Colombia - Development Banking Project

Document of The World Bank FOR OFCIAL USE ONLY MICROFICHE COPY Report No. 10620-CC Type: (PCR) ANDERSON, / X31676 / T9111/ OEDD2 PROJECT COMPLETION REPORT COLOMBIA DEVELOPMENT BANKING PROJECT (LOAN 2477-CO) APRIL 30, 1992 Trade, Finance and Industry Division Country Department III Latin America and the Caribbean Region This document has a restricted distribution and may be used by recipients only in the performance of their ofricial duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit - Colombian Peso (Col$) Average Rate During Year of: 1984 US$1 = 100.8 Col$ 1985 US$1 = 142.3 Col$ 1986 US$1 = 194.3 Col$ 1987 US$1 = 242.6 Col$ 1988 US$1 - 299.2 Col$ 1989 US$1 = 375.1 Col$ 1990 US$1 = 502.3 Col$ GLOSSARY OF ABBREVIATIONS BR Central Bank of Colombia CDT - Term certificate of deposit CF = Private development bank DBP - Development Banking Project DTF - Average 90-day time deposit rate FRR - Financial rate of return IDB = Inter-American Development Bank NPA = Non-performing assets PCR = Project completion report PFI = Participating financial intermediary SAR = Staff appraisal report SB - Superintendency of Banks SW = Staff-weeks FISCAL YEAR OF THE GOVERNMENT OF COLOMBIA January 1 - December 31  FOR OMCIAL USE ONLY THE WORLD BANK Washington, D.C. 20433 U.S.A. OEf'ce of Directot-CGeirita Optaltios Evaluati<n April 30, 1992 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Project Completion Report on Colombia Develogment Bankin, Proiect (Loan 2477-CO) Attached, for information, is a copy of a report entitled "Project Completion Report on Colombia - Development Banking Project (Loan 2477-CO)" prepared by the Trade, Finance and Industry Division, Country Department III of the Latin America and the Caribbean Region, with Part II contributed by the Borrower. No audit of this project has been made by the Operations Evaluation Department at this time. Attachment 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.  FOR OFFICIAL USE ONLY PROJECT COMPLETION REPORT COLOMBIA DEVELOPMENT BANKING PROJECT (LOAN 2477-CO) TABLE OF CONTENTS PAGE NO. Evaluation Su..ary . . . . . . . . . . . . . . . . . . . . . . . . . i Part I BNINK REVIEW OF THE PROJECT 1 1.2 Project Identity . . . . . . . 1......... . 1 1.2 Background . . . . . . . . . . . . . . . . . . . . . . 1 1.3 Project Objective and Description . . . . . . . . . . 2 1.4 Project Design and Organization . . . . . . . . . . . 3 1.5 Project Implementation .. . . 4 1.6 Project Results and Sustainability . . . . . . . . . 6 1.7 Bank and BR Performance .. ....... .... 8 1.8 Conclusions . . . . . . . . . . . . . . . . . . . . 9 Table 1.1 Profile of All Subloans . . . . . . . . . . . . 11 Table 1.2 Profile of Subloan Sample Used in Ex Post Evaluation . . o . . . . . . . . . . 15 Table 1.3 Key Performance Indicators of CFs . . . . . . . 17 Part II BORROWER REVIEW OF THE PROJECT . . . . . . . . . . . . . . 21 2.1 Introduction . . . . . . . . . . . . . . . . . . . . . 21 2.2 Features of IBRD Development Banking Project Loan 2477 . . ......... . . . . . . 21 2.3 Types of Project Financed . . . . . . . . . . . . . 23 2.4 Intermediation of Resources . . . . . . . . . . . . . 24 2.5 Conclusions . . . . . . ... 30 PART III STATISTICAL DATA . . . .................. 33 Table 3.1 Related Bank Loans . . . a . . .. . . . . . . .. 33 Table 3.2 Project Timetable . . . . . . . . . . . . .. . 34 Table 3.3 Cumulative Estimated and Actual Disbursements . 35 Table 3.4 Project Costs and Financing . . . . . . . . . . 36 Table 3.5 Project Results . . . . . . . . *.... .. 37 Table 3.6 Status of Loan Covenants . . . . . . . . . . . . 38 Table 3.7 Use of Bank Resources . . . . . . . . . . . . . 39 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.  PROJECT COMPLETION REPORT COLOMBIA DEVELOPMENT BANKING PROJECT (LOAN 2477-CO) PREFACE This is a Project Completion Report (PCR) for the Development Banking Project (DBP) in Colombia for which Loan 2477-CO of US$90.0 million was approved by the Executive Directors on November 6, 1984. US$84.7 million was disbursed by the original closing date of June 30, 1990 and the remainder of the loan cancelled upon the closing of the loan account in October 1990. US$14.4 million had been repaid as at April 30, 1991 by the Borrower, the Colombian Central Bank (Banco de la Republica, or BR). The PCR was prepared by the Trade, Finance and Industry Division of Country Department III of the Latin America and Caribbean Region. BR has submitted its own assessment of the Project, which has been translated from Spanish to English by the Bank, which is presented as Part II of this Report. The PCR was compiled on the basis of information available in the LAC Info' ation Center, the Staff Appraisal Report, reports produced by BR and the Project's participating financial intermediaries (PPIs), a report of a consultant engaged by the Bank whose selection and terms of reference were agreed upon with BR, correspondence with the Bank, and staff Supervision Reports.  - lii - PROJECT COMPLETION REPORT COLOMBIA DEVELOPMENT BANKING PROJECT (LOAN 2477-CO) EVALUATION SUNMARY Proiect ObJectives and Description 1. The Development Banking Project (DBP) was prepared in late 1983 following an era of marginal industrial growth and reversals in the comprehensive financial sector reform undertaken in the mid-1970s. Bank support for Colombian industry up to that time had consisted of three enterprise-specific operations, three credit lines for smaller scale industrial development, and eight credit lines for larger scale industry. The operations for larger scale industry had utilized eight relatively well performing local development banks (CFe) as participating financial intermediaries (PFIs). It had also focused successfully upon encouraging their institutional development and fostering the capacity of the borrower, the Central Bank of Colombia (BR), to progressively take over the oversight of 6 subproject appraisal and supervision functions. The DBP marked an opportunity in the Bank's eyes to increasingly address broader financial sector issues (paras. 1-3). 2. The DBP loan was made as part of the Bank's strategy to support the Government's own efforts to reform and strengthen the financial system. Its 4mmediate objectives were to (a) make available to PFIs longer term financing for subloans and equity participations to support industrial investments; and (b) strengthen through technical assistance the institutions implementing financial sector reforms. The credit component of the Project was supported by US$89.8 million of the US$90 million Bank lo&n (the remainder covered the capitalized front-end fee of the loan) and was paralleled by an IDB loan of an identical amount. All CFs were eligible to become PFIs, provided that each met one of two groups of criteria. The interest rates to PFIs were substantially free of subsidies, though the 3-4 percentage point fixed spreads were markedly below those for commercial market operations. The financing of technology development, pollution control, technical assistance and equity investments was encouraged via special maturities, grace periods and foreign exchange risk arrangements for subloans. BR and PFI staff were to receive training under the Project-s technical assistance component, financed by BR and the Government, in the promotion and evaluation of investments projects, project supervision and term transformation control. The Superintendency of Banks (SB) was to impro're its information monitoring systems, inspection and analyses of financial institutions (paras. 4-7).  - iv - Implementation and Results 3. The loan was signed and made effective within four months of Board presentation and disbursed by the original loan Closing Date. The loan supported 195 sublcans for 150 subprojects undertaken b-y 147 enterprises (a number of subprojects had a syndication of two or more subloans). Loan proceeds were devoted almost entirely to covering the foreign exchange requirements of fixed assets and represented about 17Z of the Project's total investment cost. Enterprises themselves contributed an average of 34Z of total cost, while parallel directed credit of BR su?ported 30% and PFIs met 192 of total costs. Eight CFs acted as PI'Is for the Project, of which three ac^ounted for nearly two- thirds of the volume (paras. 15-16). 4. About one-half of the Bank's loan volume went to larger Colombian enterprises with total assets exceeding US$2.5 million, and about three-quarters of the loan volume went to enterprises involved in chemical products, printing and publishing, textiles and agroindustry. Subprojects for technology development, pollution control and equity participations totaled about 1.3Z of loan volume, substantially below appraisal estimates of 201 for these purposes. Though some 23 subprojects (12S of the total) represented the creation of new enterprises, this is likely (data is incomplete) to be substantially below appraisal estimates of the 35-40% for new enterprise creation and product line innovation (para. 21). 5. An ex post analysis of a sample of subloans (23% of the total Bank loan) suggested that about two thirds of the subprojects aimed to increase production capacity and achieved increases of 60Z-1001. This was a substantially higher number of subprojects than suggested by survey data at appraisal (201- 251), and probably reflects expectations by PFIs that, as for domestic directed credit, BR accorded a first priority to subloans financing capacity expansion over those increasing the efficiency of existing capacity. Still, most subprojects had an element of technical change with the purchase of new equipment and efficiency increases were detected in most cases. The aggregate average revised financial rate of return amounted to 17.5% against original expectations of 22.51, substantially in line with appraisal estimates. Employment generated by the subproject sample was equivalent to 12.3% of those employed at subproject appraisal (paras. 22-24). 6. Over 1987-89, the SB gradually strengthened prudential regulations and its enforcement capacity, though no indication was found that this was directly a part of the Project-related program. As urged by the Bank's sector work, a decree was adopted to help eliminate the major gap in performance between CFs traditionally acting as PFIs in Bank loans and other CFs. The SB established unified accounting standards for financial institutions and criteria and procedures for portfolio assessment and classification. These steps as well as the reinforcement of SB personnel and equipment substantially improved the transparency of financial sector information and improved the accuracy of indicators of its liquidity, solvency, efficiency and portfolio risk. Over 1985- 89, nearly all CF. increased their capital substantially in real terms so as to return debt:equity ratios to sound levels, increased profitability above pre- recession levels, and markedly reduced non-performing assets. This was due  - v - generally to a combination of strong gtowth in aggregate demand stemming from gcod macroeconomic management, deliberate efforto to mobilize more equity capital and work out non-performing assets (NPA), and higher finaocial margins on longer-term capital intermediation. By 1990, all 16 CFO had also met the eligibility criteria established by the Government in 1987 (paras. 25-28). 7. All but one CF substantially maintained the Project's PFI eligibility criteria, and BR and the Government were in substantial compliance with the covenants in the Loan and Guarantee Agreements. Overall Project supervision by BR was of good quality. BR performed well its responsibilities for the verification of expenditures, procurement and reporting. However, several of its practices reduced ito effectiveness. These mainly involved its performance of ex post appraisals of subprojects within PFI free limits, which led PIls to delay disbursements some 50-60 days to ensure that approved subloan rediscounts were not canceled ex post by SR. Further delay and friction occurred bstween BR and PFIo over terms of subloans, as the former souSht to expedite repayment of funds while the latter aimed to accommodate client concerns (paras. 17-21). Findinas and Lessons 8. The DBP met most of its immediate objectives on foreseen in the provision of longer-term credit to :arge scale Colombian industry, reinforcement of financial sector reforms associated with CFs and enhancement of supervision capabilities. The Project departed from those preceeding by helping to implant the use of variable rates for lending operations, an important early stop to facilitate term transformation, the development of a longer-term capital market and sustainable term financing. These changes have proven to be central to the financial sector and durable. Its supervision of PFIs was al;o good, though it could have been improved by helping to correct some of BR's costly practices. As is now the case with subsequent Bank operations, DBP implementation by BR would have bonefitted from greater decentralization of subloan appraisal ond approval to PFIs through higher free lflmits, simplification of directed credit regulations, and increased ex post monitoring (paras. 28-30). 9. The Project's design was generally well geared to its objectives. However, ad in proceding Bank loans, its mechanisms to encourage now PFI entry of CPs operating in the short-term market, reduced credit concentration in large scale firms, technology development, pollution control and equity financing were ineffective and unrealistic in the absence of an appropriate enabling environment. It was also unable to influence the oligopolistic control of five CFo over this segment of the financial market and the high coscentration of their portfolios in associated enterprise lntersets (paras. 8-14). 10. In Colombia's highly trade-protected environment of the 1980s, it is most unlikely that the investments financed under the Project reconfigured enterprise so as to be internationally competitive. As the sample evaluation indicates, however, it is likely to have reduced the competitiveness gap which firms must now overcome following the substantial acceleration of trade reforms undertaken by Colombia in 1990. It also helped to create the basis for the change in focus of the financial reform process, which was articulated at about  _ vi - the same time as the trade reform, from improvements in prudential regulations and the financial condition of instiltions to inc'easing the competitiveness and efficiency of the sector (para. 32). 11. In this sense, the DBP was an important transitional forerunner to the Bank's subsequent loan, approved in May 1991, to support industrial restructuring Und development. This operation helped to foster and is predicated upon these broader refcrus in the real and financial sectors. The breadth of the Government's current financial sector reform program offers real hope of reducing institutional concentration, which Bank credit line projects up through the DBP implicitly supported, and of establishing l _ term capital market mechanisms (para. 33).  PROJECT COMPLETION REPORT COLOMBIA DEVELOPMENT BANKING PROJECT (LOAN 2477-CO) PART Is PANK REVIEW OF THE PROJECT 1.1 Proiect Identity Project Name: Development Banking Report Loan Number t 2477-CO Loan Amount t US$90.0 million equivalent RVP Unit s Trade, Finance and Industry Operations Latin America and the Caribbean Region Country : Republic of Colombia Subsector s Finance and Industry 1.2 Background 1. The Development Banking Project (DBP) was prepared in late 1983 and early 1984 following four years of marginal growth in Colombia's industrial output and declining exports. This performance was due ostensibly to weak domestic and international demand, an overvalued Peso, increased quota restrictions and tariff rates, and competition from contraband. However, over the longer run, manufacturing was also characterized by volatile growth, a relatively independent regional market structure, an unusually prominent consumer goods industry, and declining labor absorption as (largely export-oriented) labor-intensive production fell in relation to that of (largely domestic-market oriented) capital intensive industries. 2. T'he decline in investment which had accompanied the retu2n to a highly protected market 1eft many facilities obsolete. Project preparation work thus identified a critical need to modernize the industrial base in orier to reduce product cost and improve quality. Yet, a number of major issues untercut the financia3 sector's ability to support this modernization. In particular, a comprehens4!.-i financial sector liberalization in 1974 had been largely reversed in an effort to contain strong inflationary pressures by the imposition of restrictive interest rate ceilings, renewed emphasis on forced investments and selective credit allocation. In addition, the Colombian development banking system (Corporacion Financieras, or CFs), which had been established in the early 1960s by commercial banks to provide medium- and long-term debt and equity financing to private productive firms primarily in the industrial sector, was operating mainly in the short-term market or in longer-term funds rediscounted by the Colombian Central Bank (Banco de la Republica, or BR). 3. Enterprise-specific Bank support to Colombian industry up to 1984 was associated mainly with steel and nickel exploitation enterprises and an export processing zone. The Bank had providti three credit lines totaling US$52.5 million to BR through the Corporacion Financiera Popular to finance small and  -2- medium scale enterprises. It had also made eight credit lines totaling US$493 million to R since 1966, which on-lent the funds to qualifying CFs designed to encourage efficient, productive invesments of large scale industry. Eight of the 16 private sector CFs in Colombia had acted as participating financial intermediaries (PIsl) under most of these loans. These loans had focused successfully upon both assisting the institutional development of the CFO and fostering the capacity within BR to progressively take over the subproject appraisal and supervision functions of the Bank. It was felt during Project preparation that this was a turning point which enabled the Bank to increasingly address broader financial sector issues. 1.3 Prolect Obiactives and Descriltion 4. The DBP loan was made as part of the Bank's strategy to support the Government's own efforts to reform and strengthen the financial system. Its immediate objectives were to: (a; make available to PFIs medium-term financing for subloans and equity participations to support efficient investments in the manufacturing, agro-industrial, tourism and mining sectors; and (b) strengthen through the provision of technical assistance the institutions implementing financial sector reforms in developing long-term credit market mechanisms, operating the variable interest rate system and enhancing banking sulpervisory capabilities. s. The credit component of the Project was supported by US$89.8 million of the US$90 million Bank loan (the remainder covered the capitalized front-end fee of the loan) and was paralleled by an IDB loan of an identical amount. The loan was to finance the estimated foreign exchange cost of fixed assets, permanent working capital and technical assistance services required by industries. No enterprise or investment was to receive subloans of more than US$5 million equivalent (US$3 million as equity), in order to help reduce the concentration of credit in the largest enterprises. 6. All CFa were eligible to become PFIs provided that each met one of two groups of criteria, namely that a CF's (a) total debs:equity ratio did not exceed 10:1 (both Groups A and B), (b) minimum equity capital was at least Col$500 million (Group A) or Col$300 million (initially for G>ap B), and (c) meodir- and long-term loans plus equity investments were not less than 552 of tota. assets (Group A) or 30Z (initially for Group B). For Group B PlIs, Bank loan commitments were not to exceed the lower of two times its equity or US$10 million. The interest rate on US Dollar-denominated subloans to enterprises was set at the London Interbank Offering Rate (LIBOR) on 180-day deposits plus 2.5 perce3tage points and peso-denominated loans bore a floating rate of the certificate of deposit (CDT) plus 3 percentage points, approximating a prime rate equivalent. Spreads to PeIs were 3 percentage points for the former and 4 percentage points for the latter. Enterprises had the option to denominate the fi;:st US$0.5 million equivalent in Pesos or US Dollars, with any excess required to be in US Dollars. An exception to this was made for subloans to finance technology development, pollution control, technical assistance and equity  -3- investments, for which up to US$2 millior. equivalent could be in Pesos. This was expected to result in a relatively higher proportion of Peso financing going to smaller firms, though the total was not expected to exceed 50% of the total loan. 7. Under the technical assistance program, BR and PFI staff were to receive training in the promotion and evaluation of investment projects, project supervision and term transformation control. The Superintendency of Banks (SB) was to improve its information monitoring systems, inspection and analyses of financial institutions. BR and tha Government were to finance their respective parts of the program and a detailed action program was to be presented for Bank comment within 6 months of loan signing and implemented promptly (.hereafter. 1.4 Proiect Design and Organization 8. From available information, the Project's design appears to have beer, well understood and accepted by those primarily concerned, namely BR and the PFIs. This Was due undnubtedly to experi.ence acquired from the substantial number of previous credit line projects involving these entities, the Bank financial sector work completed in 1983. as well as to the Colombian and Bank staff time invested prior to Project start-up (79.7 Bank staff weeks (sw) through Project appraisal and 9.4 sw thereafter through Board approval). 9. The Project's design was generally well geared to its objectives. The Bank made a substantial effort in collaboration with the Colombian financial authorities prior to making the DBP loan to address the financial sector constraints to real sector development in its 1983 sector report. The most positive aspects of Project design were derived from some of the key recommendations related to CFs participation in the Project made by this work. Most importantly, it based subloan interest rates on the newly created certificate of deposit floating rate indicator (the CDT rate) as a means of linking rates to the marginal cost of funds and promoting a suitable term transformation instrument to help encourage longer-term financial markets. To further increase profitability and improve overall financial condition, it included increased spreads or the subloans under the Bank's loan and the PFI eligibility criteria outlined in para 7 above. 10. The Bank had also prepared a set of broader recommendations for financial sector reform aimed to improve resource allocation and develop capital markets, though these were not included in the DBP. In particular, it proposed the progressive liberalization of interest rates, the elimination of other restrictions such as forced investments, lower exposure limits on loans to one firm or group, restraints on interlocking elr ectorates between financial and resl sector firms, and greater clarity in the roles of different kinds of financial institutions. It further urged tax reforms to eliminate biases against equity financing, exemption of CFs from forced investment requirements and new requirements forcing all CF. to adopt minimum capital structure standards. While substantial changes were eventually made in tax regulations, exposure limits, intersectoral ownership and CF capital structure requirements, action on most other fundamental reform steps was deferred.  - 4 - II. The Government agreed to include in the DBP those adjustments which were closely associated with and justifed by the immediate Project objective of ensuring the provision of credit to industry by CFs. This Government policy has been consistent with respect to Bank loans involving the financial sector and it is unlikely, even had today's strong tradition of sector adjustment lending been as strong when the loan was made, that the Bank would have been able to Incorporate broader reforms. Recent agreement between the Bank and the Government on it medium-term financial reform program, upon which a series of Bank loans depend, is likely to be a more viable approach. 12. Several mechanisms in the Project's design sought to achieve results which, in reality, could not be brought about by the Project preparation work undertaken and credit program regulations alone. The establishment of a Group B eligiblity category to encourage smaller CF. operating predominently in the short-term market to move increasingly to the longer-term market was a creative step failing the adoption by the Government of across-the-board capital structure standards for CFs. However, CF. which were not already members of the "World Bank club" (Colombian terminology) were not adequately motivated to do so. This was most probably aue both to the weakened condition of many financial institutions in the wake of the recessionary years of the early 1980s and to the fact that profitability in short-term instruments at commercial rates still exceeded the fixed margins under the Project. 13. Technology (not explicitly defined in Project documentation) and pollution control subprojects, as well as equity and technical assistance fLnancing, were accorded incentives under the Project like extended maturity and grace periods and higher ceilings for peso financing. Skeletal checklists were also provided as guides to examining such subprojects. It is instructive, however, that almost no subproject with these designations were financed by the loan. Clearly, the more fundamental enabling conditions which would drive demand for such financing were lacking, as was the sense of proportionality of what results could reasonably be expected from these very modest incentives. 14. In addition, subloan ceilings were established with the apparent intention of limiting credit access to larger firms. While the concentration of loan proceeds in larger firms may have been reduced, it did not slow the overall concentration accorded to them by the Colombia's financial markets. Similarly, the use of a maximum subloan limit to handle foreign exchange risk, which was intended to address the perceived greater reluctance of smaller enterprises to accept such obligations, is not likely to have increased materially the access of smaller enterprises to term financing. In fact, it probably acted more to motivate enterprises to reduce subproject and/or subloan size in order to qualify for peso financing. 1.5 Project Implementation 15. The loan was signed on November 27, 1984, within one month of Board approval, and made effective three months later. As per one of the two Project risks identified in the SAR, loan commitments were made at a pace slower than expected because of the major stabilization program undertaken by the Government in 1985 and to the priority given by BR to the IDB loan already in place. The  Commitment Closing Date was consequently extended from December 1986 to December 1988. However, strong aggregate demand over most of 1986-88 accelerated commitments and the loan was fully disbursed by the original Closing Date of June 30, 1990. While US$89.3 million of the loan was committed, US$84.6 million was actually disbursed due to cancellations of previous subloan commitments. 16. The loan supported 195 subloans for 150 subprojects undertaken by 147 enterprises (a number of subprojects had a syndication of two or more subloans), which was consistent with appraisal estimates of 100-150 subprojects. The average subloan was US$479,000 equivalent, with its proceeds devoted almost entirely to covering the foreign exchange requirements of fixed assets. The Bank's loan represented about 172 of the Project's total investment cost. Enterprises themselves contributed an average of 34% of total cost, while parallel directed credit of BR supported 301 and PFIs met 19Z of total costs. About 761 of these subloans were peso-denominated and represented 491 of the loan volume, as estimated at appraisal. Eight CFs acted as PFIs for the Project, of which three accounted for nearly two-thirds of the volume: CF del Valle (26.2%), CF Colombiana (21.52), and CF Nacional (14.4%). The PFIs were responsible for the preparation, appraisal and supervision of subprojects. 17. BR, through its Department of Industrial Credit, was responsible for the overall supervision of PFIs. In general, the procedures used by BR corresponded to those required by the Loan Agreement. Appraisal and supervision procedures were thorough and of good quality, and PFIs repected the professional quality of BR staff. BR performed well tne verification of expenditures and fulfilled its responsibilities of closely monitoring items financed by the Bank loan and ensuring that they were reasonably priced and appropriate for their intended use. Reporting and monitoring procedures were also adequate, though they could have been improved with more decentralized computer systems to provide more specific data on subloans. BR and the Government were in substantial compliance with the covenants in the Loan and Guarantee Agreements. All CF. met the Project's standards for minimum equity, debt:equity and the specialization ratios excepting CF Occidente, which was made ineligible as it fell short of the debt:equity ratio ceiling. 18. Several BR practices, however, reduced its effectiveness as the second-tier credit management institution. BR applied procedures similar to those utilized for domestic directed credit lines it managed which, given the subsidies involved, implied substantial ex ante controls over expenditures of "scarce" resources. Consequently, although the loan established a free limit between the PFI and BR of US$250,000 equivalent, all subprojects under the free limit were appraised by BR on an ex Dost basis. Since PFIs wished to avoid ex post cancellation of rediscounts, they delayed disbursements until subprojects had been approved by BR. This process took an average of 50-60 days, substantially slowing the process, Further delay and friction occurred between BR and PFIs over terms of subloans. Whereas the PFI aimed foremost to meet clients' business concerns, BR aimed mainly to ensure control over and to expedite the repayment of funds. In addition, many cancellations of subloans were apparently due to the substantial formal exchanges of correspondence required when changes were necessary in suppliers and/or to minor adjustments made in equipment specifications.  -6- 19. The Project provided for subloan free limits of US$3 million of Group A PFIs and US$750,000 of Group B PFlI, and an equity free limit of US$650,000. The Bank actually reviewed ex ante 16 subprojects (excluding 13 additional requests for increases) accounting for 22% of loan volume, which was comparable to appraisal estimates. Ex ante review of subprojects above the free limit averaged an estimated 2.1 sw per year and the processing of subprojects within the free limit averaged 0.75 sw per year (including increases and cancellations) of the responsible division in the Projects Department (now LA3TF) during the loan commltment period. Annual loan supervision work by the Bank averaged a reasonable 13.5 sw and was focused, particularly in the early years of implementation, on monitoring the financial performance of PFIs and encouraging steps to reduce portfolio arrears. 20. Regarding the technical assistance component, BR provided training on supervision policies and procedures and the SB undertook a substantial upgrading program. However, there was no record found in the preparation of this Report of a submission by BR or the SB of an explicit Project-related technical assistance program, nor of Project-related resources explicitly being associated with these improvements. 1.6 Proiect Results and Sustainabilitv 21. Investment. As expected, about one-half of the Bank's loan volume went to large Colombian enterprises with total assets exceeding US$2.5 million (Table 1.1). About three-quarters of the loan volume went to enterprises involved in chemical products, printing and publishing, textiles and agroindustry. The geographical distribution of the loan was consistent with the rather high concentration of industrial value added in Colombia's three principal cities. Subprojects for technology development and pollution control (4 totaling US$0.5 million) and equity participations (1 totaling US$0.7 million) totalled about 1.3Z of loan volume, substantially below appraisal estimates of 20Z combined for these purposes. Overall, 23 subprojects (12% of the total) represented the creation of new enterprises, which is likely to be substantially below the expectation at appraisal that 35-401 would involve new product lines and/or new enterprises L . Only 2 of the 61 subprojects with subloans exceeding US$2.5 million represented the creation of new firms, while 13 new enterprises were created among the 32 subloans in the smallest subloan category of less than US$420,000 equivalent. 22. A detailed financial analysis was conducted on a sample of 15 subprojects, accounting for about 81 of the total number and 231 of the total volume of Bank subloans (Table 1.2). The average subloan size of the sample was US$1.4 million equivalent, markedly above the Project average and reflective of the larger, more sohisticated subprojects financed under the Project. Data for this analysis was provided primarily by BR and PFIs as part of their normal supervision work and by enterprise interviews. In many cases, readily available information was related to the enterprises and not to the individual subprojects. 1 / The number of new product lines was not, however, among the subproject data generated during the Project.  - 7 - The quality of information and the reliability of the resulting performance indicators are further reduced by other factors, such as differing financial statements for tax and operating purposes, inadequate statement detail, transfer pricing between affiliates, and informal sales of some smaller firms. 2 23. Keeping this in mind, the subproject sample reflected delays in subproject execution in 11 of 15 cases, with the average delay being 7.1 months. As a result, cost overruns were frequent. About 67% of the number of subprojects aimed to increase production capacity and achieved increases of 60Z-100. This was a substantially higher number of subprojects than suggested by survey data at appraisal (20%-25%), and probably reflects BR's traditional policy whereby directed credit should be accorded for capacity expansion before increased efficiency of existing capacity. Only 4 subprojects in the sample sought primarily to increase efficiency through changes in the mix of production inputs and technology. Still, most subprojects had an element of technical change with the purchase of new equipment and and efficiency increases were detected in 10 of 15 cases. 24. The average revised financial rate of return (FRR) (excluding two cases in which subproject implementation was not complete and two others in which data could not be obtained) amounted to 17.5% against an original expectation of 22.5%. This is substantially in line with appraisal estimates of a range of 152- 30%. All but three revised FRRs exceeded the 11% subproject appraisal threshold and the overall range was -25.52 to 46.5%. In all 15 cases, debt service was being paid as agreed. Actual employment generated by the subproject sample, while varying substantially for each subproject, totaled 1,177 jobs. This is equivalent to 12.3% of those employed at subproject appraisal. The resulting average investment cost per job was a high US$181,000, reflecting the fact that about two-thirds of the sample subloan volume was devoted to moderate to highly capital intensive subsectors. 25. Policy and Institutional Changes. The Project's technical assistance program was expected fundamentally to help improve the performance of the SB, BR and PFIs and to promote the availability of domestic resources on a longer-term basis. Over 1987-89, the SB gradually strengthened prudential regulations and its enforcement capacity. As urged by the Bank in its earlier sector work, Decree 2041/87 was adopted to help eliminate the major gap in performance between CFs traditionally acting as PFIs in Bank loans and other CF.. It basically asserted that all CF. would be required by 1988-90 to meet the eligibility criteria established under the DBP if they wished to maintain their operations. This was aimed to help increase solvency through capitalization programs and profitability via diversification of CF markets and financial services. The Decree authorized CFs to finance leasing companies and to develop activities such as factoring, underwriting, and financial restructuring advisory services. The SB established unified accounting standards for financial institutions and 2 / In the absence of some data, the following main assumptions were made: (a) the marginal profitability of the enterprise was assumed to be representative of the subproject's profitability; and (b) total investment cost per job was computed by dividing the incremental assets by the incremental number of employees.  - 8 - criteria and procedures for portfolio assessment and classification. These steps as well as the reinforcement of SB personnel and equipment substantially improved the transparency of financial sector information and improved the accuracy of indicators of its liquidity, solvency, efficiency and portfolio risk. 26. Over the first half of the 1980s, capital among the 16 private CFs fell in real terms modestly and debt/equity rose in the aggregate from 6.9 to 9.0 (7.8 for DBP PFIs) (Table 1.3). In contrast, this indicator for the whole banking system rose from 10.1 to 42.31 Profitability also deteriorated as net profits/paid-in capital plus legal reserves fell from an average of 24.1Z in 1981 (29.6Z for PFIs) to -44.21 (15.71 for PFIs). The relatively high quality of lending work of the CF. was also evident in the modest rise in portfolio arrears over this period, with non-performing assets (NPA)/total portfolio rising from an average of 1.22 (1.3Z for PFIs) to 6.9Z (5.41 for PFIs)---it reached 381Z for the banking system overall. 27. By 1989, nearly all CFs had increased their capital substantially in real terms, with the total nearly doubling. The debt:equity ratio fell steadily to an average of 7.9 (7.4 for PFIs) and profits rose substantially above pre- recession levels to an average of 45.62 of paid-in capital plus legal reserves (47.8Z for PFIle). This was aided by a fall in NPA to an average of 0.5Z of total portfolio at the end of 1989, with only 3 CF. having arrears which exceeded 3Z. Overall, this was due to a combination of strong growth in aggregate demand stemming from good macroeconomic management, deliberate efforts to increase equity capital mobilization and work out NPA, and increases in financial margins on the intermediation of longer-term capital. Those CFs acting as Project PFIs also managed to perform better than the remainder of the financial system in mobilizing certificates of deposit, as its share of total CDTs increased over 1985-89 from 7.0Z to 17.91 of this market. And by 1990, all 16 CF. had met the eligibility criteria established by the Government in 1987 under Resolution 2041. 28. Despite this impressive performance, certain problems remained at the close of the Project. One such issue (also pertaining to the whole financial sector) was the concentration of five CFs in development banking activity and the difficulty of attracting new entrants into the longer-term market. Despite efforts to ease entry criteria under the DBP (Group B), only one new CF (Progreso) joined the Project's PFIs (in Group A), the first new entrant since the number of PIle increase from 5 to 8 in the early 1970s. A related problem involved the ob1jectives and composition of the investment portfolio of the CFs, which is higl.ly concentrated in related enterprises. A review of a sample of investments suggests few cases of the provision of risk capital, support of new enterprises or substantial turnover in holdings. Individually, PIs committed at least 601 of proceeds of the Bank's DBP loan to no more than three industrial subsectors at the 3-digit International Standard Industrial Code level (Table 1.4). 1.7 Bank and BR Performance 29. The Bank's performance was strongest in its ability to use the DBP to establish or solidify fundamental sector policy and institutional changes (variable interest rates and capital structure criteria). These changes have  - 9 - proven to be central to the financial sector and sustainable. The Bank'e appraisal estimates of the character and results of the credit program itself also proved to be quite accuarate, though its expectations were exaggerated about the DBP's impact on technology, pollution control and equity financing. Its supervision of PFIs was appropriate and constructive. However, better project preparation and supervision work could have been done with BR on its management of the credit program in order to help correct some of the cumbersome procedures which increased aubloan processing delays and costs. Also, the technical assistance program should have been better defined prior to loan negotiations if it was indeed the priority reflected in loan documentation. 30. As in prior projects, BR was diligent in implementing the agreed credit regulations under the Bank's loan. It performed the credit allocation function within the Project's rules in relatively neutral way and ensured adherence to procurement, accounting and auditing and reporting requirements. However, BR should have adopted for the DBP many of the measures employed in later years (particularly since 1990) to decentralize ex ante work to PFIs and concentrate more on the monitoring of PFI performance. Higher free limits, simplification of directed credit regulations and an increased ex post orientation toward documents review would have permitted more attention to activities more approrpriate to a second-tier organization such as monitoring the financial performance of PFIs, early detection of potential repayment problems and measurement of impact of different types of subprojects. Performance indicators also should have been more subproject- rather than enterprise-specific for this purpose, to help enable BR to provide feedback to various policymakers. 1.8 Conclusions 31. The DBP met most of its immediate objectives as foreseen in the provision of longer-term credit to large scale Colombian industry, reinforcement of financial sector reforms associated with CFs and enhancement of banking supervisory capabilities. The ex post analysis of a sample of subprojects suggests that satisfactory returns were generally achieved from the investments financed. In addition, the Bank's sector work underpinning the Project contributed to broader financial sector reform steps which were taken in parallel with Project implementation. 32. The Project can bt judged as successfully contributing to industrial and financial sector development in an environment of slow but progressive policy and institutional change. In Colombia's highly trade protected environment of the 1980s, it is most unlikely that the investments financed under the Project configured enterprises to be internationally competitive. As the sample evaluation indicates, however, it is likely to have reduced the competitiveness gap which firms must now overcome following the substantial acceleration of trade reforms undertaken in Colombia in 1990. It also helped to create the basis for the fundamental change in focus of the financial reform process, which was also articulated in 1990, from improvements in prudential regulations and the financial condition of institutions to increasing competitiveness and efficiency of the sector.  - 10 - 33. In this sense, the DBP was an important transitional forerunner to the Bank's subsequent loan, approved in May 1991, to support industrial restucturing and development. This operation helped to foster and is predicated upon these broader reforms in both the real and financial sectors. It is now more reasonable to expect that those investments undertaken and financed by this loan will yield contributions sustainable in a relatively open international market environment. The breadth of the current financial sector reform program also offers real hope of reducing institutional concentration, which Bank credit line projects up through the DBP implicitly supported '/and that longer-term capital market mechanisms will develop. 3 / Under the Industrial Restructuring and Development Project loan, all CPs and commercial banks meeting broad eligibility criteria can become PFIe.  TABLE 1. 1 Page 1 of 4 Colombia Develomaent Banking Pro'fect Profile of all Subloans Lending by Type of Project (USS 000) Ordinary Equity Technological Total Peso USS Investment Dovelopment/ Denominatad Denominated Pollution W/O Risk with Risk Control 1985 Number Approved 1 1 2 Valus Approved 500 71 571 1986 Number Approved 34 17 3 54 Value Approved 12,591 22,144 485 35,220 1987 Number Approvad 51 12 1 64 Value Approved 14,830 8,222 700 23,752 1988 Number Approved 55 14 1 70 Value Approved 17,315 13,281 48 30,644 1989 Number Approved 4 1 5 Value Approved 1,358 707 2,065 TOTAL Number Approved 145 45 1 4 195 Value Approved 46,594 44,425 700 533 , 92,252 Source: LAC Files; Banco de la Republica.  - 12 - TABLE 1.1 Page 2 of 4 No. Projects No. as % of Total Value as C of Total LendLng by Financlal Intermediary CF ColombLana 42 21.54% 19.77% CF de Caldas 18 9.23% 9.09% CF de Santander 20 10.26% 10.74% CF Progreso 2 1.03% 0.35% CF del Norte 26 13.33% 15.00% CF del Valle S1 26.15% 28.63% CF Suramericcana 8 4.10% 2.66% CF NacLonal 28 14.36% 13.75% TOTAL 195 100.00% 100.00% Lending by Location AntLoquLn 31 15.90% 14.90% Atlantico 13 6.67% 9.68% Bogota 60 30.77% 22.13% BolLvar 11 S.64% 11.33% layaca 2 1.03% 1.11% Caldas 9 4.62% 3:52% Casanare 2 1.03% 0.66% Cesar 7 3.59% 2.70% Cordoba 2 1.03% 2.07% Cundlanamarca 11 5.64% 9.37% Magadalena 1 0.51% 0.06% RLsaralda 4 2.05% 1.92% Santander 12 6.15% 5.52% Tolima 1 0.51% 0.25% Valle dol Cauca 29 14.87% 14.78% TOTAL 195 100.00% 100.00% Lending by Economlc Sectog 13 FLshLng 3 1.54% 1.12% 31 Food, Beverages, Tobacco 37 18.97% 15.82% 32 TextLles, Leather 37 18.97% 16.74% 33 Wood Products 2 1.03% S.17% 34 Paper, Printing 32 16.41% 16.34% 35 ChemLcals, petroleum 43 22.05% 25.00% 36 Nonmetal Mlnerals 16 8.21% 9.22% 37 Baslc Metals 6 3.08% 5.18% 38 Metal Products, Machlnery is 7.69% 4.66% 39 Other Manufacturing 4 2.05% 0.76% TOTAL 195 100.00% 100.00% Sources LAC Fil-ee Banco de la RepublLca.  13 - TABLE 1.1 Page 3 of 4 Lending According to Subloan and Enterprise Size (US$ Equivalent) 1/ Lending According to Subproject Value Existing New Subloans between: I Loans Value as Z of Total Firms Firms Less than 82,600 58 7.54% 55 3 82,600 to 165,300 62 20.27Z 55 7 165,300 to 330,600 59 34.64% 50 9 330,600 to 1,900,000 16 37.55Z 12 4 TOTAL 195 100.002 172 23 Lending according to Enterprise Size (Assets): Assets Between: 3,300 to 420,000 45 14.892 32 13 420,000 to 1,300,000 50 14.32Z 46 4 1,300,000 to 2,500,000 37 18.172 33 4 2,500,000 to 7,500,000 46 29.48Z 44 2 7,500,000 to 36,000,000 17 23.14% 17 -O TOTAL 195 100.00% 172 23 1/ US$ equivalent figures vera computed at current exchange rates ($60511 US$). Source: LAC Files; Banco de la Republica.  Lending By Economic Sector Ceographic Distribution of Subprojects Loans 1857 and 2477 Loans 1857 and 2477 KI. x *n s~~~~~~~~~~~~~~~~~~~~~~~I Sam 30 x 25 1 ' 4 . 5 inKmI U?U3 inmN ft 0- m3W 0*  - 15 - TABLE 1. 2 Page 1 of 2 Colombia Develoument Bangkiu Prolect Prof il of Subloan Samole Used in E qout Evaluation LOAN 2477-CO Details ot Sample Projeets (1W9? ColS ffN) Enterpriso Name Project Financial Economic IORO Loan ?mpiementation Date Location lntorm.dlaru. Sector (USJ 0ff) Projected Real Aesit. Comet. Sinu Cordoba CF do Caldee 31 1,675.4 12/88 01/91 Alptna CF Colomblns 31 1,153.S 12/80 12/88 Ind. Quim Andina Bogota CF Nacional as 1s5.7 09/88 12/88 Carvojal Valle CF Vail 34 5,600.6 12/SO 00/07 Comentoe Vail. Valle CF Valle 36 250.0 12/88 12/86 Cieelne Cesar CF Nacional 38 237.1 12/88 12/38 Colpapel Antloqula CF Nrcional 34 412.3 01/67 01/87 Coop Prod do Loch. Atlontico CF Norte 31 234.4 1/038 12/83 Cryo sn Cundinamarca CF Nacional 36 2,56.0 "6/S9 01/91 Palmer CF VaIll 31 655.4 "6/33 06/39 Pizano S.A. Cundinamarea CF Colombians 33 45.0 01/83 01/89 Pelimeros Col. Antioqula CF Vaill 32 3,153.0 67/89 63/90 Sider. Caribi Bolivar CF Boyaca 37 3,66.6 01/39 11/89 Tesieol Santander CF Santander 35 1,454.6 01/33 11/S9 Viepack Valle CF Valle 35 1,382.3 61/87 06/37 TOTAL 21,268.6 Source: LAC Files.  - 16 - TABLE 1. 2 Page 2 of 2 LOAN 2477-CO Investment ProJ-ct Evaluation Proj. Exec. Employment Tner.oo Cost/Job Internal Rate Return Dolays Expected Actual Actual Expected Actual (Months) (USS 900) Aceit. Comest. Sinu 13 n.s. n.a. n.a. 23.0X n.o. Alpina 0 22 -SO n-g 17.1% 30.0X Carvajal 8 186 See 88.6 24.9M 18.0% Comentos Valle O 6 40 56.9 n.r. n.r. Cicolac 9 n.s. n.a. n.a. n.e. n.r. Co I,ap.l O e 254 77.2 18.4% 23.40 Coolech*rx 2 20 1i9 23.8 49.5X -25.5X Cryogas 7 21 n.a. n.a. IC.3X 12.06 nd. Quim. Andlna 8 17 9 72.8 n.a. 20.7% Palmar 12 132 160 74 12.6% 7.61 Pizano S.A 12 22 44 416.4 SC 9% 48.6X Polimero. Col. 13 40 so 144.7 22.06 28.0% Sider. Caribe 10 397 n.m. n.o. 24.9% n.a. resicol 22 36 16 183.8 16.6C 4.ex Visipack 6 37 17 227.9 14.6% I4.SX TOTAL 107 612 1,177 181 AVERACE 7.1 22.SX 17.5X a/ Raw Material Substitution and Technical Assistance Project. n.r. - tfJt Relevant n.s. - Not Available Source: LAC File .  - 17 TABLE - 3 Page I of 3 Colombia Developmuent Bankdin Proiect Key Perform Indicators of Crs Profttabiliey of Development ank., 19L--1990 NET PROFZTS/PAIO-ZN CAPITAL * LEGAL RESERVES 1981 1982 1932 1934 1985 1980 1987 1988 1989 l996 World Bank Qualified CFo (9) 29.6 20.3 11.6 11.0 16.7 18.1 33.6 45.4 48.4 64.2 Other CF. (7) 20.9 14.0 8.1 -51.9 -33.1 -11.2 -16.4 44.2 31.2 86.6 TOTAL 24.1 21.6 9.1 -29.0 -44.2 18.7 28.1 45.2 45.6 61.3 NET PROFITS/TOTAL AVERACE ASSETS 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 World lank qualified CF. (9) 2.7 1.3 1.6 9.9 1.2 1.2 2.1 2.5 2.4 2.3 Other CF. (7) 2.4 1.6 0.8 -5.4 -4.3 -1.3 -1.6 2.6 1.9 2.5 TOTAL 2.7 1.8 0.9 -0.3 0.2 0.8 1.6 2.5 2.3 2.7 DObt: Equity Ratio 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 World Bank qualified CF. (9) 8.9 7.7 7.8 8.1 8.0 7.8 8.2 7.3 7.5 7.4 Other CFn (7) 7.0 8.0 8.1 10.8 21.8 29.5 35.0 80.2 14.6 13.5 TOTAL 6.9 7.8 7.8 8.5 9.6 9.0 9.4 6.5 8.1 7.9  - 18 - TABLE 1. 3 Page 2 of 3 Risk Manag..nt of Development Banks, 19809-1099 NON-PERFORMING ASSETS/TOTAL PORTFOLIO (X) 2/ 1980 1981 1982 1982 1984 1986 1986 1967 1988 1989 990o World Senk qualified CFa (9) 0.6 1.3 8.3 3.2 5.4 5.4 4.4 2.5 1.8 0.5 9.5 Other CF. (7) 0.7 1.1 2.2 5.3 14.4 12.9 19.2 7.3 1.9 0.4 0.3 TOTAL 0.6 1.2 3.1 3.7 7.3 6.9 5.6 3.5 1.2 0.6 9.5 NON-PERFORMING ASSETS/PAID-IN CAPITAL + LEGAL RESERVES 19890 1981 1982 1983 1984 1965 1986 1987 1988 1989 1990 World Bank qualified CFx (9) 2.8 10.4 23.6 26.2 46.8 51.5 48.7 32.1 18.0 11.0 10.0 Other CFo (7) 9.0 6.6 4.7 4.9 3.3 2.1 76.1 74.8 14.7 6.3 4.6 TOTAL 4.6 9.7 19.8 20.6 36.9 37.6 55.8 41.6 17.5 10.2 9.1 2/ Includos post due payments within and exeooding on. year  - 19 - TABLE 1. 3 Page 3 of 3 Operational Etficloney of Dovelopment Banks OPERATIONAL EXPENDITURES/TOTAL ASSETS (K) 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 World Bank Qualified CF. (9) 1.4 1.6 1.6 1.8 1.7 1.6 1.3 1.2 1.2 1.2 Other CFs (7) 1.7 2.0 2.0 2.3 2.1 2.1 1.8 1.9 1.9 2.2 TOTAL 1.4 1.6 1.7 1.9 1.7 1.5 1.3 1.3 1.3 1.4  - 21 - PROJECT COMPLETION REPORT COLOMBIA DEVELOPMENT BANKING PROJECT (LOAN 2477-CO) PART II: BORROWER REVIEW OF THE PROJECT 2.1 Introduction 1. This ex post evaluation of the success of IBRD Development Banking Project Loan No. 2477 first of all analyzes the characteristics of the line of credit made available by the World Bank to Colombia, the types of project financed, and the sectors to which financing was mostly directed. 2. Subsequently, an examination is made of the chief measures which were taken over the period 1985-1989, when the proceeds of the line of credit were onlent, and which contributed to the improved performance of the development banks ln conjunction with the higher levels of growth seen throughout the economy in general. 3. Finally, an assessment is given of the performance of the financial intermediaries that participated in placing the proceeds of the line of credit during the project period, comparing it with that of other financial institutions which had no access to these funds. 2.2 Features of IBRD Development Bankina Prolect Loan 2477 4. On November 27, 1984, the International Bank for Reconstruction and Development and Colombia's Banco de la Repdblica, entered into a Loan Agreement under which IBRD made its ninth line of credit, for US$90 million, available to Colombia to be onlent through development banks for the financing of production facilities and other investments in the manufacturing, tourism and mining sectors that would contribute to the country's economic and social development. 5. Under earlier IBRD lines of credit, the funds made available had been earmarked for various purposes through use of a series of restrictions, which proved to be obstacles to onlending of the funds rather than instruments that promoted a deconcentration of investment. This being so, line of credit 2477 did not call for specific allocations to different types of project, nor did it prescribe requirements governing the size of beneficiary enterprises or interest rate differentials as a means of fostering particular categories of project, which had been the case previously. Restrictions on asset levels were eliminated, not only where access to the funds was concerned but also as regards the conditions under which they would be made available (i.e. with or without exchange risk).  - 22 - 6. The loan ceiling per beneficiary was set at US$5 million over and above balances outstanding under IDB line of credit 475-OC-CO, treated cumulatively per beneficiary so as to preclude fragmentation of projects. Initial sums of US$500,000 were made available in pesos for projects not involving pollution control, technological improvements or equity investments; since there was obviously a connection between the size of an enterprise and the scale of its borrowing, availability of an initial US$500,000 in pesos tended to favor small enterprises. The peso ceiling on projects to promote technological Improvements, industrial pollution control and equity investments was set at US$2 million in view of the importance to Colombia of ventures of these types. 7. The proceeds of IBRD-2477 were distributed almost evenly with and without exchange risk. When the comparison is made against ordinary investment projects and placement of the proceeds of IBRD-1857, the following facts become apparent: - More projects have always been financed without than with exchange risk. Although there had been a reduction under IBRD-1857 in the number of those financed without exchange risk to 612, that figure rose again under IBRD-2477 to 76Z. - In terms of value, projects with exchange risk, which had absorbed 612 of the proceeds of IBRD-1857, absorbed 512 under IBRD-2477. - Average subloan size was US$481-216 under IBRD-1857 and US$479,047 under IBRD-2477. - Average participation in project financing declined from 22.672 under IBRD-1857 to 17.672 under IBRD-2477. 8. These figures show that industry, in order to lessen the effects of exchange risk on investment finincing, was no longer resorting to the creation of new enterprises as it had done when access to resources without exchange risk was limited according to applicants' asset levels. However, there is evidence that total demand for financing was cut back so that the credit ceilings beyond which it became obligatory to assume exchange risk would not be exceeded. 9. Generally speaking, IBRD-2477 funds were channeled into the formation, rehabilitation, expansion, modernization and improvement of enterprises in the manufacturing, agroindustrial and mining sectors, construction of storage facilities for perishable products, and laying of natural gas pipeline networks. Projects to control industrial pollution (from plants in operation for more than a year) were also financed, as were technological improvement projects associated with R & D programs. Onlending terms were as follows:  - 23 - Interest Rate Discount Rate Peso Funds DTF (Weekly index of CD 4 points below interest rate interest rates) + 3 points Dollar Funds LIBOR + 2.5 [3 points below interest rate 10. It was initially anticipated that applications would be submitted to the World Bank by December 31, 1986 and that the disbursement deadline would be June 30, 1990. However, these dates had to be changed: the deadline for submission of applications was extended to December 31, 1988 and the disbursement deadline to August 30, 1990. These changes were more a consequence of the simultaneous commitment of IDB line of Credit 475 than of difficulties surrounding commitment and release of funds available under IBRD-2477. il. IBRD-2477 also had an advantageous effect on the finances of the Banco de Is Repdbllca, since it was the first line of credit negotiated under the currency basket system; this made it possible to achieve equitable distribution among all borrowers of fluctuations in the exchange rates of the currencies making up the basket, and also to facilitate the reimbursement process. 2.3 Times of Proloct Financed 12. The total value of the line of credit was US$90 million. Loan applications to a value of US$92.2 million were approved, an amount subsequently reduced to US$88.2 million because of cancellations, giving a net utilization rate of 96Z. 13. The proceeds of the line of credit were committed between November 1985 and May 1989. The year showing the highest approved value of subloans was 1986, also the year within that period when the economy grew at the highest rate (GDP growth of 5.82) and also industry (with 5.9Z growth). The next year In order of value of subloans approved was 1988, when GDP declined from the two previous years to 4.2Z, a reflection of Colombia's lower coffee export quotas under the International Coffee Agreement and the problems created by damage to its crude oil pipeline system. The rest of the economy (excluding petroleum and coffee, but including the coffee processing industry) grew by 5.21, a gain of 0.7 points over the previous year. The high volume of subloan approvals in 1988 may also have been a result of the entry into force of Decree 2041 of 1987, which gave impetus to the promotion of private development banks. 14. In all, 195 subloans were financed, of which 190 (97.4Z) involved ordinary investment projects, 49Z of them without exchange risk and 511 in dollar funds. Credits for investment in corporate equities and technological improvements/pollution control counted for only one and four approvals respectively, which absorbed 1.31 of all funding approved. 15. Those 195 subloans funded 150 projects, since 41 projects received two subloans each, while two others received three each. A total of 147 enterprises obtained financing, since three firms were granted two credits each, while a fourth was granted three. On the basis of these figures, averages were  - 24 - as follows: each subloan amounted to US$473,087; each project received US$615,013; and each enterprise received US$627,564. 16. The economic sector with the highest number of subprojects was printing and publishing, followed by other plastic products, yarns and textiles, and manufactured milk products. In terms of value of loans approved, printing and publishing absorbed 11.742 of all funds available, chemical products (except fertilizers) 11.47Z, yarns and textiles 9.11Z, and other plastic products 8.62Z. 17. The proceeds of the line of credit went mainly to Bogota, Antioquia, Valle del Cauca and Bolivar. As with other development resources, no significant demand comes from enterprises not located in the principal cities, an indication that the implied subsidy in long-term credit is not a sufficient incentive to bring about changes in the regional distribution of production. 18. Analysis of the distribution of IBRD-2477 funds by size of subloan shows that 120 (or 61.52) of. the 195 subloans were for amounts below Col$100 million, and that the bulk of the line of credit was concentrated in the remaining 75 subloans, which absorbed 75.2% of the total resources available. It is also clear that subloan size had no connection with the length of time the sub-borrower enterprise had been in business; new enterprises were among the group which took the largest subloans, just as well-established enterprises were among those granted small subloans. 19. Similarly, classification of subloans according to sub-borrowers' asset levels shows that 95 of the 195 subloans (48.72) were made to enterprises with total assets of less than Col$750 million, although they received only 29.2Z of the proceeds of the line of credit, whereas the 17 largest enterprises (8.7Z) received 23.1Z of these resources. It is also worthwhile noting that more new enterprises were at the lower end of the scale, and that none of the enterprises at the top of it -- those with investment plans involving more than Col$4.5 billion -- were new. 20. Of the 195 subloans, 23 (11.8Z) were made to new enterprises, which received 14.7% of IBRD-2477. As to resources sought for ordinary investment, new enterprises received 12.4Z of them without exchange risk and 11.1% with it. 21. The proceeds of IBRD-2477 were onlent through eight financial intermediaries. The three which made most subloans were C.F. del Valle, CF. Colombiana and C.F. Nacional, for 28.6Z, 19.8% and 13.8Z of loan proceeds respectively. The proceeds of the line of credit were onlent through the intermediary institutions to enterprises throughout the economy, without adding to the degree of concentration in any one sector. 22. The Bank's line of credit was 18.33Z of total cost of subprojects, while sub-borrowers themselves put up 33.84%, other lines of development financing were the source of 28.31Z, and other resources accounted for 19.52Z. 2.4 Intermediation of Resources 23. Economic Climate and Retulations Governine DeveloDment Banks. In contrast to the first half of the 1980s, when the economy -- including the  - 25 - financial sector -- went through a severe crisis, the second half saw not only higher economic growth rates,.especially in 1986 and 1987, when they reached 5.8Z and 5.3Z of CDP respectively, but also improved functioning of the financial system. In 1989, productive activity again slowed down, as a result of: the fall in the international price of coffee following the collapse of the International Coffee Agreement in the middle of the year; disturbances in public order; and the decline in commercial activity with Venezuela as a consequence of policy measures adopted there. This new slowdown in productive activity in Colombia had an adverse effect on the indicators of activity in its financial sector. 24. As early as 1981, the financial sector itself began to face serious problems, consequences of the recessive cycle through which the economy was passing, its own exposure because of the high level of corporate debt, and the degree of disequilibrium in the public sector manifested in fast growth in the volume of unrecoverable debt and in the deleterious effects of this on financial system liquidity, profits and capitalization. 25. Efforts were made to counteract these difficulties by fostering corporate and financial sector capitalization through such mechanisms as: (a) the Corporate Capitalization Fund; (b) the Banking System Equal Access and Capitalization Fund, later extended to include other financial intermediaries; (c) minimum capitalization requirements for intermediaries as a pre-qualification for access to certain lines of development credit; (d) preferential taxation provisions associated with equity investments, especially in corporations with stock ownership open to the public; and (e) capitalization requirements as a pre- qualification for use of certain development financing facilities and special lines of credit made available by the Banco de Is RepablIca.' 26.- In the second half of the 1980s, a series of factors accounted for a marked degree of recovery in the situation of the development banks, mainly as regards their exposure levels, solvancy and earning power (Table No. 11). Among those factors were: the measures through which the crisis of the preceding period had been managed; the ongoing control and supervision exercise by the authorities through various legal and regulatory provisions (to be discussed further on); and more efficient management of the financial institutions themselves. 27. The private developmeut banks, too, showed a degree of recovery, to judge by their ratio of bad debts to total portfolio, which moved down from 6.36% in 1985 to 1.14Z in 1988 -- a figure only slightly higher than that recorded in 1981, at the beginning of the crisis -- and then subsequently increased to 4.85Z in 1989. 28. The ratio of net worth to assets, one possible measure of development bank solvency, rose from 11.512 in 1985 to 15.81 in 1989, an indication that these entities grew by relying not only on their liabilities but also on their net 1~/ LXI Annual Management Report to the Board of Directors, Banco de la Repabllca, Colombia, 1984.  - 26 - worth. However, larger surpluses have added to net worth, although this is no guarantee of the permanence of intermediaries' r'isources, as would be the case if they had increased their capital. If the conventional debt ratio is used, that of liabilities to capital, the degree of indebtedness appears greater, increasing from Col$11.2 for each peso of capital to Col$19.8 over the same time period; this means that more funds were lent on a narrower capital base, which can offset losses in productivity over the short term or improve returns but signals less capacity to cope with exposure. 29. Rate of return, taken as the ratio of net profit to net worth, rose from 0.982 in 1985 to 14.63Z in 1988, then falling slightly to 13.63Z in 1989. 30. If performance efficiency means that payroll and administrative costs decline in relation to volume of borrowing and lending operations, then it may be concluded that the performance of the development banks improved, since these costs represented 2.852 of liabilities and 2.52Z of assets in 1985 but 2.20Z and 2.122 respectively in 1989. 31. Among the policy measures that tended to put the development banks on a firmer financial footing, improving their solvency, earning power, liquidity, portfolio quality and performance efficiency, the following may be mentioned: 32. In 1985, the Financial Institutions Guarantee Fund was set up under Law 117, to strengthen the capital position of Colombia's lending institutions. In 1985, the Monetary Board issued Resolutions 52, 56 and 58, "with the twofold objective of strengthening the productive sector and thereby favoring the financial system through the power given by the Banco de Is Rep abllca of making special loans to banking and financial institutions secured on their own portfolios and on a prior requirement that separate agreements be entered into between creditors and debtors, as a fundamental aspect of the campaign to improve the financial position of corporations and of the financial sector itself."2 Also in 1985, the Monetary Board issued Resolution 55, which modified the Corporate Capitalization Fund. 33. In 1986, a number of supplementary measures were instituted pursuant to Law 117 -- for instance, Decrees 32 and 59 and Resolutions 2, 5 and 9 of the Monetary Board, which specified what the functions and sources of revenue of the Financial Institutions Guarantee Fund were to be, the general aim being to eliminate the deficits of some financial institutions and attend to their solvency problems. Throughout the period, regulations would continue to be issued pursuant to Law 117, adapting the functions and resources of this Fund to changing circumstances and regulating the loans granted to institutions: for instance, Monetary Board Resolutions 104 of 1985, 7 of 1986, 17 of 1987 and 21 of 1988g Decrees 2008 of 1986 and 2154 of 1989; and Decrees 2476 of 1986 and 1892 of 1989, which introduced supplementary measures for the dismantling at a later date of nationalized financial institutions. 2/ LXII Annual Management Report to the Board of Directors, Colombia, 1985.  - 27 - 34. Decree 2041 of 1987 was the principal instrument for comprehensive reform of the development banks. It was designed to "broaden the transformation of short-term saving into long-term saving" and channel resources toward key sectors of the economy; it reformulated the corporate purposes of the development banks, making them specialists in channeling savings toward the productive sectors for both the medium and long terms; their capital structure was also reinforced through the prescription of minimum capital ceilings for them, introduction of controls on their degree of indebtedness, and diversification of their activities toward investment banking, factorii.g, provision of consulting services for enterprises in the private sector, etc. -- all calculated to improve their earning power.3 Subsequently, Decree 2039 of 1988 approved inclusion of the public vehicular surface transportation subsector as one of the spheres for the authorized activities of the development banks. 35. Also noteworthy were Monetary Board Resolutions 58, 59, 60 and 61, which introduced new policies on reserve requirements for financial intermediaries, modifying ceilings and altering the formulas by which they were computed. In addition, Board Resolutions 57 and 72 of 1987 allowed "negotiation of the financial assets that constitute the legal reserves backing bank and corporate CDs, development credit securities issued by commercial finance companies (Resolution 57 of 1987), and agricultural development securities. In this way, while meeting reserve and investment requirements through the initial taking up of such securities, intermediaries may now negotiate them, thereby increasing their earning power in line with prevailing borrowing and lending rates."4 In its turn, this means sector entities bear less of a burden as far as funding of the Fondos Flnancleros is concerned. 36. In addition, through its Resolutions 24 and 25 the Monetary Board tied the discountable portion of development credits to the weekly index of CD interest rates (the DTF), thereby rendering obligatory investments more profitable, and eliminated the subsidy represented by the difference between discount and borrowing rates, tie aim being to preclude distortions in the financial market in view of the cost which the transfer implicit in that subsidy cast on the economy as a whole. 37. In 1988, Resolution 3600 of the Superintendency of Banks came into effect. This mandated adherence to uniform accounting standards, which allowed more effective control of financial institutions when used in conjunction with the program of financial alert indicators set up subsequently through ;he Superintendency's Resolutions 2053 and 3535 of 1989. 38. In 1989, Monetary Board Resolution 81 prescribed new measures for regulating financial activity. This instrument imposed limits on the asset holdings of development banks, specifying that as of July 1, 1990 their risk- weighted assets could not exceed 12 times their technical net worth. At the same time, it redefined the concept of net worth and prescribed a new method for _/ LXIV Annual Management Report to the Board of Directors, Colombia, 1987. 4/ "Notes on the Financial System in Recent Years," Revista del Banco de la Repdblica, September 1988.  - 28 - controlling the degree of capitalization of the financial system, in view of the fact that the conventional method of computing capital on the basis of liabilities contributed to decapitalization of the system. 39. Among the measures designed to encourage intermediaries to engage in development credit operations must be counted Monetary Board Resolution 59 of 1989, which aimed at a link between interest rate and term of deposit that would reflect the degree of maturity of the investment project concerned and also make the capitalization of interest possible. 40. In order to improve financial system competence and capitalization, Decrees 1982 of 1989 and 500 of 1990 were issued pursuant to Law 74 of 1989 governing foreign investment in the financial sector. The impact of these Decrees, which regulate reprivatization of financial institutions, will make itself felt' in the next few years. 41. Finally, it may be noted that the recovery in the financial system was accompanied by: a monetary policy designed to reduce the burden of reserve requirements on financial institutions through the utilization of open market operations to shrink the money supply; and a trend toward elimination of obligatory investments. "This policy of unfreezing resources made intermediaries' sources of funding more productive; it was applied not only to banks but also development banks and savings and loan institutions. With the same end in view, measures were also introduced to dismantle obligatory or reserve-substitute investments as far as possible."5 Where interest rate management was concerned, the policy attempted to "establish a stable climate which will allow general application of flexible interest rates that can be adjusted to positive real levels, approximating market conditio.;s in the case of directed credit. In practice, almost all directed credit interest rates today are tied to a market indicator, the weekly index of CD interest rates (the DTF)."' 42. Evolvement of DeveloDment Banks (1985-1990). The intention here is to examine the financial behavior of the development banks which took part in onlending the proceeds of IBRD line of credit 2477 as compared with that of other development banks. The former will be referred to from here on as "IBRD development banks" and the latter as "other development banks." 43. As will be noted, an increase occurred over the subject period in the mobilization of CDs (certificadoo de dep6sitos a t6rmino) by the development banks, with higher annual growth rates being achieved by the IBRD development banks, among which there was an average annual growth rate of 51.29Z from 1985 to 1989, compared to a 23.842 rate for other development banks. j/ "Financial Development and Deregulation: Some General Considerations and Their Application to the Case of Colombia," Revista del Banco de la RopOblica, September 1990. 6/ Ibid.  - 29 - 44. In the mobilization of funds throughout the financial system, the CDs of private development banks absorbed a growing share of financial savings. This increase can be ascribed to the management of the IBRD development banks, whose CDs increased by comparison with those of the system as a whole from 6.97Z to 17.88Z between 1985 and 1989, while those of the other development banks declined from 5.06Z to 4.98Z over the same period. The faster growth in CD mobilization by the development banks observed in 1989 was a consequence of the entry into effect of Decree 1734 of 1988, which set interest rates for the mobilization of funds by development banks and commercial finance companies at levels up to 1.5 points annually higher than those set for banks; it was also a consequence of the more aggressive marketing attitude of the former, reflected in borrowing rates systematically higher than those offered by other lending institutions, given the tax control measures in place, as occurred with banks and savings and loan associations.7 45. The financial solidity of the development banking group as a whole declined over the 1985-1990 period. This is particularly true of the subgroup of other development banks, where the initially high indicator fell by as much as six points over the period, whereas there was a fall of only two points among the IBRD development banks. 46. The fact that this ratio was higher for the other development banks reflects what appeared to be their greater financial solidity compared to the IBRD group, since the latter showed fiscal year losses or accumulated losses which reduced the size of their asset holdings, so that any component of them came to represent a larger proportion of their total assets. 47. The financial solidity of the IBRD development banks, however, was based on the greater weight of their net worth, profits and appreciation in their total assets throughout ths period by comparison with the other group. For instance, the average ratios of net worth, profits and appreciation to total assets were 14.61S, 1.8Z and 6.41 for the IBRD group and 11.49Z, 2.17Z and -0.181 for the other group. 48. The ratio of bad debts to total portfolio quality improved between 1985 and 1988 as the proportion of bad debts declined but then began to deteriorate again in 1989, although without dropping to the levels that prevailed at the beginning of the period (especially for the other development banks). This improvement mirrored the fluctuations in the economic cycle, since in this period there was not only a correction of the tendency toward overexposure but also an improvement in the administrative management of lending institutions. 49. Likewise, provision for portfolio losses, which represented over 1002 of profits in 1985 and 1986 for all development banks, essentially because of the problems faced by the group of other development banks, declined to 10.212 in 1988, although it then rose to 13.62Z at the end of the period. 2/ "Editorial Notes: Credit and Money-Like Instruments," Revlata de! Banco de la Repdblica, June 1989.  - 30 - 50. For the IBRD development banks, the ratio of bad debts to total portfolio was always lower than for the other group. The explanation for this is that the IBRD group, as specialists in investment project financing, employed trained staff to appraise loan applications, which cut the risk factor considerably; they were also more demanding on the subject of what would constitute satisfactory guarantees in the eyes of the World Bank and Banco de Is Repdbl4ca. 51. For all development banks throughout the pariod, the various indicators of earning power (net profit to capital plus reserves, gross spread, gross spread plus earnings on investments, and operating results) improved notably. The IBRD group, however, always performed better than the other group, in the sense that their profits increased annually throughout the period at rates higher than inflation, something which occurred with the other group only in 1988. This can be ascribed to the types of activity pursued by the IBRD group, the structure of the market, and their greater flexibility of action, financial solidity, and ability to weather fluctuations in the productive cycle. This may be seen in the ratio of net profits to capital plus reserves, where the IBRD group always showed an index not only much higher than that of the other group but also continually on the rise, even in 1989, when the initial signs of recession were visible in the productive sector -- a change that inevitably affected the group of other development banks, which had itself just begun to recuperate in 1988. 52. As to gross spread, it increased with the degree of control intermediaries exercised over their resources. Income and fees earned by all development banks were supplemented by returns on investments, from which were met such costs as fees payable, administrative and payroll expenses, and portfolio protection, particularly over the first three years for the IBRD group and until 1988 for the others. 53. "System spread has increased in real terms because of greater financial productivity and a reduction (again in real ttrms) in the significance of loss provisions. Moreover, as economic and financial activity has grown, in conjunction with apparent improvements in system operating efficiency, the impact of operating costs on total assets and on spread was reduced considerably from 1985 onward, with obvious repercussions on intermediaries' profits and greater likelihood of a reduction in lending rates."$ 2.5 Conclusions 54. Given the complexities and continuous changes in the regulations governing the two previous IBRD lines of credit, a particular feature of IBRD-2477 was that its simpler requirements made it much more flexible to implement, with the result that placement of the funds took just three years, although IDB line of credit 475 was being implemented at the same time. 55. Some 147 enterprises in the industrial sector benefitted from IBRD-2477, subloans being approved to a total value of US$92.2 million. The 8/ LXIV Annual Management Report to the Board of Directors, Colombia, 1987.  - 31 - subsectors where there was most demand for funding were: printing and publishing; other plastic productst yarns and textilest and manufacture of milk products. 56. While the proceeds of the line of credit were being invested, from 1985 to 1989, both the development banks and the financial sector as a whole began to recover from the crisis that had arisen in the early part of that decade; this was the outcome of improved performance in the formal industrial sector, new measures introduced by the monetary authorities, and the effort made to ensure these measures were well administered. 57. The development banks through which IBRD line of credit 2477 was implemented, compared with the group made up of other private development banks, have continued to perform better in terms of portfolio quality, capitalization and earning power because of the impact of World Bank and Banco de 18 Repablica programs on funding availability and continuing supervision of the activities of the intermediaries themselves.  - 33 - PROJECT COMPLETION REPORT COLOMBIA TABLE 3.1 DEVELOPMENT BANKING PROJECT (LOAN 2477-CO) PART III: STATISTICAL DATA COLObMIA Ninth Development Fnance Companies Projects Loan 2477-CO Table Is Related Bank Loans Loan Title Loan Amount Year of Approval Status Development Finance 250 1966 Fully disbursed Companies Project and repaid. Second DFC Project 12.5 1968 Fully disbursed and repaid. Third DFC .Project 25 1969 Fully disbursed and repaid. Fourth DFC Project 40 1971 Fully disbursed. Fifth DFC Project 60 1973 Fully disbursed and repaid. Sixth DFC Project 80 1976 Fully dis.ursed. Seventh & Eighth DFC Project 100 1978 Fully disbursed. source: LAC Files.  - 34 - TABLE 3.2 Table 2: Project Timetable Date Date Date Item Planned Revised Actual - Identification Aug-83 - Preparation 13-Oct-83 - Appraisal Mission 26-Oct-83 12-Nov-83 - Loan/Credit 04-Jun-84 27-Aug-84 Negotiations - Board Approval 05-Jun-84 06-Nov-84 - Loan/Credit Aug--Sep-84 27-Nov-84 Signature - Loan/Credit Jan-85 25-Feb-85 Effectiveness - Loan/Credit 31-Dec-90 30-Jun-90 Closing Source: LAC Files.  Table 3.3 - 35 - Table 3: Cumulative Estimated and Actual Disbursements ESTIX&TE ACTUTAL Cumul. Cumul. Date Amount Date Amunut (U'S$m