financing towards sustainable and green projects via partial credit guarantees offered by the GF, and (c) the potential reduction in GHG emissions resulting from increased utilization of renewable energy sources and the enhancement of energy efficiency among MSMEs. Financially, ENPV of the project is positive. The borrower's assumption of exchange rate risk affords the provision of local currency financing to final beneficiaries (MSMEs) on concessional terms, which, in turn, facilitates the mobilization of private sector capital, estimated at US$148 million during the first 5 years of the project. This estimate is predicated on co-financing arrangements, a moderate uptake of green financing by MSMEs, and the provision of guarantees. In the first 5 years of the project, the total green financing will reach about US$150 million, corresponding to 50-60 thousand tons of CO2 reductions, based on an intensity measure that assumes that each US$ 1 million of loans increases CO2 emissions by 300 tons; therefore, based on conservative assumption, the greening of the loan portfolio will reduce the carbon footprint by the same amount33. A recent study by the World Resources Institute (WRI) suggests that climate-friendly investments are more effective at job creation. If the WRI’s assumptions are followed, proper allocation of funds along the priority areas will generate 70% more jobs, leading the total number of new jobs created to 5-7 thousand within the first 5 years in the Kyrgyz Republic. Associated increases in net income, salaries, and technology imports are expected to generate additional fiscal revenue of US$ 2.1-3.1 million in the form of dividends, PIT, CIT, and VAT income during the first 5 years of the project. The relatively high level of additional revenue is driven by the VAT income associated with the large volume of green technology imports. B. Fiduciary 33 An intensity measure of loans is taken from Kutlukaya, 2023. Page 18 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) (i) Financial Management 52. The FM risk is assessed as Moderate. An assessment of the FM arrangements of the project has been carried out in terms of staffing, budgeting, accounting, internal controls, flow of funds, financial reporting, and external audit. The assessment concluded that the FM arrangements are acceptable subject to the FM section of the POM completed with the procedures applicable to the project prior to the effectiveness of the Financing Agreement. This assessment was updated during the appraisal, and the conclusions reached during the negotiations were reflected. 53. The FM performance of the ongoing ES4MSMEs project is Satisfactory. There are no outstanding or unsatisfactory IFRs or audit reports under the ongoing project. The new project will mirror the existing FM and disbursement arrangements under the ES4MSMEs project. The current FM project team is considered adequate and well- familiar with the World Bank procedures. Staffing capacity will be regularly assessed and may be supplemented during implementation in line with the project needs. 54. The project will use the traditional disbursement mechanism, similar to the ongoing ES4MSMEs project. A separate DA in the Loan currency (US$) in the commercial bank will be opened for the proposed credit. Credit funds will be withdrawn to the respective DA up to the account`s ceiling as defined in the DFIL of the project. The accounting for the new project will be kept on a cash basis to an adequate level of detail in the existing project financial software, which will be upgraded to accommodate the records of the new source of financing by Loan effectiveness. 55. The internal controls framework instituted for the ongoing project is considered reliable and will continue to be used for the new project. The FM section of the POM will be completed as a condition for the effectiveness of the Financing Agreement with the arrangements applicable to the new project, with emphasis on the controls related to the sub-loans and grants components. Separate quarterly cash-based interim-unaudited IFRs will be prepared for the project and submitted to the Bank 45 days after each quarter's end. The format of the IFRs will be the same as that used under the ES4MSMEs project. The project financial statements will be audited by an independent auditor acceptable to the Bank, as per terms of reference agreed with the Bank. The audit reports will be due for submission to the Bank in six months from the year end. The audit terms of reference will be like the ones agreed upon for the ES4MSMEs project. (ii) Procurement 56. The Procurement risk is assessed as Moderate. Procurement functions will be implemented by the MoF CLMU with the assistance of technical consultants and staff of other relevant units of the Implementing Agency. The CLMU implements several WB-funded projects and has adequate capacity and personnel to support project implementation and application of procurement rules and procedures of international donor organizations. The CLMU will assign one qualified procurement specialist to handle all procurement related matters of project implementation. 57. Risks identified in procurement capacity assessment of IA/CLMU include: i) fluctuations in gas and oil prices could lead to increased costs for end products, potentially exceeding initial cost estimates, ii) there is a risk that government officials may try to exert undue influence over procurement decisions, which could compromise the accountability of these decisions, iii) project beneficiaries may lack the expertise to develop detailed designs and technical specifications for the investments, which could affect the quality and effectiveness of the procurement process; iv) based Page 19 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) on past experiences, procurement processes are likely to face delays due to insufficient procurement capacity and market limitations; additionally, depreciation of the local currency might deter potential bidders from submitting bids or quotations in that currency, v) the current challenges in logistics, particularly in goods transportation, are expected to impact the timely delivery of goods, especially from countries within the Commonwealth of Independent States and other European regions, and v) the procurement environment is generally unstable, with frequent changes to the PPL and a high level of corruption, as indicated by Transparency International's measurements. 58. These risks necessitate careful planning, robust risk mitigation strategies, and continuous monitoring to ensure the procurement process is efficient, transparent, and yields the best value for the project. Procurement risk is assessed as Moderate. 59. Procurement for the proposed Project shall be carried out per the World Bank Procurement Regulations for IPF Borrowers, dated September 2023 (Procurement Regulations). Specific procurement procedures to be followed for managing project resources will be documented in the POM. According to the Procurement Regulations, CLMU needs to develop a PPSD and Procurement Plan PP. The PPSD and PP were reviewed and agreed upon with the World Bank before the Project was negotiated. The PPSD is a living document that should be regularly updated during the Project implementation period to provide necessary justifications for procurement arrangements, PP, and its updates. For each contract financed by IDA, the procurement method, market approach, cost estimate, World Bank review requirements, and timeframe for implementation shall be agreed between the borrower and IDA and duly reflected in the most updated Project PP. The Project will use the World Bank’s Systematic Tracking of Exchanges in Procurement (STEP) online tool to plan and track all procurement transactions. C. Environmental, Social and Legal Operational Policies @#&OPS~Doctype~OPS^dynamics@padlegalpolicy#doctemplate Legal Operational Policies Triggered? Projects on International Waterways OP 7.50 No Projects in Disputed Area OP 7.60 No 60. The project’s environmental and social risks are assessed as Moderate at the Appraisal stage. The standards relevant to the Project are ESS1, ESS2, ESS3, ESS4, ESS6, ESS8, ESS9, and ESS10. The overall environmental and social impacts of the project investments are expected to be generally positive. The project will be beneficial for both (i) new and existing MSMEs by narrowing the large climate and green financing gap and ensuring that women and vulnerable populations and MSMEs are not left out in their adaptation and transition to a green economy and (ii) PFIs through development and integration of an Environmental and Social Management System (ESMS) aligned with the national requirements and the WB ESF, and creating an enabling environment for sustainable finance. However, some potential adverse environmental risks include temporary ones with site specific construction of the renewable energy installations, Page 20 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) renovation of the manufacturing/processing lines, and use of pesticides, soil loss related to agricultural activities. The project is also expected to produce minor environmental impacts such as emission of dust, water use, noise, limited waste generation, and similar that will be readily addressed by national legislation and regulations. Some project activities may cause direct and indirect disturbance of natural habitats. As per national environmental regulation companies developing renewable energy sources are subject to environmental impact assessment and environmental permitting that includes mitigation measures for environmentally significant installations. Minor OHS risks exist in relation to renewable energy construction and installation works, and these will be addressed by national legislation. Possible exclusion of potential beneficiaries, including vulnerable groups such as WMSMEs, disabled, and youth, from access to project benefits (credit lines, capacity building) will be addressed through awareness campaigns, transparent communication about project scope, clear eligibility and selection criteria, and application procedures. No significant risks related to labor influx, sexual exploitation and abuse/sexual harassment (SEA/SH), child labor, or community health and safety are expected. 61. The project workers (direct and contracted) are expected to be hired locally. The investment activities with potential impacts under ESS5 will not be eligible for project financing. It is expected that enterprises will use existing land/facilities in which they currently operate or are locally available. To address the environmental and social risks, the Project prepared a Stakeholder Engagement Plan (SEP) and a Labor Management Procedures (LMP), and during the project implementation, the PFIs’ ESMS will be developed in accordance with the WB ESSs relevant to the project, as per ESS9. The GRM will be established to receive, accept, review, and resolve any project-related concerns or feedback and be easily accessible to project-affected parties and workers. The exclusion list for financing under the project, acceptable to the Bank, will exclude sub-projects with land acquisition, involuntary resettlement, livelihood, and cultural heritage impacts, activities involving child and forced labor, and other activities as further set out in the POM. The PFIs will categorize any beneficiary MSME activities that involve significant risks and impacts on the environment, biodiversity, community health, and safety, labor, and working conditions and screen these out as ineligible for financing in accordance with the POM. As part of the credit approval procedure, E&S due diligence will be conducted by each PFI for their respective sub-borrowers prior to a decision to finance investments. Grievance Redress Services: Grievance Redress. Communities and individuals who believe that they are adversely affected by a project supported by the World Bank may submit complaints to existing project-level grievance mechanisms or the Bank’s Grievance Redress Service (GRS). The GRS ensures that complaints received are promptly reviewed in order to address project- related concerns. Project affected communities and individuals may submit their complaint to the Bank’s independent Accountability Mechanism (AM). The AM houses the Inspection Panel, which determines whether harm occurred, or could occur, as a result of Bank non-compliance with its policies and procedures, and the Dispute Resolution Service, which provides communities and borrowers with the opportunity to address complaints through dispute resolution. Complaints may be submitted to the AM at any time after concerns have been brought directly to the attention of Bank Management and after Management has been given an opportunity to respond. For information on how to submit complaints to the Bank’s Grievance Redress Service (GRS), visit http://www.worldbank.org/GRS. For information on how to submit complaints to the Bank’s Accountability Mechanism, visit https://accountability.worldbank.org. V. KEY RISKS Page 21 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) 62. The Overall risk of the project is Moderate. However, there are substantial Sector Strategies and Policies, Institutional Capacity for Implementation and Sustainability, and Technical Design of Project risks. This is primarily due to the introduction of new financial products, such as green finance and green guarantees, in the country and the new role assigned to the SDB and the GF as implementing entities for two project components. Proposed mitigation measures involve leveraging the capacities of the SDB and the GF, both of which have shown sufficient capacity to manage these risks effectively. Specifically, the SDB has demonstrated its capacity through a growing portfolio, which has reached US$22.5 million by end of 2024, and the GF has a track record of successful implementation of the ES4MSMEs project. Page 22 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) ANNEX 1. RESULTS FRAMEWORK @#&OPS~Doctype~OPS^dynamics@padannexresultframework#doctemplate PDO Indicators by PDO Outcomes Baseline Closing Period Mobilized green and sustainable finance An increased share of sustainable finance in the financial sector (Percentage) Feb/2025 Dec/2030 0 5 Developed ecosystem and enhanced capacity-building of financial institutions The number of financial institutions with built-in capacity under the project, offering new sustainable finance products to MSMEs (Number) Feb/2025 Dec/2030 0 18 Intermediate Indicators by Components Baseline Closing Period Green and Sustainable Finance Businesses using debt financing (Number of businesses) CRI Feb/2025 Dec/2030 0 2,500 ➢Businesses using debt financing - Women-led (Number of businesses) CRI Feb/2025 Dec/2030 0 875 Total private capital mobilized (Amount (USD)) (Amount(USD)) Page 23 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) Feb/2025 Dec/2030 0 30,000,000 The number of participating PFIs (Number) Feb/2025 Dec/2030 0 10 Green Guarantees The number of MSMEs that received green guarantees (Number) Feb/2025 Dec/2030 0 1,600 The number of Women-MSMEs that received green guarantees (Number) Feb/2025 Dec/2030 0 560 The percentage of green sub-projects financed by the project's components that contribute to climate change mitigation or adaptation (Percentage) Feb/2025 Dec/2030 0 80 Total private capital mobilized (Amount(USD)) Feb/2025 Dec/2030 0 118,000,000 The number of participating PFIs (Number) Feb/2025 Dec/2030 0 8 Project Implementation and Sustainable Finance Capacity Building Establishment of an online citizen engagement platform (Yes/No) Feb/2025 Dec/2030 No Yes Page 24 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) Monitoring & Evaluation Plan: PDO Indicators by PDO Outcomes Mobilized green and sustainable finance An increased share of sustainable finance in the financial sector (Percentage) The baseline for this PDO indicator is 0.03% of the banking sector-wide loan portfolio. The growth rate of sustainable Description finance is expected to become 5%. The CLMU will collect the data from the National Bank of the Kyrgyz Republic for monitoring and evaluation purposes. Frequency Every 6 months Data source The SDB and GFF Methodology for Data The agencies responsible for implementing Component 1 and Component 2, in collaboration with the National Bank of Collection the Kyrgyz Republic, will track and monitor the data and provide the data to the CLMU Responsibility for Data The responsible staff at the CLMU. Collection Developed ecosystem and enhanced capacity-building of financial institutions The number of financial institutions with built-in capacity under the project, offering new sustainable finance products to MSMEs (Number) The baseline for this PDO indicator is 0, with a target of 12 by the end of the project. The CLMU will collect the data and Description monitor and evaluate the results. Frequency Every 6 months Data source The SDB and GFF Methodology for Data The agencies responsible for implementing Component 1 and Component 2 in collaboration with the National Bank of Collection the Kyrgyz Republic, will track and monitor the data and provide the data to the CLMU Responsibility for Data The responsible staff at the CLMU. Collection Monitoring & Evaluation Plan: Intermediate Results Indicators by Components Green and Sustainable Finance Total private capital mobilized (Amount (US$)) (Amount(US$)) The baseline for this indicator is 0, with a target of 30,000,000 by the project's closing date. The CLMU will collect the Description data from the technical implementing agencies for monitoring and evaluation purposes. Frequency Every 6 months Data source The SDB and GFF Methodology for Data The agencies responsible for implementing Component 1 in collaboration with the National Bank of the Kyrgyz Republic, Collection will track and monitor the data and provide the data to the CLMU Responsibility for Data The responsible staff at the CLMU. Collection The number of participating PFIs (Number) The baseline for this indicator is 0, with a target of 6 by the project's closing date. The CLMU will collect the data from the Description SDB for monitoring and evaluation purposes. Frequency Every 6 months Data source The SDB and GFF Methodology for Data The agencies responsible for implementing Component 1 in collaboration with the National Bank of the Kyrgyz Republic, Collection will track and monitor the data and provide the data to the CLMU Responsibility for Data The responsible staff at the CLMU. Collection Businesses using debt financing (Number of businesses) CRI Description Number of MSMEs using debt financing services Page 25 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) Frequency Every 6 months Data source The SDB and GFF Methodology for Data The agencies responsible for implementing Component 1 in collaboration with the National Bank of the Kyrgyz Republic, Collection will track and monitor the data and provide the data to the CLMU Responsibility for Data The responsible staff at the CLMU. Collection Businesses using debt financing - Women-led (Number of businesses) CRI Description The number of women-led businesses using debt financing services Frequency Every 6 months Data source The SDB and GFF Methodology for Data The agencies responsible for implementing Component 1 in collaboration with the National Bank of the Kyrgyz Republic, Collection will track and monitor the data and provide the data to the CLMU Responsibility for Data The responsible staff at the CLMU. Collection Green Guarantees The number of MSMEs that received green guarantees (Number) This indicator's baseline is 0, and its target is 1,600 by the project's closing date. The CLMU will collect the data from the Description GF for monitoring and evaluation purposes. Frequency Every 6 months Data source The GF Methodology for Data The GF responsible for implementing Components 2, in collaboration with the National Bank of the Kyrgyz Republic, will Collection track and monitor the data and provide the data to the CLMU Responsibility for Data The responsible staff at the CLMU. Collection The number of Women-MSMEs that received green guarantees (Number) The baseline for this indicator is 0, with a target of 560 by the project's closing date. The CLMU will collect the data from Description the GF for monitoring and evaluation purposes. Frequency Every 6 months Data source The GF Methodology for Data The GF responsible for implementing Components 2, in collaboration with the National Bank of the Kyrgyz Republic, will Collection track and monitor the data and provide the data to the CLMU Responsibility for Data The responsible staff at the CLMU. Collection The percentage of green sub-projects financed by the project's components that contribute to climate change mitigation or adaptation (Percentage) Description Green sub-projects financed by the project's sub-components that contribute to climate change mitigation or adaptation Frequency Every 6 months Data source The GF Methodology for Data The GF responsible for implementing Component 2 will track and monitor the data and provide the data to the CLMU Collection Responsibility for Data The responsible staff at the CLMU. Collection Total private capital mobilized (Amount(US$)) The baseline for this indicator is 0, with a target of 118,000,000 by the project's closing date. The CLMU will collect the Description data from the technical implementing agencies for monitoring and evaluation purposes. Frequency Every 6 months Data source The GF Methodology for Data The GF responsible for implementing Component 2, in collaboration with the National Bank of the Kyrgyz Republic, will Collection track and monitor the data and provide the data to the CLMU Page 26 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) Responsibility for Data The responsible staff at the CLMU. Collection The number of participating PFIs (Number) The baseline for this indicator is 0, with a target of 8 by the project's closing date. The CLMU will collect the data from the Description GF for monitoring and evaluation purposes. Frequency Every 6 months Data source The GF Methodology for Data The GF responsible for implementing Component 2, in collaboration with the National Bank of the Kyrgyz Republic, will Collection track and monitor the data and provide the data to the CLMU Responsibility for Data The responsible staff at the CLMU. Collection Project Implementation and Sustainable Finance Capacity Building Establishment of an online citizen engagement platform (Yes/No) Description The CLMU will confirm the establishment of an online citizen engagement platform Frequency Every 6 months Data source The CLMU Methodology for Data The CLMU will collect and monitor the feedback from the citizens through the online citizen engagement platform Collection Responsibility for Data The responsible staff at the CLMU. Collection Page 27 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) ANNEX 2: National Development Financial Institutions and Financial Intermediary Financing Due Diligence SDB 1. The Kyrgyz Republic Government established the SDB in late 2022. This is the first national development bank in the country that aims to mobilize financing to diversify and stimulate the economy of the Kyrgyz Republic. Globally, National Development Banks (NDBs) gained importance in providing counter-cyclical financing during the crises, including the recent COVID-19 pandemic. Further, with trillions of dollars needed towards achieving Sustainable Development Goals (SDGs), there is a renewed expectation for NDBs to play an important role in mobilizing the necessary financing. With their mandates to support sustainable development and growth of the national economy, the NDBs in many countries are also playing an important role in boosting sustainable finance through private capital mobilization and influencing to improve the management and disclosure of climate and environmental risks. The SDB can potentially play a catalytic role as a green NDB and channel sustainable finance to fill the significant financing gap for climate change and sustainable development. 2. SDB’s operations commenced in April 2023 after capital payment procedures and share issue registration were completed. Governed by the Law "On the SDB of the Kyrgyz Republic" and regulated by the Cabinet of Ministers’ Resolution No. 533 of October 9, 2023, the Bank operates with an authorized capital of KGS 19.7 billion (US$ 226 million) after the latest capitalizations for a total of KGS 2.9 billion in 2024, with the Cabinet of Ministers of the Kyrgyz Republic as its sole shareholder. Operating independently under Kyrgyz Republic legislation, it conducts activities within established authorities without interference from state bodies, except as permitted by law. As a designated financial institution, it operates without a license from the NBKR but adheres to all economic norms and regulatory requirements. 3. Since April 2023, the SDB has made substantial progress to become operational, using both loans and bonds as instruments. The management board is fully staffed, with a new chairman and deputy chairpersons appointed, though some lower and mid-level positions remain vacant. About one hundred internal regulatory documents – including a Risk Appetite Framework, an Asset Liability Management framework, and Audit and Compliance policies- were approved by the BoD. Loan applications began in August 2023, with actual lending totaling KGS 1.96 billion (US$ 22.5 million) as of December 2024 and credit lines opening for KGS 3.4 billion (US$ 38.8 million) as of February 2025. Additionally, SDB acquired KGS 80 million (US$ 930,000) of a social bond issued by the Bank of Asia aimed at supporting MSMEs and women entrepreneurs. Finally, SDB is disclosing material information to the public in three languages, Kyrgyz, English, and Russian, through its corporate website. 4. SDB adopted a Green Finance and Sustainable Development Policy (i.e., ESG Policy) and integrated the ESG risk assessment into its lending and investment operations. It has adopted its own green taxonomy, which covers key climate mitigation and adaptation categories, such as renewable energy, energy efficiency, waste management, clean water, transport, and sustainable agriculture. Additionally, a new wholesale green loan program has been developed to provide targeted financing for projects and MSMEs that meet the green criteria as defined in SDB’s internal green taxonomy through partner banks. 5. The team performed a separate FIF confidential assessment, showing some positive trends. In broad terms, the assessment indicates that SDB plans to match the future expansion of assets with a stronger governance framework and internal control system, particularly a sounder risk management framework. Likewise, SDB is investing in systems, human Page 28 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs PROJECT APPRAISAL DOCUMENT (P505643) resources, and better procedures to ensure the financial sustainability of its operation in the long term, as it is adopting ESG standards. SDB's total capital adequacy ratio is very high, given the small size of its portfolio and the investment, while loan provisioning of about 2% is consistent with the low risk of its portfolio, which is fully performing. 6. By 2026, the SDB aims to become one of the country's major financial institutions, a goal it sees as ambitious yet attainable through systematic goal achievement, favorable external factors, and effective capital utilization. It plans to operate based on sustainable development principles and implement the best corporate governance, lending, and risk management practices. The targets for the long term are to reach an aggregate revenue of customers receiving financing of over KGS 130 billion, newly created jobs at financed enterprises of over 17,000 people, and an aggregate tax and social contributions by the Bank's borrowers of over KGS 10 billion. 7. SDB exposure to Alfa Telecom, while significant, has begun to fall and will be further reduced. SDB acquired Alfa Telecom for KGS 14.8 billion, generating an exposure equivalent to about 88.1% of SDB capital, despite the World Bank team’s warning, which came as the transaction was nearly finalized. The acquisition of Alfa Telecom from the Ministry of Digital Development (the telecom industry regulator) in the Fall of 2023 was an unusual move for a development bank and created a single exposure that is beyond a prudent level. Given the World Bank’s warnings, the government has committed to making SDB an institution that follows international best practices. Since the transaction took place, the team has been working with SDB on a plan to reduce such exposure and align with best international practices. As of December 2024, such exposure has been reduced to 74.0%, and the objective is to reach less than 60% by the end of 2025. GF 8. The Open Joint Stock Company GF was incorporated in 2016 to help improve access to finance by sharing risk with and reducing collateral requirements from financial institutions . The initial authorized capital was KGS 72 million. Total capital is currently representing more than 90% of total assets. Since its inception, the GF has been providing individual loan guarantees. The PRSF was introduced in January 2022 with the support of the ongoing ES4MSMEs project. The GF operates on a financially sustainable business model and has been profitable since 2017.34 It has played a key role in improving firms’ access to finance during and after the COVID-19 crisis. In addition to the individual loan guarantee product offered by the GF, the launch of the PRSF in early 2022 helped respond to the COVID-19 crisis quickly and maintain the credit flows to MSMEs. Unlike individual guarantees, where the GF needs to conduct independent credit analysis for each individual loan guarantee application, the PRSF follows a principle of automaticity where all loans meeting eligibility criteria will be automatically included in the portfolio coverage. This approach allowed the GF to issue guarantees in scale. In the first year of the PRSF operation, the GF issued four times more guarantees than the individual guarantees. 9. The PRSF shares the credit risk with participating financial institutions (PFIs) for loans extended to eligible MSME portfolios. This arrangement enables PFIs to provide loans to borrowers who might otherwise struggle to secure financing or to offer loans with improved terms, thus facilitating greater access to credit for MSMEs. As of December 2024, the PRSF has shown steady growth, with 6,629 loan guarantees issued, amounting to 5.26 billion KGS (equivalent to US$61.6 million). Out of this, KGS 2.3 billion (US$27.1 million) is covered by guarantees, benefiting 2,254 women-led firms. 34 The GF has been profitable since 2017, with a return on assets of 6.93% and a return on equity of 7.64% as of March 01, 2024. Page 29