Mexico - Financial Sector Technical Assistance Project

Documnt of The World Bank FOR OMCIAL USE ONLY Repwt No. P-6451-ME MEMORANDUM AND RECOMNENATION OF THE PRESIIENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN THE AMOUNT EQUIVALENT TO US$23.6 MILLION TO NACIONAL FINANCIERA, S.N.C. WITH THE GUARANTEE OF THE UNITED MEXICAN STATES FOR A FINANCIAL SECTOR TECHNICAL ASSISTANCE PROJECT DECEMBER 22, 1994 MICROGRAPHICS Report No: P- 6451 ME This document has a restricted distribution and a" Type: MOP their official duties. Its contents may not otberw  Currency Equivalents (As of December 19. 1994) Currency Unit = Mexican New Peso (MexN$) US$ 1.0 = MexN$ 3.4 Abbreviations and Acronyms Used CAS Country Assistance Strategy CNB Comision Nacional Bancaria (National Banking Commission) CNSP Comisi6n Nacional de Seguros y FYanzas (National Insurance and Bonding Commission) CNV Comision Nacional de Valores (National Securities Commission) CONSAR Comision Nacional del Sistema de Ahorro pam el Reuiro (National Commission of the Retirement Savings System) DVP Delivery versus Payment FOVISSSTE Fondo para la Viienda de los Trabajadores del ISSSJE (Government Workers' Housing Fund) FSAL Financial Sector Adjustment Loan (3085-ME) GOM Government of Mexico ICB International Competitive Bidding 1DB Inter-American Development Bank IEIU Investment, Energy, and Industry Unit IMF International Monetary Fund IMSS Instituto Mexicano de Seguro Social (Mexican Social Security Institute) INDEVAL Instituci6n para el Dep6sito de Wlores (Securities Depository Institute) INFONAVIT Instituto del Fondo Nacional de la Viuenda de los Tabajadores (National Workers' Housing Fund Institute) ISSSTE Institato de Seguwidad y Servicios Sociales de los 7qbajadores del Estado (Institute of Security and Social Services for Government Workers) LCB Local Competitive Bidding NAFIN Nacional Financiera, S.N.C. NAFTA North American Free Thde Agreement OIC Over-the-counter PECE Pacto de Estabilizaci6n y Crecimiento Econ6mico (Economic Stabilization and Growth Pact) SAR Sisteina de Ahorro para el Retiro (Retirement Savings System) SHCP Secretarfa de Hacienda y Credito P(blico (Ministry of Finance and Public Credit) SIC Sistema Internacional de Codtzaciones (International Share Quotation System) SOE Statement of Expenditure SRA Self-Regulatory Association SRO Self-Regulatory Organization  FOR OFFICIAL USE ONLY FINANCIAL SECIOR IECHNICAL ASSJSThNCE PROJECT LWAN AND PROJECT SUMMARY Nacional Financiera, S.N.C. (NAFN) United Mxn States Imenting Ministiy of Finance and Public Credit (SHCP) Agmn: eiciar: The Investment, Enegy, and Industry Unit (EU of SHCP and four commissions under SHCP: National Banking Commission (CNB); National Securities Commission (CNV); National Insumce and Bonding Commission (CNSF); and National Retirment Savings System Commission (CONSAR). Not Applicable. ~mounlt: US$ 23.6 million equivlent. lbrms: Repayment in 15 years, including a five-year gmace period, at the slandard variable rate. CofmmtmFent e: 0.75% on undisbursed loan balances, beginnng 60 days after signing, less any waiver. Qn-lend Tens: Not Applicable. Einauf PLan: See Schedule A. N I?snt aue: Not Applicable. Staff A isal Not Applicable. MWdoet haa sctid dlsbudtand Wmay be ued by cpiets oy in the p oma oftr IffdItes& 1nenmyntotthe ise -bedsedwittWodanut*  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCllON AND DEVELOPMENT TO THE EXECUTIVE DIRECIIORS FOR A PROPOSED LOAN TO THE UNITED MEXaCAN STATES FOR A FINANCIAL SECrOR TECHNICAL ASSISTANCE PROJECF 1. I submit for your approval the following memorandum and recommendation on a proposed loan to Nacional Fuanciem, S.N.C. with the guarntee of the United Mexican States for the equivalent of US$ 23.6 million, to help finance a Financial Sector Technical Assdstance Project (FTAL). The loan would be at the Bank's standard variable rate, with a maturity of 15 years, including 5 years of grace. 2. Backgrwnd. The World Bank supported Mexico's adjustment program in the FY 1987-1991 period with a lending progm totalling about US$ 10.4 billion. Half this amount was committed under sector adjustment loans in trade, finance, agriculture, transport, industry, and for an interest reduction loan linked to Mexico's debt reduction package with the commercil bans. The Financial Sector Adjustment Loan (PSAL) supported important policy actions to deregulate Mexico's financial system beginning in 1988. The FSAL supported the deregulation of interest rates on deposits, eliminated forced lending, and reduced the role of special trust funds (eicomisos) as intermediation channels for Government resources. The PSAL also supported efforts to begin to modernize banking regulation and supervision. Technical assistance was provided to improve procedures for asset classification and capital adequacy requirements, develop provisioning policies, and improve disclosure requirements for commercial banks. Support was also provided through the FSAL to strengthen the economic evaluation of public investment projects and related budgeting process to finance such projects by the Investment, Energy and Industry Unit MU) of the Secretariat of Finance and Public Credit (SHCP). 3. In response to the economy-wide restructuring program, and the financial sector fiberalization in particular, large amounts of private capital flowed into Mexico. During 1991-1993, net capital inflows averaged over US$ 27 billion per annum; Although substantial amounts were channeled toward direct foreign inestment and borrowing by domestic firms, nearly 50% of the total during these years flowed into equities and peso- denominated Government debt. The role of foreign hedge funds and mutual fund investments in Mexican debt and equity instmments has become massive. In addition, the large holdings of Mexacan assets by foreigners heighten the importnce of takng actions to increase the development and liquidity of domestic Mexican securities markets. More developed domestic securities market inclusive of a larger base of institutional investors that can gradually contribute to Mexico's long term investment requirements in such areas as infrastucture will be critical in the years ahead. 4. During 1991-1994, Mexico continued to implement reforms to liberalize the financial system. In this period, eighteen commercial banks were te-privaized, fourteen new banking licenses were issued, and five more received clearance. The legal and regulatory ftamework for banking and non-bank financial services was also strengthened. The North American Free Trde Agreement (NAFTA), which came into force on January 1, 1994, grdually permits greater competition in financial services, particularly in the provision of non-banking services. In October 1994, 52 foreign financial institutions received clearance from the Secretaria de Hacienda y Credito Publico (SHCP) to initiate operations in Mexico. The  -2- finms included 18 banks, 16 brokeage firms, 12 insurance companies, 5 holding companies and 1 leasing company. 5. Tbe Govemnent of Mexico (GOM) undertook refom of the national social security and pension systems throuw'h creation of the Sistema de Ahorro pam el Redro (Retirement Saving System or SAR) in 1990. Under the SAR, every employer is required to establish at a commercial bank an individual account for each employee, to which 2% of gross wages must be contributed each pay period. 1T date, commercial banks have been resticted to provision of account administration services: all funds accumulated in SAR accounts must be kept in a specific Central Bank account paying no less than 2 percent in real terms. 6. As a result of recent reforms, Mexico is now poised to enter a new financial era. In order to take full advantage of this opportunity, Mexico needs to act quickly to further develop the country's institutional infrastructure and skdlls base in a two broad areas: 7. First, improved regulation and supervision are necessary to ensure the continued safety and soundness of financial institutionq and to sustain the confidence of the intemational investment community. A new philosophy in regulation and supervision is needed to: (i) reduce the administrative burden on private institutions through streamlined reporting procedures; (ii) improve the quality of available information and reduce the roleof drect Government supervision and associated costs through greater incentives for self-monitoring - regulation by market participants and Self-Regulatory Organizations and Associations"1; (iii) provide a wider mnge of more effective enforcement tools in order to reinforce the incentives for financial institutions to strengthen risk measurement and management systems; and (iv) esblish clear and explicit procedures aid definition of liabilities for the rsolution of failed fnancial institutions, an issue highlighted by the recent Government intervention of Banco Cremi-Union. Importantly, the increased incentives for self-regulation combined with streamlined procedures for regulatory and supervisory activities would result in reduced costs for both private financial market participants and Govenmment supervisory agencies. 8. Second, appropriate Govenment policy should be designed to encourage the development of financial markets. Development of a broader base of domestic institutional investors through the Retirement Savings System would increase liquidity of the system while providing security for pensioners. It would also improve the allocation of savings across imnvestents via the impact of istitutional investors on the corporate govemance of nonfinancial corporations. Fmally, a stmnger group of institutional inestors could also play a critical role in ensuring the integrity and development of more complex securities such as asset-backed securities and derivative instruments. This last effect occurs via the much greater incentives such large investors have to carefully evaluate the risks entailed in more complex securities structures.Y These types of secunties or financial contacts can reduce 1/ The scope of instiutions categoriued as Self-regulatory Organizations (SRO) inleudes entities which provide services to members and gvern the relations beween member, such as exchanges, clearing, and custody corporations. lhe term Self-regulatory Association (SRA) generally refes to other groups whose members are subject to internal guidelines prescribed by their respective associatons and may be overseen by supervisory agencies. Examples of SRAs include associations of auditors, accountants, actuaries, appraisers, securities dealers, and even warehouses in the Mexican case. 2/ Such considerations have been highly important in developed country securities markets in the Unite States, Canada and in some European countries.  -3- the cost of capital to firms through more effective management of risk at lower transactions costs. To obtain these advantages will require actions to modernize the regulatory and legal framework governing provision of pension benefits and insurance so that pivte investment management of SAR accounts can be credibly introduced. In addition, the operations for coUecting contributions to SAR accounts will need to be modemized. 9. In addition to upgrading Mexico's supeiisory and regulatoty system and broadening the class of institutional inwestors via pension and insurance reform, a broader set of reforms will need to be developed to modernize Mexico's financial system and markets. Consistent sets of reforms will need to be developed to: improve the possibility for market-based provision of financial services to the urban and rural poor; improve the public registries for commercial transactions, real estate and land titling; modernize the payments systems to reduce credit risk exposure of the Centmal Bank and permit reduction of the credit risk exposure of market participants in securities trading; modernize and rationalize Mexico's system of housing finance; finance basic infiastructure development with private-sector participation; and improve efficiency of social security and pension-related services at the federal and state level both by the Government and the private sector. These other critical areas of reform are currently being addressed through other Bank/IDB economic and sector work and project initiatives or independent GOM efforts. 10. In light of Mexico's enormous need for investment in basic infrastructure, the strengthening of eWaluation and budgeting for public investment projects remains a critical priority. Building on the taining and studies financed under the FSAL (para. 2), a more extensive progm wiU be developed to improve standards for project evaluation both within the EIEU and in other key fedeal government agencies that play a role in evaluating public sector involvement via investment or other forms of intervention in complex infrastructure projects. The IBU will take the lead in establishing standards in project evaluation for all federal agencies. The unit wiUl also take a leading role in the coordination of project evaluation under the proposed infrastucture fund that will constitute another source of public fince in association with the private sector, and which will coordinate with public development baks which would participate in the financing of these projects. 11. Rationale for Bank Involvement. The Bank has played an important role in recent reforms to Mexico's financial sector and in improving public investment evaluation and budgeting, both through the FSAL (para. 2) and through an active and ongoing dialogue on emerging issues of concern. As described above, a substantial agenda for refbrm remains despite Mexico's efforts to privatize and deregulate the financial system and its program to upgrade the capacity of IEIU. The first priority of the Bank's Country Assistance Strategy (CAS), discussed by the Board on June 9, 1994, is to encourage a smooth tsition to higher rates of private sector-led growth. The CAS, along with the FY94 Country Economic Memorandum (CEM) Fostering Pvate Sector Development the 1990?, identified the strengthening of financial sector supervision, imprvements in the pension system, development of Mexico's domestic securities markets, and upgrading basic infrastructure as important near-term actions to support private sector-led economic gowth in Mexico. The proposed project is thus fully consistent with the Bank's Country Assistance Strategy. 3/ issued May 16, 1994, Report No. 11823-ME.  -4 12. The Bank has worked closely with the IMP since early 1993 to support this sategy and has diagnosed the shortcomns of Mexico's system of financial conglomerate supervision. The proposed project represents the naual outgrowth of this joint Bank-I effort. The Bank has been able to offer the GOM sevel advantas when compared to other potential advisers, such as privwe consultants and reprsentatives of national regulatory agencies. The key advantage has been the ability to field teams with a high degree of objectivity combined with intrnational, multi-disciplinary experience. The Project complements the IDB's efforts in providing technical assistance to NAFIN to improve its internal risk measurement and management process since it would support efforts to improve supervision of development banks and enforce recently-issued capital regulations for such entities. MB's prgram of technical assistance will also focus on direct provision of assistance to commercial banks on risk measment and management techniques. Finally, all aspects of the Pzoject dealing with non-bank services and development of securities markets have been closely coordinated with the IFC. 13. Project OWetves. The proposed operation is intended to meet three inelad objectives: (i) to improve the saety and soundness of the financial system through improved prudential regulation and superiision, and via gtdatr incentives for self-mgulation by market participants; (ii) to support the development of the pension system; and (iil) to strengthen public investment eWluation and budgeting. The project, coupled with other Govemment reforms undertaken independentdy (para. 9), would act to help reduce the cost of capital to all fims and to encourage the efficient development of Mexico's financial institutions and securities markets. 14. PnleD. Project activities would include: hiring extrnal consulants to assist in the development of specific policies and reguations; commissioning of related studies; financing participation in seminars, advanced maining programs, and other human resource development actvities to be conducted both within Mexico and externally; secondment of specidal long-term consultants to strengthen specific actives of the Commissions; and procurement of necessary software, hardware, and equipment. The Project is fuly descibed in the Technical Annex. Cost estimates are provided in Schedule A. The Project Implemenation Plan (Attachment to Technical Annex) provides information on the expected output, forms of assisnace, and timing of activities financed by the Ptoject. The Project would include two inter-relad components, as follows: 15. &n dal&Ser SaWoL and &"nIr&o. This component, with a total esfimated cost of US$ 23.67 million including US$ 17.60 million in Bank financing, would finance coordinated assistance through the Secretar(a de Hacienda y C&to Pabco (SHCP - Mistry of Fmance and Public Credit) over a 3 year period to four Commissions: the Comisi6n Nadonal Baila (CNB - National Banking Commission), the Comision N onal de dloms (CNV - National Securities Commission), the Comisin Naconal de Seguros y F sanzas (CNSF - National Insuance and Bonding Commission), and the Comsi6n Nadonal del Sisema de Ahonr, pam el Redro (CONSAR or National Commission of the PReirement Savings System).# These effois would focus on: stengthening supervision of finanial conglomerates and securities markes, including an enhanced role for SROs; and making efficient use of Govenmment regulatry and supervisory resources through greater incentives I/ 'Me law creating this Commission was approved by the Congess in July 1994. 'Me CONSAR began opentions in August 1994.  -5- for self-policing and monioing of financial conglomerates by SROs and SRAs; and assisting the development of the newly-created CONSAR. Particular focus would be placed on the larst Commission, the CNB, in implementng a comprehensive program for insdtutional development and restucuing. The component would integmate teciWical assistance activities across all four Commissions precisely because the evolution of the fnancial services markes in Mexico requr an increasing degre of coordination and like philosophies among regulators and supervisors 16. Assistance to the =NB would be prvided to stengte and improve: authorization polcies and procedures; reulatoy and supervisory policies'; regulaltoy reports; regulatory accounting principles; suparision processes (both in situ and ewm sft): rocedures for consolidation of regulatory reports and supervsion of financial conglomerates; modermization Of informatio systems; and insttutionaliation of human resource development. 17. Assstance provided to the OAX would stress: the moderization f the regulatory and supervisory policy ftamewor$' of Mexdco's organized securities markets2l; mechanisms for self-rgulation, particularly regarding conflicts of interest; increased disclosure of financial inormation by securities issuers, muual funds and brokerage firms; analysis of the legal and regulatory environment for new istruments such as denvatives and asset-backed securities; and revision of regulatory accounting and reporting requirements for brokerage firms consistent with changes in other Commissions. 18. In the case of the CNSF, emphasis would be.placed on assistance to: upgrade supervision processes; modernize regulatory and 4ervisory policies applicable to insurance compies, insurnce btokers, adjusters and rince companies; upgrade capacity to evaluate acWarial audits and improve certification procedus for actuaries; and to review and modify regulatoy reporting standards and accounXt principles. 19. In the case of the OQNSA& the emphasis would be placed on assta to develop the information and operation systems for Mexico's rerment savig system over a 2 year period begning in 1996. TIis subcomponent would ance temnal constants, twaining, specific studies, and hardware and software to assist in the orgaizaion of the CONSAR. Prvision of technical assista would permit the CONSAR to caury out certain primary functions including: the develpment of CONSAR's intl comunicatns tem; the development of CONSAR's natonal infrmaion network; and the procrem t and use of computer and communcations hardware and sotwae for these purposes. Finally, this I/ The pogrm vwoud minude support to help moderniz the pudntial egulatoty framework inars incluig: capital aquacy; rW eposrs (lendg lmis); rlatd party ftrncton (cnected ledig; concetadtiw in asset allocadon (geogmphic); coaficts of mterest; trading practco rplations in secmuities transactions; and gudelnoes and policies applicable to SRAs. I Review of rgltoy and supeory policies will include: brker/deoler capital standards; rading pactices; -Self-Regulatory Orpnintions and Associatin (in xaistence and prposed); ass-backed secuities markets (securitiation); gante ftnd for bkage firms; investment advisors and managr; conflicts of interest; and the framework for echange-raded derivatives. I/ The CNV has supervisory rsponsiblty for scurities tmdug on orgniZd maketL CNV also oversees over-the-counter (OMV) tadiwg of equty secuies Ovmsight of all other alC tansactions is under the jurisdiction of the Central Bank of Mexico  -6- component would also finance a prelininary study, jointly with CNSF, of Mexico's annuities market and implications for its furthe; development as the SAR systm matures. 20. Relationship and Sequencing of Subcomponents. The various subcomponents defined above are highly inter-related and highlight the importance of taking an integmated approach. The emphasis of the Project would be to upgrade the capabilities of staff in each of the commissions, while ensuring a consistent definition and application of supervisory and regulatory policies across the financial system and for financial conglomerates. Lack of a consistent approach across Commissions increases the possibility of regulatory and supervisory arbitmageW while undermining the credibility of Government regulations and supervision. Private-sector monitoring would also be strengthened, requiring increased interaction between the Warious Govenunent agencies and SROs and SRAs. Activities financed under each subcomponent would be inter-related because many types of financial services can be provided by multiple entities within a Mexican financial group. For example, many securities operations can be undertaken by a commercial bank or by an afflliated brokerage firm. Similarly, banks, insurance companies, and brokerage firms are likely to gain responsibility for management of SAR accounts in the future; therefore, improvements in regulation and supervision implemented under each subcomponent would be mutully reinforming. Moreover, improvements in certification standards for acuaries and the development of a regulatory framework for provision of annuities would have important i-mplications for the insurance and pension industries which are currently regulated and supervised by both the CNSF and CONSAR. Fmally, the sequencing of the assistance provided will be carefully analyzed so that functions such as off-site surveillance and regulatory reporting will be initia}ly emphasized. Upgrading on-site inspection capacity will receive attention throughout the Project implementation period, but will receive even greater emphasis during the latter stages. 21. Pubfic Invesonent Evaton and Budgedne. This component, with a total estimated cost of US$ 7.69 million including US$ 6.0 million in Bank financing, would strengthen the evaluation of public investment projects and budgeting procedures. This component would also support the GOM in developing adequate guidelines for the coordination of the public investment progmm with the operations of the proposed infrstructure fund and the loan and guarntee operations of public development banks in the infrstrucre sector. The Investment, Energy, and Industry Unit (IBU) of SHCP would carry out the activities to be financed by this component, including studies and t_aining. Emphasis would be placed on: inter-institutional coordination; establishment of project evaluation standards, and dissemination of these standards, and training in project evaluation; evaluation of sector- and region-specific public investment projects; establishment of a national inventory of public investment projects and a system for ranidng and prioritization within and across sectors; multi-annual budgeting; and ex-post monitoring and evaluation of projects. 22. Project Costs and Eranc. Estimated Project costs, described in Schedule A (total cost including Bank and GOM financing of US$ 31.36 million) are as follows: Financial Sector Regulation and Supervision component including the -CNB (US$ 17.50 million), CNV S/ Supervisory arbitage as distinguishod from regulatoby arbitage occurs when a financial group will shif the booking of transactions to that entity that is least well supervised. By contmast regulatory arbitmge would involve transfer of transactions to that entity which is, ceteris paribus, subject to the least stringent set of prudential regulations.  (US$ 1.94 million), CNSF (US$ 1.86 million), CONSAR (US$ 1.93 million), and a Project Implementation Consultant Fund for the four commissions (US$ 0.44 million); and the Public Investment Evaluation and Budgeting component (US$ 7.69 million). The Bank would provide US$ 23.6 million, approximately three-quarters of the total financing, and the GOM the remaining US$ 7.76 million. Retroactive financing, in an amount not exceeding US$ 1.9 million equivalent, would be available for expenditures made after October 1, 1994. A special account of up to US$ 2.3 million would be maintained by the Borrower and Executing Agency at the Central Bank of Mexico to facilitate payments under the Loan. Separate accounts of all expenditures financed by the Project would be maintained by the Borrower and each Commission. The accounts and statements of expenditures would be audited each year by auditors satisfactory to the Bank. As noted above, the Project would finance consultants and procurement of hardware and software, but would not finance any recuring expenditures. 23. Proiect Implementation. The United Mexican States would be the Guarantor for the loan made to Nacional Financiera, S.N.C. (NAFIN), a state-owned development banlk (the Borrower). Execution of the project would be undertaken by SHCP in conjunction with the following entities which are legally under SHCP: (i) CNB, CNV, CNSF, and CONSAR for the Fmancial Sector Regulation and Supervision component; and (ii) IEIU for the Public Investment Evaluation and Budgeting component. Each commission and the IMTU would establish a small Implementation Unit which would coordinate assistance to be provided by the Bank and work closely with the Borrower (NAFIN) and the Executing Agency (SHCP). As the commissions do not have experience in implementing a Bank project, consultants would be hired with the proceeds of the Loan to support each Implementation Unit in Bank administrative procedures and procurement (pam. 25). 24. lT ensure that the activities financed under the Project remain closely tied to the evolving priorities for the financial system and the GOM public investment program, a Project Implementation Review would be conducted on a semi-annual basis to update the rolling annual program of assistance. During each review, the Bank, Executing Agency, Borrower and each Commission and the IEI2U would assess the status of project implementation, eWaluate the workplan for the next six months, and agree on any needed modifications to the originally proposed program. The project completion date would be December 31, 1997 and the closing date would be June 30, 1998. 25. Procurement. Two types of procurement would be undertaken through the Loan: (i) consultant services for each of the four commissions and the IEtU; and (ii) goods, primarily computer hardware and software and communications equipment, for the CNB and the CONSAR (see Schedule B). As financial agent, NAPIN would act as the coordinator and adviser to the Commissions for all procurement activities under the Loan. Consultants would be hired with proceeds of the Loan to finance consultants to assist each Commission in procurement activities (pam. 23). 26. Selection and appointment of consuant for studies, technical assistance, and support of project execution would be carried out in accordance with the Banks "Guidelines: Use of Consultants by World Bank Borrowers and by The World Bank as Executing Agency' (August 1981).  -8- 27. Procurement of gogds would follow the Bank Guidelines for Procurement (May 1992). lb the extent feasible and practicable, the procurement of goods would be done by grouping the various items in bid packages eshtnated to cost US$ 350,000 equivalernt or more. Packages in this category would be required to follow Intermational Competitive Bidding (ICB) procedures using the Bank Standard Bidding Documents. Local Competitve Bidding (LCB) would be undertaken for goods estimated to cost more than US$ 100,000 but less than US$ 350,000 using the Standard Bidding Documents for Goods satisfctory to the Bank. For equipment which cannot be grouped in packages valued at US$ 100,000 or more, local shopping procedures would be followed. In the case of procurement and implementation of complex information and communication systems, the Bank would recommend that a 2-stage bidding process which includes a stage for technical qualification prior to economic evaluation be adopted. 28. Bank review of procurement prcedures would be as follows: (i) for consulting serics the Bank would conduct prior review for all contacts eeding US$ 50,000 equivalent for individuals and US$ 100,000 equivllent for firms; and (ii) for procurement of Zood the Bank would review ex ante documentation pertining to each ICB undertaken and for the first two LCBs; (iii) all other procurement documentation is subject to cc post review. This review process wouiJ result in a prior review of approximately 70% of all Bank- financed contracts for goods. 29. Accounts and Audits. NAFIN and the Executing Agency would maintain adequate records to reflect all expenditures made under the project. The accounts and statements of exenditures would be audited each year by auditors satisfactory to the Bank, in accordance with appropriate auditing principles consistently applied. The audit reports would be submitted to the Bank not later that six months following the close of the fiscal year. 30. Project Sustainabi_4v. Given the high degree of success achieved by the GOM in impiementing and sustaining the program of stucural reforms undertaken to date, the prospects for Project sustainability appear strong. 'With strong support of the incoming administraion which twok office in December 1994, the reforms and institutional development of the Commissions financed by the Loan would provide a solid basis for the future operatons of the regulatory and supervisory institutions involved (see pam. 36 for discussion of risks associated with Project). Sustainability of the project will also be evaluated on the basis of monitoring indihators as noted in the matrices (see Project Inplementation Plan, Technical Annex) and on the basis of impact indicators that the Government and the Bank have committed to establish at the time of the first project implementation review (see para. 35). Fmally, the sustainability of this project will not be compromised upon completion because the financing provided represens only a very small portion of the overall budget of each entity. 31. Lessons frm Previous Bank Involvement. The design of this project draws on the lessons leamed from the experience of the Ban in the delivery of technical assistance around the world and in Mexico. Bank experience highlights the need for (i) a high level of Goverment commitment essential for successul implementation; (ii) well-defined Project objectives overall and within sub-components which accurately assess the country's needs and absorptive capacity; (iii) regular monitoring of Project perfoirance indicatois and rigorous supervision offering substantive, issue-oriented support. Based on these experiences, the Proect contains a limied number of highly focussed components wbich the GOM, working  -9- closely with the Bank, has identified as critical to the sector. In addition, the semi-annual Project Implementation Review (para. 24) is designed to combine flexibility in execution with close monitoring and substantive support by Bank staff. 32. The design of this project also draws on recent Bank experience with the Industrial Restmuring rie (Loan 3047-ME). Under this Loan, the Project Agreement was amended to provide direct assistance to SHCP and the CNB.29 33. Environmental Asnect. The Project, classified under Category C, is expected to have no adverse environmental impact. 34. Program Objectives Categories. The project supports private sector development and institutional strengthening. Efforts under this project to streamline legislation and regulation for provision of all financial services, are considered to be critical components of an overall strategy in the area of private sector development.0' The project will also support the institutional strengthening of certain critical functions of supervision, and public investment evaluation and budgeting carried out by SHCP and its legally related entities. 35. Proiectnefits. In overall terms, the Project when coupled with parallel reforms to be undertaken by the GOM, would enhance the prospects for economic growth by reducing the costs of capital and improving domestic and foreign investor confidence. The Project would encourage greater accountability and coordination between Government entities responsible for the regulation and supervision of financial conglomerates within a consistent and integrated framework. The Project would also assist the development of Mexico's domestic securities and capital markets through a more rational and efficient regulatory and supervisory framework applied to securities markets or participants such as brokeage firms, mutual funds, insurance companies, and pension funds (i.e. SAR accounts). Finally, the component related to the MlU will assist the Mexican government to leverage scarce public esources to develop basic infrastructure more effectively which will, in turn, improve the competitiveness of Mexican industry and improve prosects for economic grwth. 36. Ae_ents Reached. The Bank and the GOM have agreed to the following: (i) each Commission and the IEIU will submit an annual worl:plan to the Bank; (ii) each Commission and the IEIU will appoint a coordinator to work with SHCP and the Borrower in the administration of their portion of the project; (iii) one or more specialized consultants will be retained to assist the commissions and the IEIU in all adminstrative matters regarding the project; (iv) the Guarantor (SHCP), the Borrower, each of the Commissions, the IE3U, and the Bank will carry out semi-annual reviews of the project to assess progress during implementation, and to evaluate and determine if modifications are needed to the workplan; and (v) impact indicators acceptable to the Bank shall be established at the time of the first semi-annual project implementation rview and will be measured at the time of the midterm and final reviews of the project. 21 See Mexico: Industrial Restrfturing Project (Loan 3047-ME) Amendment to the Loan Agreement, R93- 225. 10/ See FY94 Country Economic Memorandum (CEM) Fosteing Priwte Seaor Devdopment in die 1990s.  -10- 37. Risks. Although the GOM has given every indication that the Project will continue to ecive strong support, several risk factors remain at this time: (i) possibility that the recommended reforms to improve financial conglomerate supervision may be slowed due to political considerations; (ii) possibility that mandatory SAR contributions remain below level required for economic viability of system despite the reforms undertaken through the project; and (iii) non-implemenitation of proposals derived from studies or inadequate follow-through in implementation of the program by counterpart agencies. 38. The design of the project will reduce these risks to the extent that the ewecuting agency is SHCP and the functions to be strengthened are legally part of SHCP responsibilities. Additionally, as officials from SHCP and the Central Bank are members of the Board of Directors of the commissions, their participation and close coordinaton will mitigate many of the risks noted above related to follow-through or implementation of the assistance program. 39. Recommendation. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve it. Lewis Preston President Attachments Washington, District of Columbia December 22, 1994  PaP I of 2 MEXICO FINANCIAL SECTOR TECHNICAL ASSISTANCE PROJECT Project Costs and Fhancing - | . _ US* Equivalent PROJECT SUB-COMPONENTS Foreign Local Total S cOMS#StONA~~~lOt#AI~~~'M& AQ~~6~ ~ cost_cos 1. Modernization of Authorization Function 2e,0 80000 370,000 2. Evaluation and Uporading of Regulatory and Supervisrv Policy 780.000 810 000 1.390.0001 3. irprove General On-Site Supervision and Inspection Process 380,000 110.000 490,000 4. Specialized Technical Expertise in Supervision 1 1.4S0000 1080,000 12o,10,00 S. Upgrading Financial Analysis Capability and Off-Site Supervision 880.000 040 000 1,520,000 6. Improve Regulatory Reports, Report Processing and Output, and 240,0001 70,000 310.000 Public Disclosures 7. Information Systems and Budgeting Proces 2.540,000 3,040,000 56,80,000 8. Upgrade Capecity of Supervision of Development Banks 100.000o 30,000 130,000 9. Human Resource Development 4.040 000 1 180 eo0001 5,200.000 Subtotal 10,700,000 8,800,000 17,500,000i 1. Evaluation and Uggrading of Regulatory and Supetvisory Policy 550.000 180.000 740 000 2. Improve Disclosure Standards and Ensure Consstency with 120 000 90,000 210,000 nternational east Practice 3. Development of Supervision Systerns for Exchange-traded Derivative 320.0001 120.000 440,000 4. Strengthen Self-Regulation bV Market Participants 140 0001 40.000 180,000i 5. Development of Regulatory Reports Consistent with Intemational 180,000o 70,000 2S0000 Standards 6. Support Development of the Siterna Intemacional de Cotizaciones 90000 30,000 120,000 Subtotal 1.400000 540,000 1.940.000 1. Upgrade Inspection Process for Insurance Companies and Brokers 33120,000 450O000 2. Evaluation and Upgrading of Regulatory and Supevisoy Polie 10000 80,000 290,000 for Insurance and Re-insurance Companies 3. Rationalize and Upgrade CNSF Actuarial Service 380,000| 130,000 490 000 4. Improving Desk Anasisie and Monitoring of Institutions t70Q0001 70.000| 240.000 5. Review of Regulatoty Accounting Standards and Regulatory Reports 100.0001 4000o0 140,000 8. Develo Public Awareness Program for Regulatory Standards and 180 0001 70,000 2s0,000 Practices Subtotal 1 350000 510, 0o 1 860.000 1. Intenal Information Systems for CONSAR 26 I o0 I20 0 800 2. CONSA National Information Network 540000 41000 95000 3. Special Studies 100000 18000 Subtotal 1 190 000 740,000 1,930,000 1. Consultant fees 0 440,000 440 000 1. Inter-institutional Coordination 2. Standards, Diffusion and Training 200000 3. Project Evaluation 2, OC0 C 80 4. Project Inventory and Prioritization 4000 00C 130,00 5. Multi-annual Budgeting 600 0170,000 170 000 6. Ex-Post Evaluation and Monitoring 100 000 30,000 130,000 Subtotal 7,P90,00 I - TOTAL 18,64000 1 720,000 31 ,30,0001  Pav20f2 MEXICO FIIANCIAL SECTOR TECHNICAL ASSISTANCE PROJECT Project Cost and finandng (M. Equtahmt) .I .Local Foreign Total Bank 5 2580000 18.350,000 238600.000 Govemment I 7470,001 290.000 7,760e000 Total 12720000 18,640000 3136  MEXICO FINANCIAL SECTOR TECHNICAL ASSISTANCE PROJECT Procurement and Disbursement Arrangements Procurement Methods by Category (Bank financing shown in parentheses) Thousands of US$ nCategory Pocuremen Mod Total _____.___j_CeB LCB I Otheia/ N.B.F. I 1. Consultant 19,380j 19,380 services, training (19,000) (19.000) and relted expenses b/ ... . ._.. 2. Goods and 3,190 1,140 900 5,23 Equipment c/ (2,900) (950) (750) (4,600) 3. Operating Expenses 6,750 6,75 Total r 3,190 1,140 20,280 6,750 31,36 -_______________ J{(2,900 (9I50 (19,750) (23,600) N.B.F.: Not Bank-Financed a/ Other' category consists of shopping (goods) and employment of consultants. bl Contract of consultants according to World Bank guidelines (para. 26). cI Guidelines for procurement of goods and equipment (para. 27). di Operating expenses consist of incremental salaries and benefts, taxes, and installation charges incurred by the Comrnmissions, lEIU, and SHCP to Implement the Project. Disbursement (US1O. 0 :ieuivalet -- _ Category Amount P!centage 1. Consultant servIces, 19,000 100%of foreign training, and related expenditures & expenses 90% of local expenditures 2. Goodsl 4,600 100% of foreign Equipment expendites & -90% of local ______________ ___ ____ expenditures TOTAL 7 23,600 _ _ , It Estimated IBRD Disbursements (US*'000) - - I0 0 _FY951 Y Y 1Annual 8.0001 10.000 51600 fCummuatVe 8,0001 .18.000 23,600  Sch-edwle C MEXCO :IANCALSECrOR TECHNICAL SSAC IJC Timetable of Nac ftgaft (a) Tlme aken to prepare: Ten months () Prepared by: SHCP, CNV, CNB, CNSF, CONSAR, and IMMU with Bank sur (c) First Bank mission: January 1994 (d) Appraisal mission departure: June 1994 (e) Negotiations: November 1994 (t) Board presentation: January 1995 (planned) (*) Planned Effectiveness: February 1995  STATUS OF BANK GROUP OPERATIONS IN MEXICO A. STATEMENT Of BANK LOANS (As of September 30. 1894) lgtos" IDullw dwbibu 13,788.10 Of wlioh SICALs. $ALs, Pmgtsm Loans, and Interest Support I.n. 1929-ME 1S81 BANO -RAS RealwaylIV 149.88 Ln. 2331-ME 1983 BANCOMEXT Export Development 349.33 Ln. 2882-ME 1988 BANCOMEXT Trade Policy Loan 11 SOO.OO Ln. 2918-ME 1888 NAVIN Agrultural Seor Loan 300.00 Lin. 3158-ME 1880 BANCOMEXT Interest Support Loan 1,260.00 Ln. 3207-ME 1990 BANOBRAS Road Transport & Telcom. 380.00 Ln. 3087-ME 1889 NAFINII Indutrial Sector PolRy 497.51 L. 2745-ME 1987 BANCOMEXT Trade Policy Loan I 498.63 Ln. 3085-ME 1988 NAFIN Pubtl Enterprise Reform 499.39 Ln. 2777-ME 1987 BANCOMEXT Export Developnmnt It 246.37 Ln. 2919-ME 1988 NAFIN Fertier Seor 240.20 in. 3300-ME 1991 BANCOMEXT Export Sector 25.00 Ln. 3357-ME 1991 NAVIN Agutural Secor AdJ. It 400.00 Subtotal 5,346.31 i-n. 268-ME 1988 NARN AgrIcultural Dev. Prodertth It 88.30 32.28 Ln. 2606-ME 1986 BANO8RAS MunIcipa Stgthening 40.00 1.77 ii. 2869-ME 1988 SANOBRAS Solid Waste Management Pilot 25.00 10.91 Ln. 2824-ME 1987 BANOBRAS Utban Transport I 90.98 21.42 Ln. 2858-ME 1987 NAfIN SmalMoedkum4Scale Industry IV 100.00 2.92 Ln. 2875-ME 1988 itANOSRAS Highway MaIntenance 135.00 2.78 iLn. 2916-ME 1988 NAFIN Steel SectorReatruoturb 321.01 64.76 Ln. 2945-ME 1988 BANO3RAS Ports RehabNitation 47.66 1.82 iin. 3047-ME 1989 NAFiN Industrial Restructuring 230.00 27.54 Ln. 3083-ME 19889 NARN Hydroelecroi Development 460.00 86.06 Ln. 3085-ME- 1989 BANOCOMEX Financi Sector Adjutment 487.14 0.73 Ln. 31 15-ME 1990 NAFIW Forestry Development 45.50 29.48 Ln. 3140-ME 1890 BANOi3RAS Low-Income Housing 11 350.00 22.43 Lin. 3141-ME 1990 NAFRN Agricultural Market II 100.00 0.47 Li. 3189 -ME 1980 NARN Transmisbn & Disrbution 450.00 104.37 Ln. 3208-ME 1990 BANO8RAS Telcomm. Techicoa Assstance 22.00 2.05 Ln. 3271-ME 1991 iANOiRAS Water Supply & SantaIon 300.00 7.70 Ln. 3272-ME 1981 NAFiN Bsic Health Care 180.00 77.31 Ln. 3310-ME 1991 NAFIN Decentral2ation & Regional Develop. 350.00 52.80 in. 33S8-ME 1991 NAFIN TlehnIcsl Train III 152.00 74.40 Li. 33-ME 1991 NARN Mining Soctor Restruturing 200.00 107.56 Ln. 3407-ME 1992 NAFiN Priary Education 250.00 117.04 Ln. 3419-ME 1992 NAFIN Irrgation & Drainae Sector 400.00 223.83 Ln. 3461-ME 1892 RANO-8RAS Envitronmenta/Natural Resoumes 50.00 37.84 Ln. 3465-ME 1992 NARiN Agricultural Technology 150.00 130.58 Ln. 3475-ME 1992 NAFiN ScInce & Technology InfrastnrctUre 189.00 187.55 Lin. 3497-ME 1992 BANORS Housing Market Oeveiopment 450.00 183.16 in. 3518-ME 1993 WNARIN Itial Education 80.00 70.64 in. 3542-ME 1993 NARN ibor Market & Prd. Enhanemn&P t 174.00 125.29 Ln. 3543-ME 1993 NARiN Transport Air Pollutbn Conrl 220.00 200.07 Lin. 3558-ME 1993 BANO3RAS Me C Transport 200.00 188.01 Li. 3628-ME 1993 BANOIRAS Highway Rehb. & Traff Sat 480.00 372.74 In. 3704-ME 1994 NARIN OnFam&MinorIrigationNetwok 200.00 186.00 Ln. 3722-ME 1994 NAFIN PrImary Education 412.00 412.00 Ln. 37SO-ME 1894 BANOBRAS N. Bord I EnvIonent 368.00 368.00 Ln. 3751-ME 1984 BAANOfUS Water/Sanistson St 350.G0 350.00 Ln. 37S2-ME 1994 8ANOBRAS Solid Waste ll 200.00 200.00 Ln. 3778-ME 1095 NAFIN Rainfed Ares Deelpnt 85.00 79.50 Ln. 3790-ME 1995 NARN Second Decentralation .00.00 500.00 Totl 22,720.90 4,623.38 Of Which has been repaid 6,897.2t Total now held by the Bank 15,426.77 Amount sold : 92.34 Of which has been repaid: 92.34 Total Undisbursed 4245.53 4.245.53 SAL., SECAL, or Program Loan under niplementatlon. a> Not yet eftectsve  SCHEDULE D APage 2 of 3 StA1E4Et OF IFC INVEStMEMtS As of Seotember 30, 1994 (In miltlions US Oottebrs) - Original Gross Coemitments - Hetd Metd Undisb Fiscal Years IFC tFc by by rTnl. Coemitted obTisor Type of Business Loan Equity Partic Totats IFC Partic Partic 1958 S/ Bristol de Mexico, S.A. IndustrSal aquipment and .52 * .52 1958159 */ Industrias Perfect industrtal equipment and .80 - .80 . 1961 a/ Acero Solar, S.A. Industrial equipmnt and - .28 .28 - - 1962/65/66/64 of FundTdora Monterrey, S.A. Iron and steel 1.81 21.45 .48 23.74 1963 of 5uimlca det Ray, S.A. Chemicals and petrochemlc .07 .68 .75 - 1963 o/ Tuos de Acero de Mexico, Iron and steeL .81 * .19 1.00 1964/66 a/ tndustria dol 1ierro, Industrial equipment and 1.96 - 1.96 - 1.70 of Miner* del Nort*, S.A. Iron nd stel .75 J .73 1.50 1971 a/ Cewanese Mexicans, S.A. Textiles 8.00 - 4.00 12.00 - - 1972 o/ Promotrs de Papat Timber, putp and paper .03 - .03 - - 1973/79 a/ Cementos Veracrut, S.A. Cement ad construction m 11.35 - 4.50 15.85 1974/81 / Cancun Aristos Hotel TourIsm .98 .32 1.30 1975f78 of Mexinox, S.A. tron and steat 12.00 3.18 - 15.18 1978 t/ Tereftalatos Moexicnos, Chemicals and petrochemic 19.00 1 19.00 1978/81/84 a/ Papeles Ponderosa, S.A. Timber, pulp ard paper 6.20 4.96 4.50 15.66 1979/81/7 Hottel Camino Real Ixtapa, Tourism 4.20 4.20 4.20 1979/84 a/ Epresas Tolteca de Cement and costruction m 30.00 7.95 138.00 175.95 1979/91 Conductores Monterrey, Industrial equipment and 8.41 - 13.00 21.41 1.92 1980 a/ Industriss Resistol, S.A. Chemicals and petrochemic 8.00 - 17.00 25.00 1980 a/ Minera Real de Angeles, Mining 30.00 * 80.00 110.00 1980 a/ Vtdric Plano d Mlexico, Industrial equipment and 15.00 - 99.90 114.90 181 a/ Grupe Industrial Alfa Gener4at mnufacturing 15.50 44.00 59.50 1981 a/ Universal de Valores, Food ad agribusiness 6.30 3.00 5.00 14.30 1984 a/ Capital Goods facility Oevelopmemt financing 34.00 66.00 100.00 1984/88/94 Hetalsa, S.A. Automtive and accassorte 32.00 1.40 35.00 68.40 25.25 35.00 25.00 1985 a/ Proteison, S.A. do C.V. Food and agribusiness 1.95 .82 2.77 1985/90 Grupo Primex, S.A. de Chemicals 4nd petrochemic 32.00 - 4.40 36.40 14.80 1986 Celulosa y Papel do Timber, pulp and pper 10.00 3.07 - 13.07 5.00 1987 a/ Agro tndustrial Food and arsibuness 1.50 .50 . 2.00 1987 ao Industries Sultfmx, S.A. Fertiliers 2.00 .50 2.50 1988 Sealed Power Mexicana, Automctive and aceessorie 9.00 * 9.00 1.50 1988 Sigma Atimentos, S.A. de Food and agribusiness 20.96 2.00 22.96 3.50 1988 Vulica Shipping Coepawy tndustrial services - * 0.0O 18.00 1988/91/92193 Apasco, S.A. de C.V. Cment ad comstruction m 156.41 - 40.00 196.41 37.20 40.00 1988/92 Calizas industrialas del Mining 73.00 - 73.00 26.81 1m 9anes Serfin, S.N.C. Capital morkets 60.00 * 60.00 54.00 1989 Cemx. S.A. Cmnt nd construction m 60.00 * 8.00 68.00 12.86 i989/92 fomento Sconomico General manufacturing 80.00 27.60 - 107.60 63.78 i989/92 Polimr, S.A. de C.V. Chtemcals and petrochemic 19.10 - 19.10 11.02 1990 2i lancomr, S.N.C. Capitl mrkets 20.00 - 20.00 1990 lanco Macionat de Mxico, Capital markets 60.00 - - 60.00 42.23 6.25 2.40 1990/92 6rupo Condumex S.A. de General mnufacturing 35.00 9.54 18.00 62.54 26.25 10.80 1990/94 Indelpro, S.A. de C.V. Chemicals ad petrochemic 31.00 3 3.00 34.00 27.84 1.50 1991 a/ The Mexico Equity nd Finaial serices 6 6.57 6.57 1991 Petrecel S.A. Chemicals and petrochemil 32.00 * 32.00 30.00 199 Vitro Flotado, S.A. de Industrial quipment ard 25.00 * 101.00 126.00 24.69 75.75 1991/92 Vitro S.A. Geewral ufacturing - 18.21 - 18.21 10.17 1992 Aislantes de Ledn, S.A. Automotive and accesscrie 10.00 7.03 . 17.03 10.00 19 Banco Merchntil del Capital markets 20.00 . 20.00 7.30 7.30  SCRDULE D Page 3 of 3 xatco STATEMENT OF IFC INVESTMENTS As Of Septedber 30. 194 (In hillions US Collars) - original Gross Comitments - Held Held Undisb Fiscat Yeers IFC IFC by by inst. Camnitted ObIigor Type Of usisnes LEan Equity Partic Totals IFC Parttc Partic 1992 Celular de tetefonta tIndustrial services 15.00 1.00 37.00 53.0t 16.00 36.73 2.88 1992 Grupo financiero Capitat markets * .50S 7.50 7.50 199 aCrupo Irnustrial 31mb., Food nd agribusiness 25.00 75.00 100.00 23.21 66.67 1m Grupo Posadas, S.A. do Tourism 20.00 3.72 33.50 57.22 20.00 33.50 1993 The Nexico City Toluca Industrial servics 13.73 - 13.5 9.73 1993 Celulcsa y Oerivados, Textiles 11.00 t 26.00 37.00 11.00 34.07 1993 Masterpak, S.A. de C.V. Tiaber pulp and pap.r 12.00 * 28.00 40.00 12.00 25.93 1994 Alimentos Naturales Food and agribusnesgs - 0.00 3.00 , * 1994 Aurur-Heller Fectorale, Capital markets * 8 * .98 .98 94 . C-upo Idesa S.A. de C.V. Chemicals and petrochefic 15.00 8.00 42.S0 65S.50 23.00 i.S0 4400 1994 Grupe Operador de Industriat services 4.00 2.00 6.00 12.00 6.00 2.2R 1994 Internacianol de Ceramica Cement and eanstruction m 31.00 . 17.50 38.50 21.00 17.50 1994 Mexicana de Cobra, S.A. Nonferrous etats 25.00 - 35.00 60.00 25.00 35.00 20.00 1994 Pyosa, S.A. de C.V. Generat n2nufacturing - * * 0.00 9.70 Total gross commitmants bl 1162.17 147.49 988.18 3297.84 Less cancellations, terminations, repayment & sates 566.36 96.86 S36.98 1200.20 Total cocmitments now held c/ 595.81 50.63 451.20 1097.64 646.44 451.20 10s.82 Pending contitments BANCOMER MGMT - - .15 - .15 CTAPV 5.00 2.00 7.00 GIRSA 30.00 a 30.00 60.00 KAPTA 9.85 - 9.85 Sigmn Altients, S.A. de Food and agribusirnss 20.00 5.00 20.00 45.00 Tereftelatos 14excanos, Chemicals and patrochemfc 20.00 - 20.00 40.00 Total pending coseitments 75.00 17.00 70.00 162.00 Total comitments hetd end pending cocuittents 670.81 67.63 521.20 1259.64 Total wdisbursed comitments 43.27 - 63.55 105.82 ao tnvestments which have been fully ancelted, terminated. writen-off, sold, redeemed, or repaid. b/ aross cciftments consist of approved and sIgned projects. c/ Held cometments consist of disbursed and undisbursed Investments.