The program supports the Government of Uzbekistan's efforts to promote sustainable and inclusive growth as part of the Uzbekistan 2030 Strategy, by supporting access to finance for unbanked and underserved micro-entrepreneurs. This will be achieved by focusing on three key reform areas to support growth in inclusive finance: (i) improving the policy enabling environment, (ii) enhancing the regulatory and supervisory frameworks, and (iii) diversifying the funding sources available for market participants. The program is supported by an approved technical assistance (TA) grant. The government has recognized that the benefits stemming from the National Financial Inclusion Strategy 2021-2023 need to be shared across the population. Uzbekistan's rising budget deficits also require renewed efforts to improve the solvency and profitability of policy banks and accelerate the growth of the private lenders to service underserved and low-income clients. The government will need to improve the enabling regulatory regime to encourage private banks and NBCIs to facilitate inclusive finance. In late 2023, through a series of presidential decrees the government commenced significant reforms through three strategic objectives: (i) improving the policy environment, including the repositioning of policy banks to scale up commercial microfinance and gradually phase-out government policy lending, (ii) improving the enabling supervisory and regulatory environment for the microfinance industry including transitioning MFOs to MFB deposit takers and (iii) improving access to funding through the provision of a wholesale funding platform. Modality. An SDP is a suitable modality to simultaneously address upstream policy issues and stimulate downstream financing through (i) a PBL to drive policy reforms gradually removing barriers in the financial system, and (ii) a FIL to address the large funding and financing gap in the microfinance industry. The FIL will promote microcredit based on sound commercial principles by targeting policy banks, MFOs, MFBs, and a dedicated wholesale lender as intermediaries, thereby replacing directed credit through market-based mechanisms. Synergy of policy and financial intermediation components. In addition to policy reforms targeted to overcome supply and demand issues constraining growth of the microfinance sector, the PBL supports mandating of an existing legal entity, Entrepreneurship Development Company (EDC), to become a wholesale financier to provide affordable funding through loans and guarantees for policy banks and MFOs. The FIL will provide affordable funding through a combination of EDC and two policy banks who will act as financial intermediaries to provide retail and wholesale-based lending to the microfinance sector. The PBL further supports the transition to market-based financing by redirecting loan recoveries from funding redirected out of social directed lending to EDC and the three policy banks. The policy actions in the policy matrix (Appendix 2) cover three key reform areas: (i) improving the policy environment for inclusive finance, (ii) enhancing the regulatory frameworks and supervisory capacity for inclusive and sustainable microfinance, and (iii) diversifying funding sources for the microfinance market. All 12 prior actions for subprogram 1 have been completed. Reform area 1: Policy environment for inclusive finance improved. Under subprogram 1, four policy actions were achieved. First, the government commenced the transition from policy lending to commercially viable microfinance by redirecting funding away from directed credit programs to commercial microfinance. This policy shift will ultimately promote a self-sustainable microfinance sector along with a level playing field with the private sector whilst reducing the fiscal burden associated with state directed lending. Second, to further support the National Gender Equality Strategy and improve access to financing for women, the CBU became a signatory to the Women Entrepreneurs Finance code (WE-Fi Code) with a commitment to improve sex-disaggregated data requirements of the banking industry. Third, to develop a greater understanding of underlying poverty levels nationwide and to support evidence-based development policymaking, the Center for Economic Research and Reforms developed a Multidimensional Poverty Index (MPI) methodology and rolled it out including through the integration of the index data requirements into the National Household Budget Survey. Finally, to support the growth and diversification of the financial sector through Islamic financial services in the microfinance sector, CBU developed a regulatory framework on Islamic financing for microfinance, which once rolled out will enable access to financial services for the micro and small businesses, as well as sizeable segment majority of the population currently excluded for religious preferences. Under subprogram 2, CBU will roll out a comprehensive new National Financial Inclusion Strategy (NFIS) 20252030, including a financial inclusion and sustainability dashboard along with the framework for Islamic microfinance. In terms of Islamic microfinance, the GOU will submit the draft of the Law on Islamic banking to the Parliament. The WE-Fi code will also be rolled out fully across the gender ecosystem to include banks and non-banks alike as potential signatories. The government will also approve a dedicated MSME development strategy, including definitions of and baselines for sex-disaggregated information and related performance targets. Reform area 2: Regulatory frameworks and supervisory capacity for inclusive and sustainable microfinance enhanced. Under subprogram 1, seven policy actions were completed. First, legal and regulatory reforms were adopted, including (i) introducing new legal forms and related business permits for MFOs and MFBs, (ii) doubling of the upper limits for microloans, (iii) permitting qualified MFOs and MFBs to provide payment services, and (iv) reducing collateral requirements for banks to provide microfinance services to self-employed and micro-businesses. Second, a new legal and regulatory framework was developed to allow for a new specialized banking license, namely the Microfinance Bank (MFB) license to be issued for suitably qualified financial institutions, (not limited to MFOs) that will be permitted to offer a full financial service offering including importantly, deposit taking from customers, while maintaining a mandate focusing on the poor and financial inclusion. Third, to upgrade the capacity of the regulator to support future market growth, the CBU established and staffed a dedicated coordination, supervision, and monitoring department focused on microfinance providers. Fourth, to boost formal savings rates and improve the resilience of customers using banks, the government, and the CBU, submitted a legislative package to the Cabinet of Ministers to expand the deposit guarantee schemes' coverage to include business entities, as well as individual entrepreneurs. Fifth, the CBU has approved a time-bound and comprehensive action plan for the enhancement of institutional mechanisms, introducing risk-based supervision for consumer rights protection and improving regulatory framework to align it with best international practices, as well as strengthening dispute mechanism to better support the microfinance sector. Sixth, to promote good corporate climate and governance, the CBU developed and adopted a Strategy for Managing and Supervision of Climate-Related Financial Risks in the Banking Sector and commenced providing information on risks associated with climate change in the Financial Stability Review from 2024. Finally, to foster greater access to finance through asset-based lending, the government submitted to the Cabinet of Ministers a set of legislative amendments to enhance the factoring regulatory framework, including the definition of factoring and contractual obligations, in line with best practices for developing the factoring market. Subprogram 2 will continue this policy reform agenda by (i) submitting the legislative package to the cabinet of ministers on amending the Law on Non-Bank Credit Institutions and microfinance activities and ii) the CBU will develop and adopt a new regulatory framework for MFB transformation, including prudential requirements and the issuance of new operating licenses to at least 2 MFBs. Reform area 3: Funding sources for the microfinance market diversified. Under subprogram 1, the main reform accomplished was to develop wholesale (apex) microfinance services. The government designated the EDC as a special legal entity to provide wholesale microfinance services and capacity building to banks, MFBs, and MFOs and submitted to the Cabinet of Ministers a law to mandate CBU to regulate and supervise the EDC. To fund EDC's new mandate, the government approved allocation of SUM1 trillion. Under subprogram 2, the CBU will establish the EDC's prudential regulations, and the government will provide long-term loan financing to the EDC and update the credit guarantee scheme based on international practices. The FIL activities will provide part of the Credit Line Facility (CLF) for EDC to lend commercially to eligible microfinance borrowers, including both MFOs and new MFBs. The remainder of the CLF will be used to support both retail and wholesale lending to micro borrowers through two or more SOCBs, with at least 30% of the CLF being provided for women borrowers, a further 20% allocated for green finance and at least four MFOs receiving funding on a commercial basis from one or more SOCBs. ADB's value addition and integrated solutions. ADB is a strategic partner and investor in the banking sector in Uzbekistan, engaging with key public and private banks that are strategically focused on supporting the MSME sector sustainably, such as Xalq Bank, Hamkorbank, and Ipak Yuli Bank. Through a TA project, ADB has supported the commercialization and transformation of one of Uzbekistan's largest banks, Xalq Bank, since May 2022. ADB adds value as a long-term trusted partner in driving forward the commercialization and financial sustainability of strategic SOCBs to enhance overall competitiveness; and providing integrated solutions in policy and regulatory reforms, advisory and capacity building, and financing to address critical supply and demand constraints for a more inclusive finance sector. ADB's value addition has been established by the government's buy-in to microfinance sector reforms and will culminate in the development of a robust NFIS, 2025-2030 using its convening power across public and private sector stakeholders. In addition, the climate actions in this program complement other ADB projects that support climate action, with the program supporting TA to strengthen the capacity of microfinance institutions (MFOs) to provide affordable and accessible finance to MSE. The program also reinforces the outcomes from the capital market reforms of the Financial Market Development Program, which focuses on addressing supply and demand factors impacting access to financial markets and ADB's nonsovereign operations that support MSMEs, agriculture borrowers, microfinance institutions, and trade and supply chain finance. The SDP's policy reforms also benefit two new ADB nonsovereign transactions in Uzbekistan, especially in climate risk management and deposit insurance reforms. Private sector development and synergies. Since 2013, ADB nonsovereign operations have invested in Uzbekistan's banking sector, including Hamkorbank and Ipak Yuli Bank, all strategically focused on MSMEs and rural clients. The PBL reforms create a more conducive environment for the private sector through (i) the expansion in the deposit guarantee coverage for entrepreneur deposits, and (ii) a doubling of microcredit limits to self-employed and microenterprises. In addition, CBU drives a climate risk strategy and green taxonomy for banks to scale up and align private capital contributions to the country's nationally determined contribution (NDC) commitments. In addition, ADB is supporting the commercialization and investment readiness of SOCBs, particularly Xalq Bank and Business Development Bank, including their transition to more commercially sustainable, agile, and innovative entities, to introduce competition and a level playing field with private enterprises for more dynamic and sustainable private sector development. While nonsovereign investments are still remote given the nascent and weak risk profile of MFOs and major SOCBs in microfinance, ADB's sovereign FIL provides a unique structure for ADB to channel funding through commercially viable mechanisms to the most underserved private sector-the microenterprises until market financial institutions mature to access investment at commercial terms and conditions. ADB TA and sustainability. The SDP design and sustainability have been supported by a TA project by (i) performing analytics and diagnostics to understand the microfinance ecosystem, and (ii) supporting the subsequent development of key policies in conjunction with regulators and ministries based on best practices. In addition, a TA project approved in March 2024 is supporting program preparation and capacity building through (i) supporting the regulatory reforms for subprogram 2 (including NFIS, gender equality, and WE-Fi Code); (ii) enhancing selected MFOs and MFBs in areas covering corporate governance, credit processes, risk management, product development, environmental and social safeguards; and (iii) enabling EDC readiness to fulfill its funding mandate to the microfinance sector including the development and operation of suitable Anti-Money Laundering (AML) and Combating the Financing of Terrorism AML (and CFT) frameworks. The TA will also strengthen the capacity of MFIs to provide green finance products and strengthen the capacity of MSE to invest in low carbon and climate resilient practices. The sustainability of the FIL is safeguarded by prescribing specific eligibility criteria to ensure that only financial institutions with satisfactory financial performance, an existing microfinance business orientation, and adequate monitoring arrangements will be able to access funding under the FIL. ADB engagement and development coordination. ADB regularly meets and consults with the IMF, including during staff visits and its Article IV missions, to exchange quantitative analyses and discuss macroeconomic projections. Recommendations from the latest Article IV mission on the acceleration of finance sector reforms including privatizing state-owned banks and reducing structural excess liquidity, are relevant to this program. ADB participated in a Country Donor Coordination Platform led by the Agency for Strategic Reforms under the President of Uzbekistan, and dialogue platforms run by CBU and the Ministry of Economy and Finance (MOEF). ADB has shared information and discussed the program with development partners engaged in inclusive finance. These discussions include the Islamic Development Bank on women and Islamic financing and with the World Bank Group on State Fund governance; with the German development cooperation through KfW regarding women and youth in business, business advisory, and green finance for SMEs; with the European Bank for Reconstruction and Development on facilitation of actions in supporting women-led micro, small, and medium enterprises under Women Finance Code initiative, led by European Bank for Reconstruction and Development; International Finance Corporation on apex development, digital financial services, and financial literacy; with the United States Agency for International Development on market system approaches; and with the International Monetary Fund on debt sustainability analysis and macroeconomic projections. Lessons learned. The program incorporates lessons and knowledge gained from supporting the MSE developing member countries, including SDPs and PBLs in Bangladesh, Pakistan, the Philippines and Uzbekistan. The lessons from these projects confirm an ADB Institute study and an Independent Evaluation Department (IED) synthesis note which found that a program cluster approach which combined both policy and regulatory measures through a policy-based intervention with funding via a financial intermediation loan to support greater access to finance is optimal in achieving the maximum in 2018 identified key lessons including (i) policymaking is only as useful as the practical implementation, making the role of regulators critical to drive transformative changes for inclusive finance; (ii) collection of sex-disaggregated data from financial institutions to benchmark performance and inform policymaking is important ; and (iii) the provision of capacity building to the finance sector is needed along with suitable incentives and targets to ensure business models are adapted to meet the needs of underserved segments. The expected outcome is expanded access to finance with commercially viable financing mechanisms for unbanked and underbanked microenterprises, to support sustainable and inclusive growth. This will be achieved through three main outputs, namely i) policy environment of inclusive finance improved, ii) Regulatory frameworks and supervisory capacity for inclusive and sustainable microfinance enhanced and (iii) Funding sources for the microfinance market diversified. The PBL will enhance the effectiveness and sustainability of the FIL by (i) addressing supply-side constraints, particularly through reforms to reduce policy lending and promote the commercialization of state-owned banks for the provision of inclusive finance, which will lead to a stronger and more sustainable microfinance industry; (ii) removing key constraints associated with access to funding, which will also help scale up microfinance provision through banks and nonbanking institutions; and (iii) improving risk diversification across the industry. A summary of program impact includes reaching out to more than 220,000 MSEs borrowers, with increases in (i) total loan portfolio outstanding of microfinance organizations (MFOs) increased to $2.5 billion (2023 baseline: $1 billion); (ii) the percentage share of commercially priced microcredit across the industry increased to at least 70% (2023 baseline: commercial microcredit portfolio, 43%); (iii) the share of lending to women across the microfinance sector increased to 30% (2023 baseline: 20%) and finally (iv) an increase in the numbers of microfinance borrowers reached by the financial sector increased to 1.8 million (baseline: 2023: 0.7 million). Uzbekistan's development financing needs. According to the macroeconomic projections of the MOEF, the government's development financing requirement (overall fiscal deficit) is projected to be $4,142 million (4.0% of GDP) in 2024. As detailed in Table 1, this will mainly be externally financed ($2,500 million) through borrowings from international financial institutions and bilateral creditors. The remainder ($1,642 million) will be financed domestically through the issuance of domestic securities and other borrowings. ADB's loan of $200 million for subprogram 1 is estimated to represent 4.8% of the government's financing needs in 2024. Overall financing. The SDP is estimated to cost $600 million. Based on the development financing requirements of the program and to finance the policy component of the SDP, ADB will provide concessional lending of up to $400 million in the form of a programmatic approach comprising two subprograms, supported by policy-based loans of $200 million each for subprogram 1 and 2. The FIL of $100 million in subprogram 1 will be matched with government funding of an equal amount. Policy-based loan. For subprogram 1, the government has requested a concessional loan of $200 million from ADB's ordinary capital resources to help finance the program. The loan will have a 25-year term, including a grace period of 5 years; an interest rate of 2.0% per year during the grace period and thereafter; and such other terms and conditions set forth in the draft loan agreement. Financial intermediation loan. The government has requested a regular loan of $100 million from ADB's ordinary capital resources to help finance the program. The loan will have a 15-year term, including a grace period of 3 years; an interest rate determined in accordance with ADB's Flexible Loan Product; a commitment charge of 0.15% per year and such other terms and conditions set forth in the draft loan agreement. Based on the straight-line method, the average maturity is 9.25 years, and there is no maturity premium payable to ADB. The government, through the MOEF acting as the executing agency, on receipt of the FIL proceeds, will relend their sum equivalent to eligible participating financial institutions (PFIs) for retail or whole lending to the microfinance beneficiaries.