Peru - Financial Sector Adjustment Project

 Financial Sector Adjustment Report No: ; Type: Report/Evaluation Memorandum ; Country: Peru; Region: Latin America And Caribbean; Sector: Financial Adjustment; Major Sector: Finance; ProjectID: P008050 Peru - Financial Sector Adjustment Loan (Loan 3489-PE) The Peru Financial Sector Adjustment Project, supported by Loan 3489-PE for US$400 million equivalent, was approved in FY92. The loan was closed in FY96, following two one-year extensions of the closing date, and was fully disbursed. The Implementation Completion Report (ICR) was prepared by the Latin America and Caribbean Regional office. The Borrower’s comments are included as an appendix. The Financial Sector Adjustment Loan (FSAL) was part of a package of three adjustment loans, and one of the Bank’s first programs under the policy of Additional Support for Workout Programs in Countries with Protracted Arrears. It was a key element in the successful completion of a reform program involving stabilization, structural adjustment and implementation of an external financing plan. Peru cleared its arrears to the IDB, the IMF and the Bank, and benefited from several Paris Club reschedulings and, in 1997, completed a debt service reduction agreement with commercial bank creditors. The FSAL supported Peru’s medium term program of macroeconomic stabilization and structural reform, with special emphasis on the financial sector, by providing balance of payments assistance. Financial sector reform objectives included reducing state participation in banking (by eliminating the development banks, curtailing activities of Banco de la Nacion, and privatizing state-owned commercial banks); improving the regulation of banks (by re-casting banking regulations and strengthening the banking superintendency); and reinforcing capital markets (by strengthening regulations and introducing a private pensions system). The loan was successful in supporting macroeconomic stabilization and the external financing program. Fiscal and monetary discipline, together with structural reform and a targeted program to assist the poor, resulted in a notable improvement in the economy and a reduction of poverty. Real GDP growth, which had been negative in 1986-90, averaged 5% per annum during 1991-96. Inflation, which averaged over 800% per annum over 1986-90 was reduced to 12% by 1996. The package of FSAL-supported financial reforms has fostered substantial improvements in the depth of financial intermediation and the health of the banking system. State participation in the financial sector has been reduced. The operations of development banks, which were dependent on Central Bank credit, were terminated and they are being liquidated gradually. The role of the Banco de la Nacion is gradually being curtailed. All other publicly-owned banks have been privatized or liquidated. Banking legislation, passed in 1993, strengthened regulations and prudential standards. The supervisory and regulatory authority of the Securities Commission was strengthened. A new private pension system was instituted allowing the opening of individual retirement accounts in private pension funds. The ICR, which is satisfactory, rates the project outcome as highly satisfactory, achievement of institutional development objectives as substantial, sustainability as likely and Bank performance as highly satisfactory. OED concurs with this evaluation. The Bank underestimated the time required to obtain internal consensus and take the required action in two specific areas: transfer of financial assets of the wound-up development banks to the private sector and completion of actions to restructure the Banco de la Nacion. The release of the second tranche was delayed two years, the Bank ultimately waived the tranche release conditions on the grounds that substantial progress had been made toward fulfilling these conditions.  This operation demonstrated the synergy between stabilization, growth and financial sector development. Macroeconomic stability reduces uncertainty and increases the willingness of investors to trade off liquidity for return, a stable currency enhances the capability of the financial sector to manage its global liquidity position and economic growth makes it easier for financial intermediaries to manage credit risks. Implementation of the project also illustrated the importance of avoiding vague conditions phrased in imprecise language, including only conditions that are essential to achievement of project objectives, and making sure that complex tasks can be realistically fulfilled within the time frame provided. No audit is planned.