Announcement of the World Bank's Loans to Mexico on June 22, 1995

The World Bank 1818 H Street NW, Washington, DC 20433, USA Bank News Release No. B95/S99 Contacts: Ciro Gamarra, tel. (202) 473-8721 Merrell Tuck, tel. (202) 473-9516 Al Drattell, tel. (202) 473-1782 Broadcast: Marie-Christine Bonzom tel. (202) 473-0697. (B-roll available) WORLD BANK LENDS $1.51 BILLION TO MEXICO Washington, June 22, 1995-The World Bank today approved $1.51 billion for three loans to Mexico-one for $1 billion to help support the banking system, $500 million to provide basic social services, and a $13.8 million supplemental loan for a Financial Sector Technical Assistance project. The loans are designed to lay the foundation for a sustained recovery in the Mexican economy, building on emergency assistance already granted by other bilateral and multilateral donors. The loans will be supplemented by $1.25 billion from the Inter-American Development Bank, which is providing $500 million for the government's social program and $750 million for the banking reform program. World Bank Vice President for Latin America and the Caribbean Shahid Javed Burki said that "the loans are a measure of our confidence that the Mexican economy remains fundamentally sound. It is important, however, that the Mexican government continues its current program of removing structural barriers to economic growth through measures such as privatization and decentralization. The financial and technical assistance from the World Bank will provide an infusion of resources that will support the government's medium-term economic plan as well as address the short-term crisis in the financial sector. The Bank is particularly committed to helping the poorest members of Mexican society, who have been hurt most by the economic crisis." NOTE: Money figures are expressed in US dollar equivalents. 1f'orldBanAfexico Archives/Records Center, l of16 H B1-001 ( 1) The World Bank's Board of Executive Directors approved the $1 billion loan to support the Government of Mexico's Financial Sector Restructuring Program. The $500 million social sector loan will enable the government to protect the provision of the most essential social services for the poor following the country's currency crisis and the resulting sharp contraction in the economy. With the overall objective of reducing poverty among the most vulnerable members of Mexican society, the loan will help finance the government's Program of Essential Social Services, which focuses on education, health, nutrition, and employment generation. On December 20, 1994, facing near-depletion of its foreign exchange reserves, Mexico was compelled to allow the peso to depreciate beyond the limits of the band it had previously defended. A currency crisis ensued and, as a result, the economy contracted sharply this year. The present program is an outcome of intensive discussions between the Bank and Mexico's financial authorities between January and April 1995. Financial Sector Restructuring Loan Prior to the December 1994 devaluation and ensuing financial crisis, the National Banking Commission (CNB) had intervened in two banks and the financial groups with which they were affiliated. Intervention in a third financial group (BANPAIS) occurred in February 1995, following inspection of its commercial bank by the CNB. During the first three months of 1995, Mexican authorities took a number of actions to mitigate the impact of the crisis on the banking system. These included: provision of liquidity, intensive inspection of banks resulting in increased reserves, and a temporary recapitalization scheme. The World Bank has worked with the Mexican authorities to ensure that these actions become part of an integrated program. Additional safeguards and policy reform measures have been identified to restructure the financial sector. The government has taken several measures to contain losses and minimize risky behavior by troubled banks. These include: * prohibition of dividend payments by banks that are receiving temporary capitalization from the government because they are unable to mobilize additional equity capital from existing shareholders to meet the 8 percent capital asset requirement; * strict enforcement of the 8 percent capital adequacy rule; * an increase in the level of reserves equivalent to 4 percent of the loan portfolio or 60 percent of past due loans; World Bank/Afexico 2 of 6 * separate reporting of credits being rolled over; and * limits on new lending and large exposures. The $1 billion World 1lexico's Banking System: Growing Problems Bank loan aims to restore By July 1992 the government had sold controlling shares investor confidence and of the 18 financial institutions it had previously owned. Between financial soundness to the 1991 and 1994 commercial bank assets grew at an annual rate of Mexican economy by 18.1 percent in real terms. Loan portfolios expanded even faster, containing the losses of the at an annual growth rate of 23.7 percent. However, average loan portfolio quality deteriorated, in banking system while part due to its rapid growth. Past due loans increased from 4.09 sustaining the credit and percent of gross loans in 1991 to 7.33 percent by the end of 1994. payments system, which is Non-performing credits increased from 5.2 percent to 8.8 percent essential to economic over the same period. At the same time Mexican banks did not allocate sufficient provisions to cover their actual and potential recovery, loan losses, and between 1991 and 1993 the ratio of provisions to past due loans actually decreased from 50.8 percent to 42.7 The Bank loan will percent. also help the government The banking system was severely shaken by the peso establish a more efficient and crisis following the December 1994 devaluation. Several banks stable financial system by incurred foreign exchange losses on their open share positions. Banks also saw an impairment in the value of their investments improving regulation, resulting both from the economic contraction and from the sharp supervision, and the legal rise in interest rates which followed the collapse of the peso. In framework for lending. These addition to these losses, banks are facing significant liquidity measures will enable the pressures which substantially increase their funding costs. financial system to mobilize The result has been a further deterioration of the loan increasing amounts of portfolios of the banks. New loan provisions and increased funding costs have, in turn, eroded the banks' capitalization. This domestic and foreign capital, led to the establishment of the temporary recapitalization program thereby restoring economic (PROCAPTE) for banks whose shareholders could not growth. immediately restore capital to the required level. The government's Financial Sector Restructuring Program supported by the World Bank loan will build on existing measures to: * restore the solvency and soundness of Mexico's banking system, restructure banks, and improve confidence in the financial system; * reform the accounting standards and prudential regulations for banks and strengthen supervision to prevent recurrence of systemic problems; * improve discipline in the provision of liquidity by Mexico's Central Bank; and * initiate reforms in development bank lending, deposit protection measures, and accounting practices and regulation of financial groups. World BanklAfexico 3 of 6 These measures will be attained through Debt Restructuring: the UDI Scheme government efforts to determine the health of To stabilize banks and enable debtors to service loans, the the banking system and, government has introduced a number of support programs to permit the restructuring of commercial and development bank loans based on on that basis, restructure the Unidad de Inversion (UDI), a unit of account reflecting the price troubled banks and level. The Central Bank periodically adjusts the UDI's new peso strengthen bank value based on an index of national consumer prices. supervision. Other Under the UDI scheme, loans based on the nominal interest measures will improve rate would be converted into longer-term UDI-denominated loans, l athereby eliminating the accelerated repayment of principal associated discipline and reduce with the inflation component of nominal interest rates. To support risks in the provision of the scheme, the government will lend funds to the banks at a real rate liquidity support by the of 4 percent to finance the restructured loans. Central Bank, establish new accounting standards (consistent with US generally accepted accounting principles) and prudential regulations for banks and other financial institutions, and reform the regulatory framework to facilitate corporate work-outs and debt restructuring. The World Bank loan for the Financial Sector Restructuring Program will be disbursed in two $500 million tranches: the first one will be disbursed upon loan effectiveness; the second will be released in about nine months following the government's compliance with conditions stipulated under the agreement, including continued implementation of the economic stabilization program and progress in the execution of restructuring plans for Mexico's banking sector. Upon successful initiation of the Financial Sector Restructuring Loan, the Bank may consider a follow-up loan of $500 million to provide additional resources in support of the program. Loan proceeds will be used to finance general imports, with the exception of goods financed by other agencies, luxury goods, military equipment and other specifically prohibited goods. The $13.8 million loan will supplement an earlier one of $23.6 million approved last January to finance a Financial Sector Technical Assistance project. The project aims to improve the safety and soundness of the financial system through improved regulation and supervision and to support the development of the pension system. Support for financial technical assistance will include the services of auditors and investment banking advisers to assist in the resolution of troubled banks. The Mexican government has formed an ad hoc Financial Sector Working Group to improve coordination and implementation among government agencies, such as the National Banking and Securities Commission, the Central Bank and the Ministry of Finance. World Bank/lexico 4 of 6 Program of Essential Social Services Loan In response to the increased demand for social services precipitated by the economic crisis, the $500 million World Bank loan will finance high priority government programs in education, health, employment, and nutrition. By providing a social safety net and protecting some of the gains achieved in social indicators in recent years, the project furthers the work of the Bank and the IDB in poverty reduction and human resource development, which remain key to achieving growth, equity, and sustainable development in Mexico. The objectives of the Program of Essential Social Services are to: * protect essential social services for the poor, through the maintenance of access to basic education in isolated rural areas and the provision of a minimum health package including vaccination and medical supplies; * strengthen existing social safety net measures to cushion the poor from the effects of the economic crisis by creating short-term employment opportunities and implementing a nutrition program for vulnerable groups in the poorest areas; and * establish the foundation for measuring and implementing efficiency gains in the social sectors through technical assistance and program monitoring. Targeted toward poor rural and peri-urban areas, the program emphasizes strong community participation, with local workers involved in health care and nutrition projects, and local communities managing small infrastructure projects with technical support from state and municipal governments. The loan will finance the cost of production, acquisition and distribution of textbooks for the basic education services sub-program, and civil works; acquisition, storage and distribution of vaccines, essential drugs, medical supplies and basic equipment for the health services sub-program. The project is expected to cushion the effects of the recession on the poor, as well as lessen the impact of necessary fiscal adjustment measures undertaken by the Mexican government. Indigenous people will benefit from services provided under the basic education, health, and nutrition programs, while also gaining an estimated 550,000 short- term jobs a year through their participation in implementing the programs. The loan will also help finance a two-year training program for 800,000 unemployed workers. The total cost of the program is $2 billion, with the Government of Mexico providing $1 billion in addition to the World Bank and IDB loans. World Bank/Mexico 5 of 6 In the past, the Bank Loan Terms vigorously supported Mexico's economic adjustment and debt The three loans, totaling $1.51 billion, will be made to redconprgradjstms,eth ls dNational Financiera with the guarantee of the United Mexican States. The $1.5 billion in loans for the Financial totaling $11.4 billion during fiscal Sector Restructuring Program and the Program of Essential years 1986-91. Since fiscal year Social Services will be fixed rate US dollar loans, with an 1992, annual lending has overall repayment period of up to 15 years. Each loan averaged $1.4 billion, with the tranche will have a maturity of 12 years, including 3 years' focus of operations shifting from grace. The lending rate will be fixed for each semester's disbursements at a rate tied to the fixed rate equivalent, for adjustment lending to poverty the loan tranche maturity, of 6-month LIBOR [London reduction, human resources Interbank Offered Rate]. These loans are the first made by development, and the the Bank under the expanded single currency loan program environment. The Bank has approved by its Board on May 30, 1995. The $13.8 million consistently maintained a strong supplemental loan for the Financial Sector Technical cronsaisn inAssistance project will be a multicurrency loan (currently in programdin $2.binfastru targeted currency ratios of 1 US dollar: 125 Japanese yen: 2 providing $2.4 billhon i fiscal deutsche Mark equivalent), with a variable lending rate years 1991-94, or 40 percent of (currently 7.09%) based on the Bank's cost of funding for total lending. In fiscal year 1994, these loans, and a 15-year repayment period, including 3 Mexico received $1.5 billion for years' grace. projects in education, the environment, and water supply and sanitation. The loans are critical elements of the coordinated response of the World Bank, the International Monetary Fund (IMIF), the IDB, and other multilateral and bilateral lenders to assist Mexico in resolving its economic crisis. The IMF and the World Bank will work particularly closely in implementing the Financial Sector Restructuring Loan, because of the inter-dependence of financial and macroeconomic stability. World Bank President James D. World Bank Lending to Mexico Wolfensohn outlined the Bank's plans to assist 3 2.61 Mexico in his inaugural 2.5 2 23 2.38 press conference on June 1, 2.03 2 1995. In late July, he will 2168 1.49 1.53 visit Mexico and the state of E 1.5 1 Chiapas, one of the areas where poor and indigenous people will benefit from 0.5 today's loans. 0a F.- CD 0) 0 - Na 00 O 0 0) 0) a 0) 0) Fiscal Year World Bank,,Vexico 6 of 6