Philippines - Financial Sector Adjustment Loan and Cottage Enterprise Finance Projects

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 15834 PERFORMANCE AUDIT REPORT PHILIPPINES FINANCIAL SECTOR ADJUSTMENT LOAN (LOAN 3049-PH) AND COTTAGE ENTERPRISE FINANCE PROJECT (LOAN 3312-PH) June 28, 1996 Operations Evaluation Department This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Currency Equivalents Currency Unit = Peso p US$1.00 = p 24.5 (at Appraisal, July 1990) US$1.00 p 24.3 (Average 1990) US$1.00 p 27.5 (Average 1991) US$1.00 = p 25.5 (Average 1992) US$1.00 p 27.2 (Average 1993) US$1.00 = p26.4 (Average 1994) US$1.00 p 25.7 (Average 1995) Abbreviations and Acronyms BPI Bank of Philippines Islands BSP Bangko Sentral ng Pilipinas DBP - Development Bank of the Philippines DOF - Department of Finance DTI Department of Trade and Industry EFF - Extended Fund Facility FSAL - Financial Sector Adjustment Loan GDP - Gross Domestic Product GRT - Gross Receipt Tax ICC - Investment Coordinating Committee IGLF - Industrial Guarantee and Loan Fund KfW - Kreditanstalt fuer Wiederaufbau MGA - Mutual Guarantee Association NEDA - National Economic Development Authority NGO Non Governmental Organization OED - Operations Evaluation Department PAR - Performance Audit Report PCI - Philippines Commercial International Bank PCR - Project Completion Report PDIC - Philippine Deposit Insurance Corporation PFI - Participating Financial Institution PNB - Philippines National Bank SBGFC- Small Business Guarantee and Finance Corporation SEC - Securities Exchange Commission UCBP - United Coconut Plant Bank Fiscal Year Government: January I to December 31 FOR OFFICIAL USE ONLY The World Bank Washington, D.C. 20433 U.S.A. Office of the Director-General Operations Evaluation June 28, 1996 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Performance Audit Report on the Philippines Financial Sector Adjustment Loan (Loan 3049-PH) and Cottage Enterprise Finance Loan (Loan 3312-PH) Attached is the Performance Audit Report (PAR) on the Financial Sector Adjustment Loan (Loan 3049-PH) and Cottage Enterprise Finance Project (Loan 3312-PH) prepared by the Operations Evaluation Department. The first loan for an amount of US$300 million equivalent, approved in May 1989, was closed in December 1993. The second loan of US$15 million, approved in May 1991, is scheduled to close in June 1996. There was no cancellation for the first loan (3049-PH). Unutilized balances of US$13.5 million under the Loan 3312-PH were canceled in August 1993. This loan was cofinanced and the cofinancier, KfW, also canceled most of its loan at the same time. Financial Sector Loan The objective of the loan was to strengthen financial sector institutions in the Philippines. First, the supervision and regulatory framework for commercial banks was to be strengthened. Second, institutional arrangements for depositor protection were to be improved. Third, intermediation costs of the banking system were to be reduced. Fourth, delivery systems for long term credit were to be made more effective. All major objectives established at appraisal were reached, and the objective added during project implementation (restructuring the central bank) was reached as well. One important measure, however, the progressive removal of GRT and the withholding tax on interbank deposits, was not implemented. Moreover, a critical analysis of Central Bank performance by the Bank came very late in the picture. It was done in 1992 through a capital markets study, which found that the financial system was not viable at the observed levels of losses of the Central Bank. In light of these findings, the audit mission rates the outcome of the FSAL "satisfactory", instead of "highly satisfactory" as rated in the PCR review. The sustainability of the project is rated as likely and its institutional development as substantial, which is consistent with the PCR review. One lesson of experience for this loan is that the Bank should pay more attention to the financial performance of central banks, including "off balance sheet items", especially guarantees and derivatives. Another is that a FSAL focusing on institutional strengthening has a better chance to succeed when the economy has reached a significant level of trade and financial sector liberalization. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Cottage Enterprise Finance Loan The Cottage Enterprise Finance project, approved in FY91, had two major objectives. The first was to develop a viable guarantee system for retail lending to cottage industries. The second was to provide funds with a wide geographical distribution, and to a significant proportion of women entrepreneurs. The Development Bank of the Philippines (DBP) was chosen as the apex institution for onlending through participating financial institutions (PFIs), mainly commercial banks. The project had a poor outcome. Twenty-three Mutual Guarantee Associations (MGAs) were ready to operate during project implementation, but then only a few banks were ready to lend to MGA members on the basis of the guarantee of the association. The major reason mentioned in the PCR was that commercial banks are not interested in small and micro lending because of high asymmetry of information between the lender and the borrower leading to high processing costs. The audit mission collected additional findings in the field and concluded that the major cause of failure was a faulty project design. As in the PCR review, the project outcome is rated as unsatisfactory, sustainability as unlikely, and institutional development impact as negligible. The lesson from this project is that an untested approach for lending to cottage industries should not be adopted on a large scale basis without first trying a pilot operation. Attachment Contents FOR OFFICIAL USE ONLY Preface........................................................... 3 Basic Data Sheets ...................................................... 5 Evaluation Summary ......................9........ .................9 1. Financial Sector Adjustment Loan (Loan 3049-PH) .........7.........17 Background............... .................... .............. 17 Problems Facing the Financial Sector....................7.......17 Objectives and Relevance of the FSAL ......................... ..... 18 Implementation...............................................18 Strengthening Supervision.......................................18 Protection of Depositors........................................18 Intermediation Cost......................... ..................19 Long Term Credit............................................19 Directed Credit..............................................19 Restructuring of DBP.......................................... 20 Outcome.................................................... 20 Money Market............................................... 20 Financial Deepening.......................................... 21 Cost of Intermediation......................................... 21 Central Bank Restructuring .................20...... ..............22 Assessment................ ................................. 23 Impact ...................................................... 23 Sustainability ....................................... .......... 24 Bank Performance .. ........................................... 25 Borrower Performance .............................. ............ 26 Taxation .........................23........ ................26 Central Bank Restructuring ................................ ...... 26 Project Rating and Covenants............................... ...... 26 Findings and Lessons of Experience ....................... ......... 26 Summary of the Findings .................................. ..... 26 Lessons of Experience ................................. ........ 27 This report was prepared by Nicolas Mathieu, Task Manager, who audited the projects in November 1995. Jasmine Mason-Anderson provided administrative support. The report was issued by the Country Policy, Industry and Finance Division (Manuel Pefialver, Chief) of the Operations Evaluation Department (Francisco Aguirre-Sacasa, Director). This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed wihout World Bank authorization. 2 Contents (Cont'd) 2. Cottage Enterprise Finance Project (Loan 3312-PH) ...................... 29 Background .............................................. .... 29 Objectives.................. ....................... ......... 29 Relevance .................................................... 29 Design ...................................................... 30 Implementation ......................................... ...... 30 Mutual Guarantee Associations (MGAs) . .................. ........... 30 Participating Financial Institutions (PFIs)....................... 31 Implementation of the MGA Concept ................................. 32 Role of Consultants........................................... 32 Outcome .................. . ........................ ........ 34 Why Commercial Banks were not Interested ..................... 34 "Competing" Schemes not Really Competing ..................... 35 Bank Performance ................................................ 36 Design .................... . ........................ ..... 36 Approval Process ..................... ................. 37 Borrower Performance .......................................... 37 Project Rating and Covenants ..................................... 37 Findings and Lessons of Experience ................................ 38 Findings...................... ....................... ..... 38 Lessons of Experience ............................................ 39 Future Action on this Project ..................................... 39 Future Challenges in Lending to Cottage Industries... ................. 40 Boxes 1. Public Resource Mobilization ...................................... 19 2. The MGA of Maycauayan in Bulacan Province ............................. 31 3. Unpaid Consulting Fees....................................... 33 4. Alternative Schemes of Lending to Small Cottage Enterprises...... .......... 35 Annexes 1. Economic Reforms Supported by Bank Loans........................... 43 2. Performance Indicators of the Financial Sector.......................... 45 3. Comparison Between Expected and Actual Performance of the Central Bank........... 47 4. Financial Sector Statistics ........................................... 53 3 Preface 1. This is the Performance Audit Report (PAR) of the Financial Sector Adjustment Loan (FSAL, Loan 3049-PH) and the Cottage Enterprise Finance (Loan 3312-PH) Projects. The Financial Sector Adjustment Loan in the amount of US$300.00 million equivalent was approved on May 4, 1989, and closed on December 20, 1993. There was no cancellation. The last disbursement was made on January 10, 1994. The Cottage Enterprise Finance Project in the amount of US$15.00 million was approved on March 26, 1991, and is scheduled to close on June 30, 1996. There was a disbursement of only US$1.5 million. The undisbursed balance from the loan amounting to US13.5 million was canceled on August 11, 1993 at the Government's request. The last disbursement was made on August 10, 1992. 2. The Kreditanstalt fuer Wiederaufbau (KfW) cofinanced the Cottage Enterprise Finance Loan. KfW committed DM 20 million (US$13.4 million), of which DM 17.5 million was on terms similar to IDA and DM 2.5 million was a grant to fund the technical assistance. There was a disbursement of DM 2.75 million. In line with the Bank loan, the cofinancier also canceled its loan in August 1993. 3. The PAR was prepared by the Operations Evaluation Department (OED) and the Project Completion Reports (PCRs) were prepared by the East Asia and Pacific Regional Office with Part II of the Reports contributed the Borrower. The PAR is based on the PCRs, the Staff Appraisal and President's Reports, the loan documents, staff files, and discussions with Bank staff. An OED mission visited the Philippines in November 1995. 4. Acknowledgments are addressed to The National Economic Development Authority (NEDA) who hosted the mission, facilitated the dialogue with government officials, the banking and the business community. NEDA also helped collecting additional valuable facts, identified major evaluation issues and discussed them with the mission. The mission is grateful to the Statistical Department of the Central Bank of the Philippines who provided a large number of up to date time series on the financial sector. The mission also wishes to thank government officials, members of the business and financial community, members of Mutual Guarantee Associations, consulting companies and individual consultants who participated in the project for their full cooperation and support to the evaluation process. 5. The PCRs of both projects are of good quality. The audit intends to bring value added in specific areas where findings in the field complements the findings of the PCRs. For the FSAL this includes government taxation measures, causes and magnitudes of past central bank deficits, and a systematic measurement of outcomes of the adjustment program. For the second loan, more insight on project implementation is given, particularly the role of consultants in setting up the mutual guarantee associations and the reasons for lack interest from commercial banks to onlend funds from the project. On the basis of these additional facts, the audit derives new lessons of experience and implications for future lending. 6. A draft report was sent to the Borrower and cofinanciers for comments. The comments from the Development Bank of the Philippines (DBP), Kreditanstalt flir Wiederaufbau (KfW) and the Central Bank of the Philippines (BSP) are incorporated in the report.  5 Basic Data Sheet FINANCIAL SECTOR ADJuSTMENT LOAN (LOAN 3049-PH) Key Project Data (amounts in US$ million) Appraisal Actual or Actual as % of estimate current estimate appraisal estimate Total project costs 304.7 304.7 100.0 Loan amount 300.0 300.0 100.0 Cofinancing Cancellation Date physical components - completed Economic rate of return Institutional performance Cumulative Estimated and Actual Disbursements (US$ million) FY90 FY91 FY92 FY93 FY94 Estimated Cumulative 150.0 300.0 - - Actual 150.0 150.0 150.0 150.0 300.0 Actual as of % of Estimate 100.0 50.0 50.0 50.0 100.0 Date of Final Disbursement: January 10, 1994 Project Dates Date Planned Actual Date Initiating Memorandum 11/88 11/88 Appraisal 11/88 12/88 Loan Negotiation 03/89 03/89 Letter of Development Policy 02/89 04/89 Board Approval 04/89 05/89 Loan Signature - 05/89 Loan Effectiveness 06/89 07/89 Second Tranche Release 08/90 12/93 Loan Closing 12/91 12/93 Account Closed 12/91 12/93 a In addition, the Bank disbursed technical assistance grant funds (TF) amounting to Yen 607.5 billion (US$4.7 million). 6 Staff Input (staff weeks) Pre FY89 FY90 FY91 FY92 FY93 FY94 TOTAL FY88 Lending Dev. 0.7 2.8 -- - 3.5 Preappraisal 12.3 44.8 -- - 57.1 Appraisal - 22.6 - - - - - 22.6 Negotiations - 11.9 - - - - - 11.9 Supervision - 0.4 9.9 8.4 7.3 7.7 6.6 40.3 TF Supervision - - - 3.6 7.0 1.0 - 11.6 PCR - - - - - - 5.4 5.4 TOTAL 13.0 82.5 9.9 12.0 14.3 8.7 12.0 152.4 Mission Data Date Number of No. of Report Persons Weeks Date Preparation 06/88 4' 4.0 06/88 Preappraisal 09/88 2 4.0 11/88 Appraisal 12/88 5 2.8 12/88 Supervision 1 05/89 1 1.4 06/89 Supervision II 03/90 3 3.4 03/90 Supervision III 03/91 2 1.6 03/91 Supervision IV 11/91 1 2.2 12/91 Supervision V 07/92 1 2.0d 07/92 Supervision VI 12/92 3c/e 1.4 12/92 Supervision VII 04/93 5c 1.8 05/93 Supervision VIII 08/93 4c/e 1.4 08/93 Supervision IX 11/93 1 0.8 11/93 1The loan was more intensively supervised than reflected through this table especially during 1992 and 1993, when the Task Manager made brief stops in the country and when he was in the East Asia Region. In addition, the supervision involved constant dialogue among all the parties in the Philippines and the Bank (Headquarters and Resident Office in Manila), and often involved the IMF staff and representatives of Cofinanciers as well. b Includes the time required for the discussion of the Financial Sector Study Report, which provided a basis for proposing the FSAL. C Includes the IMF Staff (Legal or Financial Expert). d Includes the time required for starting preparation of the proposed Capital Market Development Loan. ' In addition, representatives of the Cofinanciers-JEXIM and OECF-also participated in the mission. 7 Basic Data Sheet COTTAGE ENTERPRISE FINANCE PROJECT (LOAN 3312-PH) Key Project Data (amounts in US$ million) Appraisal Actual or Actual as % of estimate current estimate appraisal estimate Total project costs 28.4 1.5 5.2 Loan amount 15.0 1.5 10.0 Cofinancing 13.4 - - Cancellation 26.9 - - Date physical components completed 06/96 08/93 Economic rate of return - - Institutional performance Cumulative Estimated and Actual Disbursements (US$ million) FY91 FY92 FY93 FY94 FY95 FY96 Estimated Cumulative 1.5 2.7 6.3 10.5 13.4 15.0 Actual - 1.5 1.5 1.5 1.5 1.5 Actual as of % of Estimate - 55.5 23.8 14.3 11.2 10.0 Date of Final Disbursement: August 10, 1992 Project Dates Date Planned Actual Date First Presented to the Bank 05/89 Preparation 03/90 Appraisal - 07/90 Loan Negotiations 10/90 12/90 Board Approval 12/90 03/91 Loan Signature - 04/91 Loan Effectiveness 01/91 08/91 Loan Closing 06/96 - 8 Staff Input (staff weeks) FY86 FY87 FY88 FY89 FY90 FY91 FY92 FY93 FY94 TOTAL Pre-Appraisal - - - - 24.5 - - - - 24.5 Appraisal - - - - - 26.7 - - - 26.7 Negotiations - - - 10.3 - - - 10.3 Supervision 0.3 - - - - 3.0 3.8 8.4 2.0 17.5 TOTAL 0.3 - - - 24.5 39.9 3.8 8.4 2.0 78.9 Mission Data Number of No. of Performance Month/Year Persons Weeks Rating Through Appraisal 03/87 1 0.4 06/89 3 0.2 10/89 2 0.4 03/90 2 2.4 Appraisal through Board Approval 07/90 3 2.8 - Supervision 10/91 1 0.6 2 09/92 1 1.0 2 05/93 1 1.6 2 08/93 1 0.2 Other Project Data Borrower/Executing Agency: Government of the Philippines FOLLOW-ON OPERATIONS Operation Loan no. Amount Board date (US$ million) Third Industrial Restructuring Project 3287-PH 175.00 03/91 9 Evaluation Summary FINANCIAL SECTOR ADJUSTMENT LOAN (LOAN 3049-PH) Background 1. The adjustment program supported by FSAL (approved in FY89) is part of a long history of economic and financial reforms in the Philippines. Major financial sector reforms were already undertaken in the first half of the 1980s, when interest rates on industrial loans were liberalized, deposit rates were deregulated, and banks had more opportunities to engage in long term lending. Financial sector reforms were associated with reforms in trade, industry and agriculture with imports liberalization, exchange controls removed and agriculture price distortions eliminated. 2. In 1986-87, the two largest government financial institutions, the Development Bank of Philippines (DBP) and the Philippines National Bank (PNB) were completely restructured with Bank support. In the subsequent years, the government took a number of important measures to develop the financial sector, including auctions for Treasury bills, and improved supervision of securities market institutions. Measures were also taken to restore internal and external macroeconomic equilibria with the support of short term IMF programs. The full impact of these measures appeared more towards the end of the 1980s and the early 1990s. 3. The contraction of the economy during the first half of the 1980s highlighted nevertheless the fragility of the banking system, even after the two large public banks were restructured. In 1987 the Bank undertook a financial sector study and identified four problem areas: bank supervision, protection of depositors, intermediation costs, savings mobilization and delivery of long term credit. These problem areas became the starting point of a dialogue with the Government of Philippines for the preparation a Financial Sector Adjustment Loan (FSAL) in late 1988. Objectives and Relevance of the FSAL 4. The loan was to strengthen institutions of the financial sector in the Philippines. More specifically, the loan had four main objectives. First, the supervision and regulatory framework of commercial banks had to be strengthened. Second, institutional arrangements for depositor protection were to be improved. Third, to reduce intermediation costs of the Banking system. Fourth, the delivery systems for long term credit had to be improved. 5. The loan objectives were particularly adapted to the overall initial conditions of the financial sector and the macroeconomy in 1989, where the banking sector was still fragile and the balance of payments needed support. The loan was also relevant to development strategy of the Philippines at that time. With World Bank support, it was expected that bank supervision, depositor protection and bank financial intermediation would improve in effectiveness, thereby enhancing confidence in the banking system and lowering the cost of services provided to real sectors. These factors, combined with better savings mobilization and delivery of long term funds would give a new impetus to economic growth. 10 Implementation 6. Regarding bank supervision, important amendments were incorporated in the Central Banking Act: guidelines for emergency loans to bank in distress, transparent criteria to for issuing cease and desist orders, new rules for borrowings by bank insiders, and liability insurance for central bank staff. The measures taken to strengthen supervision were effective enough to prevent bank failures. 7. As intended in the loan, the Philippines Deposit Insurance Corporation (PDIC) was able to modify its fee structure and to increase its capital by three billion pesos (US$ 115 million). Two major problems, however, remain. First, although PDIC is authorized to bring civil suits against those whose wrongful actions contributed to bank failure, the corporation does not always win its cases. Second, rapid reimbursement of depositors from their losses is often impossible because the amounts are not known. 8. To reduce intermediation costs, it was agreed at negotiations that (i) the 20% withholding tax on interbank deposits would be eliminated in the first year in which the agreed target ratio of tax revenues to GNP was reached or exceeded, and (ii) that the 5% Gross Receipt Tax (GRT) would be reduced by 1% every time the agreed ratio is reached. In fact, the overall public resource mobilization effort has been substantial during the period 1989-1992. The above taxes, however, are still being applied. 9. As agreed, the directed credit schemes have been transferred from Government Ministries to the Development Bank of Philippines (DBP). DBP is to be privatized in the next four years. DBP has reduced its staff by half since 1987. Now the company counts about 3,000 persons. Presently 60% of DBP operations are wholesale and 40% are retail. The objective for the company is to become 80% wholesale. Outcome 10. The FSAL had a successful outcome in the sense that all major objectives established at appraisal were reached, and the objective added during project implementation (restructuring the central bank) was reached as well. As a result, interest rates in the money and financial markets returned towards long term equilibrium trends. During the period 1990-92 the Treasury bills (TB) rates were twice as high as they are now. Moreover, financial deepening measured as M2/GDP has accelerated in recent years. From the early 1980s to the end of that decade the ratio increased from about 30% to 34%. In 1994, the same ratio reached 42%. Finally, the restructuring of the central bank, the increase of PDIC capital and a more efficient bank supervision have also been very significant elements of positive project outcome. 11. The margins of intermediation at the deposit banks, however, have remained in the range of 4 to 5% in the last seven years. High intermediation margins have been linked to the limited competition among financial intermediaries. Although the financial sector structure is not conducive to the establishment of a cartel, some large banks can act as leaders to establish the level of interest rates in the market and the smaller banks follow. 12. On the negative side also, the central bank deficits calculated on a cash basis, which appeared in the mid 1980s, substantially increased in the early 1990s. The major causes of the 11 deficit were off balance sheet operations, especially currency swaps operations. Other sources of deficit included interest payments on foreign exchange liabilities, central bank bills issued during the mid 1980s, and emergency advances to distressed banks. Impact 13. One major impact of the restructuring of the central bank was to provide the bank with enough liquidity to intervene on the monetary market and face eventual crises on the foreign exchange markets. Interventions of the central bank in the money market have also improved. Overall, the macro stabilization policies are now better shared between fiscal and monetary authorities according to their relative advantage. Nevertheless, the restructuring of the central bank had a negative effect on the government budget, since the losses, and the corresponding recapitalization were taken over by the government (as opposed to the banking system), and financed by Government bonds. Sustainability 14. The sustainability of the program, i.e., the prolongation over time of the benefits resulting from the program, requires continued attention to keep improving financial sector soundness. Continued macrostability is also essential to maintain the gains from the financial sector adjustment program. Past and future agreements with the IMF are key to the realization of the macro stabilization objectives. In the past the IMF had mostly short term programs with the Philippines government. Since 1994 the Philippines government is implementing an Extended Fund Facility (EFF) which includes both macro and structural measures. Bank Performance 15. The FSAL was appraised in 1989, after a decade of government attempts to liberalize the Philippines economy. The program supported by the FSAL was implemented in a framework of a freed interests rates and open capital flows. The successful performance of the Bank is not only due to what the PCR refers as skilled bank staff and careful monitoring. It is also due to a decade of efforts of Bank support to the Philippines liberalization process. All these efforts created positive externalities to support further strengthening of financial institutions. 16. On the negative side, a critical analysis of central bank performance by the Bank came very late in the picture. It was done in 1992 through a capital markets study, which found that the financial system was not viable at the observed levels of losses of the Central Bank (on a cash basis). Another negative point is the lack of monitoring of the project beyond checking whether the institutional strengthening measures in the program were well implemented. There was virtually no quantitative outcome analysis, or use of performance indicators in the PCR. Borrower Performance 17. One important measure, the progressive removal of GRT and the withholding tax on interbank deposits, was not implemented. Future changes regarding these categories of taxes could be part of larger package of tax reforms in the banking and business sectors, where some tax items could be reduced and others increased in order keep improving the overall tax revenue performance. 12 18. It may have been easier, and less costly for the Treasury to deal with central bank deficits towards the end of the 1980s. These costs should have been identified and carefully analyzed beforehand. More generally, timely warnings of the consequences of central bank deficits, and early action to stop the losses would have been preferable to the "last minute" approach. Project Rating and covenants 19. Mainly due to the above comments on achievement of objectives, the audit mission rates the outcome of the FSAL "satisfactory", instead of "highly satisfactory" as rated in the PCR review. In addition, the sustainability of the project is rated as likely and its institutional development as substantial. Program covenants were complied with, except for the reduction of the GRT and the withholding tax on interbank deposits. Findings and Lessons of Experience 20. The audit mission found the following: (i) the Gross Receipt Tax (GRT) and withholding tax on inter bank deposits were not progressively eliminated in spite of an increase in overall fiscal effort; (ii) although interest rates declined from the very high levels of the early 1990s, intermediation margins remained constant at about 5%; and (iii) the total cost to the financial system of central bank losses, mostly due to off balance sheet operations in the 1980s, amounts to 180 billion pesos (US$8.7 billion). Lessons of Experience 21. In addition to the lessons mentioned in the PCR, the audit suggests the following: (a) Good technical work (ESW) can be of long term use. The financial sector and the capital market studies included proposed regulations to strengthen various aspects of the financial sector. Many of the recommendations have been implemented. The remaining ones are still relevant today. (b) In preparing financial sector studies, the Bank should pay more attention to the financial performance of the central bank and, to the extent possible, review "off balance sheet items", especially guarantees and derivatives operations. (c) A FSAL focusing on institutional strengthening has a better chance to succeed when the economy has reached a significant level of trade and financial sector liberalization. (d) In order to ensure sustainability of the FSAL operation, it is necessary to keep a low inflationary environment and therefore to pursue macro stabilization policies. At the micro level, further reductions of the GRT (now VAT) and withholding tax on deposits will contribute to lower intermediation margins and help maintain a lower cost of bank credit. 13 COTTAGE ENTERPRISE FINANCE PROJECT (LOAN 3312-PH) Background 22. In 1990, interviews with cottage firms and banks as part of project preparation indicated that cottage firms had almost no access to credit through banking channels. The banks indicated that the small loan size combined with a high risk and the lack of collateral deterred them from lending to cottage firms. The main issue was that cottage firms lack real estate titles other than their homes which are already mortgaged. 23. In the Philippines, two thirds of the cottage enterprises value added comes from outside Metro Manila. Given the very large regional disparities in the country, the development of cottage industries is an important vehicle for poverty alleviation. Another characteristic is the high percentage of women in the labor force, and women have a more difficult time than men getting credit because of the superiority (albeit subtle) of husbands' rights on family property. Objectives 24. The Cottage Enterprise Finance project, approved in FY91, had two major objectives. The first objective was to develop a viable guarantee system for retail lending to cottage industries. The second was to provide funds with a wide geographical distribution, and to a significant proportion of women entrepreneurs. Relevance 25. The project was relevant to the Philippines development and poverty alleviation strategies supported by the Bank. It was to strengthen the capacity and interest of the financial system to provide loans to a large number of cottage enterprises, especially in the countryside where existing industrial programs are unable to expand. The project was also designed to provide a collateral substitute to collateral weak firms, and thereby help to alleviate this important constrain on women entrepreneurs' access to credit. 26. The Mutual Guarantee Association (MGA) proposed in the project was not a traditional Philippines institution. The MGA concept, however, appears relevant to the social environment in the Philippines. In the MGAs, potential borrowers gather to establish local self managed associations that issue guarantees to banks on their behalf. It is appropriate to try to group potential borrowers in a country where community activities are highly valued. The idea to target micro enterprises is also relevant to the Philippines where the informal sector is so important. But in practice, the project did not strictly target cottage enterprises. Design 27. The design of the project was overly complex and demanding. The administrative process designed to create the MGAs was too cumbersome. The National Economic Development Agency (NEDA) noted these aspects early in the appraisal process and was not favorable to the project. The Bank expressed the view, however, that the project was worth 14 being pursued because it was addressing relevant poverty alleviation and financial institution building objectives. Implementation 28. Thirty nine MGAs were legally established in three years from project preparation to project closure, against a four year target of 60 MGAs. Out the 39 created, 23 MGAs were ready to operate, having received matching loan funds. From the 23 above, only 17 did effectively operate with members using mutual guarantees in order to borrow funds from financial institutions at project closure. At present, 21 MGAs are still registered, and 12 of them are active. During implementation, the targeted size for each MGA was reduced from 60 to 40 members. Indeed, the actual number of members per MGA was about 35 on average. 29. The participating financial institutions had first to be accredited by the Development Bank of Philippines (DBP) in order to onlend funds from the Bank credit line. When MGAs finally reached the level of formal registration and were ready to operate, they found only a few financial institutions ready to lend to them. The average amount of individual loans provided was between 70,000 and 75,000 pesos (US$ 2,700-2,900), with a maturity of one year. 30. In spite of the limited positive experience from surviving MGAs, accredited financial institutions, especially commercial banks were reluctant to lend. The PCR suggests that commercial banks in general are not interested to lend to small scale enterprises and that they had to compete in that segment of the market with a number of subsidized schemes. This report provides some more insight on two aspects of this type of lending: (i) the particular way the MGA system was implemented, and (ii) the degree of competition of the other program especially directed to cottage industries. 31. One component was not carefully handled during project implementation: the training of MGA administrators in management. It arrived too late or never. During the first phase of implementation, the consulting firm, while spending substantially on foreign expert services, showed pride in reports to the cofinancier to "save on training". The lack of training explains in part the low rate of survival of MGAs. Outcome 32. The project had a poor outcome. Twenty-three MGAs were ready to operate during project implementation, but then only a few banks were ready to lend to MGA members on the basis of the guarantee of the association. The major reason mentioned in the PCR was that commercial banks are not interested in small and micro lending because of high asymmetry of information between the lender and the borrower leading to high processing costs. The audit mission found, however, other factors affecting this project outcome. First, the scheme was not implemented as originally intended. For a credit of 90,000 pesos (US$ 3,500) at the beginning of the scheme, the guarantee was only covering 10,000 pesos because there were no "matching funds". Obviously this kind of reduction in coverage was less likely to be acceptable to commercial lenders. 33. Second, the scheme has an "image problem". The potential borrowers had the idea that the loan included some form of subsidization, as part of a new credit facility initiated by the 15 government and supported by international organizations. Third, there was a geographical mismatch between the location of accredited bank subsidiaries and the location of formed MGAs. A number of MGAs were in remote areas, relatively far from the branches of the accredited banks. Fourth, the bank margin for this type of loan was lower than margins obtained from loans to larger enterprises. 34. The PCR argued that one of the difficulties met in implementing the credit line was the existence of competing subsidized schemes. The audit mission looked into these schemes, and found out they are very specific and limited in terms of lending outreach, and that they competed with the Bank loan only marginally. These alternative schemes are described in Box 4. Bank Performance 35. The Bank overestimated the size of the project. The loan amount was first estimated at US$50 million. It was then progressively reduced to US$25 and 15 million. In the end only US$1.5 million was disbursed. In retrospect, the Bank should have started with a pilot project of US$1 million to test the design. Second, when the project was appraised, the Bank did not focus on the costs of setting up MGAs. During implementation, it was found that this cost was excessively high compared with the resulting benefit of increased borrowing capacity. Finally, the matching funds to facilitate the initial growth of MGAs were in the forms of loans at zero interest rate. The donor community now tends to agree that no zero or subsidized interest rates loans should be granted to finance micro enterprise activities, because experience shows it does not lead to sustainable lending schemes. Borrower Performance 36. The Borrowers' commitment to the project was in fact quite limited. First a key government agency was not favorable to the project since the beginning. Second the implementing agencies, mainly DBP and Department of Trade and Industry (DTI) did not have the full institutional capacity to implement such complex and demanding operation. Finally, the implementation agencies had difficulties to convince potential borrowers of the benefits of MGAs. One consequence of the limited local institutional capacity to implement the project was the delay in training the new MGA administrators Project Rating and Covenants 37. In agreement with the previous PCR review, the Audit mission rates the outcome of the cottage industry project as unsatisfactory. The sustainability of the project is rated as unlikely and its institutional development impact as negligible. Project covenants were complied with. Findings and Lessons of Experience 38. The audit mission collected additional findings in the field: (a) Out of the 39 MGAs established by the end of 1993 when the project was closed, 21 MGAs still existed legally in 1995, and, among them, only 12 were active. 16 (b) NEDA was opposed to the project since the beginning, but the Bank insisted on the ground that project objectives were to alleviate poverty. (c) Local consultants claim that some of the services rendered remained unpaid and DBP claims that correspondence with a German consulting firm remained unanswered. (d) The project did not exclusively target cottage enterprises: to be eligible for the Bank loan, enterprises were allowed to own assets up to a maximum of 3 million pesos (US$ 120 thousand), instead a maximum of 0.5 million pesos (US$ 20 thousand), the asset based criteria used by the banking sector to identify cottage industries. (e) The MGA design was too complicated and MGAs had difficulties to raise matching funds. (f) Onlending arrangements to cottage industries were not implemented because (i) the number of guarantee funds set up was well below expectations (ii) the commercial banks' mode of participation was not clearly spelled out, and when MGA members were finally able to propose guarantees, banks did not find them attractive. (g) There was a mismatch between local availability of MGAs (in remote areas) and local availability of intermediaries willing to lend. Lessons of Experience 39. The lessons from this project experience are summarized as follows: (a) An untested approach for lending to cottage industries should not be adopted on a large scale basis without first trying a pilot operation. Project design should remain simple, while aiming to reduce the asymmetry of information between lenders and borrowers. (b) To ensure sustainability of the project, it is necessary to create procedures for easy access to credit, within a context of poor information and lack of banking technology. This may require temporary subsidies. (c) The Bank must ensure that its promotion efforts had lead to a complete understanding of the commercial aspect of loans to cottage industries. Future Action for this Project 40. Regarding the case of unpaid consulting fees, the Bank should keep encouraging the two parties to settle their differences in an amicable way. 17 1. Financial Sector Adjustment Loan (Loan 3049-PH) Background 1.1 The adjustment program supported by FSAL is part of a long history of economic and financial reforms in the Philippines. Major financial sector reforms were already undertaken in the first half of the 1980s, where interest rates on industrial loans were liberalized, interest rates on deposits deregulated, and banks had more opportunities to engage in long term lending. Financial sector reforms were associated with reforms in trade, industry and agriculture with imports liberalization, exchange controls removed and agriculture price distortions eliminated. 1.2 In 1986-87, the two largest government financial institutions, the Development Bank of Philippines (DBP) and the Philippines National Bank (PNB) were completely restructured with Bank support. The restructuring programs were broadly implemented as planned. At present, PNB and DBP are profitable and do not rely upon government subsidies. 1.3 In the subsequent years, the government took a number of important measures to develop the financial sector: auctions for Treasury Bills, and improved supervision of securities market institutions for example. Several of them were recommended by the Bank through studies and country dialogue (Annex 1). Measures were also taken to restore internal and external macroeconomic equilibria with the support of short term IMF programs. 1.4 The full impact of a decade of measures on macro aggregates appeared towards the end of the 1980s and the early 1990s (Annex 2). GDP growth rate recovered from 1985 to 1989, then declined, and increased again in recent years. The budget deficit declined significantly in recent years and the balance of payments deficit is a much lower share of GDP in the 1990s than in the previous decade. 1.5 It is therefore in a relatively more favorable macro framework that the financial sector loan was undertaken in 1989. This also applies to the cottage enterprise finance project which was approved in 1991. Problems Facing the Banking Sector 1.6 The contraction of the economy during the first half of the 1980s highlighted the fragility of the banking system, even after the two large public banks were restructured. Since 1980, three commercial banks had to be closed, and tens of small thrift and rural banks failed. Institutional arrangements for safeguarding the interest of the insured depositors were inadequate. In addition, the expected increase in demand for investment prompted concern about the lack of institutional framework for the mobilization and provision of long term funds on a market basis. 1.7 In 1987 the Bank undertook a financial sector study and identified four problem areas: bank supervision, protection of depositors, intermediation costs, savings mobilization and delivery of long term credit. These problem areas became the starting point of a dialogue with the Government of Philippines for the preparation a Financial Sector Adjustment Loan (FSAL) in late 1988. 18 Objectives and Relevance of the FSAL 1.8 The loan was to strengthen institutions of the financial sector in the Philippines. More specifically, the loan had four main objectives. First, the supervision and regulatory framework of commercial banks had to be strengthened. Second, institutional arrangements for depositor protection were to be improved. Third, intermediation costs of the Banking system were to be reduced. Fourth, the delivery systems for long term credit had to be improved. 1.9 The loan objectives were particularly adapted to the overall initial conditions of the financial sector and the macroeconomy in 1989, where the banking sector was still fragile and the balance of payments needed support (see Annex 2). The loan was also relevant to the development strategy of the Philippines at that time, which focused on reestablishing balance of payments equilibrium and pursuing policy and institutional reforms in the financial sector. With World Bank support, it was expected that bank supervision, depositor protection and bank financial intermediation would improve in effectiveness, thereby enhancing confidence in the banking system and lowering the cost of services provided to real sectors. These factors, combined with better savings mobilization and delivery of long term funds would give a new impetus to economic growth. Implementation Strengthening Supervision 1.10 Important amendments were incorporated in the Central Banking Act: guidelines for emergency loans to bank in distress, transparent criteria for issuing cease and desist orders, new rules for borrowings by bank insiders, and liability insurance for central bank staff. The measures taken to strengthen supervision were effective enough to prevent bank failures. The central bank emergency loan line has been used only once as a "bridge loan" to finance treasury bills purchases made by a bank in the secondary market. Otherwise the central bank did not have to rely upon extraordinary measures to help maintain the viability of the banking system. Protection of Depositors 1.11 As intended in the loan, the Philippines Deposit Insurance Corporation (PDIC) was able to modify its fee structure and to increase its capital by an amount of three billion pesos (US$ 115 million). Moreover, some borrowings have been converted into equity. This improved considerably the financial position of the corporation. Moreover, the income statement is now in equilibrium. 1.12 Two major problems, however, remain. First, although PDIC is authorized to bring civil suits against those whose wrongful actions contributed to bank failure, the corporation does not always win its case. Bank assets to be seized in case of bank failure are difficult to know because some credits are implicitly rolled over (not immediately recorded in the books) and the extent of the "roll over" not fully known. Second, rapid reimbursement of depositors from their losses is often impossible because the amount of deposits are not fully known. Accounting standards are not rigorously applied, or at times even known by financial institutions. 19 Intermediation Cost 1.13 It was agreed at negotiations that the 20% withholding tax on interbank deposits would be eliminated in the first year in which the agreed target ratio of tax revenues to GNP was reached or exceeded. It was also agreed that the Gross Receipts Tax (GRT), which is levied on both interest and capital gains, would be reduced by 1% every time the target ratio was reached. These agreements were not complied with. 1.14 The overall public resource mobilization effort has been substantial during the period 1989-1992 (see Box 1). Progressive reduction of the withholding tax and the GRT tax should have taken place as early as 1990. The taxes, however, are still being applied. Therefore the fiscal pressure on intermediation margins has not been reduced. Moreover, the conversion of the GRT tax into a VAT tax during 1996 is designed to keep the overall tax revenue almost unchanged. Box 1: Public Resource Mobilization The original targets agreed upon during FSAL negctiations and the actual shares of tax revenue over GNP are as follows: 1989 1990 1991 1992 Target 12.4% 13.5% 13.8% 14.2% Actual 13.4% 14.0% 14.4% 15.1% Resource mobilization efforts consisted in improved tax administration: the tax base was widened; inspection of imports became tighter. Also an oil tax was introduced. Import tariffs were reduced but their negative impact on revenues was compensated a large increase of imports over GDP. This tax effort was pursued in 1993 and 1994 with realized ratios of 15.2% and 15.5% respectively. Long Term Credit 1.15 The program of promotion of long term credit had two main components: the transfer of the directed credits schemes from government ministries to the Development Bank of the Philippines (DBP) and the restructuring of DBP. Directed Credit 1.16 As agreed, the directed credit schemes have been transferred from the Central Bank to the Development Bank of Philippines (DBP). DBP operates at a wholesale level by onlending through a variety of financial institutions, which then onlend to final borrowers. The sources of funding are the Industrial Guarantee and Loan fund (IGLF), a fund owned by the Government, the World Bank Industrial Restructuring Project loan (IRP), ADB loans, OECF and Japan 20 Eximbank credits. These loans are now provided with interest rates at market prices. Occasionally, interest rates for IGLF funded projects are set below market levels to test loan demand in remote regional areas. Restructuring ofDBP 1.17 A strategy has been adopted to privatize DBP within the next four years. The privatization process consists of creating first a holding company which will own a number of subsidiaries. The subsidiaries will take over all the business lines of DBP (retail lending, portfolio investment, and other customer services), while the wholesale activity will be directly managed by the holding. Initially, the holding will be 100% owned by DBP. In a second phase, the subsidiaries will be sold to the private sector. 1.18 DBP has reduced its staff by half since 1987. Employment is now about 3,000. The future privatization does not require additional personnel reductions, but a great deal of personnel reallocation and intensive retraining of staff. Productivity gains will also be achieved through further computerization of administrative tasks and services to clients. The current financial position of DBP is sound and its lending activity is sustained by a strong demand for long term funds in all sectors of manufacturing. 1.19 At present, 60 percent of DBP operations are wholesale and 40% are retail. The objective for the company is to become 80 percent wholesale. One long term view expressed by government authorities to the evaluation mission is for DBP to concentrate on two tasks only: (i) to channel funds from international agencies to commercial banks as a wholesale lender; and (ii) to finance directly large projects in the energy and utility sectors. DBP should progressively phase out its retail lending activities. Outcome Money Market 1.20 The FSAL had a successful outcome in the sense that all major objectives established at appraisal were reached, and the objective of restructuring the central bank, added during project implementation, was reached as well. As a result interest rates in the money and financial markets returned towards long term equilibrium trends. Two good indicators of the level of interest rates are the Treasury Bill (TB) rate and the money market rate (MRR). The rate on time deposits is tied to the rate of treasury bills. Now it is close to 9%. 1.21 The annual average rates for 91-day TB in the last seven years are as follows: 19m 191 19 199 199. 1991 1992 1991 1994 1995 (percent) 16.1 11.5 14.7 18.6 23.7 21.5 16.1 12.3 13.6 10.0 91 days TBs are now around 10%. During the period 1990-92 the rates were twice as high. The reduction in the budget deficit was a factor of decrease in TB rates. Although the consolidated 21 public sector accounts still record a deficit, the current budget is now in surplus. The restructuring of the central bank and the increased supervision supported by the Bank program, as the PCR points out, have also been significant factors. 1.22 While they helped reduce the level of interest rates, these policies do not account for the entire magnitude of the reduction. The high rates also resulted from exogenous factors which do not exist any longer. The attempted "Coup d'Etat" of 1989 was followed by a period of political instability, which generated more uncertainty in the money and financial markets. The political stability was restored with the advent of the Ramos Government (1992). Also the early 1990s were marked by natural disasters: an earthquake in 1990 and a volcano eruption in 1991. It is then more relevant to compare current levels of interest rates, which are still double digit, to the levels of the second half of the 1980s. The average 91 days TB rate was 18% between 1986 and 1991. Financial Deepening 1.23 Financial deepening measured as M2/GDP has accelerated in recent years. From the early 1980s to the end of that decade the ratio increased from about 30% to 34%. In 1994, the same ratio reached 42%. In general, time deposits have not grown much, but savings deposits have. The latter can be considered as quasi liquidities, because essentially holders of these deposits use them for transaction purposes. Cost of Intermediation 1.24 The margin of intermediation of the commercial banks has remained in the range of 4 to 5% in the last seven years (see Annex 2). The result is somewhat surprising since the ratio of commercial banks' administrative cost over assets has been declining over time, indicating some increase in administrative efficiency. These gains have not yet induced a substantial decrease in costs because the pressure from competition to do so is not strong enough. Moreover, the cost includes about I to 2 percentage points of taxes, which have not changed. The fiscal share will be only marginally reduced when the GRT tax is converted into a value added tax in 1996. 1.25 High intermediation margins are related to the limited competition among financial intermediaries. Presently about one tenth of the commercial banks hold close to 40 percent of the assets of the commercial banking system. The main commercial banks in the Philippines are: Metro Bank, Philippines National Bank (PNB), PCI (Philippines Commercial International Bank (PCI), Bank of Philippines Islands (BPI), and Far East Bank. This tendency of relatively high concentration has increased in recent years (the ratio was about 35 percent in 1990). 1.26 Although the present financial sector structure is not conducive to the establishment of a cartel, some large banks can act as a leader to establish the level of interest rates in the market and the smaller banks follow. Only a few new banks have entered into the market so far. This situation is likely to change when 10 foreign banks recently authorized will be in full operation. The recent increase in the concentration ratio may just indicate that domestic banks are trying to improve their position in the local market before the arrival of foreign banks. 22 Central Bank Restructuring 1.27 Central bank deficits calculated on a cash basis appeared in the mid 80s and increased substantially in the early 90s, as shown below (see details in Annex 4): 1M 194 195 198 19.81 199Q 1991 1992 1993 1994 (billion pesos) -7.5 -25.7 -15.2 -18.2 -10.7 -16.9 -20.9 -22.0 -20.6 -21.5 -1.2 5.3 The total cumulative amount of losses from the year the losses started to occur (1983) to the year the central bank was recapitalized (1993) amounts to 180 billion pesos (US$ 8.7 billion). These losses seem to have been unknown to, or ignored by, the Bank in 1989, when the Bank began to support financial sector reforms. The losses were identified formally for the first time in the course of a Bank capital market study in 1992. The central bank financial problems became public knowledge. At that time, the Government of the Philippines agreed with the Bank to include in the second tranche of the FSAL an additional covenant that required restructuring of the central bank finances. In 1993, 220 billion pesos of securities were issued for the recapitalization of the central bank which was completely restructured and changed name from the Central Bank of the Philippines (CBP) to Bangko Sentral ng Pilipinas (BSP). 1.28 The central bank was completely restructured in 1993 and changed name from the Central Bank of the Philippines (CBP) to Bangko Sentral ng Pilipinas (BSP). The financial restructuring was implemented in two phases: (i) the transfer of certain asset/liabilities from the old central bank to BSP which gave BSP an initial capital of 10 billion pesos (effective July 3, 1993); and (ii) the issuance to BSP of 220 billion pesos worth of government securities mainly to reimburse BSP for advances made during the transition period (July 3 to December 20, 1993). These advances were to pay maturing obligations retained with the old central bank and effectively assumed by the Government. 1.29 Major causes of the deficits in the 1980s were off balance sheet operations, especially forward cover and currency swap losses. The central bank assumed the foreign exchange liabilities of public and private entities whose liabilities were under central bank guarantee, or which deposited their payments with the central bank in advance. Other sources of deficit included substantial interest payments on foreign exchange liabilities and central bank bills issued during the foreign exchange crisis of the mid 1980s. The evaluation mission was informed that the deficits of the central bank were also due to emergency advances to distressed banks such as Manila Bank and Banco Philippino. 1.30 Overall, the central bank made losses as early as 1980 and was progressively decapitalized to the point that the central bank position became unsustainable in 1993. The losses did not appear in the central bank income statements. They were accounted for in the balance sheets, in the form of capitalized or deferred charges as required under the old central bank charter. 23 Assessment 1.31 The financial restructuring of the central bank was successful but costly. Part of the high cost was due to late intervention and to the restructuring strategy of a full restructuring of the entire institution. This paragraph discusses possible alternatives to the solution supported by the Bank and assess their feasibility. (a) First, the cost of restructuring the central bank in 1993 may have been reduced by (i) having a better exchange rate policy, (ii) dealing only with the foreign assets/liabilities gap, not the entire balance sheet of the central bank, (iii) transferring more liquidity from the banking system with higher reserve requirements and low payments on the reserves, and (iv) not counting the entire amount of currencies in circulation, about 90 billion pesos as short term liabilities. In this way a lower amount of bonds could have been issued to recapitalize BSP. This alternative is not without problems. Higher reserve requirements would have been detrimental to the liberalization efforts that the FSAL was promoting. These reserve requirements were already very high (24%) and so was the central bank indebtedness from foreign exchange transactions. Moreover, financial intermediaries would not have performed well under high reserve requirements.I (b) Second, it may have been feasible for the government to handle the central bank crisis much earlier, in 1989, when the loan was appraised. This could have reduced the magnitude of the problem, and the restructuring costs would have been significantly lowered. The problem, however, was that in 1989 the external debt reduction, not the central bank assets and liabilities structure, was the primary concern of the Philippines Government. At that time, the task of handling both issues simultaneously was hardly feasible, and debt reduction had to come first. Impact 1.32 One major impact of the central bank restructruring was to halt the current and potential deficits of the bank (see details Annex 3). The restructuring also provided the central bank with enough liquidity to intervene on the monetary market and face the risk of eventual crises on the foreign exchange markets. The capacity to intervene in the foreign exchange markets has now increased to the point that the central bank can intervene to reduce market pressures towards appreciation, in order to accommodate exporters, as was recently the case. While exporters are better off, the use of the new facility, however, can increase the burden of foreign liabilities carried by the central bank. On this first point, the Central Bank (BSP) notes that the magnitude of the securities issued was determined by the configuration of the assets/liabilities transferred to BSP, which were in turn mainly determined by the requirements of the new BSP charter. A lower amount of government securities could have been issued to BSP by varying the configuration of the other assets/liabilities not specifically earmarked by the BSP charter, but this would have meant that asset/liabilities of lower quality would have been transferred to BSP, thus making the BSP balance sheet less strong than it is today. 24 1.33 Interventions of the central bank in the money market have also improved. This regulatory function was performed before by the Department of Finance (DOF), but DOF did not have enough liquidity base and took too long to react. Now that the central bank has taken the relay with open market operations, interventions on the money market are better timed and more effective. In addition, before the restructuring, the Treasury had to issue bills at high interest rate levels to cover the central bank deficit. Then, the disappearance of the deficit reduced considerably the pressure towards higher levels of Treasury bills. 1.34 Overall, the macro stabilization policies are now better shared between fiscal and monetary authorities according to their relative advantage. Before all the burden of macro adjustment was on the fiscal side. But the budget was often in deficit, and the central bank was pressed to create more liquidity. Now, with a clearer separation between monetary and fiscal instruments and a better performance of the monetary policies, stabilization is easier to achieve and the economy can operate on the base of real positive interest rates. Presently the economy is not really overheated: GDI/GDP is increasing relatively fast, but GDS performance is improving as well. 1.35 Nevertheless, the restructuring of the central bank had a substantially negative effect on the government budget, since the losses, and the corresponding recapitalization was taken over by the government (as opposed to the banking system), and financed by Government bonds.2 The Philippines domestic debt is now as high as 64% of GDP. Sustainability 1.36 The sustainability of the Bank program, i.e. the prolongation over time of the benefits resulting from the program, requires continued attention to keep improving financial sector soundness. Reserve requirements should be further reduced, and a decrease of taxes on interbank deposits should lead to lower intermediation costs. In addition the Government should pursue stabilization policies which lead to positive real interest rates and reduce expectations that are detrimental to the sustainability of the financial intermediation strengthening program. 1.37 Continued macrostability is essential to maintain the gains from the financial sector adjustment program. Past and future agreements with IMF are key to the realization of the macro stabilization objectives. In the past IMF had mostly short term oriented programs with the Philippines government. More recently IMF changed to a longer term type of support. Since 1994 the Philippines Government is implementing an Extended Fund Facility (EFF) which includes both macro and structural measures. 1.38 The EFF program started on a sound base, as one precondition to grant it was the completion of the restructuring of the central bank, and this was done in 1993. The macro economic component of the program includes monitoring the growth of the monetary base and the main monetary aggregates, while taking into account the structural changes in the trends of these aggregates due to the liberalization of the financial sector. It also includes a monitoring of the government fiscal position, international reserves, and external debt. The structural 2 The Central Bank (BSP) notes, however, that a significant portion of the deficits was due to quasi fiscal operations undertaken by the central bank in the mid 1980s, i.e. subsidies to agriculture, oil companies and the National Food Authority. The government expected at the least no deterioration of the consolidated public sector deficit as a result of the CB restructuring operation. 25 component of the EFF program includes reforms of income and excise taxes, various tax incentives and extending the value added tax (VAT) to the financial sector. It also includes trade reforms, especially a re-evaluation of the imports tax base, and reforms in the energy sector with a review of oil subsidies and redirection of public expenditures towards financing infrastructure. 1.39 Although the tax effort, as measured by tax revenue over GNP, has grown in recent years (see Box 1), government fiscal performance could be hampered in the future by further import tariff reductions and the privatizations, with newly privatized firms being less inclined to pay taxes than were their public predecessors. Further reductions in the fiscal burden of the financial sector would not be appropriate in this new context. The audit mission concludes that removal of the GRT and the withholding tax on interbank deposits should be delayed to a post reform period leading not only higher but steadier overall fiscal performance. Another reason for not changing now the current taxation of the financial sector refers to equality and equity in the allocation of the fiscal burden across economic agents at the national level, where the financial sector should carry its share. Bank Performance 1.40 The FSAL was appraised in 1989, after a decade of government attempts to liberalize the Philippines economy. The program supported by the FSAL was implemented in a framework of freed interests rates and open capital flows. The government had strong incentives to implement a program of strengthening financial institutions in this context. The success of the Bank is not only due to what the PCR refers as skilled bank staff and careful monitoring. It is also due to a decade of efforts of Bank support to the Philippines liberalization process. 1.41 On the negative side, a critical analysis of central bank performance by the Bank came very late in the picture. It was done in 1992 through a capital markets study, which found that the financial system was not viable at the observed levels of losses of the Central Bank (on a cash basis). The previous financial sector report of 1988 did not include an analysis of the central bank financial performance in spite of doubts expressed on the quality of the bank's assets (see Report No. 7177- PH, page 20). When the project was appraised in 1989, no one knew the magnitude of the deficits of the central bank, because the accounts were more on an accrual basis than on a cash basis and a number of asset values should have been removed from the books because they did not correspond to claims any longer. The deficits on a cash basis were retroactively calculated to 1983. Substantial losses on foreign accounts (due to the depreciation of the peso) caused the deficits to balloon in the early 1990s and reach unsustainable levels. 1.42 Another negative point is the lack of monitoring of the project beyond checking whether the institutional strengthening measures in the program were well implemented. There was virtually no quantitative outcome analysis, or use of performance indicators in the PCR. The only outcome mentioned is that nominal interest rates have substantially declined since 1992. Fortunately, the facts collected by the audit mission and summarized in Annex 1 confirm the intuition of the PCR that the program had a positive outcome. 26 Borrower Performance Taxation 1.43 Changes in the withholding tax should have been part of an overall package of reform of the tax structure of the banking and business sector, in which some tax items may be reduced and others increased in order to improve overall tax revenue performance. Central Bank Restructuring 1.44 It may have been easier, and less costly for the Treasury to deal with the deficits towards the end of the 1980s. Actually, in 1989, the Government agreed with the IMF to infuse annually 5 billion pesos to the central bank, but this decision had to be approved by Parliament. There was a great deal of opposition in Parliament and the deficit grew to the point that financial restructuring became the only viable solution. 1.45 In 1989, the country was facing a severe financial crisis; they were many priorities, and they could have been handled in various orders (central bank first, then banking system, then external debt or the reverse) and each solution carried a cost. We do not know even a posteriori what would have been the lowest cost. These costs should have been carefully analyzed. Project Rating and Covenants 1.46 The PCR states that all the proposed measures in the project were implemented and even more was accomplished because the central bank was restructured in the middle of project implementation. As a result, the PCR rated the outcome as highly satisfactory. While not denying the relevance of the project, the positive outcome and the high expertise involved, the audit is pointing out that one important measure, taxation, was not implemented and that early warnings of central bank deficits, and early action to stop the losses would have been preferable to the "last minute approach". 1.47 Regarding central bank restructuring, although the message of the PCR is that the FSAL did more than it was originally committed to do, the audit suggests that original commitments may not have been fully adequate. It would have been preferable to focus on the central bank global financial position early in the process. An assessment of the central bank financial position should have been part of appraisal, or earlier ESW. Consequently the Audit mission rates the outcome of the FSAL as satisfactory instead of highly satisfactory. In addition, the project sustainability is rated as likely and its institutional development as substantial. Covenants of the FSAL program have been fulfilled, with the exception of the reduction the GRT and the withholding tax on interbank deposits. Findings and Lessons of Experience Summary of the Findings 1.48 The PCR correctly enumerates the accomplishments of the adjustment program which are the financial restructuring of the central bank, the amendments to the Central Banking act on 27 emergency measures for banks in distress, the transfer of Government sponsored programs from central bank to appropriate institutions, the improvement of supervision procedures and the strengthening of deposit insurance (PDIC). 1.49 In addition, the audit mission found the following: (a) The Gross Receipt Tax (GRT) and withholding tax on inter bank deposits was not progressively eliminated in spite of an improved overall fiscal effort. (b) Although interest rates declined, intermediation margins of commercial banks remained constant at a high level of 5%. (c) The total cost to the financial system of central bank losses amounts to 180 billion pesos: (US$8.7 billion) when estimated as the sum of the deficits on a cash basis from 1983 to 1993. Earlier diagnosis of the central bank's financial difficulties and-to the extent possible-earlier application of remedies may have avoided drastic restructuring of 1993 and reduced the cost of adjustment. Lessons ofExperience 1.50 In addition to the lessons mentioned in the PCR, the audit suggests the following: (a) Good technical work (ESW) can be of long term use. The financial sector and the capital market studies included proposed regulations to strengthen various aspects of the financial sector. Many of them have been implemented. The remaining ones are still relevant today. They deserve attention when it comes to elaborate future strategies of financial sector development in the Philippines. (b) In preparing financial sector studies, the Bank should pay more attention to the financial performance of the central bank and, to the extent possible, review "off balance sheet items", especially guarantees and derivatives operations. (c) A FSAL focusing on institutional strengthening has a better chance to succeed when the economy has reached a significant level of trade and financial sector liberalization. (d) Necessary conditions to maintain the sustainability of FSAL operations include: (i) macro stabilization (EFF); (ii) minimize the tax burden on intermediation costs. The last two lessons are new and need to be confirmed by future audits of FSAL operations.  29 2. Cottage Enterprise Finance Project (Loan 3312-PH) Background 2.1 In 1990, interviews with cottage firms and banks as part of project preparation indicated that cottage firms had almost no access to credit through banking channels. The banks indicated that the small loan size combined with a high risk and the lack of collateral deterred them from lending to cottage firms. The main issue is that cottage firms lack real estate titles other than their homes which are already mortgaged. Thus they have only chattel mortgages, which are inferior to home mortgages, especially in the case of cottage industries where the chattel may apply to small machines that can be easily moved, difficult to value and to repossess. 2.2 A significant characteristic of the cottage industry sector is its regional dispersion. In the Philippines, two thirds of the cottage enterprises value added comes from outside Metro Manila. Given the very large regional disparities in the country, the development of cottage industries is an important vehicle for poverty alleviation. Another characteristic of cottage industi ies is the high percentage of women in the labor force. A Bank Report (Philippines: Women in Development - Issues for the World Bank; August 23, 1989) indicated that women in the Philippines have a more difficult time than men getting credit because of the superiority (albeit subtle) of husbands' rights on family property. Objectives 2.3 The project aimed at developing the cottage industry sector in the Philippines. The project had two major objectives. The first objective was to develop a viable guarantee system for retail lending to cottage industries. The second objective was to provide funds with a wide geographical distribution, and to a significant proportion of women entrepreneurs. Relevance 2.4 The project was relevant to the Philippines development and poverty alleviation strategies supported by the Bank. It was to strengthen the capacity and interest of the financial system to provide loans to a large number of cottage enterprises, especially in the countryside where existing industrial programs are unable to expand. The project was also designed to provide a collateral substitute to collateral-weak firms, and thereby help to alleviate this important constrain on women entrepreneurs' access to credit. 2.5 The Mutual Guarantee Association (MGA) proposed in the project was not a traditional Philippines institution. The MGA concept, however, appears relevant to the social environment in the Philippines. In the MGAs, potential borrowers gather to establish local self managed associations that issue guarantees to banks on their behalf. It is appropriate to try to group potential borrowers in a country where community activities are highly valued. Persons to be grouped should have already something in common, professional relationships, or family relationships and they should be in the same location. In a number of cases, however, the groups 30 were artificially made, just to meet the minimum quotas. These associations are not relevant any more. 2.6 The idea to target micro enterprises is also relevant to the Philippines where the informal sector is so important. But in practice, the project did not strictly target cottage enterprises. To be eligible for the Bank loan, enterprises were allowed to own assets up to a maximum of 3 million pesos (US$ 120 thousand), instead a maximum of 0.5 million pesos (US$ 20 thousand), which is the asset based criteria used by the banking sector in the Philippines to identify cottage industries for lending purposes. Design 2.7 The design of the project was overly complex and demanding. A typical MGA should group 40 to 100 members that contribute financially to a guarantee fund owned by the MGA. The fund is placed in a bank account and pledged as collateral for future borrowing of individual members. The administrative process designed to create these MGAs was too cumbersome. For example, MGAs had to register at the Security Exchange Commission (SEC). Not surprisingly the set up of a MGA cost as much as 133,000 pesos. The National Economic Development Agency (NEDA) noted these aspects early in the appraisal process. NEDA analysis of the project was already critical at that time. The Bank expressed the view, however, that the project was worth being pursued because it was addressing relevant poverty alleviation and financial institution building objectives. 2.8 The use of the MGA scheme to lend to cottage industry was entirely a Bank idea. By the time this project was appraised, other successful lending schemes were already applied to microenterprises in the Bank, the Indonesia BRI/KUPEDES microfinance project and the Chile SMI loan for example. The main idea of the this Philippines project, however, was to find a substitute for collateral, which the other projects did not attempt to do. A major problem was the lack of past relevant MGA experience. Some MGA schemes existed in western Europe among high income professions, but none were operating yet in developing countries Implementation Mutual Guarantee Associations (MGAs) 2.9 Two MGAs were set up in the Philippines in 1990, to prepare for the project. By October 1993 when the project was closed, 39 MGAs had been legally established against a four year target of 60 by the end of 1994. Now, 21 MGAs are still legally in existence, and among them, only 12 are active, with members using mutual guarantee in order to borrow funds from financial institutions. Out of the 12 MGAs, 10 are institutionally strong and likely to remain in activity for a long period. 2.10 During implementation, the targeted size of each MGA was reduced from 60 to 40 members. Indeed, the actual size became 35 on average. The approximate total number of active participants is now about 400. Many MGAs regroup persons in the same town (see example Box 2). The few remaining MGAs with memberships spread across cities and towns are running into organizational difficulties. 31 Box 2: The MGA of Meycauayan in Bulacan Province Maycauayan is a small town near Manila. The MGA has about 30 members, who are individual entrepreneurs in leather goods, confection, and jewelry. Many of them are women. The members meet at least once every 6 months to discuss current business and borrowing strategies. They have put an initial contribution of 10,000 pesos and therefore can only borrow up to 90,000. With this limited amount they can borrow only for inventories. A small machine for their business, however, costs at least 200,000 pesos. Even to purchase supplies and raw materials, this amount is not enough. Raw materials for three gold pieces with a few small diamonds already cost 40,000 pesos. The members of the MGA would like to increase the maximum amount per loan, and would be willing to increase their individual contribution to the guarantee scheme for that purpose from 10,000 pesos to 40,000 pesos. Since the World Bank loan and KfW cofinancing are now closed, DBP cannot supply matching funds at zero interest rate, and the members are also unwilling to borrow the matching funds at market prices. Therefore the ceiling of 90,000 pesos cannot be increased. The members also discussed more convenient forms of borrowing, with terms of more than one year and principal to be repaid in one lump sum at the end of the amortization schedule, while interest rates are still paid quarterly. Participating Financial Institutions (PFIs) 2.11 The financial institutions had to be accredited by the Development Bank of Philippines (DBP) in order to onlend funds from the Bank credit line. The banks were contacted in due time at appraisal. Many accepted to participate on the basis that: (i) the proposed intermediation margin was attractive to them; (ii) they would receive deposits from the borrowers, including the 1,500 pesos annual fees; and (iii) they would reach out to enterprises with growth potential and lend higher amounts as these enterprise grow. 2.12 When finally MGAs reached the level of formal registration and were ready to operate, they found only a few financial institutions ready to lend to them. These institutions were private commercial banks endowed with a large branch network (such as UCBP), private rural banks (such as Meycauayan rural bank), and a number of savings and loan associations. Lending grew within this narrow range of activity. In October 1995, the total amount of loans approved to MGA members amounted to 129.8 million pesos (US$ 5.1 million) compared with 72.8 million in 1993. During that time the number of MGAs remained constant. The net outstanding balance of loans was 18.4 million pesos in 1994. 32 2.13 The average amount of individual loan provided was between 70,000 and 75,000 pesos (US$ 2,700 and 2,900), with a maturity of one year.3 About 90% of the loans are rediscounted by DBP. The rediscounting rate is tied to the Treasury Bill rate, presently at 10.6%. 2.14 Regarding loan application, individuals do not really have an income statement. The bank evaluates their present cash flow and future cash flow requirements to support loan repayments. As of now, none of MGAs have been in default. Regarding individual members, past due loans amounted for 5-10% of total outstanding. Most of these past due loans became loans in default. 2.15 In spite of this very limited positive experience from surviving MGAs, accredited financial institutions, especially commercial banks, were reluctant to lend. The PCR suggests that commercial banks in general are not interested to lend to small scale enterprises and that they had to compete in that segment of the market with a number of subsidized schemes. This report provides some more insight in focusing on two aspects: the particular way the MGA system was implemented, and the degree of competition of other programs especially directed to cottage industries. Implementation of the MGA Concept 2.16 Implementation was time consuming and costly. Considerable amount of documentation was necessary to set up an MGA. Separate agreements were needed for matching loan funds, guarantee agreement, registration with SEC, memorandum of understanding, registration of individuals, preparation of financial statements, and notarization of documents. Many MGAs were formed artificially just to meet the deadlines and their targeted size was reduced form 60 to 40 members each to facilitate multiple establishments. 2.17 The few surviving MGAs registered some growing activity. The way it was implemented, however, the MGA scheme became unattractive to banks. Initial contributions from individuals amount from 10,000 to 30,000 pesos. With 10,000 pesos an individual can get up to 90,000 pesos credit. This proposition is not very attractive for a commercial bank who does not know this customer well. Even in the case of a maximum contribution, the bank is covered only in a proportion of 47 percent of the loan.4 Role of Consultants 2.18 Consultants were asked to prepare and implement the details of the arrangements to set up MGAs. Probably because of the complexity of the task, the consulting work was successively subcontracted to three firms. 2.19 During the first phase of project implementation, in 1991, the first group of consultants spent about one million dollars but nothing came out of it. No MGAs were formed. The consulting firm employed sequentially about 10 international experts who went around in the Over the years this amount could have grown with the growth of the guarantee funds to which a multiplier of three can be applied to evaluate the amount of the loan one can request. 4 See PCR, part II :(100% -33%) - 20% = 47%; the 20% represents the assets of the individual; 33% represents matching funds plus individual contribution. 33 country with the aim of helping potential MGA members to fill a questionnaire and the two local consultants were left to interpret the results. The future MGA members were chosen out of listings prepared by DTI. The questionnaire results were poor and all "filled out with the same handwriting" because people needed help to answer the questions. Consultants were paid with considerable delays. 2.20 When the second group of consultants took over in 1992, it was able first to set up 4-5 MGAs, and, in a second phase, managed to get 20 more MGAs registered at the SEC. Many MGAs were formed among Chinese communities. Even then the implementation did not work out without problems (see Box 3). Only 12 MGAs were operating during project implementation, and several of them are still functioning at present. 2.21 One aspect neglected during implementation was the training of MGA administrators. Training of administrators in management and accounting came too late or never. Indeed, during phase one, the consulting firm, while spending substantially on foreign expert services, showed pride in his reports to the cofinancier KfW to "save on training". The lack of training explains in part the low rate of survival of MGAs. Box 3: Unpaid Consulting Fees In a first bidding process, the contract was awarded to a small foreign consulting firm whose office was located in France. This firm spent a large amount of resources in a short period, but was unable to deliver. After the failure of the first contract, another contract was awarded to a German consulting firm. Given the complexity of the project, the German firm felt it was necessary to use the services of some qualified local consultants. The German firm then subcontracted to the local Philippines subsidiary of an international consulting company and to another local firm. The relationship between the subcontractors and the German firm turned sour when the subcontractors did not get paid for some of the services rendered (February 1994). The German firm just stopped responding to the consultant requests. Now the local subsidiary still holds DM 33,000 of receivables corresponding to salary and out of pocket expenses occurred from January 1992 to September 1993. They represent about 10% of the total amount of the contract. The consulting subsidiary had warned the cofinancier, KfW, of the situation. In response, KfW, who was disbursing funds to the German firm upon presentation of statements of expenses, did put pressure on the firm to activate the payments to the subcontractors, but was unable to get the remaining receivables cleared. The second local firm who shared the subcontracting from the German firm holds a higher amount, DM 57,000, of unpaid services and was not able to recover this amount either. In the framework of the contract, the local consulting subsidiary was to facilitate the creation of MGAs-including registering them with the Securities Exchange Commission (SEC) as a corporation, selecting a leader for each one of them, providing training and support for computerized accounting. The local subsidiary helped set up about 20 MGAs, 12 of which were actively borrowing, and provided 1,800 training days with an average of 2 to 3 days per person. 34 Outcome Why Commercial Banks Were Not Interested 2.22 One major reason mentioned in the PCR was that commercial banks were not interested in small and micro lending because of the difficulty for the lender to get adequate information from borrower and the resulting high processing costs. The audit mission found, however, other factors affecting this project outcome. 2.23 First, the MGA scheme could take different forms. When the accredited commercial banks learned about the scheme during project preparation, they overlooked all the possible configurations of the guarantee arrangements. One of them was that the potential borrower who was a MGA member would ask for a maximum credit line while presenting to the lender only a very minimal (but legal) level of guarantee. Most borrowers used right away the facility to the maximum extent, instead of operating progressively from 30,000 pesos to 90,000 pesos ( US$ 1,200 to 3,500), they asked for a 90,000 pesos credit at once. For a credit of 90,000 pesos, however, the guarantee was only covering 10,000 pesos at the beginning of the scheme, because of no "matching funds". 2.24 The above formula was promoted by the project teams in the field as a way to provide incentives to borrowers to form MGAs. It also ended up as the only possible configuration because of the lack of matching funds. It was the lack of matching funds which made the guarantee proposition unattractive to commercial lenders. A few banks, however, those who were accustomed to deal with small borrowers made use of the facility. The banks were BCI, BPI-Family Bank, UCPB. 2.25 Second, in spite of Bank staff promotion efforts, the scheme has an "image problem". Potential borrowers had the idea that the loan included some form of subsidization, as part of a new credit facility initiated by the government and supported by international organizations. They also thought that repayments conditions would be "flexible" in practice. 2.26 Third, there was a geographical mismatch between the location of accredited bank subsidiaries and the location of formed MGAs. A number of MGAs were in remote areas, relatively far from the branches of the accredited banks. 2.27 Fourth, commercial bank margins for this category of loans were too low. By the time the credit was implemented, because of onlending arrangements, the commercial banks could not lend at more than 18% to cottage industries, while they could lend at 22% to larger enterprises and at a lower loan processing cost. This interest rate limit imposed to commercial banks was not supported by the Bank, but was known to exist.. 2.28 Fifth, the implementation of the Bank credit scheme was too centralized. Although funds were to be provided with a large geographical distribution, final approvals of subprojects by DBP had to take place in Manila. Matching funds are additional guarantee funds brought in through borrowings as distinct from the original endowment funds. 35 2.29 Given all these implementation difficulties, one alternative envisaged during implementation was to start on a pilot basis, and then proceed on a larger scale. This alternative proved to be impractical, however, because DPB and the Bank were pressing for the immediate creation of a large number of MGAs to activate borrowing and get the loan disbursed. "Competing" Schemes not Really Competing 2.30 The PCR argued that one of the difficulties met in implementing the credit line was the existence of competing subsidized credit or guarantee schemes. The audit mission looked into these schemes, and found that they are so specific and limited in terms of lending outreach that they competed with the Bank loan only marginally. At the limit the guarantee schemes were used as complements to the extent allowed, as long as borrowers could not obtain the full coverage of the loan amount with one guarantee scheme only. These alternative schemes are described in Box 4. Box 4: Alternative Schemes of Lending to Small Cottage Enterprises There are in the Philippines other forms of group lending or borrowing, for very small loan amounts: (a) The Paluwagan system in which about ten persons give to the group regularly a small amount (100 pesos) in a prearranged order, each one of the member receives the total amount collected during a limited period. These amounts are usually below 5,000 pesos. This is often too low to purchase a small equipment. A sewing machine for handicraft work, for example, costs from 10,000 to 50,000 pesos. (b) The current DTI micro enterprise program does not rely upon commercial banks lending to individuals. DTI funds are channeled to NGOs through divisional unit of Land Bank. The NGO is the recipient of the credit and onlends it to individuals. It is up to the NGO to repay Land Bank and to be repaid. The NGO acts as MGA and an onlending unit. This system is similar to Grameen where the cell is both a guarantee and a base for on lending. (c) The Small Business Guarantee and Finance Corporation(SBGFC) created by law in 1992 to facilitate required (directed) lending of banks to small industries (10% of their portfolio). The scheme is supposed to be self sustaining, but presently it is still subsidized. The program is to provide a guarantee for a fee to small entrepreneurs who cannot-or do not wish-to provide a collateral. The loans linked to these guarantees are provided at market rate. There are exceptions, however, in the case of lending to poor and remote areas, where the interest rate is subsidized. SBGFC was part of the reforms to promote the development of small scale industries. The law was voted in 1990, but implementation started in 1992. This guarantee scheme, which can cover up to 85% of a credit amount turned out in practice to be complement of the guarantees provided by the MGAs (not a substitute as stated in the PCR). (d) The Tulung Sa Tao program also uses NGOs as a conduit for credit to cottage industries. It applies to households with a monthly income of 10,000 pesos or less. The field of activity covers manufacturing, agro processing, and services-not agriculture. Since the creation of the program in 1988, loans have been given to 1,200 NGOs for a total amount of 1.1 billion pesos. The loan maturity was from one to five years. The NGO borrowed from DTI at 12% and onlend at "market rates" (about 24%). Arrears amounted to 21% of loan portfolio before rescheduling and 15% after. The loans definitely in default accounted for only 2% of the portfolio. (e) The program ofthe Poorest ofthe Poor applies to households whose income is less than 5,000 pesos. NGOs borrow at 5% and relend at 15%. The percentage of loans in arrears before rescheduling is 13%. The default rate is presently negligible. Since the creation of the program in 1994, the loan 36 disbursement amounted to 46 million pesos. The objective is to graduate NGOs from these programs but none has graduated yet. Depending on the size of their assets, enterprises are eligible to the various programs according to the relative size of their assets (land excluded); Asset size <0.15 0.15<A<1.5 1.5<A<15 15<A<40 (million pesos) Program poorest cottage small medium (f) Informal markets use the 5/6 formula (I lend you 5 and you repay 6). The loans have a very short maturity, one month maximum. The loan amount is a few thousand pesos only, and no need for documentation. (g) The ADB sponsored micro program. The program works as follows: ADB lends to DOF interest free, 35 years. DOF onlends to Land Bank (PCFC) at 4% to cover foreign exchange risk. PCFC onlends to NGOs at 10% through a rediscounting mechanism. NGOs onlend to final borrower at market rate (24%). This approach is substantially different from the MGA because here the cell is both a guarantee and an onlending unit. In term of documentation, this approach saves at least one set of legal arrangements because the unit which guarantees is also the unit which receives the funds to be channeled to individual members. PCFC has accreditation criteria to select NGOs. This is analogous to accreditation criteria for banks. (h) The lGLF program. This guarantee program is not a substitute for a cottage enterprise type of guarantee. IGLF does not exclude cottage industries, but the facility is not designed to - and in fact does not-reach them. It was envisaged once to amend some IGLF conditions to reach poverty pockets in remote areas, but there was no follow up. Bank Performance Design 2.31 The loan amount was first estimated at US$50 million. The amount was then progressively reduced to US$25 and US$15 million. In the end only US$1.5 million was disbursed. In retrospect, the Bank should have started with a pilot project of US$1 million to test the design first. 2.32 When the project was appraised, the Bank did not focus on the costs of setting up MGAs. During implementation, it was found that the cost of setting up a MGA guarantee scheme was excessively high compared with the resulting benefit of increased borrowing capacity. First, the project did not benefit from any past experience in this area. The implementation agencies discovered that there was no model available as reference. Second, the implementation agencies had to identify potential MGA members and convince them to become participants and bring a substantial financial contribution. Third, the company had to be registered with the SEC. This required a great deal of documentation. Fourth, a competent manager/accountant had to be found and hired for each MGA. Fifth, a MGA leader had to be selected. Sixth, training had to be provided to future MGA participants. Seventh, the scale of the MGA was too small to be profitable. Because the set up cost was too large and many micro enterprises could not support it, the criteria of eligibility for the loan were extended to small scale enterprises during project implementation. 37 2.33 Matching funds were provided by DPB, with an initial financing from the cofinancier KfW, in order to increase the size of the guarantee funds in new MGAs. The matching funds obtained by MGAs from loans at zero interest rate. The donor community now tends to agree that no zero or subsidized interest rates loans should be granted to finance micro enterprise activities, because experience shows it does not lead to sustainable lending schemes. Approval Process 2.34 The project went through an approval procedure in the Philippines at the same time it was submitted for approval in the Bank. The approval process in the Philippines was simplified. Because the initial project size was relatively small, the project proposal did not go to the Investment Coordinating Committee (ICC) an inter agency committee. It went to a steering committee which included only agencies directly involved in the project (DTI, DBP, DOF). In that case the National Economic Development Authority (NEDA) had only an advisory function. In September 1990, NEDA clearly advised against the project. But NEDA's view was a minority view and the project was approved by the steering committee. Before loan negotiations, the World Bank resident mission discussed with NEDA the relevance and the soundness of the project. The Bank expressed the view that the project was not risk free but was addressing two relevant objectives for the Philippines: poverty alleviation and financial institution building. Ex post, with insight, the pressure of the Bank on NEDA proved to be a mistake. Borrower Performance 2.35 The Borrowers' commitment to the project was in fact quite limited. First a key government agency was not favorable to the project since the beginning. Second the implementing agencies, mainly DBP and DTI did not have the full institutional capacity to implement such complex and demanding operation. Finally, the implementation agencies had difficulties to convince potential borrowers of the benefits of MGAs. 2.36 One consequence of the limited local institutional capacity to implement the project was the delay in training the new MGA administrators. When the second consulting company took over the job 6 months after the first one had started working on setting up MGAs, the training component was not implemented. It then took about 6 more months for the second one to establish a training program. By the time the training effectively started, MGAs were already in place for at least a year. Project Rating and Covenants 2.37 In view of the above mentioned assessments, the project outcome is rated as unsatisfactory, its sustainability as unlikely, and its institutional development impact as negligible. Project covenants were complied with. 38 Findings and Lessons of Experience Findings 2.38 The PCR concluded that the failure of the project was mainly due to (i) poor implementation especially regarding consultants work; (ii) the existence of competing subsidized schemes to deliver credit to the poor; and (iii) commercial bank ex post reluctance to onlend. The Borrower supported the assessments of the PCR. The Borrower's statements were in agreement with the PCR. 2.39 The audit mission collected additional findings in the field and concluded that the major source of the project's failure was its faulty design. Other detailed findings are as follow: (a) Out of the 39 MGAs established by the end of 1993 when the project was closed, 21 MGAs still existed legally in 1995, and, among them, only 12 were active. (b) NEDA was opposed to the project since the beginning, but the Bank insisted on the ground that project objectives were to alleviate poverty. (c) Local consultants claim that some of the services rendered remained unpaid and DBP claims that correspondence with German consulting firm remained unanswered. (d) The project did not exclusively target cottage enterprises: to be eligible for the Bank loan, enterprises were allowed to own assets up to a maximum of 3 million pesos (US$ 120 thousand), instead a maximum of 0.5 million pesos (US$ 20 thousand), which is the asset based criteria used by the banking sector to identify cottage industries. (e) The MGA design was too complicated. MGAs had to register at the Security Exchange Commission. Not surprisingly the set up of a MGA cost as much as 133,000 pesos. The MGA program was overburdened with legal arrangements covering too many cases of non compliance. (f) Onlending arrangements to cottage industries were not implemented because (i) the number of guarantee funds set up was well below expectations; (ii) the commercial banks mode of participation was not clearly spelled out, and when MGA members were finally able to propose guarantees, banks did not find them attractive. (g) There was a mismatch between local availability of MGAs (in remote areas) and local availability of intermediaries willing to lend. Many bank branches were in urban areas while MGAs were in rural areas. 39 Lessons ofExperience 2.40 The Bank's experience in lending to cottage industries is still limited. The lessons of experience below are solely based on the experience of the cottage loan to the Philippines: (a) An untested approach for lending to cottage industries should not be adopted on a large scale basis without first trying a pilot operation. This would allow the Bank and the Borrower to test the feasibility of the scheme. Project design should remain simple, while aiming to reduce the asymmetry of information between lenders and borrowers. (b) To ensure sustainability of the project, it is necessary to create procedures for easy access to credit, within a context of poor information and lack of banking technology. This may require temporary subsidies. Grameen Bank in Bangladesh relies upon subsidized training to set up and develop small groups of borrowers (cells), as well as volunteer time. The Indonesia KUPEDES program, which charges market rates to small borrowers, received subsidies for seed capital and to help cover expected losses in the first two years of operation (OED Report No. 14511, para. 1.4). (c) Design of microfinance projects should remain simple, while aiming to reduce the asymmetry of information between lenders and borrowers. In addition, the Bank must ensure that its promotion efforts lead to a complete understanding of the commercial aspects of the loan, i.e. that it is not a government subsidized operation. (d) Regarding consulting services, cascade subcontracting should be avoided. Local consultants should be directly involved in the implementation of a project of this type. There is no real need for intermediary consulting companies. (e) To ensure sustainability of the project, it is necessary to create procedures for easy access to credit, low cost, no collateral, within a context of poor information and little technology available. This may require temporary subsidies. Grameen Bank in Bangladesh relies upon subsidized training to set up and develop small groups of borrowers (cells), as well as volunteer time. The Indonesia KUPEDES program, which charges market rates to small borrowers, received subsidies for seed capital and to help cover expected losses in the first two years of operation (OED Report 14511, para. 1.4). (f) MGAs had difficulties to raise matching funds. Project for cottage industries based on mutual guarantees should look into the opportunity of setting up a small matching fund facility for existing MGAs. Future Action on this Project 2.41 Regarding the case of unpaid consulting fees (see Box 3), the Bank should keep encouraging the two parties to settle their differences in an amicable way. 40 Future Challenges in Lending to Cottage Industries 2.42 On the basis of this lending experience, the success factors to build a credit scheme based on MGAs appear to be the following: (i) select individuals who really intend to develop their business; (ii) select rural banks and credit unions who know their customers and are willing to lend small amounts; (iii) select a good MGA leader; preferably someone with a higher education and a successful business; (iv) minimize documentation of the guarantee coverage ; (v) whatever the formula chosen for the guarantee scheme, it should be attractive to the banks; and (vi) potential borrowers should understand that the credits are commercial credits to be repaid, not quasi grants. 41 ANNEXES  43 Annex 1 Economic Reforms Supported by Bank Loans OBJECTIVE MEASURES TAKEN DATE LENDING INSTRUMENT Strengthen CBP undertook review* of reporting Already done by FSAL (L3049) supervision and requirements, loan loss provisions and GAAP first tranche regulatory Draft amendments to the Central Banking Act release (1989) framework for (relating to emergency loans to bank, troubled commercial banks bank, cease and desist orders, loans to insiders and secrecy of depositors and protection of CBP staff) not made Improve Enactment of amendments to PDIC Act*. PDIC Act FSAL (L3049) institutional Increase of PDIC's paid-in capital* (yes, but did passed in Feb arrangements for not meet target) 1992 depositor protection Reduce Action planned on reducing taxes on financial effectively 1993 FSAL (L3049) intermediation intermediation but not done*. CBP recognized as costs in banking majQr source of cost through high reserve system requirements (RR reduced (as part of CB restructuring) and is expected to reduce intmd. costs) Improve Eliminated CBP's role in credit allocation APEX, IGLF FSAL (L3049) institutional (APEX and IGLF operations transferred to transferred in framework for DBP)*. 1990, 1991. delivery and DBP revamped to act as wholesaler of long-term Wholesale mobilization of funds and achieve agreed interim performance targets met in long term credit targets*. (was to be achieved through Dec.1992. privatization which did not take place however, share of wholesale loans met agreed targets) Restructuring CBP Central Monetary Authority (CMA) Bill passed 1993 FSAL (L3049) (Central Bank) Nov.1993. Actual financial restr.measures taken by Dec.1993 Reform of Govt. Major restructuring *of PNB and DBP 1986-1987 Economic Financial undertaken and non performing assets Recovery Institutions (GFIs) transferred to Asset Privatization Trust for Program (L2787) and reduce disposal* government Redefined Financial Sector Policy to allow entry presence in the of private banks*, and started privatization of six sector banks previously acquired by the Govt.* liberalization of interest rates on loans to the 1981-82 Joint Bank-Fund industrial sector and deposits, gave more mission study - flexibility to banks to undertake longterm Aspects of the lending, and limited CB role as lender of last Financial Sector resort. (report no.2546, in 1979) and Industrial Annex 1 44 Finance Loan (early 80s) Recommendations (that do not overlap with 1988 Financial Sector conditionalities): Study (report no. Improve supervision of Securities Market 7177 in 1988) Institutions Improve Narrow the differences in tax rates on income 1992 Capital Markets efficiency of from capital Study (report capital markets no.10053) Improve Recommendations: open up auction process 1992 Capital Markets efficiency of for govt. securities. Study (report capital markets Govt. should issue securities with longer no.10053) maturities Govt. should adopt uniform capital gains tax. CBP should help develop and information system available to all dealers and banks. Govt. should consider converting existing clearing system to a book-entry system CBP Central Bank of the Philippines CMA Central Monetary Authority GAAP Generally Accepted Accounting Principles IGLF Industrial Loan and Gurantee Fund PDIC Philippine Deposit Insurance Corporation PNB Philippine National Bank RR Reserve Requirement * Loan conditionality 45 Annex 2 Performance Indicators of the Financial Sector 1. Macro Environment and Financial Depth Rate of Inflation (Change in CPI) Nominal and Real Exchange Rates 150 so ___3_ 125 40 100 30 75 30o 20 25 10 W) L- [ g g *-NER Mdex (1987-100) --0-- RIER Index (1987-100) Current Acct. (BOP) and Fiscal (Govt.) Deficits, % M2/GDP ofGDP 50 4% 4%40 30 I20 -8% 10 -12% 75777981.. ..-------- 0 A P S 2 " is 1 8 a; 75 77 79 a1 85 87 89 91 93 -...BOPlGDP a-Govt/GDP 2. Interest Rates and Capital Market Real Deposit Rate Domestic and Foreign Spreads 20 20 ........ 20 ....... . ........... . ..... .. .... ........ 10 15 10-g1 -10 5 0. -20 -5 -30. 75 77 79 81 83 85 87 Be 91 93 75 77 79 81 83 85 87 89 91 93 foreIgn spread ---- domestc spread Real Money Market Rate Capitl Market Performance (IFCQ Price Index) 20 .......___400-- ..0 350 k400 10 300 5 250 50 -10100 10 -20 0 100 -50 50 .30 250 00 75 77 79 81 83 85 87 89 91 93 . FCG % 0 hange F Idex (19872100) Annex 2 46 3. Banking Bank Capital Adequacy: capitallassets Eank Asset Qaity: Lons CDLo~ 6.00% 1 5.60% 25% 5.20% 480%15% l00/o 10% 4.00% fl CO CO CO CO CO- - C ~ Cr) L0> Bank Management: Adm. Expenses/Assets Bank Profitability: Income/Assets 1.40% .... 40% 1.35% 2 00% 1 30% 1 60% 1 25% 120% 1 20% 0 80% 1 15% 040% 1 10% o000% Bank Liquidity: Loans/Depos its CB Capital Adequacy: capitallassets 50% .____ ...2 50% . 40% 2 00% 30% 150% 20% 1 00% 10% 000% 0% , 00% *-- u-. ......i--mm---_ 4. Impact Real GDP Growth Rate DomesticSavings andinvestment(%ofGDP) 10 ..... .. .- . 8 3 6 25 4 20 2 15 0 10 O- -2 -4 0 -B æ- n- a) æ -o- GDI/GP ..... GDSIGDP Direct Fore ign Investment (million US $) 10 0 -......... 80 60 40 20 0 -20 . 7 7 . 8 8 8 8 9........ 75 77 79 81 83 85 87 89 91 93 Comparison Between Expected and Actual Performance of the Central Bank Table 1. Income Statement (1991-1995) Income Statement 1991 1992 1994 1995 Actual Projection Actual Projection Actual Projection Actual Projection Actual Projection Income 13.6 8.4 13.7 10.7 27.6 11.6 42.2 12.7 39.8 13.9 Loans and advances 6.3 5.5 4.4 5.6 1.7 5.8 2.6 6.1 3.1 6.4 Overdrafts 3.7 0 3.2 0 9.6 0 2.3 0 2.9 0 Domestic securities 0.7 0.7 1.2 1.4 9.6 1.4 29.7 1.4 24.5 1.4 Foreign investments 2.9 2.1 4.9 3.7 6.7 4.4 7.6 5.2 9.3 6.1 Expenses 36.3 30.4 38 33.9 28.8 37.4 32.2 41.9 28.6 46.9 Legal reserves 2.3 1.8 2.6 2.2 3.2 2.6 3 3 2.1 3.5 Blocked peso differential 3.1 2.9 1 2.5 0 2.6 0 2.8 0 3.1 NG deposits 5.5 4.2 10.3 4.1 7.9 4.1 16.1 4.1 10.4 4.1 Open market instruments 4.5 2.7 11 3.6 8.8 5.4 4.1 8.2 4.2 11.6 Foreign Liabilities 17.7 18.7 10.2 21.5 6 22.8 5.1 23.7 5.7 24.6 Forward gains/losses -0.2 0 0 0 0 0 0 0 0 0 Swap cover gains/losses 2.3 0.5 2.8 -0.2 0 -2.2 0 -1.9 0 -2.1 Overall CBP deficits -20.6 -21.6 -21.5 -23 -1.2 -28 5.3 -31.1 2.4 -35.1 Annex 3 48 Actual and Predicted Changes in Exogenous Variables The actual data for the key variables used in the projections of CBP's financial condition shows several favorable trends which would improve the income statement of the CBP. First the international interest rates as shown by the 3 month LIBOR rate over the period 1991-95 were even lower than expected. This has reduced the interest paid on foreign loans and improve CBP net income. The exchange rate has depreciated less and has reduced valuation losses in international reserves and outstanding swap and forward transactions have at least broken even during 1992-95). The reserve requirements (RR) were expected to remain unchanged but were reduced in 1994 and 95, thereby reducing the interest on RRs. The National Government Deposits at CBP have been significantly above expectations and have provided the Central Bank with an additional source of liquidity. Table 2. CBP -Major Assumptions and Actual Data, 1991-95 1991 1992 1993 1994 1995 LIBOR (90 day) 6.8 7.5 7.5 7.5 7.5 Actual 5.98 3.86 3.29 4.74 6.03 91-date-T-bill rate 23 17.7 17.7 17.7 17.7 Actual 21.48 16.12 12.25 13.62 12.94 91-day MRR 18.5 14.2 14.2 14.2 14.2 Actual 18.25 14.25 11.19 11.38 7.63 Reserve requirements(%) 25 25 25 25 25 Actual 25 25 25 20 15 Exchange rate (level period average) 28.5 30.24 32.08 34.04 36.12 Actual 27.48 26.08 26.04 27.42 25.51 NG Deposit (Billion Pesos) 55 55 55 55 55 Actual 75 137.5 113.2 84.4 71.3 Projections:Philippines Capital Market Study, Report No. 10053, p.36, February 24, 1992 Actual: CBP Philippines Data. (Data for 1995, are from the period Jan-Jun 1995) 49 Annex 3 Chart 2. CBP Selected Expenses 20 - - Foreign i5 Liabities 10 Fow ard 5 gaIms,ossos x Open mar'køl 0 operations - .5 Sw op cover gam/loasss -10 -- 1991 1992 1993 1994 1995 50 Annex 3 51 Annex 4 Fiuancal Sector Statistics Annex 4 52 Macro and Sector Data 53 Annex 4 All Year Jan/Jun Estimate .SEELES 1992 1993 1994 1995 1995 Stock MrketDa Market Capitalization (US$mill) 15589 39309 56780 54962 Number of Listed Domestic Companies 169 178 189 197.000 Local stock market price index (annual% change) 10.235 154.783 -14.068 0.730 IMF International Financial Statistics flFS) Deposit Interest Rate (period average) Time deposits 61-90 days 14.009 10.192 10.595 8.551 Lending Interest Rate (period average) average commercial lending rate 19.428 14.558 14.999 15.356 Treasury bill rate (period average) 91-day 16.118 12.251 13.620 12.947 Fin'l. Deepening Ratio, % (M3/GDP) 28.5 32.6 36.0 54.1 Deposit money banks- Level of Demand Deposits 37794 49794 56277 63074 Dep. Money Bks-Level of Time and Savings (m P) 269781 341839 451052 472551 MONEY (MI) (m P) 112092 133877 151952 151794| QUASIMONEY (m P) 269781 341839 451052 472251 MONEY PLUS QUASIMONEY (M2) (m P) 381873 475716 603004 624345 P) 63214.3 76207.2 8642.4 92173.8 p/ Balance of Payments(BOP) Data (In million US$) BOP: Net level-of direct investment 697 763f 1861 663 BOP:Net level of portfolio investment 40 -164 -437 84 BOP:Net Current Account Balance -858 -2983 -2840 -1293 National Accounts Data Gross domestic investment (billion pesos) 288.40 361.45 426.03 n.a. Gross domestic product in billions (US$,current prices) 52.98 54.37 63.92 34.71 GDP at Market Prices in billion pesos 1351.56 1474.46 1688.49 80.52 Gross domestic product in billions (1985 US$) 38.64 39.46 41.16 20.70 Gross domestic savings (billion pesos) 243.83 247.30 330.96 n.a. Exchange Rate Data pesos/USS, Market Rate, (Period Average) 26.08 26.04 27.42 25.51 US$/peso, Market Rate (Period Average) 0.04 0.04 0.04 0.04 Real Effective Exchange Rate Index, Major Trading Partners, (1988=100) 76.37 74.65 80.07 82.15 el Prices and Government Data PRODUCER OR WHOLESALE PRICE INDEX 720.6 712.6 770.8 777.0 CONSUMER PRICE INDEX 165.6 178.2 194.3 208.1 (Jan-Oct 95) Govt. Finance: Deficit(-) or Surplus (million pesos) -15966 -21891 181141 10683 15500 i I Jan/Jun Central Bank Data 1991 1992 1993 1994 1995 Reserve Requirements for KBs (percent) 25 25 25 20 15 National Government Deposits at CBP( billion pesos) 75.0 137.5 13.2 84.4 71.3 (June) 91-Day Manila Reference Rate (percent) 18.25 14.25 11.19! 11.38 7.63 (Sep.) */ Exclusive of 2% liquidity requirement p/ Preliminary e/ Estimate 1 of 1 Central Bank of the Philippines Balance Sheet 1 of 2 CBP/BSP 1/ 19801 19811 19821 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 estimate* 1995 ; STATEMENT OF ASSET AND LLABILITIES (bilions of pesos) TOTAL ASSETS 59.8 65.5 79.9 86.1 112.8 129.7 157.0 139.3 140.2 153.0 164.0 226.6 269.7 518.2 463.3 480.3 International Reserves 23.6 20.0, 24.5 12.5 17.5 20.3 50.5 40.5 43.5 51.6 55.4 120.6 130.2 161.4 170.7 214.4 Gold 2.2 3.8 7.0 1.6 5.7 9.5 16.4 21.7 23.6 21.4 31.6 34.6 23.4 34.5 26.9 Foreign currency holdings 21.4 16.2 17.5 10.9 11.8 10.8 34.1 18.8 19.9 30.2 23.8 86.0 106.8 126.9 143.8 FX rceivables 0.0 0.0 0.0 0.0 0.0 0.0 0.010.0 0.0 0.0 0.0 0.0 6.9 8.6 7.8 8.4 Dometic securities 6.1 6.4 9.2 9.8 13.31 14.5 14.9 13.1 11.2 10.5 8.3 8.0 47.5 244.0 193.1 163.1 Loans and advances 25.6 32.7 39.6 55.5 67.5 74.8 72.4 65.5 64.7 66.1 74.8 69.9 65.6 54.9 48.2 52.0 Bank premises and fixed { as18 2.0 2.1 2.1 2.1 2.0 2.2 2.2 2.1 2.2 2.0 1.9 2.0 9.3 9.2 11.1 Other Assets 2.7 4.4 4.5 6.2 12.4 18.1 17.0 18.0 18.7 22.6 23.5 26.2 17.5 40.0 34.3 31.3 LIABILITIES 64.7 70.5 91.2 129.8 205.4 251.0 313.2 324.5 349.11 385.0 443.0 527.1 583.7 497.6 457.5 465.0 Currency lssued 12.3 13.8 14.9 22.6 25.7 28.1 34.6 41.8 46.51 60.0 70.8 80.6 88.3 98.0 111.5 130.9 Depgits 28.7 28.3 35.8 42.6 61.6 106.8 120.0 136.3 160.6 186.9 201.6 240.0 294.1 269.8 248.7 250.6 Banks and other financial I 1 institutions 7.8 11.0 12.6 18.2 18.3 22.81 36.3 42.7 55.8 65.5 91.7 88.2 108.9 Treasury Dept. 2/ 5.2 10.8 7.2 15.5 41.8 57.61 68.7 66.8 75.0 137.5 113.2 84.4 63.0 Foreign fin'I institutions 9.0 12.4 18.6 26.3 26.7 28.21 29.5 24.3 36.7 41.0 46.7 42.8 38.0 Foreign currency deposits 17.7 17.6 47.7 43.1 27.6 26.51 19.6 25.2 29.7 17.3 13.9 6.8 7.7 L Others 2.9 9.81 20.7 16.9 21.9 25.5 32.8 42.6 42.8 32.8 4.3 26.5 33.0 Foreign loans payable 9.6 14.7 28.9 47.7 73.81 74.0 119.0 123.3 119.5 117.8 149.8 134.7 98.4 69.4 53.2 46.0 Allocation ofSDRs 0.9 1.1 1.2 1.7 2.3 2.4 29 3.5 3.3 3.4 4.7 4.5 4.0 4.5 4.1 4.5 Central Bank notes 11.7 10.3 8.4 5.3 7.1 2.6 1.5 0.7 0.21 0.0 0.0 0.0 0.0 0.0 0.0 0.0 BSP dcbt instruments 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 48.7 31.5 16.1 Others 1.5 2.3 2.0 9.9 34.9 37.1 35.2 18.9 19.0 16.9 16.1 67.3 98.9 7.2 8.5 16.9 CAPITAL ACCOUNTS -4.9 -5.0 -i l.3 -43.7 -92.5 -121.3 -156.2 -185.2 -208.9 -232.0 -279.0 -300.5 -314.0 20.6 5.8 15.3 Captai 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01 0.01 10.00 10.00 10.00 SupIus/reserves 0.5 0.5 0.5 0.61 0.6 0.6 0.7 0.7 0.8 0.9 1.9 2.1 2.6 6.6 12.3 14.6 CAiA -4.4 -6.1 -8.7 -11.8 -20.6 -35.8 -51.5 -66.21 -84.5 -105.1 -116.7 -136.3 -152.6, 0.0 0.0 0.0 Others gains/losses(- -1.0 0.61 -3.1 -32.5 -72.5 -86.1 -105.4 -119.7 -125.2 -127.8 -164.2 -166.3 -164.0 4.0 -16.5 -9.3 Revaluation ofIR -1.0 0.6 -3.11 -32.5 -72.5 -86.1 -105.41 -119.7[ -125.2 -127.8 -164.2 -166.3 -164.01 4.0 -16.5 -9.3 1/ Pursuant to RA No. 7653, otherwis known as the New Central Bank Act, certain assets & liabilities of the Central Bank of the Philippines (CBP) have been transferred to the Bangko Sentral ng Pilipinas (BSP) and the balance was retained with the CB-Board of Liqiodators (CB-BOL) | - 1 2/ Refers to the deposits of the Treasurer of the Philippines consisting of domestic currency deposits and foreign currency deposits. */ Estimates as of 9-27-95 1 Source: Bangko Sentral ng Pilipinas Centrai Bank of the Philippines Balance Sheet 2 of 2 CBP/BSP I/ 19801 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 estimate*1995 CB d[capital] -0.1 -6.3; -32.4 -48.8 -28.8 -34.9 -29. 7t¯23. -47.0 -21.5 -13.5 334.6 -14.8 9.5 CB d[capital]/capital _ -10 -630 -3240, -4880 -2880 -3490 -2900 -2370 -2310' -4700 -2150 -1350' 33.459 -1.48 0.95 CB income = Overali CBP/BSP deficit (-)/surplus 1.0 1.6 0.9 -7.5 -25.7 -15.2 -182 -10.7 -16.9 -20.9 -22.0 -20.6 -21.5 -1.2 5.3 2.4 CB income/capital 100 160 90 -750 -2570 -1520 -1820 -1070 -1690 -2090 -22001 -2060 -2150 -0.12 0.53 0.24 CBd[capital]/assets -0.002 -0.079 -0.376 -0.433 -0.222 -0.222 -0.2081 -0.169, -0.151' -0.287 -0095 -0.050 0.646 -0.032 0.020 CB income/assets ,! 0.02 0.0244 0.0113 -0.0871 -0.2278, -0.11719 -0.11 -0.07-7-0.120 -0.137.-0.1345 -0.0909 7972 -0.0023 0.01144 0.00499687 CB Capital/assets 0.00017. 0.00015 0.00013 0.00012 0.00009 0.00008. 0.00.006 o.oòi7 0.00007 000007 0.00006 0.00004 0.00004 0.01930 0.02158 0.02082 ul 1-0_00041 00190 00215 0.208 Central Bank of the Philippines income Statement I of 1 CB/BSP Income estimate* Statement 1981 1982 1983 1984 1985 1986' 1987 1988 1989 1990 1991 1992.1993 19941995 (billions of pesos) __- I Income l 3.51 4.6 5.2 5 .3 8 92 8.8 8.1 7.01 6.0 771 13.6 7 27.64 .2 9.8 Intl. Reserves 5 1.7 1.61 1.0 0.70 9 1.0 1.9 .3'1.11.5 2.9 4.9 6.7 7.6 9.3 Domestic Securities 0.2 0.2 0.2 0.4 0.4 0.7 0.9 0.8 0.8 0.7 0.6 07. 1.2 9.6 29.7 24.5 Loans&1Advances .8 2.7 3.4 3.9 7.1 7.6 6.9 5.4 4.9 4.2 5.0 6.3 4.4 1 6 3.1 Miscellaneous Income 3.7 3.2 .6 2.31 2.9 Fpenss 25 3.0 3.3 3.1 5. 2 7.2 2 23 26.1 25.61 36.3 380 28.8: 32.2 28.6 .4_ 0.91. 26 . Legal reserves 0 0.1 0.1 0.12 0.2 0 0 . 0. 3 3.0 2.1 Blocked peso differential 0.0 0.0 0.0 0.0 1.6 3.8. 2.0 0.8 1.2 1.5 2.4 3.1 1.0 00 0.0 0.0 NG deposits 0.0 0.0,0.0 0.0 0.0 0 0.0 1.8 5.1 59451 5.5 10 7.9 16.1 10.4 Open market instruments 1.4 1.3 1.0. 0.7 2.3 8.2 8.7 1.4 1.3 1.6 1.6 4.5' 11.01 8.81 4.1 4.2 Foreign liabilities 1.01 1.6 2.2 23 11.2 10.8 16.01 13.51 14.71 16.0 5.4 17.7110.2_6.0 5.1 57 Other liabilities 3.2 2.9 2.9 3.9 6.2 Forward gains/losses 0.0 0.0 -1.0 -1.7. -4.6_ -9.0 -0.7 -0.1 nil ni -0.' -0.2 0.0 0.0 0.0 0.0 Swap cover gains/losses 00 0.0 0.0 -8.0 -14.0 7.8ý 0.9 -0.5 -0.7 -0.8 -3.4 2.3 2.8 0.0 0.0 0.0 i47 Less:Dividends and Interest Rebates 5.01 8.8 Plus: Depreciation Expense 0.2 0.1 Overall CBP/BSP deficitI (-)/surplus 10 1.6 0.9 -7.5 -25 7 -15 2 -18 2 -107 -16.9 -20.9 -22.0 -20.6 -2 1.2 5.3 2.4 */ Estimates as of 9-27-95 Source: Bangko Sentral ng Pilipinas Commercial Banks 1 of 2 Summarized Consolidated Balance Sheets (million pesos) Assets and Liabilities of Commercial Banks In million pesos estimate* 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 19921 1993 1994 1995 Assets cash 2092 2123 2161 2918 2943 3372 4966 6083 55751 6703 83201 10694 13506 13477 15352 12993 check and other cash items 1197 1112 916 993 1153 1054 1169 642 322 508 1798 530 546 1692 784 701 due form Central Bank 7673- 9822 9206 16421 29783 33589 37078 38309t 46647 61567 744491 85835 876481 99839 106796 77058 due from banks 11600 12361 16532, 12040 22545 24392L 21838 26132 33082| 46706 59733 45082 53809 51734 69419 66525 loans and discounts 808031 94361 1067891 144432 138750 1306771 102125 1206831 1371911 158698 212245 231958 277297 383249 491947 563482 customer's liability for banker acceptances outstanding 11644 12926 12042 156051 13718 10095 8455 12498 17968 267171 30795 33500 36929 45572 49809 60330 claims on CB-BOL 1 19480 24814 27625 investments 14347 17439 23566 22564 32278 31424 34571 32141 44612 61413 71738 100862 114585 120066 1676661 184622 banking house, furniture & fixtures 3109 4225 4790 5368 6877 8691 6288 6515 7413 8790 14703 19827 24402 28381 35068 38986 other real and chattel properties 1141 1422 2298 3146 4065 11915 4916 4617 4760 3924 4528 4973 5853 9390 10509 10561 others 10884 15914 20565 32971 47113 41355 43230 39846 44742 45384 61399 65861 76524 91470 86656 95207 144489 171705 1988651 2458 222226 296564 264635 287465 342312 420410 53908, 522122 69109 84350 1058820 11B329W Loans Overdue 10157 13870 177661 17452 35050 30941 1386 16587 15274 143101 16747 18029 19917 20798 20017 22905 Liabilities and Net Worth Liabilities demand deposits 12895 14432 12081 19290 15458 14889 19808 22966 23555 29525 32607 38796 42587 54516 63608 70177 savings deposits 24249 28390 34501 42286 48476 58486 74249 84486 110039 136714 181070 211170 265973 359396 468810 484172 time deposits 37627 38832 48702 57457 73285 75280 52320 49457 65153 86152 97066 112666 118022 142887 160663 186806 due to banks 886 1596 1724 2143 1147 2509 2291 1495 2735 2035 2414 3074 -869 2999 4986 8024 officers' and managers' checks 1449 1493 1445 1750 2099 2387 1800 2496 2606 4309 4825 3850 5406 9765 5718 6729 bills payable 34466 46942 49840 68008 67673 71291 31592 33399 39498 47552 63554 68188 66988 69466 95001 96002 other liabilities 20447 24032 31266 42772 63288 46548 50327 57104 55924 66603 96338 85036 102030 118598 127679 137824 Subtotal 144490 155216 122955 233706 221426 221390 232382 251403 29951 372890 427874 522780 600117 257627 926465 2M NcLWorlh capital stock 8063 9868 11890 13742 14912 16806 14779 15408 16573 18784 22586 26410 30983 36781 48994 54716 surplus reserve and undivided profits 4408 6121 74161 9010 12889 8368 17469 20654 26229 28736 39248 49932 59979 69942 83361 93840 Subtotal 12411 I15M 19306 22 22801 25114 3224 3062 42802 42520 61834 26342 90962 10622I 1U35 148561 Commercial Banks 2 of 2 Summarized Consolidated Balance Sheets (million pesos) estimate* 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 19" 1992 1993 1994 1995 X Total Liabilities and Net Worth 156961 17105 198865 25f458 299212 296564 264635 287465 342312 42041 519108 599122 691092 864350 1058820 1138290 */ Jan-Jun 1995 Source: Bangko Sentral ng Pilipinas Liquid Assets (Low Estimate) 22562 25418 28815 32372 56424 62407 65051 71166 85626 115484 144300 142141 155509 186222 217165 185102 Total Deposits 74771 81654 95284 119033 137219 148655 146377 156909 198747 252391 310743 362632 426582 556799 693081 741155 Liquidity Ratio 0.30175 0.31129 0.3024 0.272 0.4112 0.4198 0.44441 0.45355 0.43083 0.45756 0.46437 0.39197 0.3645 0.33445 0.31333 0.249748028 Loans OD/Assets 0.0703 0.08078 0.0893 0.0681 0.1171 0.1043 0.0524 0.0577 0.04462 0.03404 0.03103 0.03009 0.0288 0.02406 0.01891 0.020122289 Net Loans OD/Assets I 1 0.05345 0.04252 0.03052 0.0256 0.02709 0.0265 0.0223 0.01782 0.018713157 Loans OD/Loans 0.1257 0.14699 0.1664 0.1208 0.2526 0.2368 0.13578 0.13744 0.11133 0.09017 0.0789 0.07773 0.0718 0.05427 0.04069 0.040649036 Adm. Expenses/Assets 0.01301 0.01295 0.0134 0.01336 0.01376 0.0134 0.01274 0.0122 0.00348066 Net Operating Income/(loss) 3333 5645 7964 12940 13295 12832 12493 15436 4984 Income/Capital 0.21632 0.34061 0.42398 0.57292 0.50341 0.4142 0.33966 0.31506 0.09108853 d[Capital] 1805 2022 1852 1170 1894 -2027 629 1165 2211 3802 3824 4573 5798 12213 5722 d[Capital]/Capital 0.18291 0.1701 0.1348 0.0785 0.1127 -0.1372 0.04082 0.0703 0.11771 0.16833 0.14479 0.1476 0.15764 0.24928 0.104576358 Income/Assets 0.01159 0.01649 0.01894 0.02398 0.02219 0.0186 0.01445 0.01458 0.004378498 Capital/Assets 0.0558 0.05747 0.0598 0.0536 0.0498 0.0567 0.05585 0.0536 0.04841 0.04468 0.04185 0.04408 0.0448 0.04255 0.04627 0.0480685941 Commercial Banks 59 Annex 4 Summarized Consolidated Income Statements (million pesos) 1987 1988 1989 1990 1991 1992 1993 1994 Jan-June 1995 Total Operating Income 241U 3262 46422 1D080 221MM Z 1=2 23254 91119 32&18 Interest Income 18086 25048 36967 53370 64296 54481 54786 73923 26702 Interbank loans receivable 526 753 1189 1516 1996 1994 1637 2541 760 Loans and discounts 11222 15675 22986 35337 41767 37316 38741 53472 20145 Investments 1624 1394 2332 3434 6764 4403 4452 6810 2299 Deposits in banks 2479 3652 4648 5350 4961 2387 2418 3164 1216 Due from CBP 1243 1709 2539 3957 4222 2390 2350 2129 450 Trading account securities 771 1471 2296 2595 3557 5605 4766 5045 1492 Others 221 394 977 1181 1029 386 422 762 340 Bank commissions 819 1069 1328 1569 1864 1972 2508 2666 821 Service charges/fees 695 9411 1167 1432 1772 2752 3435 4757 1360 Fees/commision-others 68 1071 141 108 202 346 383 456 115 Trading gain/(loss) 972 1525 1701 2624 2901 3118 2792 20091 540 Foreign exchange profit/(loss) 2327 2678 3720 92601 2560 4339 5146 2686 938 Gold trading gain/(loss) -17 9 -7 Income-trust department 440 511 605 809 1377 1702 1858 1671 440 Other income 785 736 807 908 2216 2786 2346 2951 1902 Total Operating Expenses 2Q842 26929 3465 5714 6M393 58664 60261 25683 22814 Interest expenses 10699 15186 23014 35404 40507 32697 29980 39975 15765 Deposits 7371 11558 18496 29692 33491 27604 25088 32657 13151 Borrowed funds 2576 3341 4045 4992 6233 4590 4506 6547 2281 Others 752 287 473 720 783 503 386 771 333 Finance charges 2 1 12 10 22 70 80 33 6 Compensation/fringe benefits 3533 4264 5384 6933 7950 8899 10582 12465 3829 Management & other professional fees 208 170 248 280 295 329 428 452 133 Supervision and examination fees 82 131 163 179 164 203 239 238 74 Fines, penalties and other charges i 14 15, 24 52 190 231 131 166 12 Taxes and licences 928 1377 1978 3127 3501 3540 3687 4004 1394 Insurance 222 245 306 404 519 602 1212 1483 474 Depreciation/amortization 606 761 983 1516 1826 2198 2888 3440 988 litigation/assets acquired expenses 115 96 75 111 166 285 297 3391 109 Bad debt expenses 307 645 157 202 19 101 99 1201 51 Other expenses 2904 3368 4641 5993 6933 7938 9617 11817 3395 Provisions 1222 720 1480 2929 1801 1571 1521 1151 1604 Net Oeratine Income/floss) 33M 5ddi 220 I12d6 129.1 12812 12491 1.41 41 Admin. Expenses 3741 4434 5632 7213 8245 9228 11010 12917 3962 Extraordinary Credit/(ChargesI 832 1422 IMW 2086 2411 24Q2 3342 42 L5 Recovery on charged-offassets 43 66 112 483 51 801 171 248 26 income from assets acquired 122 1351 177 120 162 213 259 424 92 Profits/(losses) from assets sold/exchanged 289 306 857 440 206 658 694 1889 473 Dividends-equity investments 100 35 5 8 289 107 300 421 21 Revaluation profits/(losses) 15 90 79 3521 -104 -402 624 227 282 Profits/(losses) on foreign exchange swap contract differential 32 42 75 280 -56 -117 53 Others 231 753 553 403 1863 1147 1246 1009 271 Net Income/(loss) Before Income Tax 41W, 2022 2822 15026 15206 15232 15840 19614 142 Provision for income tax 460 440 840 1681 1563 1067 1214 1854 456 Net Income/(loss) After Income Tax 3205 32 3282 13345 14143 14122 1A626 17800 5623 Source: SRSO. Banako Sentral na Pilipinas | 1 of I     IMAGING Report No: 15834 Type: PPAR