program and project administration memorandum · the program and project administration memorandum...

Program and Project Administration Memorandum

Program Number: 37164 Loan Number: 2279/2280 October 2007

Proposed Loans and Technical Assistance Grant Kingdom of Bhutan: Financial Sector Development Program

The program and project administration memorandum is an active document, progressively updated and revised as necessary, particularly following any change in project or program costs, scope, or implementation arrangements. This document, however, may no reflect the latest project or program changes.

CURRENCY EQUIVALENTS (as of 27 August 2007)

Currency Unit – ngultrum (Nu)

Nu1.00 = $0.0243

$1.00 = Nu41.088

ABBREVIATIONS

AASB – accounting and auditing standards board ADB – Asian Development Bank AML – anti-money laundering BOBL – Bank of Bhutan Limited CFT – combating the financing of terrorism CIB – credit information bureau EA – executing agency FIA – Financial Institutions Act FISD – Financial Institutions Supervision Division FIU – financial intelligence unit FSA – Financial Services Act FSDP – Financial Sector Development Program GAAP – generally accepted accounting principles GAAS – generally accepted auditing standards IA – implementing agency IAS – International accounting standards MOF – Ministry of Finance PMU – program/project management unit PSC – program steering committee RAA – Royal Audit Authority RICBL – Royal Insurance Corporation of Bhutan Limited RMA – Royal Monetary Authority RSEBL – Royal Securities Exchange of Bhutan Limited TA – technical assistance

NOTES

(i) The fiscal year (FY) of the Government and its agencies ends on 30 June. FY before a calendar year denotes the year in which the fiscal year ends.

(ii) In this report, "$" refers to US dollars.

CONTENTS

Page LOAN PROCESSING HISTORY ii DESIGN AND MONITORING FRAMEWORK iii I. PROJECT DESCRIPTION 1

A. Project Area and Location 1 B. Impact and Outcome 1 C. Components and Outputs 1 D. Special Features 6

II. COST ESTIMATES AND FINANCING PLAN 7 A. Detailed Adjustment Cost Estimates 7 B. Financing Plan 8 C. Allocation of Loan Proceeds 9

III. IMPLEMENTATION ARRANGEMENTS 10 A. Executing and Implementing Agencies 10 B. Program and Project Management Organization 10

IV. IMPLEMENTATION SCHEDULE 12 V. FINANCIAL MANAGEMENT DURING IMPLEMENTATION 12 VI. CONSULTANT RECRUITMENT 13 VII. PROCUREMENT 13 VIII. DISBURSEMENT PROCEDURES 14 IX. PROGRAM AND PROJECT MONITORING AND EVALUATION 15 X. REPORTING REQUIREMENTS 15 XI. AUDITING REQUIREMENTS 16 XII. MAJOR LOAN COVENANTS 17 XIII. IMPLEMENTATION OF THE ACCOMPANYING TA 18 XIV. KEY PERSONS INVOLVED IN THE PROJECT 18 XV. ANTICORRUPTION 19

APPENDIXES 1. Policy Matrix for Financial Sector Development Program 20 2. Detailed Cost Estimates and Financing Plan 25 3. Program/Project Organization Chart 27 4. Implementation Schedule 28 5. Summary of Financial Management Assessment 30 6. Project Loan: Outline Terms of Reference for Consultants, Cost Estimates,

and Financing Plan 33 7. Procurement Plan 38 8. List of Ineligible Items (or Negative List) 40 9. Sample Withdrawal Application for Direct Payment and Reimbursement 41 10. Sample Withdrawal Application Form for Imprest Fund 42 11. Sample Progress Report 43 12. Sample Audit Letter 48 13. Technical Assistance for Institutionalizing Skills and Capacity Development: Outline Terms of Reference for Consultants, Cost Estimates, and Financing Plan 50

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LOAN PROCESSING HISTORY

Milestones Dates Approval of Project Preparatory Technical Assistance 17 July 2005 Fact-Finding Mission 26 June–8 July 2006 1st Management Review Meeting 11 September 2006 Appraisal Mission 18–27 September 2006 2nd Management Review Meeting 13 October 2006 Loan Negotiations 30–31 October 2006 Board Circulation 14 November 2006 Board Consideration and Approval 7 December 2006 Loan Agreement Signing 8 March 2007 Loan Effectiveness 4 June 2007

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DESIGN AND MONITORING FRAMEWORK

Design Summary

Performance Targets/Indicators

Data Sources/ Reporting Mechanisms

Assumptions and Risks

Impact Improved depth, soundness, and stability of the financial system for supporting private sector development and economic growth

Compliance with the capital-to-risk asset ratio of 10% Reduced nonperforming loans (NPLs) in the financial sector (e.g., NPLs in the nonbank sector decreased from 20% in 2005) Decreased interest rate spreada from about 8% in 2005

RMA annual report Annual reports from other government agencies Program reports ADB review missions

Assumptions Political stability and commitment to carry out the reform process Sustained current economic growth Risk Economy affected by significant negative external shocks

Outcome Improved governance of the whole financial sector and more efficient financial intermediation

Improved autonomy of RMA under revised RMA Act Strengthened regulatory and supervisory framework under FSA covering all subsectors Introduction of private sector representatives to the boards of financial institutions Adoption and mainstreaming of AML/CFT and best practices in financial services Increased number of professionals in the financial sector (e.g., accountants, auditors, insurance underwriters, actuaries, etc.)b to be benchmarked

RMA annual reports Financial institutions’ chartered annual reports ADB review missions

Assumptions Political will to undertake reform in the financial sector Continued political dialogue between ADB, the Government, and other key stakeholders Risks Policy reforms not implemented or reversed Laws and regulations not properly implemented or enforced

Outputs 1. Improved regulation

and supervision of the financial sector

Draft revised RMA Act and FSA finalized and submitted to the National Assembly for passage Banking, insurance, and securities markets regulations completed and issued conforming to international standards Improved compliance and enforcement of financial sector supervision

Official copies of laws, regulations, and codes National Assembly’s official announcement of revised RMA Act and FSA adoption RMA official announcement of new rules and regulations adopted Certificates of training completion and professional qualification RMA annual reports

Assumptions Adequate laws and regulations are prepared on time National assembly accepts final draft revised RMA Act and FSA Risks Significant delay in passing the draft revised RMA Act and FSA Expected results and objectives of legal

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Design Summary




ADB review missions

and regulatory reform not fully met due to lack of understanding or political will

2. Strengthened

corporate governance structure and operations of financial institutions

Guidelines for corporate governance issued and enforced BOBL’s corporate structure improved and business plan adopted BOBL’s improved performance targets based on the business plan (e.g., reduced cost/income ratio from current 77.7% as of December 2005) RICBL’s structure rationalized, insurance businesses segregated, and business plan approved by BOD

RMA’s official announcement of new rules and regulations adopted Financial institutions chartered annual accounts BOBL’s board resolution to adopt a rolling business plan that will provide performance indicators of BOBL by way of signing a MOU with the Government RICBL’s board resolution to adopt the business plan and segregate insurance businesses

Assumptions Revised RMA Act gives RMA the autonomy to apply fit-and-proper tests of board members Financial institutions’ willingness and commitment to improve efficiency and to reform corporate governance Institutional capacity to undertake reforms Risks Loss and/or lack of qualified staff Delays or watered down reform process due to political interference in financial institutions’ internal affairs

3. Effective AML/CFT

regime established

AML provisions included in the FSA AML and CFT regulations adopted FIU established with adequate mandate and budget for qualified staff and information technology management information system Scope for money laundering through the financial sector reduced

Copies of FSA and AML/CFT regulations Copy of FIU’s charter RMA’s annual report and specific AML and CFT reports Copies of AML and CFT procedure manuals in the financial institutions and evidence of know-your-customers reporting to RMA

Assumptions Effective coordination among relevant government agencies, especially RMA, police, and judiciary Financial institutions’ adoption of effective management information system and staff resources to carry out AML and CFT procedures and reporting Risks Weak enforceability of AML and CFT legal and regulatory framework FIU established within RMA not granted sufficient powers to carry out its mandate

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Design Summary




Insufficient resources allocated and/or low capacity in FIU

4. Developed national

accounting and auditing policies and standards

Accounting standards committee and subsequently Bhutanese AASB established Bhutanese GAAP and GAAS approved by AASB Bhutanese GAAP and GAAS implemented in financial institutions

Plans to establish the Bhutanese AASB approved Plans to develop the Bhutanese GAAP and GAAS GAAP and GAAS manuals and workshops provided by the AASB

Assumptions Institutional capacity to undertake reform Qualified consultants promptly engaged Effective monitoring by AASB Risks Development of an unduly onerous system that discourages reporting Insufficient resources allocated and/or low capacity in AASB

5. Strengthened

information sharing

CIB established and regularly updated Legal, regulatory, and institutional framework established

Copy of CIB charter Copy of CIB rules and regulations CIB reports

Assumption Financial institutions use CIB to improve credit risk assessment Risk Misuse of information in CIB

Activities with Milestones 1. Improve regulation and supervision of the financial sector 1.1. RMA finalizes draft revised RMA Act and FSA by December 2006 and submits it

to the National Assembly for passage by June 2008. 1.2. RMA conducts stakeholder consultations on the draft regulations and education

workshops for financial institutions by June 2008. 1.3. RMA issues implementing regulations under the FSA by December 2009. 1.4. Implement the secondment program so that experienced officers of the Financial

Institution Supervision Division at RMA receive on-the-job training in countries with strong financial supervision and obtain skills and practical experience in on-site supervision of banks, development finance, insurance, and capital markets by December 2009.

1.5. Conduct the training program for enhancing RMA staffers’ accounting and auditing skills by December 2009.

1.6. The securities market expert conducts on-the-job training for strengthening professional knowledge of securities markets and related regulations by June 2008.

2. Strengthen corporate governance structure, and operations of financial institutions

2.1. RMA completes prudential regulations for corporate governance by June 2008 and issues them by December 2009.

Inputs • Program loan of $11

million to the Government to support policy reforms

• Project loan of $2

million • TA 4615-BHU:

Preparing for the Financial Sector/Non-bank Financial Institutions Reform Program (TA of $500,000, providing 13 person-months of international consultancy and 9

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Activities and Milestones 2.2. RMA conducts stakeholder consultations on the draft regulations and educational

workshops for financial institutions by June 2008. 2.3. BOBL prepares a business plan by June 2008, to be approved by its BOD, for

expanding its lending operations and determining how best to deal with its existing excess liquidity, linking management remuneration to performance, improving recruitment and performance evaluations, and developing a human resources strategy by December 2009.

2.4. The Government drafts an MOU by June 2008, for signing by the Government and BOD, to provide time-based institutional performance targets for BOBL and so commercialize its operations by December 2009.

2.5. RICBL prepares and approves a rationalization plan by June 2008 that details the necessary steps to separate its business operations. Rationalization plan is implemented by December 2009.

2.6. RICBL prepares a business plan by June 2008 for post-rationalization to ensure the phased-in segregation of business units, adequate solvency provisioning, and capital adequacy by December 2009.

2.7. Implement the training program for strengthening insurance underwriting skills by December 2009.

3. Establish effective AML/CFT regime 3.1. The Government drafts the FSA to provide RMA with the authority as the

AML/CFT regulator and supervisor in the financial sector by December 2006. 3.2. RMA develops and issues regulations by June 2008 requiring financial institutions

to establish procedures for know-your-customer processes, generating reports on suspicious transactions, and reporting them to RMA by June 2008.

3.3. RMA establishes FIU in conformity with the FSA by June 2008. 3.4. FIU takes charge of financial reporting requirements and procedures for

AML/CFT supervision by June 2008 and commences operations by December 2009.

4. Develop national accounting and auditing policies and standards 4.1. Ministry of Finance establishes an accounting standards committee with

representation of involved government agencies to take charge of accounting and auditing reform by December 2006.

4.2. The committee creates the Bhutanese AASB by November 2006. 4.3. AASB develops the Bhutanese GAAP and GAAS by June 2008 4.4. AASB discusses with stakeholders the newly developed Bhutanese GAAP and

GAAS and approve them for implementation by December 2009. 4.5. RMA establishes a training program to develop the accounting and auditing

profession and to obtain accountancy training in a relevant member country by December 2009.

5. Strengthen information sharing 5.1. RMA establishes a CIB unit for developing a plant to establish CIB by December

2006. 5.2. RMA establishes CIB with corresponding rules and regulations by June 2008. 5.3. RSEBL develops a website for disseminating mandatory market information by

December 2009. 5.4. RSEBL develops a database and system to improve depository and settlement

processes by December 2009.

Inputs person-months of

national)

• Attached TA for institutionalizing skills and capacity development on a sustainable basis in the financial sector (TA of $250,000, providing 6 person months of international consultants and 3 person-months of various resources persons)

AASB = accounting and auditing standards board, ADB = Asian Development Bank, AML = anti-money laundering, BOBL = Bank of Bhutan Limited, BOD = board of directors, CFT = combating the financing of terrorism, CIB = credit information bureau, FIU = financial intelligence unit, FSA = Financial Services Act, GAAP = generally accepted accounting principles, GAAS = generally accepted auditing standards, MOU = memorandum of understanding, RICBL = Royal Insurance Corporation of Bhutan Limited, RMA = Royal Monetary Authority, RSEBL = Royal Securities Exchange of Bhutan Limited, TA = technical assistance. a Difference between lending rates to manufacturing or services industries and 1-year term deposit rates. b Government ministries currently employ10 chartered accountants and outsource most of their financial service

needs, including accounting, auditing, and insurance underwriting.

I. PROJECT DESCRIPTION

A. Project Area and Location 1. The Financial Sector Development Program (FSDP) is designed to strengthen the legal, regulatory and supervisory framework, and the governance structure, operational efficiency, and institutional capacity of the financial sector in Bhutan. It aimed at improving the soundness, stability, and depth of the financial system to support private sector activity and sustained economic growth. B. Impact and Outcome 2. The FSDP consists of a program loan and a project loan. The program loan includes crucial policy reforms, and the project loan will provide direct assistance to facilitate FSDP implementation and ensure the smooth implementation and sustainability of the policy reforms under the program. It is envisaged that the FSDP will have a positive impact on establishing an environment more conducive to business investment and stimulating the development of a more active private sector. The outcome of the FSDP is improved depth, soundness, and stability of the financial system by strengthening the governance of the whole financial system and improving the efficiency of financial intermediation. C. Components and Outputs 1. The Program Loan 3. The Program consists of five components. The outputs and major activities are spelled out as follows, as well as detailed in the design and monitoring framework (page iii) and policy matrix (Appendix 1).

a. Improve the Regulation and Supervision of the Financial Sector 4. As a first step to ensure a strong reform regime, a revised Royal Monetary Authority (RMA) Act will need to be drafted and finalized to give RMA autonomy to act with independence on monetary matters and vest it with enhanced powers to oversee the operations of the entire financial system. In the absence of an International Monetary Fund (IMF) program to support it, the FSDP should continue its support toward ensuring the finalization and passage of the revised RMA Act, which has been finalized with Asian Development Bank (ADB) assistance1 and is currently undergoing translation for submission to the National Assembly. The program will therefore ensure that the revised RMA Act is submitted and enacted. Under the revised RMA Act, a cap will be placed on the amount that the Government can borrow from RMA on a non-revolving basis for a term not exceeding 3 months. Further, the corporate governance structure will be converted into a two-tier structure, giving RMA management greater control over RMA policy and operations. It will be composed of a restructured board and an executive committee. The current board, comprising the minister of finance (acting as chairman), secretary of finance, managing director of RMA, and two other appointed directors (one from Ministry of Finance (MOF) and one from the Ministry of Trade and Industry)—all from the public sector—is being replaced with one comprising, firstly, the governor, two deputy governors, and

1 ADB. 2002. Technical Assistance to the Kingdom of Bhutan for Strengthening the Capacity of the Royal Monetary

Authority and Royal Securities Exchange of Bhutan (Financed by the Japan Special Fund). Manila (TA 3905-BHU approved on 23 August 2002).

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four directors appointed by the Government from outside RMA. The executive committee will comprise the governor (heretofore called the managing director) and two deputy governors. Moreover, the governor and members of the board are now barred from serving as employees, shareholders, or board members of financial service providers during their tenure of office, and from being associated with them in any way. These steps are in line with the Government’s preference to proceed in measured steps towards the institution of a fully independent central bank. 5. Secondly, the need is pressing for the draft FSA to be finalized and enacted to address gaps in the regulation and supervision of the whole financial sector of Bhutan. The small size of Bhutan’s economy makes it appropriate to have RMA as the single regulator. Therefore, under the Financial Services Act (FSA), RMA is to be vested with powers to license, regulate, and supervise all financial service providers throughout the country. The draft FSA is currently under review under ADB assistance,2 and the remaining gaps in legislation and regulation for such sectors as insurance and securities exchange are to be amended in the final FSA to ensure that the FSA is comprehensive and coherent. In particular, RMA will be provided with powers to (i) conduct on-site inspections in the whole financial sector; (ii) license, regulate, and supervise the insurance sector as a separate entity; (iii) act as the securities regulator to investigate and prosecute securities violations for both licensed and non-licensed companies; (iv) issue rules and guidelines on corporate governance matters (see point [b] below); and (v) deal with anti-money laundering (AML)/combating the financing of terrorism (CFT) issues (see point [c] below). Prudential regulations on banking supervision, insurance regulations, and securities exchange will be revised, updated, and further strengthened to ensure adequate regulation and supervision in the relevant sectors. Furthermore, the FSDP will support setting up a standard chart of accounts to be followed by all financial institutions and their external auditors. It will also help draft appropriate licensing requirements and procedures for new entrants in the banking and insurance sectors to ensure and encourage fair competition in all financial subsectors.

b. Improve the Corporate Governance Structure and Operations of Financial Institutions

6. The FSDP will consider all-pervasive issues of corporate governance in the financial sector by strengthening the legal framework to include matters relating to corporate governance, improving the operations of Bank of Bhutan Limited (BOBL) and clarifying the organizational structure of Royal Insurance Corporation of Bhutan Limited (RICBL). The FSA will provide RMA with comprehensive powers to regulate and enforce corporate governance for the whole financial sector. The provisions on corporate governance will include, among other stipulations, (i) an appropriate fit-and-proper test for boards of directors; (ii) private sector representation in the structure and composition of the boards of directors, (iii) conflict-of-interest rules, and (iv) restrictions on cross shareholdings. 7. The corporate governance legal framework will provide autonomy for public sector financial institutions and ensure the commercial orientation of their operations. A memorandum of understanding will be prepared and signed between MOF and the board of directors of BOBL to provide time-bound institutional performance targets and autonomy for its operations. In turn, management of BOBL will prepare a rolling business plan that will define the parameters and performance indicators that management of BOBL will deliver to allow the board of directors to meet their commitment under the memorandum of understanding with MOF. The business plan

2 ADB. 2005. Technical Assistance to the Kingdom of Bhutan for Preparing the Financial Sector/Non-bank Financial

Institutions Reforms Program. Manila (TA 4615-BHU approved on 17 July 2005).

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will provide for expanding its lending operations and determining how best to deal with its existing excess liquidity, linking remuneration for management and the board of directors to performance, improving recruitment and performance evaluations, and developing a strategy for human resources. Management of BOBL will be recruited under clear, objective, and fair recruitment guidelines and procedures to ensure improvement in operational efficiency and financial performance. RMA, as regulator, will be informed of all discussions and agreements between the Government and BOBL. 8. It is important to improve the organizational structure of RICBL according to insurance core principles of International Association of Insurance Supervisors, which require complete separation of life insurance, other insurance, and any other financial services. RICBL will prepare a rationalization plan detailing the necessary steps to separate its business operations. RICBL will also prepare a business plan post-rationalization to ensure the phased-in segregation of business units, adequate solvency provisioning, and capital adequacy. A successful segregation of financial assets according to different operations can improve the matching and reserving system for assets and liabilities to ensure the provision of adequate solvency margins.

c. Establish an Effective AML and CFT Regime

9. The program loan will support the Government’s initiatives to establish an effective AML/CFT regime. The AML/CFT component of the program aims to strengthen the AML/CFT policies and procedures currently employed in Bhutan. This will include (i) updating legislation (i.e., the proposed FSA) to establish RMA as the AML/CFT regulator and supervisor for all financial institutions; (ii) RMA drafting and issuing regulations requiring financial institutions to establish procedures for know-your-customer processes, generating reports on suspicious transactions, and reporting them to RMA; and (iii) RMA establishing a financial intelligence unit (FIU) whose function will be to gather information on suspected money laundering or financing of terrorism and liaise with law enforcement agencies. The enhanced AML/CFT framework is in line with the Government’s Good Governance Plus Strategy (2005).

d. Develop National Accounting and Auditing Policies and Standards 10. The program loan will address the high degree of opacity and incomparability of reports and performance records of financial institutions by developing and applying uniform and consistent national accounting and auditing standards. It will support the development of the national accounting and auditing standards to form the Bhutanese generally accepted accounting principles (GAAP), in line with international accounting standards (IAS) where applicable, and the generally accepted auditing standards (GAAS) in line with international auditing standards. The FSDP envisages creating the Bhutanese accounting and auditing standards board (AASB), which will be tasked with developing the Bhutanese GAAP and GAAS. MOF will form an accounting and auditing standards committee, which will develop the plan to establish accounting and auditing standards board (AASB). Comprising the accounting and auditing standards committee will be representatives of the private sector, MOF, Royal Audit Authority (RAA), RMA, and Ministry of Trade and Industry. AASB will also have the authority to regulate and supervise the accounting and auditing profession. Of paramount importance is that the Government initiates a training program to develop the accounting and auditing profession in Bhutan.

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e. Strengthen Credit Information Disclosure

11. A reliable system for sharing credit information among lending institutions can expedite loan applications and improve credit risk assessment. It would potentially lower the cost of borrowing and facilitate financial transactions. The program loan will support establishing a credit information bureau (CIB) with the aim of improving the quality of financial institutions’ credit risk assessment. It will help the Government set up a CIB unit at RMA, which will prepare an implementation plan in consultation with major stakeholders. The CIB unit will be responsible for the institutional set-up and legal and regulatory framework for its full operation. CIB establishment will be based on the findings of the feasibility study3 on appropriate arrangements for data collection, system maintenance, and information sharing.

2. The Project Loan a. Building Sector Capacity 12. The project loan will support filling in gaps in present capacity in the financial sector, providing practical on-the-job training for the regulator and supervisor and selected key financial institutions with a view toward assuring smooth implementation of the new regime. The capacity-building schemes will be reinforced by employee incentives and retention measures to ensure the dissemination and maintenance of the training knowledge as well as to compensate for the training cost by providing a certain period of post-training service time. The retention measures will combine reward and prevention, as staff will be (i) rewarded by incorporating training in their performance evaluation for possible career advancement and greater supervisory or management responsibility; and (ii) discouraged from leaving RMA or financial institutions after completing training by a lock-in clause in their employment contracts requiring that early leavers compensate the Government for the cost of training on a pro-rata basis.

i. Secondment Program for Strengthening Financial Supervision

13. To obtain skills and practical experience in the on-site supervision of banks and NBFIs, the project loan will support a program for Financial Institutions Supervision Division (FISD) staff of RMA to be seconded to a member country with strong financial regulatory and supervisory bodies. The secondment program for improving the performance of FISD’s staff is intended to last, on an intermittent basis, for the whole FSDP implementation period. Four senior FISD staff for each supervision area (i.e., banks, development finance, insurance, and possibly the securities market) will go on secondment for a minimum of 3 months each year. After returning from secondment, the trained staff will share their practical experience with colleagues by (i) giving short training sessions, (ii) creating a supervision materials library to be regularly updated, and (iii) helping the chief of FISD to update the supervision manuals with lessons learned during secondment.

ii. Training Program for Enhancing Accounting and Auditing 14. The project loan will support a training program for two RMA staff to obtain professional qualifications in accounting and auditing (e.g., chartered accountancy from the Institute of

3 RMA has prepared a feasibility study for establishing a CIB with assistance from Dun & Bradstreet SAME Ltd. The

draft report was furnished to ADB. The study recommends the required software, operational model, and legal framework to establish and govern the CIB.

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Chartered Accountants in England and Wales). The staff will train in a country within the region so that, at the end of the 3-year accountancy training program, RMA should have in-house accountants to enhance its supervisory role.

iii. Training Program for Enhancing Insurance Underwriting Skills

15. The project loan will support a staff training program with insurance companies in member countries with a more advanced and well-regulated insurance sector to develop in-house skills in insurance underwriting and claims adjustment. This will reduce RICBL’s reliance on foreign consultants in key areas of the insurance business. Experienced RICBL officers will join the regular staff of the host company to carry out day-to-day tasks and so receive valuable on-the-job training in underwriting for general insurance (fire, motor, engineering and marine, and aviation transport), life insurance, and claims processing. In each year, six different and relevant employees will go on secondment for a minimum of 6 months each year during the 3 years of program implementation. In addition, in view of the newly identified need of technical assistance for preparing the RICB rationalization plan, a short-term international insurance expert will be recruited,

iv. Capacity Building for Securities Exchange 16. The project loan will provide on-the-job training to increase securities-trained personnel in FISD and Royal Securities Exchange of Bhutan Limited (RSEBL). The capacity-building program will cover (i) supervision processes; (ii) listings and delistings; (iii) trading modalities; (iv) settlements, payments, and depository operations; (v) governance, covering disclosure and conflicts of interest, etc.; and (vi) the new regulatory framework. The specialized training will enhance the monitoring, surveillance, and supervision of the securities market and brokers as well as strengthen the operations of the securities exchange. An international capital markets specialist will be recruited to provide the training.

v. Improving Corporate Governance 17. The project loan will help draft regulations to provide for and internalize good corporate governance measures. It will also assist institutions to carry out these proposed measures and effect appropriate organizational changes, such as fit-and-proper tests for boards of directors, enhancing the structure and composition of boards, conflict-of-interest rules, restrictions on cross shareholding, and others measures as appropriate. An international legal expert will be recruited to undertake the improvements in corporate governance, assisted by a national legal expert.

b. Developing AML/CFT Framework 18. The project loan will support the institutional development of an FIU in RMA. This support will include (i) FIU’s organizational design, (ii) operating procedures including off- and on-site supervision for AML/CFT issues, (iii) management of FIU during initial stages prior to handover to FIU staff, and (iv) the establishment of the FIU including procurement of basic IT infrastructure. Assistance will also cover associated on-the-job training for RMA, police, prosecutors, and judges regarding (i) the effects of AML on economic development and international standards, (ii) the legal requirements to meet international standards, (iii) the regulatory and institutional requirements, (iv) the compliance requirements for financial institutions, (v) building an effective FIU, (vi) domestic (interagency) and international

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cooperation, (vii) CFT, and (viii) investigating money laundering and terror financing. In addition, this component will promote compliance with the new AML/CFT regulations and reporting requirements by providing informational seminars for financial intermediaries. This will be provided by an international AML/CFT expert, assisted by a national legal specialist. c. Improving Accounting and Auditing Practices 19. The project loan will support the recruitment of an international financial sector accounting and auditing firm to (i) help the accounting and auditing reform committee (to be established by the Government) develop a roadmap for starting up and developing AASB, (ii) help AASB develop the Bhutanese GAAP and GAAS in line with IAS, and (iii) update financial reporting formats. In addition, this component will promote compliance with the new GAAP and GAAS by providing progress seminars for financial intermediaries, practitioners and professionals, affected parties, and the private sector. d. Supporting CIB Establishment 20. To help the Government establish a CIB and ensure the selection and start-up of an operational model suitable to the country, the project was initially planned to recruit a CIB expert to (i) design and plan the establishment of CIB in line with the CIB feasibility study,4 (ii) carry out procurement activities for establishing CIB including determination of appropriate powers to be vested in RMA and/or CIB for carrying out its functions, and (iii) help operationalize CIB and do pilot testing. However, due to the significant progress made by RMA in finalizing the CIB establishment plan and relevant procurement documents of Request for Financial Proposals, the TOR of the CIB expert will be revised with a focus on drafting necessary legal and regulatory framework (the TOR will be posted separately).

e. Improving Securities Information Disclosure 21. The bedrock of securities regulation is the timely disclosure of material information. To improve it, RSEBL needs to upgrade its equipment and software so it can retain copies of reports published by listed companies and upgrade the inventory of securities ownership for market disclosure. The project loan will support (i) developing a well-designed website to ensure proper information disclosure for RSEBL and (ii) upgrading and automating the database for RSEBL to improve depository information. The developed website will serve to (i) collect and disseminate information about the market, listed companies, and brokers; and (ii) help raise awareness of and interest in the securities market. The upgraded and automated database will help RSEBL enhance internal controls and inspections for the depository. Assistance will cover associated training for RSEBL and brokers on the use and maintenance of the website. D. Special Features 22. There are two special features of the FSDP. First, it provides a comprehensive and integrated approach to financial sector development, applying lessons from earlier TA to move away from an uncoordinated and compartmentalized approach. Second, the design of the FSDP supports training schemes to ensure the successful implementation of program components as well to create a pool of Bhutanese professionals in accounting, auditing, and insurance underwriting and thereby improving self-reliance in these areas.

4 RMA has prepared a feasibility study for establishing a CIB with assistance from Dun & Bradsheet SAME LTd. The

draft report was furnished to ADB. The study recommends the required software, operational model, and legal framework to establish and govern the CIB.

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23. The program loan will support strengthening the overall governance of the financial system through an improved legal, regulatory, and supervisory framework for all financial services and institutions. The FSDP comprehensively addresses the governance issue. The close coordination and integration of proposed recommendations is the important feature of the program, which is highly consistent with the Government-approved Good Governance Plus Strategy (2005) for achieving transparency, accountability, and efficiency in the whole financial system and so advance private sector and economic development. 24. The project loan will focus on strengthening key institutions for delivering the key facets of the FSDP, leading to more effective regulation and supervision and improved governance. In particular, the features of this project loan are (i) continuous development of supervisory skills that will ensure proper implementation of the regulations and up-to-date knowledge for dealing with new market situations; (ii) the creation of a pool of Bhutanese professionals in accounting, auditing, and insurance underwriting, thereby reducing reliance on foreign consultants; (iii) improved job skills for financial institutions staff; and (iv) improved financial information disclosure.

II. COST ESTIMATES AND FINANCING PLAN A. Detailed Cost Estimates 1. The Program Loan 25. The estimated adjustment costs of policy reforms under the FSDP are based on medium-term adjustment costs. The tentative estimated adjustment cost is approximately $16.5 million, which includes the following:

(i) Financial regulation and supervision. The estimated cost is $6 million, of which $4 million will be borne by the financial institutions, arising from adjustments for implementing the new regulations and adjustments to the NPL provision following a new schedule of loan classification that follows more stringent international standards, and $2 million will support RMA’s implementation of laws and regulations and, among others, for additional staffing, stakeholder consultations, downstream training, administration, supervision costs, etc.

(ii) Corporate governance. The cost is $3 million. The additional costs will arise

from implementing corporate governance rules such as introducing private sector representatives on boards, preparing and implementing business plans for BOBL and RICBL, preparing human resources strategies, strengthening performance evaluation, and conducting stakeholder workshops.

(iii) AML/CFT. The estimated cost of establishing and maintaining an FIU in RMA is

$2 million.

(iv) AASB. The cost of establishing and operating AASB and developing Bhutanese GAAP and GAAS, including market consultations, amending local legislation, drafting accounting and auditing provisions, and implementation, is about $4 million.

(v) CIB. The cost of establishing a CIB and relevant legislation for its functioning and

governance is $1.5 million, as estimated under the study commissioned by RMA.

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2. The Project Loan 26. The total project cost is estimated at $2.5 million, including contingencies and financial charges. A summary of cost estimates based on components is provided in Table 1. A detailed cost estimate is in Appendix 2.

Table 1: Cost Estimates ($’000)

Item Total Cost A. Baseline Costs 1. Component 1: Building Sector Capacitya 1,259.0 2. Component 2: Developing AML/CFT Framework 258.0 3. Component 3: Improving Accounting and Auditing Practices 500.0 4. Component 4: Supporting CIB Establishment 121.0 5. Component 5: Improving Securities Information Disclosure 120.0 Subtotal A 2,258.0 B. Contingencies 1. Physical Contingenciesb 68.0 2. Price Contingenciesc 113.0 Subtotal B 181.0 Total Project Costs (A+B) 2,439.0 C. Interest Chargesd 60.0 Total Project Costs to be Financed 2,500.0

AML = anti-money laundering, CFT = combating the financing of terrorism, CIB = credit information bureau. a Including secondment and training programs. b Estimated at 3% for equipment, training, consulting services, maintenance, and project administration. c Estimated at an annual inflation rate of 5%. d Interest charges during implementation on loans from the Asian Development Fund are at 1% during the

grace period. Source: Asian Development Bank estimates.

B. Financing Plan 1. The Program Loan 27. To support the Government’s the policy reform program, ADB provided a program loan of Special Drawing Rights (SDR)7,472,000 ($11 million equivalent) from ADB’s Special Funds resources. The borrower is the Government. The program loan will have a fixed term of 24 years, including a grace period of 8 years. The interest charge will be 1.0% per annum during the grace period and 1.5% per annum thereafter. Program loan proceeds are expected to be utilized over a period of 36 months from the date of loan effectiveness. 2. The Project Loan 28. It is proposed that ADB support the project with a loan of SDR1,359,000 ($2 million equivalent) from its Special Funds resources. A financing plan for the project is provided in Table 2. The project loan will have a fixed 32-year maturity, including a grace period of 8 years. The interest rate charge will be 1.0% per annum during the grace period and 1.5% per annum thereafter.

Table 2: Financing Plan ($’000)

Source Total % Asian Development Bank 2,000.0 80.0 Government a 500.0 20.0 Total 2,500.0 100.0

a includes office space, counterpart staff, communications, administration support and contingencies. Source: Asian Development Bank estimates.

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C. Allocation of Loan Proceeds

1. The Program 29. The proceeds of the loan shall be applied to the financing of expenditures on the Program in accordance with the provisions of the Program Loan Agreement (Reference to Article III of the Program Loan Agreement). In addition, it shall be used to finance the foreign exchange costs of Eligible Items in accordance with the provisions of Schedule 3 to the Program Loan Agreement.

2. The Project Loan 30. The loan proceeds will be applied to the financing of expenditures on the Project in accordance with the provisions of the Project Loan Agreement. The allocation of loan proceeds to the items of Categories in percentage of ADB financing is set forth in the following table (Reference to the Schedule 3 of the Project Loan Agreement).

Table 3: Allocation and Withdrawal of Loan Proceeds* (Financial Sector Development Project)

CATEGORY ADB FINANCING

Amount Allocated [SDR]

Number Item Category Subcategory

Percentage and Basis for Withdrawal

from the Loan Account 1 Equipment 75,000

1A Designing the website for RSEBL 4,000 100 percent of total expenditure 1B Upgrading and automating the depository

database 46,000 100 percent of total expenditure

1C Developing AML/CFT framework and basic infrastructure

25,000 100 percent of total expenditure

2 Consulting Services 524,000 2A Capacity Building of Capital Market

Development 67,000 100 percent of total expenditure

2B Capacity Building for Corporate Governance


2C Developing AML/CFT 105,000 100 percent of total expenditure 2D Improving Accounting and Auditing

Practice 241,000 100 percent of total expenditure

2E Supporting CIB Development 61,000 100 percent of total expenditure 2F Developing Securities IT Infrastructure 6,000 100 percent of total expenditure 3 Training 593,000

3A Regulatory and Supervisory Secondment Program


3B Accountancy Program 40,000 56 percent of total expenditure 3C Insurance Program 387,000 100 percent of total expenditure 4 Interest Charge 41,000 100 percent of amount due 5 Unallocated 126,000 100 percent of total expenditure

Total 1,359,000 ADB = Asian Development Bank, AML = anti-money laundering, CFT = combating the financing of terrorism, CIB = credit information bureau, IT = information technology, RSEBL = Royal Securities Exchange of Bhutan Limited, SDR = Special Drawing Rights. * Exclusive of Taxes and Duties

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III. IMPLEMENTATION ARRANGEMENTS A. Executing and Implementing Agencies 1. The Program Loan 31. MOF will be the executing agency (EA) for the program loan and will be responsible for coordinating with the ministries and agencies concerned on the policy reforms. 32. MOF will be the implementing agency (IA) for two components: (i) improving corporate governance and (ii) developing accounting and auditing standards. RMA will be the IA for three components: (i) improving financial regulation and supervision, (ii) establishing an AML/CFT framework, and (iii) a CIB. 2. The Project Loan 33. MOF will be the EA and responsible for coordinating support for project implementation. MOF will also be the IA for improving accounting and auditing practices. RMA will be the IA for the four components of (i) building sector capacity, (ii) establishing an AML/CFT framework, (iii) supporting CIB establishment, and (iv) improving securities information disclosure. The IAs will provide information and analyses to the program/project management unit (PMU) and coordinate the fielding and work of consultants. The PMU will be responsible for coordinating project implementation and ensuring the submission of project reports. Sound accounting and internal control systems will be adopted by the PMU. B. Program and Project Management Organization 34. MOF will set up an inter-agency program steering committee (PSC) headed by the secretary of MOF and comprising, among others, representatives of RMA, BOBL, RICBL, and RSEBL to monitor progress, coordinate implementation, and ensure effective fulfillment of the proposed policy reforms. The PSC will meet every quarter or as often as needed. It will provide ADB, for reference, all reports and minutes of PSC meetings, and ADB may attend these meetings as an observer. A program and project organization chart is in Appendix 3. 35. MOF will establish a program and PMU headed by a program director, who shall be a senior staff of RMA, responsible for program and project administration, loan disbursement, accounts maintenance, and reporting to the PSC. The program director will be assisted by representatives of respective divisions at RMA and MOF’s Division of Debt Management at the Public Accounts Department. One of the representatives will be designated as an alternate program director.

Table 4: Key Functions of the Executing and Implementing Agencies Agency Component Key Functions MOF EA • Open accounts (one deposit account for the Program, one imprest account for the

Project) at RMA to receive the loan proceeds. • Management and replenishment of accounts. • Organize audits of the accounts by chartered accountants annually. • Establish, organize, and chair the quarterly inter-agency PSC to monitor progress,

coordinate implementation, and ensure effective fulfillment of the proposed policy reforms.

• Establish a.PMU headed by a program director, who will be a senior staff of RMA for

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Agency Component Key Functions program administration, loan disbursement, accounts maintenance, and reporting to ADB. The program director will be assisted by representatives of respective divisions at RMA and MOF’s Debt Management Division at the Department of Public Accounts.

• Carry out procurement and consultant service recruitment, in coordination with the PMU.

• Liaise with PMU, IAs, and ADB to address any implementation issues. • Prepare the 6 monthly and annual progress reports based on the information

submitted by PMU and IAs. • Ensure that selection criteria is adopted in connection with identifying staff members

of RMA, MOF, RICBL, and RSEBL for training provided under the Project and the recipients of such training continue their services for no less than 2 years upon completion of the training.

MOF IA • Ensure that RMA drafts and issues regulations and guidelines on corporate

governance for financial institutions. • Ensure that MOUs are signed between BOBL and Government regarding

commercialization of BOBL’s operations. • Ensure that a formal commitment is reached between MOF, RMA, and RICBL

regarding a rationalization plan for RICBL that conforms to best practice. • Establish a committee, with representation of involved government offices and

technical persons from the private sector, to take charge of accounting and auditing reform (by December 2006).

• Ensure that the committee creates the Bhutanese AASB that will be tasked with the development of the Bhutanese GAAP and GAAS (by June 2008).

• Ensure that the AASB develops the Bhutanese GAAP and GAAS (by June 2008). • Ensure that AASB discusses with stakeholders on the newly developed Bhutanese

GAAP and GAAS and approved for implementation (by December 2009).

RMA IA • Finalize draft FSA (by December 2006) and submit to the national assembly for passage (by June 2008).

• Conduct stakeholder consultations on the draft regulations and education workshops for financial institutions (by June 2008).

• Issue implementing regulations under the new FSA (by December 2009). • Implement the secondment program for experienced officers of the FISD at RMA to

receive on-the-job training in relevant countries with a strong financial supervisor, to obtain skills and practical experiences on on-site supervision for banks, insurance, capital markets, and pensions (3 person-months each supervisor) (by December 2009).

• Ensure that a traineeship program is established to develop the accounting and auditing profession in Bhutan by supporting two RMA staff to obtain accountancy training (3 years) in a relevant foreign country (by December 2009).

• Ensure that the securities market expert conducts on-the-job training for strengthening professional knowledge of securities markets and related regulations (by June 2007).

• Complete prudential regulations for corporate governance by June 2008 and issues them by December 2009.

• Conduct stakeholder consultations on the draft regulations and educational workshops for financial institutions by June 2008.

• Supervise agreed actions of RICBL to separate accounts and business operations for general insurance, life insurance, and the credit and investment department and regarding reporting requirements (by June 2008).

• Implement the training program for strengthening insurance underwriting skills by December 2009.

• Revise the draft FSA to ensure the authority given to itself as the AML/CFT regulator and supervisor in the financial sector (by December 2006).

• Develop (by June 2008) and issue regulations requiring financial institutions to establish procedures for customer identification (“Know your Customer”) processes, and generating reports on suspicious transactions and reporting such transactions to the RMA (by December 2009).

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Agency Component Key Functions • Establish a FIU whose function will be to gather information on suspected AML/CFT

activities and liaising with law enforcement agencies. • Ensure that FIU takes charge of financial reporting requirements and procedures for

AML/CFT supervision (by June 2008) and commences operations (by December 2009).

• Establish a CIB unit for development of the CIB at RMA for preparing an implementation plan of CIB establishment (December 2006).

• Establish the CIB with corresponding rules and regulations (by June 2008). • Ensure that RSEBL develops a website for dissemination of mandatory market

information (by December 2009). • Ensure that RSEBL develops a database to improve depository and settlement

processes (by December 2009).

AASB = accounting and auditing standards board, ADB = Asian Development Bank, AML = anti-money laundering, BOBL = Bank of Bhutan Limited, CIB = credit information bureau, CFT = combating the financing of terrorism, EA = Executing Agency, FISD = Financial Institution Supervision Division, FIU = financial intelligence unit, FSA = Financial Services Act, GAAP = generally accepted accounting principles, GAAS = generally accepted auditing standards, IA = Implementing Agency, MOF = Ministry of Finance, MOU = Memorandum of Understanding, PMU = program/project management unit, PSC = program steering committee, RICBL = Royal Insurance Corporation of Bhutan Limited, RMA = Royal Monetary Authority, RSEBL = Royal Securities Exchange of Bhutan Limited.

IV. IMPLEMENTATION SCHEDULE 36. The FSDP will be completed by end of December 2009, in line with the indicative implementation schedule in Appendix 4.

V. FINANCIAL MANAGEMENT DURING IMPLEMENTATION 37. A detailed financial management assessment, including the use of financial management assessment questionnaires, reviewed the financial management arrangements of the EA and IA. The summary of the findings is in Appendix 5. The Government has a computerized financial management system that produces satisfactory financial reports and ensures the confidentiality, integrity, and availability of the data. All financial statements are subject to audit by RAA within 6 to 9 months of fiscal year closure. The external audit conducted by RAA follows the International Organization of Supreme Audit Institution’s auditing standards, which are in line with the International Standards on Auditing issued by the International Federation of Accountants. Financial management arrangements are found to be satisfactory in general. The FSDP therefore is expected to adopt the satisfactory financial management arrangements and standards. 38. Internal audits have been established in all ministries and RMA. The Financial Rules and Regulations (2001) manual contains a section on internal controls, explaining their nature and objectives. The manual provides simple advice on managers’ responsibilities for internal controls and identifies some of the main areas where they are needed. However, the internal auditors in RMA and MOF do not hold recognized professional qualifications such as chartered public accountant. Their qualifications are based on experience and ad hoc courses (auditing seminars, etc.). As further improving the awareness and specialized training in accounting and auditing for better internal controls and financial management is required, the FSDP will help the Government strengthen financial management by enhancing skills and qualifications in accounting and auditing, as well as developing national accounting and auditing policy.

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VI. CONSULTANT RECRUITMENT 39. A total of 24 person-months of international consulting services and 21 person-months of national consulting services will be financed by the project loan. The outline terms of references are in Appendix 6. Two different selection methods will be utilized, as both individual consultants and a consultancy firm will be recruited. With the exception of component 3, consulting services will be provided by individual consultants recruited in accordance with ADB’s Guidelines on the Use of Consultants (2007) (http://www.adb.org/documents/guidelines/consulting/Guidelines-Consultants.pdf). For component 3, consulting services will be provided by a consultancy firm recruited in accordance with the quality and cost-based selection method. The Project will also finance the secondment and training programs for supporting sector capacity. The breakdown of consulting inputs and selection methods for each component are summarized in Table 5. 40. The Borrower will be responsible for the recruitment of project consultants. ADB will review the request for proposals, including the shortlist, the technical evaluation of proposals, and award recommendations and contract, on a no-objection basis, to ensure that the process is carried out in accordance with agreed procedures, as required by ADB’s Guidelines on the Use of Consultants and the proposed procurement plan (Appendix 7).

Table 5: Summary of Consulting Services and Selection Method Project Loan Component

International (person-months)

Domestic (person-months)

Total (person-months)

Selection Method

A. Component 1: Building Sector Capacity 5 0 5 Individual B. Component 2: Developing AML/CFT Framework

4 6 10 Individual

C. Component 3: Improving Accounting and Auditing Practices

12 12 24 Firm by QCBS

D. Component 4: Supporting CIB Establishment 3 0 3 Individual E. Component 5: Improving Securities Information Disclosure

0 3 3 Individual

Total 24 21 45 AML = anti-money laundering, CFT = combating the financing of terrorism, CIB = credit information bureau, QCBS = quality- and cost-based selection. Source: Asian Development Bank estimates.

VII. PROCUREMENT A. The Program Loan

41. Program loan proceeds will be used to finance the foreign exchange cost of items produced (excluding local duties and taxes) and procured in ADB member countries, other than items specified in the list of ineligible items (Appendix 8) or imports financed by other bilateral and multilateral sources. All procurement under the program loan will be undertaken through normal commercial practices for the private sector or the Government’s prescribed procurement procedures acceptable to ADB, with due consideration to economy and efficiency. B. The Project Loan

42. Procurement of goods and services will be subject to the provisions of ADB’s Procurement Guidelines (February 2007) (http://www.adb.org/Documents/Guidelines/Procurement/Guidelines-Procurement.pdf). The

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procurement packages for establishing AML/CFT information technology infrastructure and designing RSEBL’s website and upgrading its depository system in the procurement plan (Appendix 7) will be procured through shopping procedures and under turnkey contracts to ensure the appropriateness and sustainability of their design, supply, and installation. The Government will be responsible for the procurement plan, and ADB shall carry out reviews on the Government’s procedures, documents, bid evaluations, award recommendations, and contract in accordance with the agreed procedures, on a no-objection basis.

VIII. DISBURSEMENT PROCEDURES A. The Program Loan

43. The Government will certify that the volume of eligible imports exceeds the amount of ADB’s projected disbursement under the loan for the given period. The disbursement of the program loan will be in accordance with Simplification of Disbursement Procedures and Related Requirements for Program Loans (2007) (http://www.adb.org/Documents/Handbooks/Loan_Disbursement/chap-06.pdf). The Government (Borrower) shall submit a withdrawal application as shown in Appendix 9 (Reference to Appendix 5 of the Loan Disbursement Handbook 2007, [http://www.adb.org/Documents/Handbooks/Loan_Disbursement/loan-disbursement-final.pdf]) and shall be in a form satisfactory to ADB. ADB reserves the right to audit the use of program loan proceeds and verify the accuracy of the Government’s certification. Prior to submitting the first application to ADB for withdrawal from the Loan Account, the Borrower shall open an account (the deposit account) at RMA into which all withdrawals form the loan account shall be deposited. 44. Tranching. The program loan will be released in three tranches. The first tranche (not exceeding $4 million equivalent) is to be disbursed upon loan effectiveness, subject to the Government’s compliance with all first tranche requirements. The second tranche (not exceeding $4 million equivalent) will be disbursed 18 months after loan effectiveness, subject to satisfactory fulfillment of the corresponding tranche release conditions. The third tranche ($3 million equivalent) will be disbursed 18 months after the second tranche, subject to the satisfactory fulfillment of the corresponding tranche release conditions. The policy matrix lists all the tranche release conditions. B. The Project Loan

45. MOF, on behalf of the Government, will open an imprest account denominated in dollars at RMA within 1 month of loan effectiveness. The imprest account will be operated and maintained in accordance with ADB’s Handbook on Loan Disbursement (2007), as amended from time to time, and detailed arrangements agreed between the Government and ADB. ADB will advance 6 months of estimated expenditures or 10% of the total, whichever is less, into the imprest account for each of the loan amount. The Borrower will use the imprest account to pay contractors, suppliers, and others for ADB’s share of eligible project expenditures incurred in local and foreign currency. The ADB statement of expenditure procedure may be used for reimbursement of eligible expenditure and to liquidate advances provided into the imprest account for any individual payment not exceeding $50,000. A sample withdrawal application is in Appendix 10 (Reference to Appendix 7 of the Loan Disbursement Handbook 2007).

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IX. PROGRAM AND PROJECT MONITORING AND EVALUATION A. The Program Loan

46. The PMU will establish and maintain a system to monitor program performance that will include a database on the status of policy measures and program indicators, based on the policy matrix and the design and monitoring framework. 47. ADB will monitor FSDP implementation through 6 monthly review and periodic progress reports and will field regular missions to confirm fulfillment of policy actions for tranche release and advise on actions to maintain implementation within the program period. 48. ADB will conduct a comprehensive review 3 months prior to the end of both the second tranche and the third tranche. A program completion review at the end of the FSDP will be conducted to evaluate its overall impact on the financial sector and the achievement of its desired objectives, as well as other benefits, intended or not, particularly for the poor. B. The Project Loan

49. The PMU, drawing on data from IAs, will establish and maintain a project performance-management system that will generate 6 monthly and annual reports. The system will be linked with the Program and established, as agreed between the Government and ADB, to ensure that the project is managed efficiently, benefits are maximized, and social impacts are monitored. 50. The Government and ADB will periodically review project implementation. ADB will field regular review missions, including midterm and project completion review missions to coincide whenever possible with the program reviews. A comprehensive midterm review at approximately 18 months from the date of loan effectiveness will be undertaken to evaluate progress. These reviews will include an evaluation of the project scope, implementation arrangements, and progress with the policy reform agenda.

X. REPORTING REQUIREMENTS A. The Program Loan

51. The PMU will submit 6 monthly and annual reports to the Government and ADB on the status of policy measures and program indicators, based on the policy matrix and the design and monitoring framework, and the information maintained in the database, including monitoring of program implementation and its impacts. The progress reports will also describe progress made and any changes to the implementation schedule and identifies any problems encountered and remedial actions taken. 52. Approximately 3 months before the anticipated withdrawal of the second tranche and the third tranche and at the end of the program period, the Government and ADB will conduct review the implementation of the Program and assess the impact of all relevant reforms in the sector. To facilitate such review, the PMU and concerned agencies shall assist ADB by providing relevant data and information in such detail as ADB may reasonably request.

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B. The Project Loan

53. The PMU will submit reports to ADB concerning the use of project loan proceeds, project administration, and financial management. The reports will include (i) 6 monthly and annual project implementation reports, (ii) a midterm review report, and (iii) a project completion report to be submitted no later than 6 months after project completion. The reports and consolidating inputs from the IAs will cover (i) expenditures, (ii) activities financed, (iii) a summary of audit issues, and (iv) the progress of project components. 54. The consultants for each component of the project loan will prepare (i) an inception report within 1 month of service commencement; (ii) midterm reports at appropriate stages of the project; (iii) a draft final report 2 weeks before completing the contract; and (iv) a final report after incorporating comments from ADB, the EA, and the IAs. 55. Table 6 summarizes the reporting requirements under the FSDP. The suggested format and content of EA progress report is provided in Appendix 11.

Table 6: Reporting Requirements under the FSDP

Reports Reporting Timing Prepared by Program Performance Report

6 monthly and annually PMU with inputs from concerned agencies

Project Administration and Financial Management Report

6 monthly and annually PMU with inputs from concerned agencies

Program and Project Midterm Progress Report

1.5 year from loan effectiveness PMU with inputs from concerned agencies

Project Completion Report No later than 6 months after project completion

PMU with inputs from concerned agencies

PMU = program/project management unit.

XI. AUDITING REQUIREMENTS A. The Program Loan

56. An audit of the use of the loan proceeds will be undertaken if requested by ADB. ADB retains the right to (i) audit any account and (ii) verify the validity of the certification issued by the Government for each withdrawal application. Prior to withdrawal, the Government will open an account (a deposit account) at RMA to receive all loan proceeds. The account will be established, managed, operated, and liquidated in accordance with terms satisfactory to ADB. A sample audit letter is in Appendix 12. B. The Project Loan

57. The PMU will maintain separate records and accounts for the imprest account in accordance with sound accounting principles and will have these accounts and records audited annually in accordance with standards acceptable to ADB. Audited accounts, including statement of expenditures, will be provided to ADB within 6 months of fiscal year-end. ADB retains the right to (i) audit any account and (ii) verify the validity of the certification issued by the Government for each withdrawal application.

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XII. MAJOR LOAN COVENANTS 58. In addition to the standard conditions and the tranche release conditions (details enumerated in the Loan Agreement), the following major covenants are directly related the Program and Project, and are considered essential to successful implementation.

Table 7: Major Program Loan Covenants

Program Implementations and Other Matters (Reference to the Program Loan Agreement, Schedule 5) Use of Counterpart Funds Throughout the implementation of the Program, the Borrower shall ensure that adequate allocations of the required counterpart funds are made, approved and released in a timely manner in order to ensure proper implementation of the Program as more fully described in para. 1 of Schedule 1 to this Loan Agreement and the Policy Letter. Implementation of the Policy Letter and Policy Matrix The Borrower shall (a) ensure that the policies and actions taken, as described in the Policy Letter and the Policy Matrix prior to the date of this Loan Agreement, shall continue in effect during the Program period and subsequently, and (b) promptly adopt all other policies and take all other actions indicated in the Policy Letter including the Policy Matrix, and ensure that such policies and actions continue in effect during and after the Program period. Policy Dialogue The Borrower shall keep ADB informed of, and the Borrower and ADB shall from time to time exchange views on, the progress made in carrying out the policies and actions set out in the Policy Letter and the Policy Matrix. The Borrower shall continue timely policy dialogue with ADB on problems and constraints encountered during implementation of the Program and on desirable changes to overcome or mitigate such problems and constraints. The Borrower shall keep ADB informed of policy discussions with other international and bilateral agencies that may have implications for the implementation of the Program and shall provide ADB with the opportunity to comment on any resulting proposals. The Borrower shall take ADB’s views into consideration before finalizing and implementing any such proposals. Project Loan The Borrower shall ensure the timely implementation of the Project under the Project Loan Agreement. Execution of Project and Operation of Project Facility (Reference to Project Loan Agreement, Schedule 5) Counterpart Funds and Facilities The Borrower shall ensure that throughout the implementation of the Project, adequate allocations of the required counterpart funds are made, approved and released in a timely manner in order to ensure proper implementation of the Project. The Borrower shall ensure that the Project Facilities are adequate for the Project and also ensure that all such Project Facilities are properly maintained during the period of implementation of the Project. Selection of Candidates for Training and Secondment The Borrower shall, and procure that RMA shall, ensure that all candidates for local and overseas training and secondment shall be selected in accordance with the Government’s policy and implementing guidelines on foreign and local training. The Borrower shall, and procure that RMA shall, ensure that all efforts shall be made to retain staff that have participated in such overseas training and secondment at their respective institutions for at least a period of 3 years following such training or secondment through necessary amendment of such employees’ terms and conditions of employment or such other method as may be satisfactory to ADB. Gender The Borrower shall give preference to, and shall not discriminate against women candidates for local and overseas training and secondment.

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Program The Borrower shall ensure coordination of Project activities with policy reforms initiated under the Program. Project Performance Management System Within 6 months of the Effective Date, the Borrower shall cause the PMU to establish and maintain a comprehensive PPMS acceptable to ADB. Drawing from information and data from the IAs, the PPMS shall carry out performance monitoring and reviews during Project implementation, to evaluate the scope, implementation arrangements, benefit monitoring, progress, and achievement of the objectives of the Project. PPMS indicators shall serve as a basis for annual reports on Project implementation and to ensure that the Project is managed efficiently, benefits are maximized and social impacts are monitored.

AAS = accounting and auditing standards, AASB = accounting and auditing standards board, ADB = Asian Development Bank, AML = anti-money laundering, BOBL = Bank of Bhutan Limited, CFT = combating the financing of terrorism, CIB = credit information bureau, FI = financial institution, FIU = financial intelligence unit, FSA = Financial Services Act, GAAP = generally accepted accounting principles, GAAS = generally accepted auditing standards, HR = human resource, IA = implementing agency, KYC = Know Your Customer, MOF = Ministry of Finance, PMU = program/project management unit, PPMS = Project Performance Management System, RMA = Royal Monetary Authority.

XIII. IMPLEMENTATION OF THE ACCOMPANYING TA 59. The technical assistance (TA) aims to help the Government establish a permanent, self-sufficient, and sustainable training institute (the Training Institute) for financial sector participants in Bhutan to address existing gaps and future requirements in capacity and institutional strengthening needs in the financial sector. TA is also designed to sustain the reforms initiated under the FSDP beyond the program period. 60. TA will require a total of 6 person-months of international consulting services from one central banking and financial sector training expert. TA will also acquire training services from resource people and/or experienced regional trainers who specialize in delivering courses and workshops on current topics in financial regulation and supervising FSA-type monetary systems, accounting and auditing for financial service providers, and other relevant fields (a total of 3 person-months from different resource persons). The consultant will be recruited using the consultants’ qualifications selection method according to ADB’s Guidelines on the Use of Consultants (2007). The resource persons will be recruited for their qualifications and the suitability of their relevant experience in delivering training programs. The outline terms of reference for the international consultant are in Appendix 13. 61. MOF will be the EA. RMA will be the IA. TA will be implemented over a period of 24 months, commencing from the date of program loan effectiveness. The consulting services will be delivered intermittently over the TA implementation period. The total TA cost is estimated at $312,000. ADB will finance $250,000 on a grant basis through its TA funding program, and the Government will contribute $62,000 in kind as counterpart staff, office accommodation, training facilities, and logistical support. The detailed cost estimates and financing plan are in Appendix 13.

XIV. KEY PERSONS INVOLVED IN THE PROJECT

Name Company Position Address Telephone/Fax/Email Ashok Sharma Asian

Development Bank (ADB)

Director, Governance, Finance and Trade Division, South Asia Department (SAGF)

6 ADB Avenue, Mandaluyong City, Philippines

Tel: (632) 632-6755 Fax: (632) 636-2337 Email: [email protected]

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Name Company Position Address Telephone/Fax/Email Chia-Hsin Hu ADB Economist (Financial

Sector), SAGF 6 ADB Avenue, Mandaluyong City, Philippines


Dasho Yanki T. Wangchuk

Ministry of Finance

Secretary Ministry of Finance Royal Government of Bhutan Thimphu, Bhutan


Tshewang Norbu Ministry of Finance

Deputy Chief Program Officer, Loans Division, Dept. of Public Affairs

Ministry of Finance Royal Government of Bhutan Thimphu, Bhutan


Daw Tenzin Royal Monetary Authority of Bhutan

Managing Director P.O. Box 154 Chhophel Lam Kawajangsa Thimphu, Bhutan

Tel: (975) 2 323111 Fax: (975) 2 322847 Email: [email protected]

Eden Dema Royal Monetary Authority of Bhutan

Chief, Financial Institutions Supervision Division

P.O. Box 154 Chhophel Lam Kawajangsa Thimphu, Bhutan


Tshering Dorji Bank of Bhutan Limited

Managing Director P.O. Box 75 Phuentsholing Bhutan


Namgay Lhendup Royal Insurance Corporation of Bhutan Limited

Managing Director P.O. Box 315 Thimphu, Bhutan

Tel: (975) 5 252453 Email: [email protected]

Tshering Gyaltshen

Royal Insurance Corporation of Bhutan Limited

General Manager P.O. Box 315 Thimphu, Bhutan

Tel: (975) 2 328620 Email: [email protected]

Tashi Yezer Royal Securities Exchange of Bhutan Limited

C.E.O. P.O. Box 742 Thimphu, Bhutan

Tel: (975) 2 323995 Fax: (975) 2-323849 Email: [email protected]

XV. ANTICORRUPTION

62. The loan is subject to ADB’s Anticorruption policy. Anyone coming in across evidence of corruption associated with the program is required to contact ADB’s Office of the General Auditor, which will investigate allegations. Further information on ADB’s anticorruption policy is available through ADB’s website: http://www.adb.org (selecting ‘anticorruption’) or directly: http://www.adb.org/Documents/Policies/Anticorruption/default.asp.

20 Appendix 1

POLICY MATRIX FOR FINANCIAL SECTOR DEVELOPMENT PROGRAM

Focus of Reform

Policy Actions Taken Prior to First Tranche Releasea

by December 2006

Policy Actions to be Taken Prior to Second Tranche Releasea

by June 2008

Policy Actions to be Taken Before Program End a

by December 2009 A. Improve regulation and supervision of the financial sector 1. Ensure the autonomy of Royal Monetary Authority (RMA) and strengthen its ability to conduct monetary policy and oversee the overall operations of the financial sector.

Review the RMA Act (1982) and undertake stakeholder consultation for legislative reform under Technical Assistance 3905 (2003). Draft and finalize the revised RMA Act.

Following Cabinet approval, the Government to submit the revised RMA Act to the National Assembly for passage as law.

2. Strengthen the legal and regulatory framework for the whole financial sector (i.e., banking, insurance, securities markets, etc.)

Review existing legislation, including the Financial Institutions Act (1992) and relevant provisions of the Companies Act (2000), and undertake stakeholder consultation for legislative reform under Technical Assistance 3905 (2003). Draft and finalize Financial Services Act (FSA), as agreed between the Government and the Asian Development Bank (ADB), giving RMA powers to license, regulate, and supervise financial service providers in the country.

Following Cabinet approval, the Government to submit the FSA, which conforms to best practice as agreed with the Government and ADB, to the National Assembly. RMA to draft regulations to set up a standard chart of accounts to be followed by all banks and their external auditors. RMA to issue regulations to license and screen potential domestic and foreign applicants for banks. RMA to formulate and revise regulations that conform with international standards with respect to (i) banking operations and supervision, to include the following:

• raising the capital to risk asset ratio to 10%;

• phasing-in loan classification, provisioning, and income

RMA to issue regulations to set up a standard chart of accounts to be followed by all banks and their external auditors. RMA to draft and issue regulations on a continuous basis as needed to include

• setting up a standard charts of accounts to be followed by insurance companies, securities dealers and brokers, and other non-bank financial institutions and their external auditors and

• licensing and related requirements in screening potential domestic and foreign applicants for insurance companies, securities exchange dealers and brokers and other non-bank financial services.

RMA to issue and initiate the implementation of revised regulations under the FSA, to include (i) banking operations; (ii) insurance regulation and supervision; and (iii) securities exchange operations, as set out in the second tranche conditions.

Appendix 121

Focus of Reform


by December 2006


by June 2008


by December 2009

Expand RMA’s authority under the proposed FSA to act as the insurance regulator.

Expand RMA’s authority under the proposed FSA to act as the securities regulator with the power to investigate and prosecute securities violations for both licensed and unlicensed legal and natural persons.

recognition to conform with international standards within a timetable agreed between RMA and ADB; and

• inspection procedures to cover both on- and off-site examination to measure and manage exposure to credit risk, liquidity risk, interest rate risk, and foreign currency risk, among others risks, using a CAMELS (capital adequacy, asset quality, management, earnings, liquidity and sensitivity to market risk) framework;

(ii) insurance operations and supervision, to include the following:

• defining solvency margins and admissible assets and

• establishing new off-site financial reporting formats and reporting standards; and

(iii) securities exchange operations, to include the following:

• setting out trading and settlement procedures with respect to (a) providing for a proper matching of buyer and seller obligations for trade settlement and (b) defining at what point beneficial ownership of securities passes to enable delivery versus payment;

• written procedures for on-site inspections of security exchanges by RMA as well as inspections of brokers by the securities exchange and RMA;

• issuer disclosure on control and related-party transactions and expanded remedies for

22 Appendix 1

Focus of Reform


by December 2006


by June 2008


by December 2009 defective disclosure; and

• Introducing internal controls and inspections for the depository.

RMA to prepare regulations requiring all financial institutions to adopt satisfactory disaster recovery plans. RMA to conduct stakeholder consultations concerning implementing regulations.

3. Strengthen the supervisory framework of the financial sector

Provide RMA with explicit powers under the proposed FSA to provide on-site inspection of banks.

RMA to draft enforcement and compliance regulations defining corrective actions and providing a specific timetable for implementation to be undertaken by financial institutions and penalties for their noncompliance.

RMA to conduct stakeholder consultations concerning enforcement and compliance regulations.

RMA to issue and initiate implementation of enforcement and compliance regulations.

B. Strengthen the corporate governance structure and operations of financial institutions 1. Strengthen corporate governance in the financial sector

Provide RMA with the authority under the proposed FSA to regulate corporate governance issues relating to the operation, management, and ownership of financial institutions.

RMA to draft regulations as appropriate for corporate governance, to include

• a fit-and-proper test for boards of directors,

• structure and composition of the board (minimum 50% private sector participation),

• conflict of interest rules, and • restrictions on cross

shareholdings. RMA to conduct stakeholder consultations concerning corporate governance guidelines.

RMA to issue and initiate implementation of regulations and guidelines on corporate governance for financial institutions.

2. Improve the structure and operations of the Bank of Bhutan Limited (BOBL)

Ministry of Finance (MOF) to agree with BOBL, by way of a memorandum of understanding (MOU) with its board of directors, that BOBL will commercialize its operations, which will include

• providing for time-bound

MOU signed. Business plan approved by the BOBL board of directors. BOBL to implement business plan as

Appendix 123

Focus of Reform


by December 2006


by June 2008


by December 2009 performance targets;

• management of BOBL’s preparing a rolling business plan that will define parameters and performance indicators against which BOBL management performance is to be evaluated for, among other things, (a) linking remuneration to performance, (b) improving recruitment and performance evaluation policies and processes, and (c) developing a human resources strategy.

measured through semi-annual performance reports.

3. Improve the structure of the insurance industry by rationalizing the Royal Insurance Corporation of Bhutan Limited (RICBL)

RICBL to give an undertaking to MOF to prepare a rationalization plan for its various operations, as approved by RMA.

RMA to supervise agreed actions of RICBL to separate accounts and business operations for general insurance, life insurance, and the credit and investment department and regarding reporting requirements. RICBL to finalize and approve plan to rationalize RICBL operations, as agreed with MOF and RMA.

RICBL to implement the rationalization plan. RICBL to adopt business plans for each of its operations post-rationalization as agreed with MOF and RMA.

C. Consolidate and improve anti-money laundering (AML) and combating the financing of terrorism (CFT) regime Provide RMA with the authority

under the proposed FSA to regulate and supervise AML/CFT for the financial sector.

RMA to establish the financial intelligence unit (FIU) in conformity with the FSA. FIU to take charge of financial reporting requirements and procedures for AML/CFT supervision of financial institutions, particularly concerning know-your-customer and suspicious transactions.

FIU to commence operations.

D. Develop national accounting and auditing policies and standards Develop national accounting and auditing standards to constitute Bhutanese generally accepted accounting principles (GAAP) in line with International Accounting Standards (IAS) and International Financial

MOF to form an accounting and auditing standards committee, with representation from involved Government offices and relevant people from the private sector, to develop a plan for establishing the

MOF to establish a national AASB, in accordance with the plan developed by the accounting standards committee. AASB to be given the authority to set accounting and auditing standards and to implement

AASB to develop an implementation plan and timeframe for adopting the new Bhutanese national GAAP and GAAS. AASB to initiate the development of the

24 Appendix 1

Focus of Reform


by December 2006


by June 2008


by December 2009 Reporting Standards, and generally accepted auditing standards (GAAS) in line with international auditing standards, where applicable.

national accounting and auditing standards board (AASB).

the Bhutanese GAAP and GAAS in line with international accounting and auditing standards and to regulate and supervise the accounting and auditing profession.

Bhutanese GAAP and GAAS in consultation with stakeholders and to promote the development of the accounting and auditing professions.

E. Strengthen information disclosure in the financial sector Improve credit information sharing. RMA to establish a credit

information unit to plan and develop a credit information bureau (CIB).

RMA to establish CIB, including the drafting and issuing of necessary regulations for the relevant legal, regulatory and institutional framework.

CIB to commence operations.

AASB = accounting and auditing standards board, ADB = Asian Development Bank, AML = anti-money laundering, BOBL = Bank of Bhutan Limited, CAMELS = capital adequacy, asset quality, management, earnings, liquidity and sensitivity to market risk, CFT = combating financing of terrorism, CIB = credit information bureau, FIU = financial intelligence unit, FSA = Financial Services Act, GAAP = generally accepted accounting principles, GAAS = generally accepted auditing standards, IAS = international accounting standards, MOF = Ministry of Finance, MOU = memorandum of understanding, RICBL = Royal Insurance Corporation of Bhutan Limited, RMA = Royal Monetary Authority, a The actions set forth in bold are conditions for tranche release.

Appendix 2 25

DETAILED COST ESTIMATES AND FINANCING PLAN

Table A2.1: Cost Estimates and Financing Plan (by Component) ($‘000)

Expenditure Account

Building Sector

Capacity

Developing AML/CFT

Framework

Improving Accounting

and Auditing Practices

Supporting CIB

Establishment

Improving Securities

Information

Total

A. Baseline Costs

1. Equipment and IT 1. Office and IT Equipment – 37 – – 74 111 2. Import Duties – 11 – – 22 33 Subtotal (1) – 48 – – 96 144 2. Training, Seminars, and Workshops 1. RMA Staff 358 – 27 11 – 396 2. Financial Intermediaries Staff 570 – 27 – – 597 3. RSEBL Staff 12 – 27 – – 39 Subtotal (2) 940 – 81 11 – 1,032 3. Specialist Support 1. Consultants (international) 164 136 319 90 – 709 2. Consultants (national) – 18 36 – 9 63 Subtotal (3) 164 154 355 90 9 772 4. Administration costs (4) 155 56 64 20 15 310 Total Baseline Costs (1+2+3+4) 1,259 258 500 121 120 2,258 B. Physical Contingencies (3%) 37 8 15 4 4 68 C. Price Contingencies (5%) 63 12 25 7 6 113 Total Project Costs (A+B+C) 1,359 278 540 132 130 2,439 D. Service Charges 35 6 13 3 3 60 Total Costs to be Financed (A+B+C+D) 1,394 284 553 135 133 2,500

AML = anti-money laundering, CFT = combating the financing of terrorism, CIB = credit information bureau, IT = information technology RMA = Royal Monetary Authority, RSEBL = Royal Securities Exchange of Bhutan Limited. ─ = not available. Note: Numbers may not sum precisely because of rounding. Source: Asian Development Bank estimates.

26 Appendix 2

26 Appendix 2

Table A2.2: Cost Estimate and Financing Plan (by Financier) ($’000)

ADB = Asian Development Bank, AML = anti-money laundering, CFT = combating the financing of terrorism, CIB = credit information bureau, IT = information technology, RMA = Royal Monetary Authority, RSEBL = Royal Securities Exchange of Bhutan Limited. Source: Asian Development Bank estimates.

Expenditure Account

Building Sector Capacity

Developing AML/CFT Framework

Improving Accounting and

Auditing practices

Supporting CIB Establishment

Improving Securities Information

Total

Baseline Costs ADB Government ADB Government ADB Government ADB Government ADB Government A. Equipment and IT 1. Office and IT Equipment 0 0 37 0 0 0 0 0 74 0 111 2. Import Duties 0 0 0 11 0 0 0 0 0 22 33 Subtotal (A) 0 0 37 11 0 0 0 0 74 22 144 B. Training, Seminars, and Workshops 1. RMA Staff 292 66 0 0 15 12 0 11 0 0 396 2. Financial Intermediaries Staff 570 0 0 0 15 12 0 0 0 0 597 3. RSEBL Staff 12 0 0 0 15 12 0 0 0 0 39 Subtotal (B) 874 66 0 0 45 36 0 11 0 0 1,032 C. Specialist Support 1. Direct Contracts (international) 164 0 136 0 319 0 90 0 0 0 709 2. Direct Contracts (national) 0 0 18 0 36 0 0 0 9 0 63 Subtotal (C) 164 0 154 0 355 0 90 0 9 0 772 D. Administration Costs 0 155 0 56 0 64 0 20 0 15 310 Total Baseline Costs (A+B+C+D) 1,038 221 191 67 400 100 90 31 83 37 2,258 Physical Contingencies (3%) 31 6 6 2 12 3 3 1 3 1 68 Price Contingencies (5%) 52 11 9 3 20 5 5 2 4 2 113 Total Project Costs 1,121 238 206 72 432 108 98 34 90 40 2,439 Service Charges 35 0 6 0 13 0 3 0 3 0 60 Total Costs to be Financed 1,156 238 212 72 445 108 101 34 93 40 2,499 ADB 1,156 0 212 0 445 0 101 0 93 0 2,007 Government 0 238 0 72 0 108 0 34 0 40 492

Total 1,394 284 553 135 133

Appendix 3 27

PROGRAM/PROJECT ORGANIZATION CHART

AML = anti-money laundering, CIB = Credit Information Bureau, CFT = combating the financing of terrorism, IA = implementing agency, MOF = Ministry of Finance, PSC = program steering committee, PMU = program and project management unit, RMA = Royal Monetary Authority, RSEBL = Royal Securities Exchange of Bhutan Limited, IT = information technology. Source: Asian Development Bank estimates.

Program

Project IA

PSC

PMU

RMA MOF

Component 1: Legal and Regulatory

Component 3: AML/CFT

Framework

Component 5: CIB

Establishment

Component 2:Corporate Governance

Component 4:Accounting and

Auditing

Building Sector

Capacity

Improving RSEBL

Information Disclosure

Developing AML/CFT

Regulations and IT

Infrastructure

Supporting CIB

Establishment

Developing Accounting

and Auditing Policies and Standards

Appendix 4

28

IMPLEMENTATION SCHEDULE

2006* Year 1 (2007) Year 2 (2008) Year 3 (2009) Activity Deadline Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

A. Loan Effectiveness

B. Tranche Payments

C. Program Components C.1 Financial and Legal and Regulatory Framework

Draft RMA Act and FSA finalized Dec 2006 Draft RMA Act and FSA submitted to the National Assembly for passage

Jun 2008

RMA reviews draft financial regulations Jun 2008 RMA issues implementing regulations under FSA

Dec 2009

RMA conducts stakeholder consultations on draft financial regulations and education workshops for FIs

Jun 2008

C.2 Corporate Governance RMA drafts prudential regulations for corporate governance

Jun 2008

RMA issues prudential regulations for corporate governance

Jun 2008

RMA conducts stakeholder consultations on draft regulations and education workshops for FIs

Jun 2008

Corporate governance prudential regulations issued

Dec 2009

BOBL prepares a business plan Jun 2008 BOBL signs MOU with the Government and implements the rolling business plan

Dec 2009

RICBL prepares a rationalization plan and a post-rationalization business plan

Jun 2008

RICBL signs and implements the plans Dec 2009

C.3 Anti-Money Laundering RMA to develop AML/CFT regulations Jun 2008 RMA to establish a FIU Dec 2009 RMA conducts stakeholder consultations on draft regulations and education workshops for FIs

Jun 2008–

Dec 2009

RMA issues AML/CFT regulations Jun 2008 C.4 Accounting and Auditing Creation of the AASC Dec 2006 AASC establishes the Bhutanese AASB

Jun 2008

AASC or AASB develops a plan for GAAP/GAAS adoption

Jun 2008

AASB develops the Bhutanese GAAP and GAAS

Jun 2008

RMA implements GAAP in FIs Dec 2009

C.5 Information Disclosure RMA establishes a CIB unit Dec 2006 RMA develops the legal and regulatory framework for CIB

Jun 2008

RMA establishes the CIB Jun 2008 D. Project Components (training programs, consulting services, and procurement)

Inception

Recruit a securities market expert (I) to strengthen RSEBL and RMA professional knowledge

Mar 2007

Appendix 4 29

2006* Year 1 (2007) Year 2 (2008) Year 3 (2009) Activity Deadline Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

Recruit a legal expert (I) to improve and draft corporate governance regulations

Jun 2007

Secondment program for FISD at RMA Jan 2007

Training program in accounting and auditing for RMA and in insurance-underwriting skills for RICBL

Jan 2007

Recruit an AML/CFT specialist (I) and a legal expert (N) to set up FIU

Mar 2007

Recruit accounting and auditing experts (I) (N)

Mar 2007

Recruit a credit information bureau expert (I)

Jun 2007

RSEBL develops a website Mar 2007

RSEBL develops a database and system to improve depository and settlement processes

Mar 2007

E. Reporting

Program reports X X X X X

TA consultants' reports X X X X X X X X X X X

ADB monitoring and review X X X X X X

Note: * Project preparation Continuous Intermittent ADB = Asian Development Bank, AML = anti-money laundering, AASC = accounting and auditing standards committee, AASB = accounting and auditing standards board, BOBL = Bank of Bhutan Limited, CFT = combating the financing of terrorism, CIB = credit information bureau, FI = financial institution, FISD = Financial Institutions Supervision Division, FIU = financial intelligence unit, FSA = Financial Services Act, GAAP = generally accepted accounting principles, GAAS = generally accepted auditing standards, I = international, MOU = memorandum of understanding, N = national, RICBL = Royal Insurance Corporation of Bhutan Limited, RMA = Royal Monetary Authority, RSEBL = Royal Securities Exchange of Bhutan Limited, TA = technical assistance. Source: Asian Development Bank staff estimates.

Appendix 5

30

SUMMARY OF FINANCIAL MANAGEMENT ASSESSMENT 1. Introduction. The objective of the financial management assessment is to determine whether the entities implementing project components under the Financial Sector Development Program (FSDP) have acceptable financial management arrangements and to ensure that actions required for sound financial management arrangements are taken before loan effectiveness. The Financial Management and Accounting Questionnaire was completed with the help of staff of the executing agency (EA) and implementing agencies (IAs). The detailed assessment and final version of the questionnaire is in Supplementary Appendix B.

2. Country Issues. Financial management has been improved by creating internal audit units in each ministry and the Royal Monetary Authority (RMA) and by separating aid management from budget and accounts. However, with only 10 internal auditors in six ministries at present, the capacity for internal auditing is not commensurate with growing requirements.

3. Risk Analysis. The financial management risk of the project arising from identified weaknesses, together with its mitigating measures, are highlighted in the following table:

Table A5: Financial Management Risk and Mitigating Measures

Risk Risk Rating Risk Mitigation Measures Limited effectiveness of the internal auditors in government departments (including the Ministry of Finance and Royal Monetary Authority)

Low/Medium Target managers who supervise finances, including internal controls, receive awareness training to fully understand the need for internal controls and give practical effect to these internal controls. Target specialized training for internal auditors

Overall Risk Rating Low/Medium Source: Asian Development Bank estimates. 4. Institutional Arrangements. For the program component under the FSDP, the Ministry of Finance (MOF) will be the EA and IA for two components. RMA will be the IA for the other three components. MOF will form the program steering committee, which will provide policy support, oversee FSDP implementation and progress, facilitate cooperation and coordination among all relevant agencies, and ensure timely achievement of reform actions with respect to the program. A program/project management unit (PMU) will be established at RMA to coordinate project activities among various IAs. 5. Funds Flow Arrangements. Generally, for the program loan component, the Department of Aid and Debt Management (DADM) will submit withdrawal applications to the Asian Development Bank (ADB) that state the fulfilled requirements. Foreign currency for the amount requested will be credited to RMA’s foreign currency reserves by ADB. A local currency equivalent will then be credited in the Government Budget Fund (GBF), which is maintained by MOF’s Department of Public Accounts (DPA) in Bank of Bhutan Limited. The GBF can then be utilized for multiple purposes depending on the requirements of the Government. 6. For the project and technical assistance components, MOF will be the EA and IA for one project component, RMA will be the IA for the other four components of the project as well as the technical assistance. DADM will submit withdrawal applications to ADB. An imprest account specifically for the project will be opened at RMA for ADB funds. RMA will inform DADM about receipt of ADB funds into the imprest account, which is in foreign currency. DADM will then direct RMA to convert and transfer the requested amount in equivalent local currency to the

Appendix 5

31

GBF maintained by DPA. DADM will advise DPA to release funds to IAs based on their requirements and monthly progress reports, i.e., specifically project letter of credit accounts (in this case, three letter-of-credit accounts, one for each of the two IAs). The counterpart funds will also be retained in the GBF. The PMU must ask DADM for access to both counterpart and ADB funds in the GBF. The requisition forms submitted by the PMU will require joint signatures. One signatory will be the managing director of RMA and the other signatory either the project director or alternate project director. 7. Staffing Arrangements. The financial management infrastructure of the PMU will be adequate to provide the requisite financial management arrangements for the project as qualified regular RMA staff will occupy various positions in the PMU. The program director will be assigned to a senior staff of RMA, and the alternate program director will be assigned to the representative from DADM at MOF. The program director will oversee the budgeting, accounting, and reporting of all financial transactions relating to project implementation, and will be assisted by the alternate program director and PMU’s accounts and finance officers.

Source: Asian Development Bank estimates. 8. Accounting Policies and Procedures, and Financial Reporting. Cash accounting is used by RMA. For MOF, the main accounting records are cash book, journal, and ledger. Accountability rests on compliance with financial regulations, including disbursement rules, as well as on the noted separation of functions between the controlling officer, drawing and disbursement officer, and accountant. A system of detailed pre-approvals reduces the scope for spending units to divert funds to unapproved purposes. 9. Accounting records in the Financial Rules and Regulations (2001) manual are kept according to a chart of accounts that differentiates expenditures by line item, function, and economic category. The financial manual explains the various periods for which accounts and supporting information must be kept, as well as the conditions under which they are to be kept. The PMU will implement RMA’s accounting processes and procedures, namely the Expenditure Rule (2000) and the Banking Manual (2004), which follow similar principles described above. 10. Information Systems. MOF’s financial management system has been computerized since 2003 for standardizing the Government’s budget and accounting system, but the system cannot automatically generate necessary project financial reports, which must be extracted

Alternate Program Director

Accounts Officer (from Royal Monetary Authority’s

Banking Division)

Finance Officer (from Royal Monetary Authority’s

Administration and Finance Division)

Program Director

Figure A5: Program Management Unit Structure

Appendix 5

32

manually from financial item codes. The PMU will implement RMA’s information systems for generating reports. Computerization for report generation by RMA will be ready by August 2006. 11. Audit Arrangements. The internal audit department at RMA reports directly to the managing director of RMA, while the internal audit department at MOF reports directly to the finance minister and finance secretary. The Financial Rules and Regulations (2001) manual provides only simple advice on managers’ responsibility for internal controls and identifies some of the main areas where they are needed. As a result, incomplete internal controls arise due to (i) the inability by managers to fully understand the need for internal controls and (ii) the failure of managers to give them practical effect. Furthermore, the internal auditors in RMA and MOF do not hold recognized professional qualifications such as chartered public accountant. Their qualifications are based on experience and ad hoc courses (auditing seminars, etc.). 12. However, external audits conducted by the Royal Audit Authority deter irregularities and ensure basic financial accountability. The external audits of MOF and RMA are conducted according to auditing standards of the International Organization of Supreme Audit Institution. Project accounts will be audited by RMA’s internal auditor and externally by the Royal Audit Authority. The audited project financial statements will be submitted to ADB within 6 months of the end of the Government’s fiscal year on 30 June. 13. Disbursement Arrangements. The ADB loan of $13 million will be disbursed over a period of 3 years. Disbursement from the ADB loan will be made in accordance with ADB’s Loan Disbursement Handbook. The imprest account procedure will be used for the project loan. As eligible expenditures are incurred and paid from the account, the EA will request liquidation or replenishment of the account by submitting a withdrawal application on a regular basis. Any balance of the advance not liquidated will be promptly refunded to ADB in the currency of the account.

14. Supervision Plan. Capacity building and closer supervision will be required initially to ensure PMU compliance with the proposed systems as outlined. Normal supervision may be applied later. 15. Conclusion and Recommendations. More detailed guidance and more intensive training for both auditors and managers are required to make the internal audit units fully effective. Many managers currently view their responsibilities primarily as the routine duties of authorizing payments, signing requests, and so on. Incomplete understanding of internal controls may generally influence attitudes toward internal audits, with detrimental effects on financial management. Furthermore, the internal auditors in RMA and MOF do not hold recognized professional qualifications such as chartered public accountant. 16. Needs include (i) detailed guidance and more intensive training for senior officers working in administration and finance, and other managers who supervise finances (including internal auditors) to fully understand the need for internal controls and to give practical effect to these internal controls and (ii) specialized training to enhance the qualifications and competency of internal auditors. The FSDP will enhance the Government’s financial management by improving qualification in accounting and auditing as well as developing Bhutanese accounting and auditing standards and policies. 17. Overall, the financial management capacities of MOF and RMA are satisfactory to ensure their smooth program-executing and implementing functions, despite training limitations in auditing and financial management. Both MOF and RMA have prior experience of successfully managing ADB-financed projects and so know ADB’s procedures and financial management requirements.

Appendix 6 33

PROJECT LOAN: OUTLINE TERMS OF REFERENCE FOR CONSULTANTS

A. Outline Terms of Reference for Consultants

1. International Consultants

a. Accounting and Auditing Specialist (12 person-months) 1. The specialist should be a certified public accountant or chartered accountant or have an equivalent certification with extensive experience in international accounting and auditing standards and practices. He or she will also have practical experience in (i) establishing national accounting boards and arrangements for developing national accounting standards, (ii) independent oversight of the accounting profession, and (iii) monitoring and enforcement of accounting and auditing standards. In addition, demonstrated good understanding of the accounting and auditing system, practices, and procedures in Bhutan, another country in South Asia, or another relevant developing country will be desirable. The specific responsibilities will include the following:

(i) Help the accounting and auditing reform committee clarify the roles and responsibilities of the Ministry of Finance, Ministry of Trade and Industry, Royal Audit Authority, Royal Monetary Authority (RMA), and other government agencies with respect to setting national standards for accounting and auditing.

(ii) Design the optimal organization structure, roles, and functions of the accounting and auditing standards board (AASB), including the development and updating of standards, accreditation of professional education and training of professional bodies (i.e., public and private sector accounting) for licensing auditors, quality assurance review of auditors, and the processes (and their sequence) of taking disciplinary action.

(iii) Design the corporate governance of the AASB, including optimal composition of the governing body, to ensure that it is free of conflicts of interest and that it has the relevant expertise and experience.

(iv) Develop a road map or business plan for transforming the accounting and auditing reform committee into AASB as agreed by stakeholders, including an implementation schedule and financing plan for each stage and the identification of resource requirements and the process necessary for AASB to effectively undertake its roles.

(v) Develop an action plan to establish the certified public accountant and associate chartered accountant qualification in Bhutan. This will involve (a) studying and discussing with stakeholders the options available (e.g., obtaining certification from an international institute or developing Bhutan’s own) and (b) developing the implementation schedule for the agreed option.

(vi) Assist the Government in developing the national accounting and auditing standards. This will involve (a) working together with the Royal Audit Authority, Ministry of Finance, tax authority, and RMA to review current accounting and auditing practices and their differences with International Accounting Standards (IAS); (b) discussing with stakeholders the best approach for Bhutan to adopt IAS and International Financial Reporting Standards; (c) developing national generally accepted accounting principles and generally accepted auditing standards within the Bhutanese context while

Appendix 6

34

incorporating IAS where applicable; and (d) preparing the corresponding manuals and the national accounting and auditing standards of Bhutan.

(vii) Update and harmonize financial reporting requirements by reviewing company law and other relevant legislation. In coordination with stakeholders, discuss the possibility of adopting simplified reporting standards for small enterprises.

(viii) Facilitate the introduction of the relevant IAS, as a whole or in part within the Bhutanese context, by (a) preparing educational materials and (b) developing training courses on the application of IAS for accounting, regulatory, and finance professionals and staff in Bhutan.

(ix) Draft standard charts of accounts to be followed by banks, insurance companies, securities exchange, and other non-bank financial institutions.

(x) Discuss the proposal with RMA and other stakeholders to ensure that key issues of accounting disclosure in the financial sector are addressed. This is likely to take the form of workshops with the regulator. Feedback received will be reviewed and incorporated into the recommendations if appropriate.

b. Capital Markets Specialist (3 person-months)

2. The capital market expert must have extensive knowledge of the operations and supervision of securities markets. The expert will be familiar with international best practice (i.e., the application of International Organization of Securities Commissions principles), with extensive experience working in developing countries, and with experience in Bhutan or South Asia desirable. The expert will have the following responsibilities:

(i) Familiarize brokers, the Royal Securities Exchange of Bhutan Limited (RSEBL), and Financial Institutions Supervision Division (FISD) at RMA with the new legal and regulatory framework to be adopted in Bhutan (i.e., the Financial Services Act and subsidiary regulation), which will need to be explained to market participants and regulators.

(ii) Conduct a needs assessment for training exchange staff, securities brokers, and regulatory staff to determine training inputs. Consideration must be made of the need to offer (a) a general course for all staff of RMA, especially of FISD, and staff of RSEBL, brokers, and financial institutions; (b) specific courses for different audiences on such topics as regulating brokers’ activities, insider trading, and modalities of securities trading; and (c) other measures necessary to upgrade the skills of securities markets participants.

(iii) Produce a detailed training strategy for the exchange, brokers, and regulators, including the timing, broad contents, target audience of modules, and the most appropriate and cost-effective sources of such training. The training will adopt a variety of forms including formal classroom courses, ad hoc informal workshops, and on-the-job training. The strategy should also include a training-of-trainers component to ensure the training materials are used for training new entrants in the future in a cost-effective and sustainable way.

(iv) Draft the training modules for formal training courses and the specifications for informal training.

(v) Deliver the training as per the strategy and support the exchange’s understanding and adoption of the new regulatory framework.

Appendix 6 35

(vi) Review the current operations of RSEBL to recommend necessary changes to its operational and marketing strategy, including its human resources strategy.

(vii) Assist the EA and RSEBL in developing the securities exchange website and database for depository information.

c. Credit Information Bureau Specialist (3 person-months)

3. The credit bureau specialist will have commercial banking and/or credit-rating agency experience and a good technical understanding of the design and implementation of credit information bureaus (CIBs). The expert will be expected to work closely with RMA. The responsibilities of the expert will be as follows:

(i) Hold workshops for all stakeholders to explain key issues surrounding CIBs and their operations and highlight international best practices on CIB establishment and operation based on the experience of other countries.

(ii) Review the feasibility study for CIB establishment provided by RMA and, based on the study, provide a suitable design and plan for establishing the CIB in RMA. The plan must include structure, organization, and operations.

(iii) Determine the status of initiatives already taken relative to regulation and/or legislation that would provide the framework for CIB.

(iv) Determine if any restrictions prevent the sharing of credit information among banks, and among banks and non-banks.

(v) Prepare an operational plan for establishing CIB. The action plan will include recommendations on (a) appropriate provisions and structure for the licensing agreement between RMA and CIB, (b) the appropriate information-storage and retrieval system and networking arrangements for users of CIB, (c) a proposed service-level agreement with CIB and financial institutions, and (d) an agreed roadmap with options for evolving into a credit rating agency.

(vi) Assist RMA in procuring the CIB system, including negotiations with the selected system provider, and conduct meetings as necessary.

(vii) Conduct basic training for RMA and financial institutions on the use of reporting information and assist in the rollout of CIB.

d. Financial Intelligence Unit and Anti-Money Laundering (AML)

Specialist (4 person-months) 4. The financial intelligence unit and AML specialist will be primarily responsible for establishing the financial intelligence unit (FIU). The expert must have substantial experience in the design and development of management information systems (MIS) for FIUs and advisory experience in establishing AML regimes. His or her responsibilities will include, but not limited to, the following:

(i) Analyze existing Bhutanese AML laws and regulations, especially provisions contained in the Draft Financial Services Act, and draft AML regulations for each class of industry participants (banking, insurance, pensions, and securities).

(ii) Review the legal provisions with respect to establishing the FIU in RMA and develop the establishment action plan, including MIS and information technology system requirement, costs, milestones, and any other steps needed to ensure that best international practice is followed.

Appendix 6

36

(iii) Establish the initial FIU including the management of equipment procurement and selection of initial staff.

(iv) Draft procedures and reporting templates for investigating and prosecuting money laundering offences, detailing procedures and work flows among various relevant government agencies, and ensuring that legal provisions are not contradicted.

(v) Design cost-effective industry compliance programs and RMA examiner auditing procedures, which will include updating on- and off-site supervision to include AML investigation.

(vi) Provide on-the-job training to FISD staff that will form part of the FIU and FISD examiner staff.

(vii) Provide high-level advice to RMA on issues arising from AML examinations. (viii) Liaise with ADB’s AML unit to ensure that all proposals and regulations are in

line with current ADB policies. (ix) Conduct workshops for stakeholders on all new regulations and procedures.

e. Legal Expert on Corporate Governance Law (2 person-months)

5. The expert must be a lawyer with practical experience on reviewing and drafting corporate governance laws and regulations. He or she should have a good understanding on international best practices as well as regional knowledge in Asia to provide good, practical legal advice on good corporate governance. The expert’s tasks will include the following:

(i) Draft relevant regulations and guidelines for corporate governance to ensure the inclusion of fit-and-proper tests for boards of directors, structure and composition of boards, conflict-of-interest rules, restrictions on cross shareholding, and other corporate governance issues, as appropriate, in the context of the overall policy actions envisaged by the FSDP.

(ii) Internalize relevant regulations by recommending appropriate steps for RMA as the regulatory authority and carry out these proposed measures and appropriate organizational changes for the affected parties to implement regulatory requirements within a reasonable time period.

(iii) Conduct consultation workshops for RMA and relevant stakeholders to improve their familiarity with and understanding of the new corporate governance rules and regulations.

2. National Consultants

a. Accounting Specialist (12 person-months) 6. One national expert with proficiency in English and detailed knowledge of Bhutan’s accounting and auditing practices and legal environment will support the international expert in the organizational design of AASB and the implementation road map. The national expert will be primarily required to do the following:

(i) Carry out research into the feasibility of the proposed new structure of AASB. (ii) Assist in the costing of resources needed. (iii) Review the existing legal framework and proposed amendments to laws, if

needed.

Appendix 6 37

(iv) Collect information on current accounting and auditing practices (i.e., operational manuals in financial institutions, the tax authority manual, and RMA’s accounting requirements, etc.).

(v) Organize discussion workshops, and coordinate with key stakeholders. (vi) Provide other relevant support services, such as arranging meetings with key

stakeholders as needed. b. Legal Specialist (6 person-months)

7. The expert will have a solid background in law and good understanding of the country’s current legal and regulatory system in the financial sector and proficiency in English. Preferably, he or she should have experience in working with international consultants and the Government. The consultant will undertake the following tasks:

(i) Assist the international FIU and AML and CIB experts in all legal aspects of the tasks within their terms of reference.

(ii) Assist international experts in collecting and reviewing required legal documents and information and in making them available in English in an organized and clear format.

(iii) Provide other relevant support services, such as arranging meetings with key stakeholders as needed.

c. Information Technology Specialist (3 person-months)

8. The consultant should have proficiency in designing websites for capital market systems and market players, especially for securities exchanges, with proficiency in English. The consultant will do the following:

(i) Assist RSEBL in developing a website, including selecting and negotiating with the website provider, to include listed companies information and up-to-date share price information. Ensure that the website can be expanded to include relevant information on small and medium-sized enterprises operating in Bhutan.

(ii) Help RSEBL upgrade and automate the database and MIS, including selecting and negotiating with the service provider, for improving depository information.

(iii) Help RSEBL and the program and project management unit monitor the procurement packages for the website and database for depository information.

(iv) Provide training support to relevant stakeholders as necessary. (v) Provide other relevant support services, such as arranging meetings with key

stakeholders as needed.

38 Appendix 7

PROCUREMENT PLAN A. Program Information

Country Kingdom of Bhutan Name of Borrower Government of Bhutan Project Name Financial Sector Development Program Loan or TA Reference To be determined (Tbd) Date of Effectiveness Targeted for January 2007 ADB Financing Amount ($) 2,000,000 Executing Agency Ministry of Finance Approval Date of Original Procurement Plan 30 October 2006 Approval of most recent Procurement Plan Tbd Publication for Local Advertisement Tbd Period Covered by this Plan 2007 to 2009

B. Procurement Thresholds for Goods and Related Services, Works, and Supply and

Installation

Procurement Method Thresholds Shopping Works NA Shopping Goods Below $0.1 million Exceptional Methods NA

C. Procurement Thresholds for Consultant Services

Procurement Method Thresholds Quality and Cost-Based Selection (QCBS) FTP: Over $1,000,000 STP: Over $500,000 and no more than $1,000,000 BTP: $ 500,000 or less Consultant Qualifications Selection (CQS) Below $200,000 Least Cost Selection (LCS) Below $100,000 Alternative Methods Individual consultant selection; and Direct selection

D. List of Contract Packages in Excess of $100,000 for Goods, Works, and

Consulting Services

Contract Description

Estimated Costa

($’000) Procurement

Method

Expected Date of

Advertisement Prior

Reviewb Consultancy Services for Capacity Building for Capital Market Development

99 Individual March 2007 Yes

Consultancy Services for Improving Corporate Governance


Consultancy Services for AML/CFT 154 Individual March 2007 Yes Consultancy Services for Developing Accounting and Auditing Standards

355 QCBS with STP

March 2007 Yes

Consultancy Services for CIB Development


Consultancy Services for Information Technology for RSEBL


One Turnkey Contract for Developing AML/CFT Framework and Basic Infrastructure

37 Shopping March 2007 Yes

One Turnkey Contract for Designing the Website for RSEBL

6 Shopping March 2007 Yes

Appendix 7 39

Contract Description Estimated Cost

($’000) Procurement

Method

Expected Date of

Advertisement Prior

Review One Turnkey Contract for Upgrading and Automating the Database for Depository Information

$68 Shopping March 2007 Yes

One Regulatory and Supervisory Secondment Program (four FISD staff/3 months per year)

$244 DS — Yes

One Accountancy Training Program (two staff from RMA)

$58 DS — Yes

One Insurance Training Program (six RICBL staff/6 months per year)

$570 DS — Yes

— = not available, AML = anti-money laundering, BTP = biodata technical proposals, CFT = combating the financing of terrorism, DS = direct selection, CQS = consultant qualifications selection, FISD = Financial Institutions Supervision Division, FTP = full technical proposals, LCS = least cost selection, QCBS = quality and cost-based selection, RICBL = Royal Insurance Corporation of Bhutan Limited, RSEBL = Royal Securities Exchange of Bhutan Limited, STP = simplified technical proposals. a Exclusive of taxes and duties. b The Asian Development Bank will assess submissions by the borrower before the contracts are issued.

40 Appendix 8

LIST OF INELIGIBLE ITEMS (OR NEGATIVE LIST)

1. Loan proceeds will finance the foreign currency expenditures for the reasonable cost of imported goods required during the Financial Sector Development Program. 2. No withdrawals will be made for the following:

(i) expenditures for goods (included in the following Standard International Trading Commodity chapters or headings):

Table A8: List of Ineligible Items (of Negative List)

Chapter Heading Description of Items

112 Alcoholic beverages 121 Tobacco, unmanufactured; tobacco refuse 122 Tobacco, manufactured (whether or not containing tobacco

substitute 525 Radioactive and associated materials 667 Pearls, precious and semiprecious stones, unworked or worked 897 897.3 Jewelry of gold, silver or platinum-group metals (except watches

and watch cases) and goldsmiths’ or silversmiths’ wares (including set gems)

971 Gold, nonmonetary (excluding gold ore and concentrates) 718 718.7 Nuclear reactors, and parts thereof, fuel elements (cartridges),

nonirradiated for nuclear reactors Source: United Nations. (ii) expenditures in the currency of the Borrower or of goods supplied from the

territory of the Borrower; (iii) payments made for expenditures incurred more than 180 days before the

effectiveness date of the loan; (iv) expenditures for goods supplied under a contract that any national or

international financing institution or agency will have financed or has agreed to finance, including any contract financed under any loans from the Asian Development Bank;

(v) expenditures for goods intended for a military or paramilitary purpose or for

luxury consumption; (vi) expenditures for narcotics; and (vii) expenditures for pesticides categorized as extremely hazardous or highly

hazardous in classes I-a and I-b, Classification of Pesticides by Hazard and Guidelines to Classification.

Appendix 9 41

SAMPLE WITHDRAWAL APPLICATION FOR DIRECT PAYMENT AND REIMBURSEMENT

42 Appendix 10

SAMPLE WITHDRAWAL APPLICATION FORM FOR IMPREST FUND

Appendix 11 43

SAMPLE PROGRESS REPORT

Pro Forma of the Executing Agency’s Project Progress Report A. Introduction and Basic Data Provide the following:

• ADB loan number, project title, borrower, executing agency(ies), implementing agency(ies); • total estimated project cost and financing plan; • status of project financing including availability of counterpart funds and cofinancing; • dates of approval, signing, and effectiveness of ADB loan; • original and revised (if applicable) ADB loan closing date and elapsed loan period based on

original and revised (if applicable) loan closing dates; and • date of last ADB review mission.

B. Utilization of Funds (ADB Loan, Cofinancing, and Counterpart Funds) Provide the following:

• cumulative contract awards financed by the ADB loan, cofinancing, and counterpart funds (commitment of funds to date), and comparison with time-bound projections (targets);

• cumulative disbursements from the ADB loan, cofinancing, and counterpart funds (expenditure to date), and comparison with time-bound projections (targets); and

• reestimated costs to completion, need for reallocation within ADB loan categories, and whether an overall project cost overrun is likely.

C. Project Purpose Provide the following:

• status of project scope/implementation arrangements compared with those in the report and recommendation of the President (RRP), and whether major changes have occurred or will need to be made;

• an assessment of the likelihood that the immediate development objectives (project purpose) will be met in part or in full, and whether remedial measures are required based on the current project scope and implementation arrangements;

• an assessment of changes to the key assumptions and risks that affect attainment of the development objectives; and

• other project developments, including monitoring and reporting on environmental and social requirements that might adversely affect the project's viability or accomplishment of immediate objectives.

D. Implementation Progress Provide the following:

• assessment of project implementation arrangements such as establishment, staffing, and funding of the PMO or PIU;

• information relating to other aspects of the EA’s internal operations that may impact on the

implementation arrangements or project progress; • progress or achievements in implementation since the last progress report;

44 Appendix 11

• assessment of the progress of each project component, such as, - recruitment of consultants and their performance; - procurement of goods and works (from preparation of detailed designs and bidding

documents to contract awards); and - the performance of suppliers, manufacturers, and contractors for goods and works

contracts;

• assessment of progress in implementing the overall project to date in comparison with the original implementation schedule—quantifiable and monitorable target, (include simple charts such as bar or milestone to illustrate progress, a chart showing actual versus planned expenditure, S-curve graph showing the relationship between physical and financial performance, and actual progress in comparison with the original schedules and budgets, the reference framework or guidelines in calculating the project progress including examples are shown in Appendix 2); and

• an assessment of the validity of key assumptions and risks in achieving the quantifiable

implementation targets. E. Compliance with Covenants Provide the following:

• the borrower's compliance with policy loan covenants such as sector reform initiatives and EA reforms, and the reasons for any noncompliance or delay in compliance;

• the borrower’s and EA’s compliance with financial loan covenants including the EA’s financial management, and the provision of audited project accounts or audited agency financial statements; and

• the borrower’s and EA’s compliance with project-specific loan covenants associated with implementation, environment, and social dimensions.

F. Major Project Issues and Problems Summarize the major problems and issues affecting or likely to affect implementation progress, compliance with covenants, and achievement of immediate development objectives. Recommend actions to overcome these problems and issues (e.g., changes in scope, changes in implementation arrangements, and reallocation of loan proceeds).

Appendix 11 45

Framework and Guidelines in Calculating Project Progress A. Introduction 1. To ensure that all implementation activities are reflected in measuring implementation progress against the project implementation schedule, the term "physical completion” in the PPR has been changed to "project progress.” 2. Physical and precommencement activities are considered in calculating project implementation progress. These activities, which may include recruitment of consultants, capacity building, detailed design, preparation of bid and prequalification documents, etc., could constitute a significant proportion of overall implementation and therefore should be counted. 3. Each activity in the implementation schedule will be weighted according to its overall contribution (using time as a reference) to progress of project implementation. These weights will then be used to calculate the percentage of project progress along the entire time span of the project. This is to provide a holistic view of the pace of implementation. B. Framework for Compiling Activity List and Assigning Weights 4. As implementation activities and their corresponding weights will vary according to the type of project, sector, and country, sector divisions or RMs will be responsible for determining and including them in the project administration memorandum. The actual project implementation progress of these activities should be reported regularly through the EA’s quarterly project progress report. To ensure ADB-wide consistency, the following framework has been established; its application will be monitored through the PPR. 1. Compilation of Activity List 5. Sector divisions or RMs concerned should identify major implementation activities and include them in the implementation schedule, which is attached as an appendix in the report and recommendation of the President (RRP). The implementation schedule should follow the critical path of the project’s major activities in project implementation taking account of various country, sector, and project constraints. 2. Assignment of Weights 6. Corresponding weights for each activity should be assigned to ensure that “project progress" measures the percentage of achievement (nonfinancial except when the project has credit components) for all events during the entire duration of the implementation schedule. To avoid disproportionate assignment of weights, to the extent possible these should be evenly distributed along the implementation schedule. When activities are concurrent, avoid “double counting.” 3. Computation of Project Progress 7. Once all activities are identified and corresponding weights assigned, project progress should be calculated using the following steps:

(i) Determine the actual percentage progress (nonfinancial) of each activity. (ii) Multiply these percentages by the assigned weight of each activity to arrive at the weighted

progress. (iii) Add up the resulting weighted progress of all activities to determine the project progress.

Page 3 of this Appendix provides an illustration of this calculation using a generic sample implementation schedule and this Appendix, page 4 a specific example in the education sector.

46 Appendix 11

Implementation Schedule with Activities and Weights

Yr1 Yr2 Yr3 Yr4 Yr5

A

a

B

b

Cd

c

De f

E

A C

T I

V I T

I E

S

1. Sum of all weights should equal 100 percent (a+b+c+d+e+f+g = 100%)2. When calculating the percentage of “project progress,” all completed activities should be counted as accomplished, regardless of when they

were scheduled to be completed. For example, when calculating the percentage of “project progress” after year 3, if activity D is completed inyear 3 rather than in year 2, it should still be included in the computation.

3. Total weight of each activity is as follows: Activity A–a; Activity B–b; Activity C–c; Activity D–d; and Activity E–e + f +g4. Project progress of a project is the summation of the actual percentage of progress for each activity multiplied by the total weight of each

activity.

Appendix 11 47

Sample Implementation Schedule

Activities Year 1 Year 2 Year 3 Year 4(a)

AssignedWeight

(b)Actual

Progress

(a) x (b)WeightedProgress

Establish PIU 5% 100% 6%

Establish Accreditation Board, etc. 5% 0% 0%

Appoint Staff and Budget 4% 75% 3%

Adopt Architecture Plans 2% 100% 2%

Shortlist Consulting Firms 6% 100% 6%

Prepare Fellowship Program 6% 76% 4%

Prepare Civil Works Tendering 30% 0% 0%

Civil Works: Classrooms, Dorms, etc. 6% 0% 0%

Procurement of Furniture and Equipment 16% 10% 2%

Field Work of Consultants 7% 0% 0%

Provide Fellowships 6% 0% 0%

Conduct Study Tours 6% 0% 0%

Provide Curriculum Standards 6% 0% 0%Total Weight 100%

Imp. Progress 24%

(a) Assigned weight for each activity(b) Actual progress of each activity(a) x (b) weighted progress for each activityProject progress = sum of all weighted progress for each activity

48 Appendix 12

SAMPLE AUDIT LETTER

ASIAN DEVELOPMENT BANK

Regional Department Sector Division / Regional or Resident Mission

[Date]1 [The Borrower] Dear Sir or Madam:

Subject: Loans 2279/2280-BHU: Financial Sector Development Program

FINANCIAL REPORTING AND AUDITING REQUIREMENTS This letter is to ensure your timely compliance with the loan covenants and the quality of financial information as required by ADB. ADB's Handbook for Borrowers on the Financial Governance and Management of Investment Projects Financed by the ADB (the Booklet) is enclosed to guide you. ADB, by its Charter, is required to ensure that the proceeds of any loan made, guaranteed, or participated in by ADB are used for the purposes for which the loan was approved. ADB requires accurate and timely financial information from its borrowers to be assured that expenditure was for the purposes stated in the loan agreement. For this particular loan, the requirements are stipulated in sections _____2 and _____3 of the Loan Agreement of ______________ between ADB and [the Borrower] and sections ______4 and _____5 of the Project Agreement6 of _____________ between ADB and [name of the EA].7 Copies of the Loan/Project Agreements are enclosed for onward transmission by your office to your EA and the auditor(s), together with a copy of this letter. The following are the main requirements:

• ADB requires the EA to maintain separate project accounts and records exclusively for the Project to ensure that the loan funds were used only for the objectives set out in the Loan or Project Agreements. The project accounts comprise the following:8

- -

The first set of project accounts to be submitted to ADB covers the fiscal year ending ________________. As stipulated in the Loan or Project Agreements, they are to be submitted up to _________________ months after the end of the fiscal year. For this loan, the deadline is by _________________. A sample report format with explanatory notes, is attached as Annex A.

• The accounts and records for the project are to be consistently maintained by using sound

accounting principles. Please stipulate that your external auditor is to express an opinion on whether the financial report has been prepared using international or local generally accepted accounting standards and whether they have been applied consistently.

ADB prefers project accounts to use international accounting standards prescribed by the International Accounting Standards Committee. Please advise your external auditor to comment on the impact of any deviations, by [name of the Executing Agency] from international accounting standards.

• Please ensure that your external auditor specifies in the Auditor's Report the appropriate

auditing standards they used, and direct them to expand the scope of the paragraph in the

Appendix 12 49

Auditor's Report by disclosing the key audit procedures followed. Your external auditor is also to state whether the same audit procedures were followed for all supplementary financial statements submitted.

ADB wishes that auditors conform to the international auditing standards issued by the International Federation of Accountants. In cases where other auditing standards are used, request that your external auditor to indicate in the Auditor's Report the extent of any differences and their impact on the audit.

• The external auditor's opinion is also required on whether

- the proceeds of the ADB's loan have been utilized only for the project as stated in the

Loan Agreement; - the financial information contains data specifically agreed upon between [name of the

Borrower or EA] and ADB to be included in the financial statements; - the financial information complies with relevant regulations and statutory requirements;

and - compliance has been met with all the financial covenants contained in the Loan or

Project Agreements.

• The Auditor's Report is to clearly state the reasons for any opinions that are qualified, adverse, or disclaimers.

• Actions on deficiencies disclosed by the external auditor in its report are to be resolved by

[name of Borrower or Executing Agency] within a reasonable time. The external auditor is to comment in the subsequent Auditor’s Report on the adequacy of the corrective measures taken by [name of Borrower or EA].

Compliance with these ADB requirements will be monitored by review missions and during normal project supervision, and followed up regularly with all concerned, including the external auditor. Yours sincerely, Director Country Director (Sector Division/ Regional or Resident Mission) cc: (EA) (External auditor of the Borrower or EA)

Notes: 1 The audit letter, with the loan and project agreements, is sent to the borrower when the auditor has been appointed or when

the agreements are sent by the program department to the Ministry of Finance or other authority of the borrower. 2 Specify section no. in the loan agreement on maintaining project accounts and records. 3 Specify section no. in the loan agreement on the audit requirements. 4 Specify section no. in the project agreement on maintaining project accounts and records. 5 Specify section no. in the project agreement on the audit requirements. 6 If there is a project agreement. 7 When more than one project agreement, provide similar information. 8 Listed are standard accounts required from nonrevenue-earning entities. Try to identify specific titles of financial statements

expected to be submitted by the Borrower and EAs. For revenue-earning entities, the submissions consist of the entities’ audited financial statements. For nonrevenue-earning entities, the submissions consist of audited project accounts.

50 Appendix 13

TECHNICAL ASSISTANCE FOR INSTITUTIONALIZING SKILLS AND CAPACITY DEVELOPMENT: OUTLINE TERMS OF REFERENCE FOR CONSULTANTS,

COST ESTIMATES, AND FINANCING PLAN

A. Outline Terms of Consultant

1. International Consultant (6 person-months) a. Financial Sector Supervision and Training Expert 1. The expert will be responsible for the overall management of the technical assistance (TA), timely delivery of reports, and recruitment and management of resource persons. The expert must have at least 10 years’ practical experience as a supervisor of financial institutions in an Asian Development Bank (ADB) member country and experience setting up and managing a training institute dedicated to building the capacity of monetary authority staff and financial sector professionals. Experience in South Asia would be an advantage. Specifically the expert will do the following:

(i) Prepare a feasibility study for the establishment of the Training Institute in the Royal Monetary Authority (RMA). This study will include an assessment of current facilities, estimation of infrastructure needs present and future, identification of staff needs, identification of a likely training curriculum to be offered, annual operational costs to run the Training Institute, and the pricing strategy for non-RMA trainees to be used to ensure the sustainability of the institute.

(ii) Prepare internal procedures for managing the institute. (iii) Prepare the pilot training program in support of the Financial Institutions Supervision

Division as it carries out policy reforms as necessary. (iv) Prepare the terms of reference for and identify resource persons. (v) Help RMA recruit and/or select the counterpart staff that will eventually head the

Training Institute. (vi) Coach counterpart staff to the level required for managing the Training Institute after

the TA completion. (vii) Select, manage, and monitor the performance of the resource persons. (viii) Organize, set up, and implement the pilot training program. (ix) Submit required reports to ADB, the executing agency, and the implementing

agency under the following schedule: (a) an inception report within 21 days of being fielded; (b) a midterm report (i.e., feasibility study of the establishment of the Training Institute) 3 months after fielding; (c) a progress report of the pilot training program 1 month after the establishment of the Training Institute; (d) a draft final report for TA, to be submitted 3 weeks before the end of the consulting term; and (e) a final report at the end of the consulting assignment. All reports will be submitted in hard and electronic form to the Government and ADB for review and comments. Consultants will duly incorporate the comments received while finalizing the reports. The reports shall be made available 2 weeks from the date of the tripartite meetings or receipt of comments.

2. Resources Persons on Various Topics of Financial Sector Supervision (a total

of 3 person-months) 2. The terms of reference for the resource persons will be developed by the international financial sector supervision and training expert based on the training needs analysis to be performed during the design of the pilot training program.

Appendix 13 51

Table A13: Technical Assistance: Cost Estimates and Financing Plan ($’000)

Item Total Cost A. Asian Development Bank (ADB) Financinga 1. Consultants

a. Remuneration and Per Diem for International Consultants 120.0 b. International and Local Travel 11.0 c. Reports and Communications 1.0

2. Equipmentb 8.0 3. Training, Seminars, and Conference

a. Resource Persons 73.0 b. Training Materials 5.0

4. Miscellaneous Administration and Support Costs 7.0 5. Contingencies 25.0

Subtotal (A) 250.0 B. Counterpart Financing 1. Office Accommodation and Office Equipmentc 14.0 2. Local Counterpart Staff 42.0 3. Local Communications 2.0 3. Contingencies 4.0

Subtotal (B) 62.0

Total 312.0 a Financed by ADB’s Special Funds resources. b Equipment is a preliminarily estimate to be revaluated during the feasibility study. c Including office space and equipment for the consultant and training facility. Source: Asian Development Bank estimates.