Completion Report

Project Number: 51054-001 Loan Number: 3533 July 2020

Mongolia: Banking Sector Rehabilitation and

Financial Stability Strengthening Program

This document is being disclosed to the public in accordance with ADB’s Access to Information Policy.

Currency Equivalents

Currency unit – togrog (MNT)

At Appraisal At Project Completion (30 June 2017) (3 August 2017)

MNT1.00 = $0.000378 $0.000426 $1.00 = MNT2,645.00 MNT2,348.50

ABBREVIATIONS

ADB – Asian Development Bank AMC

AQR – –

asset management company asset quality review

BOM CRDC

– –

Bank of Mongolia corporate debt restructuring committee

DICOM – Deposit Insurance Corporation of Mongolia ERP – Economic Restructuring Program FSC – Financial Stability Council GDP – gross domestic product IFRS – International Financial Reporting Standards IMF

JICA – –

International Monetary Fund Japan International Cooperation Agency

MOF – Ministry of Finance MTRF – medium-term reform framework NPL – nonperforming loan TA – technical assistance

NOTE

In this report, “$” refers to United States dollars.

Vice-President Ahmed M. Saeed, Operations 2 Director General James P. Lynch, East Asia Department (EARD) Director Xiaoqin Fan, Public Management, Financial Sector, and Regional

Cooperation Division (EAPF), EARD Team leader Giacomo Giannetto, Principal Financial Sector Specialist, EAPF, EARDa Deputy team leader Team members

Enerelt Enkhbold, Senior Investment Officer, Mongolia Resident Mission, EARD Junkyu Lee, Chief of Finance Sector Group, Sustainable Development and Climate Change Department (SDCC) Genny Mabunga, Operations Assistant, EAPF, EARD Anna Charlotte Schou-Zibell, Regional Director, Pacific Liaison and Coordination Office in Sydney, Australia, Pacific Department Wendy Walker, Chief of Social Development Thematic Group, SDCC

Peer reviewers Stephen Schuster, Principal Financial Sector Specialist, Public Management, Financial Sector, and Trade Division, Southeast Asia Department (SERD) Said Zaidansyah, Deputy Country Director, Indonesia Resident Mission, SERD

a Outposted to the People’s Republic of China Resident Mission.

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page

BASIC DATA i

I. PROGRAM DESCRIPTION 1

II. DESIGN AND IMPLEMENTATION 1

A. Program Design and Formulation 1 B. Program Outputs 2 C. Program Costs, Financing, and Disbursement 4 D. Program Schedule 4 E. Implementation Arrangements 4 F. Consultant Recruitment and Procurement 4 G. Monitoring and Reporting 4

III. EVALUATION OF PERFORMANCE 4

A. Relevance 4 B. Effectiveness 5 C. Efficiency 6 D. Sustainability 6 E. Development Impact 7 F. Performance of the Borrower and the Executing Agency 7 G. Performance of the Asian Development Bank 8 H. Overall Assessment 8

IV. ISSUES, LESSONS, AND RECOMMENDATIONS 8

A. Issues and Lessons 8 B. Recommendations 9

APPENDIXES

1. Design and Monitoring Framework 10

2. Status of Compliance with Loan Covenants 13

3. Policy Matrix 15

BASIC DATA A. Loan Identification

B. Loan Data

10. Disbursements

a. Dates

1. Country Mongolia 2. Loan number and financing source 3533 (ordinary capital resources) 3. Project title Banking Sector Rehabilitation and

Financial Stability Strengthening Program 4. Borrower Government of Mongolia 5. Executing agency Ministry of Finance 6. Amount of loan $100,000,000 7. Financing modality Policy-based loan

1. Appraisal – Date started – Date completed

6 February 2017 17 February 2017

2. Loan negotiations – Date started – Date completed

16 March 2017 17 March 2017

3. Date of Board approval 30 May 2017 4. Date of loan agreement 31 May 2017 5. Date of loan effectiveness – In loan agreement – Actual – Number of extensions

29 August 2017 31 July 2017 0

6. Project completion date – Appraisal – Actual

30 June 2017 3 August 2017

7. Loan closing date – In loan agreement – Actual – Number of extensions

31 December 2017 3 August 2017 0

8. Financial closing date – Actual

3 August 2017

9. Terms of loan – Interest rate – Maturity – Grace period

London interbank offered rate + 0.60% less credit 0.10% 15 years 3 years

Initial Disbursement 3 August 2017

Final Disbursement 3 August 2017

Time Interval 0 months

Effective Date 31 July 2017

Actual Closing Date 3 August 2017

Time Interval 3 days

ii

b. Amount ($’000)

C. Program Data

1. Program cost ($‘000)

2. Cost breakdown by program component ($‘000)

Component Appraisal Estimate Actual

First Tranche 100,000 Total 100,000

3. Program performance report ratings

Implementation Period Ratings

31 July 2017–3 August 2017 No ratings in e-Operations for program loans

D. Data on Asian Development Bank Missions

a = senior financial sector specialist, b = principal economist, c = counsel.

Category

Original Allocation

(1)

Increased during

Implementation (2)

Canceled during

Implementation (3)

Last Revised

Allocation (4=1+2–3)

Amount Disbursed

(5)

Undisbursed Balance (6 = 4–5)

Total 100,000.00 0.00 0.00 100,000.00 100,000.00 0.00

Cost Appraisal Estimate Actual

Foreign exchange cost 100,000 Local currency cost 0 Total 100,000

Name of Mission Date No. of

Persons No. of

Person-Days Specialization of Members

Reconnaissance and fact-finding Loan Negotiations Review

6-17–February 2017

16–17 March 2017

10–19 October 2017

(back-to-back missions)

2

3

1

20

9

5

a, b

a, b, c

a

I. PROGRAM DESCRIPTION 1. In 2016, the Ministry of Finance (MOF) of the Government of Mongolia requested financial assistance from the Asian Development Bank (ADB) in the form of a policy-based loan to stabilize and restructure the banking industry, strengthen financial stability, and enhance competition among banks. ADB’s Banking Sector Rehabilitation and Financial Stability Strengthening Program is aligned with and supported the government’s Economic Restructuring Program (ERP).1 The program’s intended impact was aligned with the ERP objective of a well-developed, stable finance sector that helps the poor and vulnerable. The intended outcome—a strengthened and stabilized banking industry—was to be achieved through the delivery of three outputs: (i) a framework for bank restructuring completed, (ii) financial stability enhanced, and (iii) competition and governance strengthened.

II. DESIGN AND IMPLEMENTATION A. Program Design and Formulation 2. Mongolia’s economy is heavily dependent on mining and vulnerable to shocks and was experiencing a rapid downturn when the program was designed in 2016. Mineral exports and fiscal revenues were falling as a result of declining commodity prices and decelerating growth in the People’s Republic of China, Mongolia’s neighbor and largest trading partner. These and other factors precipitated a steady decline in gross domestic product (GDP) growth, from 17.5% in 2011 to only 1.0% in 2016. The weak economy threatened the solvency of the banking industry, depressed business conditions, and led to a rise in nonperforming loans (NPLs). The program was designed to support the government’s efforts to restore macroeconomic stability, fix the banking industry, improve financial intermediation, promote credit extensions for job creation, and improve the public’s access to financial services. 3. The ERP was passed by Parliament following the election of a new government in June 2016. The plan aims to promote foreign direct investment, job growth, and economic diversification. Its goals for the finance sector were to strengthen governance, guarantee independence for the Bank of Mongolia (BOM), and revise the laws governing foreign exchange activities and the functioning of the Financial Stability Council (FSC). The ERP calls for the government to prepare a finance sector development plan through 2025. 4. The ADB program was consistent with Mongolia’s development objectives. It is aligned with the ERP and Mongolia’s national development strategy for 2008–2021, which calls for strengthening the banking and financial system and making practices consistent with those in developed countries,2 in part by (i) strengthening the nonbanking financial system and operations, (ii) developing the securities and capital market, and (iii) enhancing the risk management of banking and financial institutions. Mongolia’s Sustainable Development Vision 2030 has similar aims. These include the establishment of a sound development finance and financial market to underpin dependable economic growth, the enlargement of the role of nonbank financial entities, and the stabilization of all financial institutions.3

1 Government of Mongolia. 2016. Economic Recovery Program, 2016–2020. Ulaanbaatar. The ERP was approved by

the Parliament on 24 November 2016. 2 Government of Mongolia. 2008. Millennium Development Goals-Based Comprehensive National Development

Strategy of Mongolia. Ulaanbaatar. 3 Government of Mongolia. 2016. Mongolia’s Sustainable Development Vision–2030. Ulaanbaatar.

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5. The program was properly designed and highly relevant to both these national strategies and Mongolia’s urgent need at that time to stabilize its economy and strengthen the financial sector. It was closely aligned with the first pillar of ADB’s country partnership strategy for Mongolia for 2017–2020 (promoting economic growth and social stability),4 and consistent with the emphasis in ADB's Strategy 2020 on inclusive economic growth and the designation of finance sector development as a core area of operations.5 B. Program Outputs 6. The program supported a policy framework with 3 corresponding outputs and 12 policy actions, as detailed in the policy matrix (Appendix 3). All policy actions were complied with before loan disbursement. 7. Output 1: Framework for bank restructuring completed. The actions to deliver this output were designed to support an effective restructuring of the banking industry. They included (i) supporting development by the government of a clear road map to a banking industry rehabilitation program; (ii) facilitating this rehabilitation by enabling rapid NPL resolution through creation of an asset management company (AMC); and (iii) backing the creation of a corporate debt restructuring committee, supported by the Mongolian Banker’s Association, to allow major corporate borrowers and their multiple lenders to reach feasible uniform resolution of large debts through an inter-creditor framework.

8. First steps toward asset management company. In completing a policy action in support of output 1, the government took initial steps toward creating an AMC. The updated legal framework supports bank efforts to collect on loans. However, but international experience has shown that banks facing NPL ratios as high as those in Mongolia have been unable to solve the issue on their own and have instead needed to transfer bad loans from their balance sheets to AMCs. The resulting NPL reductions have proven a prerequisite for bank recapitalizations in countries as varied as Indonesia, Ireland, the Republic of Korea, Spain, Thailand, the United Kingdom, and the United States. 9. Government concern over approach. Although a law creating an AMC was submitted to Parliament in July 2019, it has not yet been approved; likely reasons include the negative overall public perception of the banking sector, and government and the International Monetary Fund (IMF) concerns regarding possible fiscal effects. However, the AMC mechanism developed under the associated technical assistance (TA) would eliminate any fiscal impact and is based on structures applied successfully in Thailand and other countries. The mechanism would also mitigate related concerns about potential issues of weak governance, moral hazard, and collateral pricing. The structure proposed is consistent with best practices and principles defined in the World Bank’s toolkit for public asset management companies.6

10. Recapitalization difficulties. The BOM managed an asset-quality review that was conducted under the IMF program and based on the 2016 end-of-year data; the review identified recapitalization needs for seven banks, including several systemically important banks accounting for more than half of banking sector assets. An IMF program deadline for raising private capital was extended for 6 months from 31 December 2018, because no banks were able to raise private

4 ADB. 2017. Country Partnership Strategy: Mongolia, 2017–2020—Sustaining Inclusive Growth in a Period of

Economic Difficulty. Manila. 5 ADB. 2008. Strategy 2020: The Long-Term Strategic Framework of the Asian Development Bank, 2008–2020.

Manila. 6 World Bank Group. 2016. Public Asset Management Companies: A Toolkit. Washington.

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capital from either existing or new domestic or foreign shareholders. The banks did report new capital infusions in June 2019, but the IMF raised questions on the propriety of the funding sources and the regulatory compliance. A forensic audit in October 2019 confirmed that the recapitalizations were not valid. No bank has yet raised proper capital in compliance with regulations. The ADB and IMF programs had differing primary emphases—ADB on reduction of NPL levels, and the IMF on bank recapitalization—but these are complementary objectives and challenging to achieve in the short run. This highlights the need for development partners to coordinate closely and build consensus in providing quality assistance and coherent advice to the government. 11. Restructuring concept not suited due to debt profile. Although the output 1 policy action on creating a corporate debt restructuring committee was completed under the program, the concept was evaluated separately through the associated TA. The review found it likely to be ineffective in Mongolia’s financial sector, because too few of the corporate NPLs were syndicated. 12. Output 2: Financial stability enhanced. Output 2 actions aimed to enhance financial stability and oversight to prevent problems from recurring. These were intended to (i) support the strengthening of the FSC’s mandate, authority, and tools, and expand its membership through endorsement of an amendment to its governing law; (ii) support stronger oversight of the banking industry—i.e., supervision that no longer encouraged regulatory forbearance—and help amend regulations to bring banking practices into compliance with international standards; and (iii) support expansion of the capacity of the Deposit Insurance Corporation of Mongolia (DICOM) to deal with possible bank insolvencies through a government commitment to providing additional financing in a financial crisis if needed. 13. Legal reforms supported. Policy actions supported an amendment to the law that governs the operation of the FSC. Among other things, the amendment enables the FSC to expand its membership to include the DICOM. Amendments were made to banking regulations to bring them into compliance with international standards. The agreement by the MOF to back up the DICOM as needed will ensure that adequate financing is available in the event of a financial crisis and major deposit insurance claims. 14. Output 3: Competition and governance strengthened. Output 3 policy actions were intended to (i) provide a foundation and step-by-step plans for improving the finance sector’s capacity and governance to better meet the needs of individuals, corporations, and the government; (ii) support the licensing and regulation of foreign bank subsidiaries to expand competition in the sector and the transfer of best practices in risk management; and (iii) support steps to privatize and restructure State Bank, a 100% state-owned systemically important commercial bank. 15. State Bank options supported. Among other output 3 policy actions taken to increase banking industry competition, the government took steps toward the privatization and restructuring of State Bank. The required resolution was adopted by Parliament, and a step-by-step plan for the privatization was agreed between the BOM, the MOF, and DICOM. Options on how to proceed, based on a full feasibility study under the associated TA, were presented to the MOF. The government has yet to prepare the details of the privatization plan. With a new government in place subsequent to the June 2020 elections, this matter is expected to be taken up as part of the draft Banking Sector Reforms that will be submitted to parliament.

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C. Program Costs, Financing, and Disbursement 16. ADB provided $100 million from its ordinary capital resources. The loan was disbursed in a single tranche on 3 August 2017, as planned. D. Program Schedule 17. The program was approved on 30 May 2017, and the loan became effective on 31 July 2017. The program period was 31 July 2017–31 December 2017. The program was completed on 3 August 2017. E. Implementation Arrangements 18. The implementation arrangements designed at appraisal were satisfactory and remained unchanged during implementation. The MOF was the executing agency and responsible for overseeing and coordinating the timely implementation of all policy actions, although this responsibility was shared in some cases with the BOM. ADB coordinated closely during the program with other development partners involved in finance sector reform, including the World Bank; the Government of Japan, through the Japan International Cooperation Agency (JICA); and the IMF. The program design and the policy actions were consistent with their recommendations. All policy actions were completed by 30 June 2017. F. Consultant Recruitment and Procurement 19. The program required no consultant services or other procurement. G. Monitoring and Reporting 20. The government complied with all loan covenants before the loan proceeds were disbursed. No policy action or loan covenant was modified, suspended, or waived (Appendix 2). 21. A brief assessment of public financial management in Mongolia was completed based on a comprehensive public financial management performance report by the World Bank. The public financial management and governance risk was assessed as low.

III. EVALUATION OF PERFORMANCE A. Relevance 22. Design, objectives, modality. The program is rated relevant in design, objectives, financing modality, and timing. Mongolia’s banking industry had become extremely vulnerable prior to program implementation. Steadily slowing economic growth (para. 2) and fiscal deficits that had surged from 5.0% to 15.4% of GDP in 2015–2016 exposed weaknesses in the banking sector and highlighted the need to strengthen corporate governance and enforce regulations in support of stronger risk management. 23. Financial intermediation and stability impaired. The prolonged economic downturn reduced loan demand to –1% over December 2014–December 2016, compared with the 75.4% expansion reported year-on-year in November 2011. Outstanding loan values were equivalent to 50.2% of GDP in 2015, up from 30.4% of GDP in 2006. As growth rates decreased, the lending that had been undertaken when the economy was stronger began to mature, and NPL levels rose.

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By December 2016, a special concern was the high concentration (42.0%) of these NPLs in mining and construction, although these industries accounted for just 19.2% of total loan volume. Mongolia’s banks, encumbered by growing risks primarily due to rapidly rising NPLs, were impaired in their critical function as a financial intermediary for the private sector. This posed further risks to an already struggling economy, as well as to the stability of the finance sector. 24. Core issues addressed by the design. The program’s policy actions, aligned with the ERP, targeted important reforms to strengthen and stabilize the banking industry, addressing its governance, risk management issues, and limited competitiveness. The reforms they supported addressed the core issues in the finance sector. Actions included the consideration of a mechanism to enable corporate debt restructuring (out of court and led by the private sector) that aimed at containing and reducing the rising level of NPLs. Policy actions expanded the framework for financial stability management by the FSC and enhanced regulatory and supervisory oversight of banks’ governance and risk-management practices. Agreements were reached by the DICOM and MOF to ensure that the MOF would provide the funding necessary should a financial crisis require DICOM to pay out deposit insurance claims. Government actions designed and taken to expand competition included first steps in the process of divesting government ownership in State Bank and issuance of regulations to enable the licensing of foreign bank subsidiaries. 25. Mode, timeliness, ongoing relevance. The program remains highly relevant after completion and provided integral support for the IMF’s ongoing program for Mongolia. The loan’s drawdown by Mongolia after all policy actions were taken made a significant contribution to and was the first funding under the extended fund facility approved by the IMF on 24 May 2017. The single-tranche modality was appropriate. Aside from responding to the urgency of Mongolia’s economic and banking industry distress, the program’s timing, modality, and design were broadly consistent with the continuous reforms in the finance sector, the need to pass and implement related laws and regulations, and the key aspects of the IMF program. Subsequent program support would benefit from a clearer understanding of the probable success of the IMF program overall as well as of the likelihood of further the government’s action to rehabilitate the banking sector and improve the banks’ ability to reduce their NPLs and raise capital. B. Effectiveness 26. Outcome performance mixed. The program is rated less than effective. The intended outcome of a strengthened and stabilized banking industry was partially achieved. The industry’s loan growth is again positive—the biennial rate to December 2018 was 38.1%, up from –1% in December 2016. The other outcome indicator target—a fall in the NPL ratio—was not met: the NPL ratio was 10.4% in December 2018 and 10.1% in December 2019, exceeding both the 2016 baseline (8.5%) and the target for December 2018 (8.0%). Further work is required to deal holistically with NPLs, bank recapitalization, and bank supervision and risk management practices. The banking sector has been strengthened and instability reduced, but more time and effort are needed before it can be considered strong and fully stable. 27. Actions taken, and outputs delivered. All seven program actions in the policy-based loan (Appendix 3) linked to loan drawdown and the five additional actions linked to the design and monitoring framework output indicators were achieved. The timing and sequencing of the policy actions were appropriate. All policy actions were completed, and all design and monitoring framework output indicators were achieved prior to the drawdown (Appendix 1). 28. Legal reform and development partner coordination. Progress on legal reform to allow banks to deal with NPLs more rapidly was slow, in part because the political will to pass the

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needed legislation declined. The underlying factors include the negative overall public perception of the banking industry and the cyclical upturn in the economy which reduced the urgency to resolve matters holistically. 29. More time needed for full outcome assessment. The changes made through the policy actions to the legal and regulatory framework and environment should reduce NPL levels in the longer term, but other reforms must happen before the full effects can be realized. A more complete assessment of the program outcome should also include the results of the associated TA, which supports development of a mechanism and legal framework to create an AMC. The TA is scheduled for completion in July 2020. The IMF’s extended fund facility program was also ongoing at program completion. Some elements are related to banking sector reform. A full rebound in financial intermediation is unlikely until NPLs are further resolved. Establishing proper and effective governance, strengthening weak banking oversight and eliminating regulatory forbearance, reducing NPL ratios, and attracting more investor capital will require a long-term commitment and coordinated support from international partners, and the completion of reforms.

C. Efficiency 30. The program is rated efficient. All policy actions were completed, and no policy waiver was required. The program was closed a little more than 2 months after Board approval. D. Sustainability 31. Urgent near-term need addressed. The program is rated less than likely sustainable. The policy actions taken by the government under the program were steps toward building a holistic framework for overall longer-term reform of the banking sector. The program helped address an urgent need to manage rising banking risks and prevent a broader systemic crisis that might have further suppressed growth and harmed the poor and vulnerable. Despite the benefits, however, progress to date is for the most part not self-sustaining. The program’s policy actions cannot be expected to create a strong and robust banking sector in Mongolia entirely on their own; at a minimum, this will require completing the tasks under the associated TA and the actions called for by the IMF program, which in turn require sustained and consistent commitment by the government and step-by-step change. 32. Ongoing ADB support. The need for ADB’s long-term support was recognized in the program’s report and recommendation of the President, which outlined a medium-term reform framework (MTRF) for 2017–2020 agreed on between ADB and the government. The MTRF guides continuing support for the necessary reforms (footnote 1). Close engagement by ADB and other development partners has been and will continue to be important in building on the program outcome of strengthening and stabilizing Mongolia’s banking industry. 33. Sensitivity to shocks. Active ADB involvement and ongoing dialogue with the government provided for the MTRF enables ADB to design a potential second program to support financial sector reforms, when and if needed, which will depend on future conditions. These conditions and the sustainability of the program outcome may be affected (negatively or positively) by the economy’s high sensitivity to external factors, particularly commodity price movements. Such shocks can quickly impact the banks and the finance sector, causing (i) NPLs to spike, and impairing the financial intermediation required for economic recovery; or (ii) driving an economic upswing, and possibly improving the high-level reported NPL ratio when commodity markets improve. However, such an economic upswing has a potential risk, in that it may reduce the appetite for holistic and sustainable financial and banking reforms.

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34. Sustainability supported by policy actions. The program has helped the government take important initial steps to strengthen and stabilize banking and the finance sector. The changes to the legal framework can provide needed time for private sector recapitalization of the banking industry and an effective government response to the high level of NPLs. The ongoing associated TA reflects the recognition that long-term engagement by ADB is needed to help develop Mongolia’s finance sector.7

35. The road map developed for rehabilitation of the industry remains relevant and provides a path toward ensuring that program results are sustained. The AMC proposal provided the government an option—which has been successfully tested elsewhere—to ease the threat to financial stability and the constraint on financial intermediation resulting from excessive NPL levels. Although the creation of a corporate debt restructuring committee was ultimately found not to fit Mongolia’s precise needs, preparatory work and feasibility exploration undertaken by the Mongolian Bankers’ Association provided lessons and possible solutions for dealing with a future crisis. A legal amendment clarified the mandate, authority, and tools of the FSC and expanded its membership and capability for holistic crisis response. Stronger banking industry oversight and the elimination of regulatory forbearance were also supported. The benefits of restructuring the BOM’s supervision department and of regulatory amendments to bring banking practices into line with international standards will also outlast the program. 36. Time and government commitment needs. While the aforementioned steps are positive, it will take time to develop a solid commitment on the part of the government and Mongolia’s financial regulatory institutions to reform the banking sector, effectively deal with NPLs, cease forbearance, and thus realize the program’s ultimate impacts. If this can be done, the reforms supported by the program’s policy actions to enhance governance, risk management, regulation and practices, competition, and the overall strength and health of the banking industry—thereby making it more attractive to private domestic capital, and welcoming to foreign investors and expertise—will deliver outcome sustainability. E. Development Impact 37. The program’s development impact was less than satisfactory. The steps undertaken through the program were designed as building blocks for ongoing and future development of the industry and the sector. Their full impact will take time to emerge. Under the program, the policy actions were undertaken and helped boost the stability of the banking industry and the finance sector as a whole. The loan growth rate jumped from –1.0% in the 2-year period ending December 2016 to 38.1% in the 2 years ending December 2018. However, overall financial intermediation is still impacted by the high level of NPLs in the banking system and the inability to raise proper capital. The government has yet to move forward on the draft AMC law submitted to Parliament. The nature and magnitude of the banking system’s NPL and recapitalization problems call for additional, well-coordinated interventions and assistance from Mongolia’s development partners. Policy discussions between the government and these partners are ongoing. F. Performance of the Borrower and the Executing Agency 38. The performance of the Government of Mongolia as the borrower and the MOF as the executing agency is rated satisfactory. The MOF and BOM demonstrated a strong commitment to the agreed policy actions. They promptly prepared and provided policy action documentation

7 ADB. 2017. Banking Sector Rehabilitation and Financial Stability Strengthening. Manila.

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while a better outcome in reducing NPLs would have realized the program’s success. The program closed within about 2 months, and on time. All loan covenants were complied with. The government’s agreement to the MTRF demonstrated its commitment to reform the finance sector over the long term. G. Performance of the Asian Development Bank 39. ADB’s performance is rated satisfactory. This program harnessed ADB’s long-term engagement with the government in developing Mongolia’s finance sector. ADB’s East Asia Department responded to an urgent and critical need to mitigate the immediate impact of Mongolia’s economic decline and contribute to the IMF program by ensuring expeditious program processing and timely Board approval. The program’s single-tranche disbursement on 3 August 2017 represented the first funds delivered under the IMF program. ADB coordinated closely and effectively with other development partners to ensure complementarity, especially with the IMF, JICA, and the World Bank. JICA used the program’s policy actions for their contribution to the IMF program. A strong long-term relationship with the government and ongoing TA projects gave ADB a deep understanding of Mongolia’s finance sector without which it could not have prepared and implemented the program so rapidly. H. Overall Assessment

Overall Ratings

Source: Asian Development Bank.

IV. ISSUES, LESSONS, AND RECOMMENDATIONS

A. Issues and Lessons 40. A long-term view required. The program underlined some key realities of finance sector reform. It is a long process and requires the commitment and coordination of many stakeholders. Benefits of policy actions and reforms are unlikely to appear instantly. Completed steps often need additional support for the reform process to progress and/or to be built upon before the full positive results will emerge. The program’s NPL ratio reduction target was not reached within the initial 2-year reporting period, although the legal and regulatory frameworks to achieve this had begun to be put into place. The draft law for creating an AMC to clear such loans from balance sheets was introduced in Parliament, thus meeting the policy action requirement, but the effects on NPL levels and the impact on financial intermediation and economic growth cannot be felt until

Criteria Rating

Relevance Relevant Effectiveness Less than effective Efficiency Efficient Sustainability Less than likely sustainable Overall Assessment Less than successful Development impact Less than satisfactory Performance of borrower and executing agency Satisfactory Performance of Asian Development Bank Satisfactory

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it is approved by the government, and the mechanism is actually in operation. The program helped steady the banking industry and build some resilience to shocks, but Mongolia’s economy and finance sector will remain vulnerable to shifts in volatile commodity prices. 41. Sustained lesson-based engagement. A considered, deliberate, and cumulative approach and continued engagement by ADB are needed to sustain the reform process. ADB must continue to work closely with the government and other stakeholders as Mongolia moves to fully adopt international best practices and standards for its finance sector. ADB is considered the lead development partner in finance sector reform and has built solid relationships with sector stakeholders. These relationships were key to quickly identifying risks and promptly formulating this program’s policy actions and outputs. They can continue to inform effective intervention designs in the future. The program’s relevance and efficiency were built on lessons from previous ADB operations in Mongolia, and this should also be the case for any future ADB interventions. 42. Development partner coordination. The complex challenges involved in reducing the NPL ratio require close continuing dialogue, coordination, and cooperation with other development partners. It is particularly important that ADB, the IMF, and the World Bank build consensus on how to approach the problem so that the advice they provide the government is sound and coherent. This cooperation should include data and information sharing to ensure that all partners are analyzing problems and formulating solutions and recommendations using the same basic knowledge and understanding. 43. The value of wide ADB support. The OneADB approach is important to preparing and designing successful programs. The program team included staff from ADB’s Economic Research and Regional Cooperation Department (ERCD) who participated in the reconnaissance and fact-finding missions and the loan negotiations. ERCD’s extensive research on previous approaches to high NPL levels taken elsewhere in Asia and globally highlighted the key elements of success that the program incorporated from inception. B. Recommendations 44. Future monitoring. ADB should continue to engage with the government and support Mongolia’s financial sector through policy-based and targeted project lending. Regular ADB dialogue with key stakeholders is needed to achieve the objectives of the MTRF and ensure that this program’s policy reforms have the intended impact. 45. Further action or follow-up. ADB should continue to guide implementation of the ongoing associated TA until closing. Mongolia’s finance sector remains vulnerable. An expansion and deepening of finance sector support by ADB and the country’s other development partners is needed. Follow-up programs, projects, and TA should focus particularly on banking reforms. 46. Close development partner coordination. Development partners should continue to cooperate closely on the important challenges in the finance sector and build consensus to coordinate their approaches, assistance, and policy advice to the government.

10 Appendix 1

DESIGN AND MONITORING FRAMEWORK

Impact of the Program is aligned with A well-developed and stable finance sector that helps the poor and vulnerable achieved (Economic Recovery Program)a

Design Summary Performance Indicators and Targets

Program Achievements

Outcome Banking industry strengthened and stabilized

By 2018 a. Biennial banking industry loan growth rate is positive (December 2016 baseline: –1.0%) b. The NPL ratio falls below 8.0% (December 2016 baseline: 8.5%)

a. December 2018: + 38.1% b. December 2018: 10.4%

Outputs 1. 1. Framework for bank

restructuring completed 2. Financial stability enhanced

By end of April 2017: 1a. Decree outlining the steps to rehabilitate the banking industry issued by the BOM (baseline: no decree) 1b. Interagency working group established to support the creation of the legal and institutional framework of an AMC (baseline: no working group) 1c. Draft law prepared by the government for the establishment of an AMC (baseline: no draft law) 1d. Working group to create a corporate debt restructuring committee established by the Mongolian Bankers Association with the support of the BOM (baseline: no working group) 2a. Proposed amendments to relevant lawsb that will strengthen the FSC’s mandate, composition, authority, tools, and powers endorsed (baseline: no amendments)

1a. Decree issued by the BOM on 22 March 2017. 1b. Working group established through a joint decree by the BOM, the MOF, and the Financial Regulatory Commission, 3 February 2017. 1c. Draft law on the establishment of an AMC confirmed on 28 April 2017. 1d. Resolution of the Mongolian Bankers Association on 24 March 2017 on the establishment of a working group tasked to form the committee; BOM letter to the Mongolian Bankers Association to express (i) support for the creation of the committee, and (ii) willingness to participate in the committee. 2a. Minutes of the June 2017 FSC meeting endorsed proposed amendments to relevant laws.

Appendix 1 11

3.Competition and governance strengthened

2b. Revised asset classification regulation that integrates practices from the Basel Committee on Banking Supervision on capital adequacy accords issued by the BOM and MOF (baseline: no regulation) 2c. The BOM’s banking supervision department restructured (baseline: no restructuring) 2d. An MOU signed between the DICOM and MOF to support the DICOM’s financing needs in case of potential payout of deposit claims (baseline: no MOU) 3a. An ERP that will outline steps to improve the finance sector’s capacity and governance to meet the functional needs of individuals, corporations, and the government more effectively approved by Parliament (2016 baseline: no program) 3b. Regulation requiring banks to prepare IFRS-compliant financial statements effective from 1 January 2016 issued by the BOM and MOF (baseline: no regulation) 3c. An MOU entered between MOF, BOM and DICOM on preparing the plan to privatize the State Bank LLC by the end of 2019 (baseline: no MOU)

2b. Joint decree by the BOM and MOF on 9 December 2016; the regulation became effective on 20 December 2016. 2c. Decree by the BOM governor on 27 December 2016. 2d. MOU between the DICOM and MOF signed on 11 May 2017. 3a. Resolution of the State Great Khural (Parliament) on the ERP’s approval dated 24 November 2016. 3b. Joint decree issued by the BOM and MOF on 20 July 2015. 3c. Parliament Resolution No. 70 to approve the 2015–2016 guideline on the privatization and restructuring of the State Bank, dated 3 July 2015; MOU signed on 22 May 2017 between the BOM and MOF. This matter is expected to be taken up by the new government as part of the draft Banking Sector Reforms to be submitted to parliament.

12 Appendix 1

AMC = Asset Management Company, BOM = Bank of Mongolia, DICOM = Deposit Insurance Corporation of Mongolia, ERP = Economic Recovery Program, FSC = Financial Stability Council, IFRS = International Financial Reporting Standards, MOF = Ministry of Finance, MOU = memorandum of understanding, NPL = nonperforming loan. a Government of Mongolia. 2016. Economic Recovery Program, 2016–2020. Ulaanbaatar. b The relevant law refers to the Law on the Bank of Mongolia. Source: Asian Development Bank.

3d. Draft amended regulations to clarify the national treatment for foreign banking subsidiaries— which will cover (i) the licensing of banks and foreign subsidiaries, (ii) the scope of authorized banking activities, and (iii) the definition of paid-in capital and shareholdings—finalized by the BOM (baseline: no amendments)

3d. Draft amended regulations endorsed in May 2017 that cover (i) the licensing of banks and foreign subsidiaries, (ii) the scope of authorized banking activities, and (iii) the definition of paid-in capital and shareholdings.

Key Activities with Milestones Not Applicable

Inputs Asian Development Bank. Ordinary Capital Resources: $100 million (policy-based loan)

Assumptions for Partner Financing Not Applicable.

Appendix 2 13

STATUS OF COMPLIANCE WITH LOAN COVENANTS

Covenant

Reference in Loan

Agreement

Status of Compliance

The Borrower shall perform or cause to be performed, all obligations set forth in Schedule 4 of the Loan Agreement

Section 4.01 Complied with

The Borrower shall furnish or cause to be furnished to ADB all such reports and information as ADB shall reasonably request concerning (a) counterpart funds and the use thereof; and (b) the implementation of the Program, including the accomplishment of the targets and carrying out of the actions set out in the Policy Letter

Section 4.02 Complied with

The Borrower shall appoint the Ministry of Finance as the Program Executing Agency, which shall oversee and coordinate the timely implementation of the policy actions, The Borrower shall also appoint BOM as the Program implementing agency, which shall be responsible for the implementation of certain policy actions.

Schedule 4, paragraph 1

Complied with

The Borrower shall ensure that all policy actions adopted under the Program, as set forth in the Policy Matrix, continue to be in effect until December 2019.

Schedule 4, paragraph 2

Complied with, as validated by ADB missions.

The Borrower shall keep ADB informed of policy discussions with other multilateral and bilateral aid agencies that may have implications for the implementation of the Program and shall provide ADB with an opportunity to comment on any resulting policy proposals. The Borrower shall take into account ADB’s views before finalizing and implementing any such proposal.

Schedule 4, paragraph 3

This is an affirmative covenant and has been complied with, as validated through the donor coordination mechanism. The government did not find it necessary to hold such discussions.

The Borrower shall ensure that the Counterpart Fund are used to finance the implementation of certain programs and activities consistent with the objectives of the Program.

Schedule 4, paragraph 4

Complied with. Available evidence indicates compliance.

The Borrower shall further ensure that no less than the equivalent of forty million Dollars ($40,000,000) shall be made available to support the resolution of non-performing loans of commercial banks and banking sector rehabilitation.

Schedule 4, paragraph 5

Complied with.

14 Appendix 2

ADB = Asian Development Bank, BOM = Bank of Mongolia. Source: Asian Development Bank.

Covenant

Reference in Loan

Agreement

Status of Compliance

The Borrower, the Program Executing Agency, and the implementing agencies shall: (a) comply with ADB’s Anticorruption Policy (1998, as amended to date) and acknowledge that ADB reserves the right to investigate directly, or through its agents, any alleged corrupt, fraudulent, collusive or coercive practice relating to the Program; and (b) cooperate with any such investigation and extend all necessary assistance for satisfactory completion of such investigation.

Schedule 4, paragraph 6

Complied with. No evidence of corrupt, fraudulent, collusive, or coercive practices has been noted; and, as a result, no investigation has been launched.

The Borrower and ADB shall carry out quarterly review of Program implementation. ADB and the Borrower shall agree on the updated outcome and output indicators to monitor Program implementation and evaluate its impact.

Schedule 4, paragraph 7

Complied with. Review missions were fielded regularly during program implementation.

Appendix 3 15

POLICY MATRIX

Policy Actions Implementation Status

Output 1: Framework for bank restructuring completed

1.The Bank of Mongolia (BOM) issued a decree that outlines the steps to rehabilitate the banking sector

Complied: Yes (Required document: Decree of BOM)

2.The Government established an inter-agency working group to support creation of the legal and institutional framework of an Asset Management Company (AMC)

Complied: Yes (Required document: Joint Decree of BOM, Ministry of Finance [MOF] and Financial Regulatory Commission)

3. The government prepared a draft law for the establishment of an AMC that ensures: (i) proper governance, transparency and operational independence and oversight; (ii) use of market-based principles and effective allocation of risks and recovery with bank; (iii) broad special authority to manage non-performing loans for the timely and enforceable transfer of asset ownership rights and the unfettered rights to dispose of assets; (iv) legal protection of management and employees performing their duties; (iv) profit maximizing goal and performance-based approach; (vi) commercial orientation and flexibility for private sector participation; (vii) the inclusion of a sunset clause; and (viii) resolution of nonperforming loans of only commercial banks.

Complied: Yes (Required document: A draft law on establishment of an AMC prepared by the BOM and MOF)

4.The Mongolian Banker’s Association, with the support of BOM, established a working group to create a corporate debt restructuring committee that will (i) prepare and approve an out-of-court corporate debt restructuring framework; and (ii) adopt an inter-creditor agreement to address corporate debt burden.

Complied: Yes (Required document: a. Resolution of the Mongolian Banker’s Association on establishment of a working group tasked to form the committee; b. Letter from BOM to the Mongolian Banker’s Association to express [i] support in the creation of the committee; and [ii] willingness to participate in the committee)

Output 2: Financial Stability Enhanced

5.The Financial Stability Council (FSC) endorsed proposed amendments to the relevant law that will strengthen its mandate, composition, authority, tools and powers.

Complied: Yes (Required document: Minutes of meeting of the FSC that endorsed proposed amendments to the relevant law)

16 Appendix 3

Policy Actions Implementation Status

6.The government and the BOM jointly issued revised asset classification regulation that integrates practices from Base Committee for Banking Supervision capital adequacy accord.

Complied: Yes (Required document: Joint Decree by BOM and MOF dated 9 December 2016 with effective date of 20 Dec 2016)

7.The BOM restructured the banking supervision department to align it with best practices that include combining on-site and offsite functions into one that will allow for continuous supervisory process and support for implementing risk-based supervision.

Complied: Yes (Required document: Decree of BOM dated 27 December 2016)

8.MOF entered into a Memorandum of Understanding (MOU) with Deposit Insurance Corporation of Mongolia (DICOM) to support the financing needs of the DICOM in cases of potential payout of deposit claims

Complied: Yes (Required document: MOU signed between DICOM and MOF agreeing to prepare a back-up financing facility)

Output 3: Competition and strengthened governance introduced

9.The Parliament approved the Economic Recovery Program (ERP) that will outline steps to improve the financial sector’s capacity and governance to better meet the functional needs of individuals, corporations, and the government

Complied: Yes (Required document: Resolution of the State Great Khural on approval of the ERP, dated 24 November 2016)

10.The government and BOM issued regulation to required banks to prepare International Financial Reporting Standards (IFRS) compliant financial statements effective from 1 January 2016

Complied: Yes (Required document: Joint Decree of BOM and MOF dated 20 July 2015)

11.The government entered into an MOU with the BOM and DICOM on the preparation of the privatization plan of State Bank by year end 2019.

Complied Yes (Required document: a. Parliament resolution No. 70 to approve the 2015–2016 Guideline on privatization and restructuring – State owned shared of State Bank LLC shall be privatized, dated 3 July 2015 b. MOF, BOM and DICOM signed an MOU to prepare a plan to privatize State Bank by year-end 2019)

12.The BOM finalized draft amended regulations to clarify national treatment for foreign banking subsidiaries. The draft amended regulations will cover (i) licensing of banks and foreign subsidiaries; (ii) scope of authorized banking activities, and (iii) defining paid in capital and shareholdings.

Complied: Yes (Required document: Draft amended regulations that cover [i] licensing of banks and foreign subsidiaries, [ii] the scope of authorized banking activities, and [iii] defining paid in capital and shareholdings)

Source: Asian Development Bank.