A CASE FOR

FINANCIAL INTERMEDIARY LENDING :

LESSONS FROM

ZAMBIA MULTIPURPOSE CREDIT FACILITY

Ahmet I. Soylemezoglu, AFTFS

· Review of Debate around FILs

· Pre - EDP Zambian Landscape

· Design & Implementation of EDP

· Lessons from Zambian Experience

FILs are commonly used

But

Controversial & Problematic

Percentage of Projects in each Sector with FILs

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

Agriculture &Rural

Development

EconomicPolicy

FinancialSector

Private SectorDevelopment

Public SectorGovernance

SocialProtection

UrbanDevelopment

Sectors

Per

cen

t o

f P

roje

cts

FILs: Lending Approved FY93-02 (by No. of Projects)

7 9

29

10 7 9

37

49

60

31

13 9

0

10

20

30

40

50

60

70

80

90

100

AFR EAP ECA LAC MNA SAR

Regions

No

. o

f P

roje

cts

Finance Non-Finance

Satisfactory Ratings of Adjustment Lending

50%

55%

60%

65%

70%

75%

80%

85%

90%

95%

100%

1

Per

cen

t

Financial Adjustment Lending

All Adjustment Lending (excl. Finance)

Financial Intermediation Loans vs. All Other Investment Lending

(Percent Satisfactory)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Percent Sat by Project # Percent Sat by Commitment

Perc

ent S

atis

fact

ory

All Other Investment FIL

Implementation of Closed Projects: Appraisal versus Actual Disbursements

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

AFR EAP ECA LAC MNA SAR

Regions

% o

f G

ross

Co

mm

itm

ent

FIL Total Lending

Commonly Stated FIL Objectives:

· Lack of Term Finance· Lack of Credit in Specific Sectors· Stimulate investments, PSD and growth· Enhance Access to Credit by certain class of borrowers (SMEs, farmers, rural consumers)

Two Sets of Arguments:

•Spend your money somewhere else

•Do it right

How do you do it right ?

· Do not distort

· Confine to correcting a specific failure

How do you not distort ?

· Price neutrality

· Sector neutrality

Price Neutrality Assumes

· existence of a set of market interest rates · existing set of rates efficient

So that..... FIL can be a “price-taker”

QUESTION : Why do you bother doing an insignificant FIL ?

Market Failures

· Financial markets related - macroeconomic conditions· Product & labor markets related - microeconomic conditions

Seems FILs could be justified easily on these grounds

BUT, Would FILs be appropriate instruments to deal with these conditions?

PRE - FIL (pre ‘96-97) ZAMBIA

QUICK FACTS

10 million people w/ $4 billion GDP

Per Capita Income declined from $1100 to $400

Dependent on copper mining

Experimented with very heavy dose of import substitution

and state enterprises

One of the most heavily indebted countries

PRE-FIL ZAMBIA

Started implementing an aggressive reform program in 1991

Four Adjustment Operations

Liberalized prices, interest and exchange rates, trade regimeopened capital account

Started dismantling parastatal sector

Launched comprehensive privatization program

Pre-FIL Zambian Financial Sector

· Small (10% GDP/M2)

· Commercial Bank dominated - Domestic and Foreign

· Volatile interest rates but stabilizing

· Treasury bills constitute a large portion of bank assets

Pre-FIL Zambian Financial Sector

· A Number of insolvent public financial institutions including a DFI (DBZ)

· Investment lending mainly financed by rolling over short term facilities

· Anxious foreign exchange markets, large balances kept abroad

WHY DID WE DO A FIL IN ZAMBIA

To support a number of policy objectives:

· Liquidation or restructuring of DBZ

· Need for a second-tier FI

· Need to improve prudential standards and compliance

· Provide funding for investment and export finance

STRUCTURE OF ZAMBIAN FIL

· Disburse through an Apex

· Long and short term (export preshipment) facilities

· All sectors eligible except domestic trade, real estate, mergers MBOs, illicit activities

· Banks and leasing companies in good standing vis a vis prudential rules

· A sinking fund to pay off IDA loan

TERMS

· Banks assume commercial risk

· Banks assume foreign exchange risk but can pay back in Kwacha

· LIBOR plus 2% wholesale rate

· Retail rate is freely negotiable between bank and the client

· Grace period is allowed and also negotiable

· minimum equity participation is 10% and up to 90% of contract value for exports

Operational Characteristics:

· PFIs apply with a waiver enabling Apex access to supervisory information

· BOZ certifies prudential compliance and the level of 1st tier regulatory capital

· Apex/IDA reserves the right to examine commercial practices of the Bank

· PFIs do loan appraisal and approval

· Apex only checks global limits for PFI and the customer and nature of the activity

Implementation Problems

Apex Problems

Political & Macroeconomic Problems

Competing Donor Facilities

Disbursement Pressure

J and MC Skeptics

Apex problems

· DBZ could not be restructured

· A Temporary Apex Contractor hired

· Temporary Apex later resented by PFIs

Political Problems

· Banks pressured by politicians

· Politicians wanted direct control

· Banks lobbied for government guarantees

· DBZ kept lobbying for a take over

Political Problems

· Privatization of copper mines stalled

· Domestic politics became turbulent

· Donor relations deteriorated

· Investments virtually stopped

Disbursement Problems and WB Skeptics

· CD is unhappy with lack of disbursement

· Res Rep under significant pressure

· TTL rates the project unsatisfactory and .............

Some Revisions:

· Transfer of Apex to BOZ

· Introduction of Euro facility

· Reduction of wholesale rate by one percent

· Indicating to Government our firmness on fundamental principles

· Threat of cancellation

And Suddenly Progress

· Number of PFIs increased

· Disbursements accelerated

· Became one of the best performing projects in Zambia

portfolio

· Became systematically important for Zambia

Performance Highlights

193 sub-loans

About $60 million in loan value

10 Actives PFIs - 3 Leasing companies, 4 locally owned, 3 International Banks

Highly Cost Effective (about $300,000 in three years)

Performance Highlights

193 loans in three years Vs. 91 loans by DBZ in 30 years

Approximately 5400 directly related jobs

Revenue Generated $52.1 million

Tax Collected $9.1 million

Exports made $13 million

Performance Highlights

No default and none expected in the foreseeable future DBZ lost all $100 mil it lent The sinking fund accumulated $1.5 million

Av.. Loan size $250,000 (Av.. DBZ Loan was $910,00)

One-third of loans below $100,000

Largest loan $750,000 (ceiling is $3mil)

Sectoral Distribution

Sector Share in Total lending(%)

Agro-processing 32 Agriculture 12 Manufacturing 15 Transport 10 Mining 9 Construction 5 Services 5 Tourism 4 Printing & Publishing 2

Qualitative Impact

· provided a vehicle to continuously engage with the regulatory system

· stimulated development of leasing and enhanced competition in the sector

· exposed failures of politically influenced DF

Qualitative Impact

. set a benchmark and framework for future operations

· leave behind a sustainable foundation for a 2nd-tier FI

· influenced donor behavior

· possible influence on sector/CD/TTL dynamics

LESSONS

A FIL could be very useful to:

· address institutional and financial sector problems

· support policy reforms

· contribute economic growth

But note

· No qualified PFIs means no FILs

· macroeconomic concerns

· regulator should share risk and responsibility

· simple design no micro-management by Apex or IDA

· ample amount of political desire to capture FILs

· prepare to stay firm against politically motivated

demands

· prepare to tolerate low disbursement ratios

· monitor closely real sector developments

· prepare to cancel

A CASE (?)

FINANCIAL INTERMEDIARY LENDING (FIL) :

LESSONS FROM

ZAMBIA ENTERPRISE DEVELOPMENT PROJECT

Ahmet I. Soylemezoglu, AFTFS