Loans for the Municipal Development Funds should be implemented as proper financial intermediary loans. The projects were designed as financial intermediation loans largely because the government wanted to disburse funds and execute subprojects quickly. MDF had the capacity and had prior experience of implementing such loans through an earlier World Bank project. However, MDF operated like a regular executing agency rather than as a financial intermediary institution, whose role is limited to transferring or on-lending funds to municipal governments; assessing the financial soundness of the investment; and determining whether the borrowing entity has the technical, safeguard, and financial capacity to implement the project. ADB argued that because MDF was not a commercial financial institution and the borrowers were not commercial entities, it should not be subject to the same assessment criteria as a financial intermediary. This evaluation disagrees with the view. MDF’s status as a government special purpose vehicle should not exempt it from the requirement to build up capacity to mobilize domestic resources and become a true revolving fund. ADB’s approval of the government’s request to make the subproject allocations mainly grant-based, even for more affluent municipalities, prevented MDF from creating a revolving fund, hence it was not consistent with the expectation that MDF would improve its financial capacity. The RRP for the first project contained several statements to indicate this was an ambition, though perhaps not a central objective. Moreover, almost all the funding from MSDP Phase 2 was for secondary and tertiary roads which do not generate revenue. For any future urban projects using financial intermediation loans, institutional and capacity development, particularly with a view to transforming MDF into a sustainable financial institution, should be key objectives.
Municipal Services Development Project and Municipal Services Development Project Phase 2