Turkey - Third Export Finance Intermediation Project

Document of The World Bank FOR OFFICIAL USEONLY ReportNo: 31440-TR PROJECT APPRAISAL DOCUMENT ON A PROPOSEDLOAN INTHE AMOUNT OFUS$201.05MILLIONAND 80.41MILLION TO THE TURKIYE SINAI KALKINMA BANKASI A.8. (TSKB) WITH THE GUARANTEE OF THE REPUBLIC OF TURKEY FOR THE THIRD EXPORT FINANCE INTERMEDIATION LOAN (EFIL 111) April 14,2005 Privateand FinancialSector DevelopmentDepartment ECCU6 Europeand Central Asia Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS (Exchange Rate Effective April 14,2005) Currency Unit = New TurkishLira (TRY) TRY 1 = US$O.74 US$1 = 1.34TRY FISCALYEAR January 1- December 31 ABBREVIATIONS AND ACRONYMS ALM Asset and LiabilityManagement BDDK BankingRegulationand SupervisionAgency BIS Bank for InternationalSettlements CAS Country Assistance Strategy CEO Chief ExecutiveOfficer CBT Central Bank of Turkey CIRR CommercialInterest ReferenceRate CIS Commonwealth of IndependentStates DC Direct Contracting ECA Export Credit Agency or Europe& CentralAsia (Region) EFIL I Export Finance Intermediation Loan EFIL I1 Second ExportFinanceIntermediationLoan EFIL 111 Third ExportFinanceIntermediationLoan EU EuropeanUnion FSL Fixed Spread Loan FMR FinancialMonitoringReports FMS FinancialManagement System FX ForeignExchange GOT Govemment of Turkey IFRS InternationalFinancialReporting Standards ICB InternationalCompetitive Bidding ICR ImplementationCompletion Report IF1 InternationalFinancialInstitution IMF InternationalMonetaryFund IPO Initial Public Offering IT Information Technology ISA InternationalStandardson Auditing ISP InternationalShoppingProcedures LAC1 Loan Administration Change Initiative NCB National CompetitiveBidding N S National Shopping TRY New Turkish Lira OECD Organizationfor Economic Cooperation and Development OM Operations Manual PFI ParticipatingFinancialIntermediary(bank or leasingcompany) PIU Project ImplementationUnit SCL Single Currency Loan SMP Staff MonitoredProgram SOE Statementof Expenditure TSKB Turkiye SinaiKalkinmaBankasi(the Borrower) Turk EXIM Bank Turkiye Ihracat Kredi Bankasi(the Borrowerunder the first EFIL) TL Turkish Lira  FOROFFICIAL,USEONLY PROJECTAPPRAISALDOCUMENT Republicof Turkey Third ExportFinanceIntermediationLoan TABLE OF CONTENTS MAINREPORT Page I.STRATEGICCONTEXTANDRATIONALE.......................................................................... . 3 A. Country andSector Issues...................................................................................................... 3 B. Rationale ForBankInvolvement ........................................................................................... 6 I1 PROJECT DESCRIPTION........................................................................................................ 7 .C. Higher Level Objectivesto whichthe Project Contributes.................................................... 7 A. LendingInstrument................................................................................................................ 7 B. Project DevelopmentObjective andKeyIndicators.............................................................. 8 C. Project Components ............................................................................................................... 8 D. LessonsLearnedandReflectedinthe ProjectDesign........................................................... 9 InEPROJECT IMPLEMENTATION........................................................................................... 10 . Alternatives ConsideredandReasonsfor Rejection............................................................ 10 . A. PartnershipArrangements.................................................................................................... 10 B. InstitutionalandImplementationArrangements.................................................................. 10 C. Monitoring and Evaluation of OutcomesResults ................................................................ 11 D. Sustainability........................................................................................................................ 11 12 F. BoardPresentationLoanConditions andCovenants............................................................ E. Critical RisksandPossibleControversial Aspects............................................................... 14 IV APPRAISAL SUMMARY..................................................................................................... 15 . A. Economic andFinancialAnalyses....................................................................................... 15 B. Technical.............................................................................................................................. 15 C Fiduciary .............................................................................................................................. . 15 D. Social.................................................................................................................................... 16 E. Environment - CategoryFI................................................................................................... 16 F. Safe&ard Policies ................................................................................................................ 17 G. Readineks............................................................................................................................. 17 H. Compliance .......................................................................................................................... 17 TECHNICAL ANNEXES Annex 1: Country and Sector or Program Background................................................................ 18 Annex 2: Major RelatedProjects Financedby the Bank andor Other Agencies......................... 25 Annex 3: ResultsFramework andMonitoring.............................................................................. 26 Annex 4: Project Description........................................................................................................ 27 Annex 5: Project Costs.................................................................................................................. 34 Annex 6: Implementation Arrangements...................................................................................... 35 Annex 7: Financial Management. Audit and DisbursementArrangements................................. 51 Annex 8: ProcurementArrangements........................................................................................... 58 Annex 9: Turkey's Export Growth. Export Loans and GeneralFX Loan Availability Analysis........................................................................................................................ 61 This document has a restricteddistributionand may be used by recipients only in the performance of their official duties I t s contents may not be otherwise disclosed . lwithout World Bank authorization .  Annex 10: Safeguard Policy Issues............................................................................................... 64 Annex 11: Project Processing....................................................................................................... 66 Annex 12: Documents inthe Project File..................................................................................... 67 Annex 13: Statement o f Loans and Credits .................................................................................. 68 Annex 14: Turkey at a Glance ...................................................................................................... 69 FIGURES Figure 1: Real Effective Exchange Rate (1995=100) .................................................................... 3 Figure 2: Turkish Exports (bymonth. US$million)...................................................................... 4 Figure 4: New Leasing Volume and GDP Growth 1999-2004 Figure 3: Turkey FinancialLeasing Receivables 2000 . .................................................... 21 2004.................................................. 22 Figure 5: Breakdown o f new leasing volume interms of equipment.......................................... 23 Figure 6: TSKB Outstanding Loan Volume, USDmillion.......................................................... 42 Figure 7: TSKB Balance Sheet - Composition of Liabilities...................................................... 43 Figure 8: TSKB Balance Sheet - Composition of Assets............................................................ 44 Figure 9: TSKB Income Statement -Results as % of Total Operating Income.......................... 46 Figure 10: GDP Local Currency (constant 1987prices) .......................................................... - 61 Figure 11: Exports/GDP Development........................................................................................ 61 Figure 12: Turkey's Export Performance .................................................................................... 62 Figure 13: Export Finance ........................................................................................................... 63 TABLES Table 1: Major Macroeconomic Indicators..................................................................................... 3 Table 2. MainExport Indicators ..................................................................................................... 5 Table 3. Turkish banking system in2001-2004.............................................................................. 5 Table 4: Turkish Exports and Imports for 1999-2004 .................................................................. 19 Table 5: Other Services by TSKB in2004 ................................................................................... 43 Table 6: TSKB -Retumon AssetdReturn on Equity.................................................................. 46 Table 7: Banks satisfying the pre-qualification criteria ranked by (i) total assets; and (ii) export sector loans/total assets..................................................................................... 48 Table 8: Leasing companies satisfying the pre-qualification criteria ranked by (i) lease total receivables; and (ii)annual volume of leasing ............................................................ 50 Table 9: Thresholds for Procurement Methods and Prior Review (inUS$ million equivalent) ..60 Map IBRD33501 11  REPUBLIC OF TURKEY THIRD EXPORT FINANCE INTERMEDIATIONLOAN(EFIL111) PROJECTAPPRAISAL DOCUMENT Europe and Central Asia Region Private and Financial Sector Development Department Date: May 26,2005 Team Leader(s): Lalit Raina Country Director: Andrew Vorkink Sectors: Financial/Private Sector Director: Fernando Montes-Negret Themes: Export development and Sector Manager Gerard0 Corrochano improved access to finance Project ID: PO93568 LendingInstrument: Financial Intermediarv Loan (FIL) \ I Project Financing Data: [XILoan [ 3 Credit [ 3 Grant [ ] Guarantee [ 3 Other: Source Local Foreign Total US$ mln. mln. US$ mln. mln. TSKB 0 0 0 0 0 IBRD/IDA 0 201.05 80.41 201.05 80.41 PFIs & Sub-borrowers* TBD FY N O 6 FY07 FY08 N O 9 F Y l O Annual US$ 36.05 45 45 40 35 Cumulative US$ I 36.05 1 81.05 I 126.05 1 166.05 1201.05 Annual 13.41 20 20 15 12 Cumulative 13.41 33.41 53.41 68.41 80.41 Does the project depart from the CAS in content or other significant o Yes o No respects? Does the project require any exceptions from Bank policies? Have these o Yes o No beenapprovedby Bank management? oYes o N o I s approval for any policy exception sought from the Board? oYes om Does the project include any critical risks rated "substantial" or "high"? oYes om Does the project meet the Regional criteria for readiness for o b o N o implementation? 1  ~ Proiect development obiective (i) Provisionofmediumandlong-termworkingcapitalandinvestmentfinancetoprivate exporters, and contribute to further facilitating export growth inTurkey; and (ii) Improvement in the quality, and safety of, and access to, finance through development o f financial intermediation in the Turkish private financial sector by banks and leasing companies. Proiect description The project will provide a new credit line, backed by the Bank's fixed spread dual tranche (US Dollar and Euro) loan o f 16 years o f maturity, including a 6-year grace period, and guaranteed by the Turkish government on behalf o f the Republic o f Turkey, to TSKB, a private Turkish investment and development bank, for further on-lending to eligible financial intermediaries - banks and leasing companies (TSKB already i s the Borrower for the ongoing EFIL I1facility). The financial intermediaries will further on-lend the credit line funds to eligible exporters. _ _ _ _ ~ Which safeguard policies are triggered. if any? ~ None. [Environmental issues for sub-borrowers, if any, will be addressed through the sub-loan environmental eligibility criteria process on a case by case basis] Significant, non-standard conditions, if any. for: ~ Boardpresentation: At least two PFIs have been selected and have submitted an expression of interest inwriting for participation inEFIL111. The Operations Manual', including the environment guidelines for the sub- loans and leases, has been adopted. Loadcredit effectiveness: At least two PFIs have undergone the qualification procedure and have signed subsidiary loan agreements. Covenants applicable to proiect implementation: None * While it i s expected that both PFIs and sub-borrowers themselves will contribute to the financing of individual sub-projects, the precise amount of such financing to be provided cannot be determined ex ante, as the loan design does not envisage the use of predetermined cofinancing requirements. Instead, maximum exposure to individual sub-borrower limits for PFIs and debt equity and debt service coverage ratio requirements for sub-borrowers will drive the amount of cofinancing to be provided. ' The Operations Manual for EFIL I11will be broadly the same as EFIL 11, with updates for the use o f dual currency loans, procurement and environment procedures as applicable. 2  I.STRATEGICCONTEXTANDRATIONALE A. COUNTRY AND SECTORISSUES 1. Recent Macroeconomic Developments. Turkey i s steadily recovering from the economic and financial crises o f 2001, but tight macroeconomic management and structural reforms remain key for future stability and growth. After significantly shrinking in 2001, the Turkish economy has grown at a rapid pace in the last three years, and inflation, supported by a stable Turkish Lira, has gone down to historically low levels in2004 - first single-digit inflation in34 years (see Table 1 for details). With the help o f a recordprimary budget surplus in2003- 2004, public debt as a percentage o f GNP has also trended downwards. Over the last three years, real interest rates, though still high, are down to around 10% from 30-35% pre-crisis levels. Besides, after 41 years o f associated partnership - the EU, in December 2004, has extended a formal invitation to Turkey to start membership negotiations. Thus both the external and internal macroeconomic and political environment for Turkey has improved substantially. However, in spite of these positive developments, some macroeconomic uncertainties remain. The current account has worsened and reached 5.1 percent o f GNP in2004, posting an all-time highUS$15.4 billion deficit. Turkey's public debt burden remains high. Structural reforms, including fiscal policy changes and state bank privatization, have not been completed. Long term productivity in the real sector and efficiency in the financial sector need to improve significantly to sustain future stability and growth and to catch up with the rest o f EUcountries inthe coming years. Table 1: M a j o r Macroeconomic Indicators GNP Growth 68.5 29.7 18.4 Net Debt to GNP 93.9 79.2 70.9 63.5 Current account/GNP 2.3 -0.8 -2.9 -5.1 Source: Turkishauthorities _~ Figure_1: Real Effective Exchange Rate (1995=100)__. _ _ _ _ _ _ _ ~ -~ ~ ~ ~~~ _ 160 150 140 130 --eCPI-based 120 110 100 90 80 Feb-97 Feb-98 Feb-99 Feb-00 Feb-01 Feb-02 Feb-03 Feb-04 - - ~ _ _ _ _______ - . _ _ _ ~~ ~ ~~ Source: Central Bank of Turkey 3  2. Strong exports growth has been one of the key contributingfactors in the continued GDP growth. Export growth continued steadily throughout 2002-04, despite the ongoing appreciation o f the real effective exchange rate (Figure 1).During2001, many exporters suffered from shortages o f working capital and lack o f internally generated resources as a result o f the shrinking economy and uncertain macroeconomic and political environment. However, the TL depreciation in 2001 created a boost for surviving exporters, and those with a somewhat price- elastic intemational demand, increased their export performance substantially. This was true for some o f the first EFIL beneficiaries. As the TL gained strength, exporters expressed fears regarding their capacity to compete in intemational markets, but exports have actually increased inthe last two years (Figure2). Increasinglabor productivity inthe short term, partly stemming from the post-crisis layoffs, and first reducing, then keeping real wages steady helpedtrim down unit labor costs and facilitated export competitiveness despite a strengtheningcurrency. Figure2: Turkish Exports(by month,US$ million) 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 Jad98 Jad99 JadOO JadO1 Jad02 Jad03 Jad04 Jad05 Source: State Institute of Statistics (SIS) 3. Though exports have grown rapidly in Turkey during the last few years, from US$36 billionin 2002 to estimatedUS$63.1billionin 2004, their continuedrapid growth in future years is critical as an engine of economic growth and competitiveness(Table 2). The external trade continues to have a negative balance o f about US$34 billion. In comparison to several large economies, Turkish merchandise exports, at almost 20% o f GNP in 2002-2003, have considerable room for further growth. Sectoral breakdown o f exports in 2003 shows that manufactured goods account for nearly 84% o f the total exports, with machinery and transport equipment contributing over a quarter o f total exports. The latter export segment also grew faster (42% in2003) than other manufacturing exports (30.5%). Half o f the exports in2003 went to the EU, while exports to the Middle East, although only one tentho f the total exports, grew fastest - 4  almost by 60%. Thus there i s ample scope for both geographical and product diversification o f exports. Table 2. Main ExportIndicators I2000 12001 I 2002 [ 2003 2004 Exports, US$ mln I27,775 III31,334 36,059 II147,253 63,100 Exports % ofGNP 13.8 17.8 19.7 19.7 21.1 ExportGrowth(%) 14 12.8 I1115.1 31.0 II1I33.5 4. Even though economic performance continued to improve, the pick up in market sentiment had not led to any significant increasein the overall level of bank credits to the productivesectorsinthe immediateyears after the 2001-02 financialcrises. However, lately, as inflation reversed course, interest rates began to fall, and the dominance o f bond returns over equity returns and credit spreads started to wither away, allowing for more funds to be withdrawn by the banks from the treasury paper investments and channeled into client lending. Loan book expansion i s now a general phenomenon, but it stems mainly from consumer credits. Banks have recently been adjusting their long-term strategies though, and corporate credit enhancement, especially targeting SMEs, i s now inthe agenda. Table 3. Turkishbankingsystemin2001-2004 Assets Cash, LiquidAssets, and Securities 40,184 46,374 64,174 77,887 Loans 28,523 31,675 46.260 72,462 of which Short-Term loans nla nla 26,464 42,830 & Medium to long term loans 19,796 29,632 Fixed Assets 39,234 40,221 5,931 6,294 Other (securitiesheldto maturity, etc.) 9,801 10,667 62,519 71,704 Total 117,742 128,937 178,884 228,347 Liabilities Deposits 81,139 86,497 111,268 142,363 Non-depositFunds 15,216 17,079 11,717 11,798 Other Liabilities 11,055 10,615 26,773 39,929 ShareholdersEquity 29,568 36,578 25,059 29,541 Retained Earnings (19,236) (21,832) 4,067 4,716 ITotal 117,742 128,937 178,884 228,347 GNP (USS million) 148,1661 1:Y,898171.67 239,059 299,400 Total Assets (% of GNP) 79.47 74.83 76.27 ITotal Deposits (% of GNP) 54.761 48.08) 46.541 47.55) 5  performing loans to total loans decreased from 13% to 6.3%, while the coverage o f the NPLs with loan loss provisions remainedunchanged at 89%. 6. Lending from private banks however remains weak due to their lack of access to mediumand long-termfundingsources and lack of institutionalcapacity to properlyassess lendingrisks of longer-termlending. The real sector is still faced with the financial system's inability to adequately offer longer-term credit resources. The 2004 year-end figures show that while the total loans in 2004 increased by US$26 billion, about two thirds o f the increase was in short term (less than one year) loans. Even among the medium term-long term loans category, experience has shown that most o f the loans are o f less than 3 years maturity, with a handful o f loans only to the best customers approaching 5 years maturity. The primary reason i s o f course a shortage o f medium to long term liabilities, both inthe form o f deposits as well as intemational lines o f credit or syndicated loans, leading to a gap betweenthe maturity o f assets and liabilities. For example, nearly 49% o f total assets (including investment/securities holdings) were o f 1 year o fmaturity or longer, but 81% o f total liabilities was o f maturities less than 1 year. Besides, over the first nine months o f 2004, even though lending to the government by the banking sector has decreased from US$50 billion or 31.2% in 2003 to US$44 billion or 22.5% o f the total banking system assets in 2004, by virtue o f its magnitude, it still constitutes a major crowding out effect for the private sector enterprises. 7. Lease finance - which often is an important source of longer-term investment finance for exporters in other countries also has remained underdeveloped in Turkey, - with the growth in lease receivables highly volatile and dependent on macroeconomic performance. Both the banking and leasing sectors still lack access to medium and long term funds- a circumstance which provides the principal rationale for the Bank's involvement and the EFILI11(see Annex 1for a more detailed discussion). B. RATIONALE BANKINVOLVEMENT FOR 8. The main rationale for the Bank's involvementis to address the development need for mediumto long term funds for investment and mediumterm working capital needs of exporting enterprises, to deepen and broaden financial intermediation capacity, and contribute to strengthening Turkey's external accounts. With nominal and real interest rate levels on Turkish Lira loans remaining prohibitively high, and loan maturities very short, demand for affordable longer-term foreign currency funds from the real and financial sectors in Turkey remains strong. To address the shortage o f longer-term credit for the real sector in the post-crisis environment, the Turkish authorities had requested the Bank for an export credit line, which would be provided through the financial system and would support private sector exporters. The Bank's support materialized through the US$300 million EFIL I1 credit line in 2004. In order to deepen financial intermediation in Turkey and expand the outreach o f EFIL I1 funds to SME exporters also, leasing companies were included for the first time along with banks as participating financial intermediaries (PFIs). To date, EFIL I1 has achieved a welcome coverage o f enterprises o f all sizes, as well as in diverse economic sectors and geographical regions. 9. The utilization success on the EFIL I1 in 2004 has created an urgent demand and rationale for a repeater EFIL I11operation in 2005 in order to maintain the momentumof assistance to exporters. The proposed new operation, EFIL I11will continue and build on the 6  performance record o f EFIL 11. In view o f the continuing surge o f commitments (US$220 million inMarch2005 - 73% o f the total available funds) and disbursements (US$189 million - 63% o f the total) duringthe first year o f EFIL 11, TSKB and the PFIs are expecting that the funds are likely to be fully committed by September 2005 and completely disbursed by end-December 2005. Based on the indications given to the Bank team by the PFIs, and assuming economic growth remains on track and macroeconomic and political stability continues, the overall demand for mediudlong term investment funds provided by the proposed new EFIL I11credit line to exporters i s likely to remain high. Even though there i s increased supply o f long term funding from other multilateral institutions like EIB, FMO, DEG, KFW, the amounts are still small compared to the overall demand for long term funding. Similarly, even in the event o f imminent commencement o f EU accession negotiations in the near future, significant flows o f pre-accession funding which would benefit exporting enterprises were unlikely to materialize duringthe lifetime o fthe proposed EFILI11operation. Thus the timing o f EFILoperation is very consistent with the current demand and insufficient supply o f long term funds. 10. The proposed project is consistent with the FY04-06 CAS for the Republic of Turkey. As stated in the CAS, an important objective is the revitalization o f the real sector by providing access to long term credit. The CAS'Skey priorities for the medium term include completing the banking and financial sector reforms and filling the current gap in accessing credit facilities, which will be also supported by this proposedproject. c. HIGHER LEVEL OBJECTIVESTO WHICH THE PROJECTCONTRIBUTES 11. One o f the main benefits o f the proposed project will be faster private sector growth and job creation, supported by a healthier and more developed financial system. Ingeneral, enterprise and financial sector performance i s expected to continue to improve in the short and medium term. In the longer run, export growth supported by the proposed operation i s expected to have an overall positive impact on poverty alleviation and private sector growth inTurkey. 11. PROJECT DESCRIPTION A. LENDING INSTRUMENT 12. The lending instrument proposed for the EFIL I11 project is the Bank's Fixed Spread Loan (FSL) in two currencies (US Dollar and Euro) with a 16-year maturity, including a 6-year grace period. The instrument will have a fixed spread over the benchmark (6-month U S Dollar Libor and Euribor), and is planned as a loan with a long maturity both for the Bank loan to the Borrower (TSKB), and for the subsidiary loans from the Borrower to participatingfinancial intermediaries. The long maturity o f the credit line i s justified by the fact that, with a revival o f demand, lower inflation and GDP growth picking up, the operational and investment planning horizon o f private exporters i s lengthening, and banks and other financial intermediaries are willing to provide increasingly longer term foreign currency funds (of which there i s a clear shortage in the market) to their well-performing clients. 7  B. PROJECTDEVELOPMENT OBJECTIVE AND KEY INDICATORS 13. The proposed project's main objective i s to follow through on the achievement o f the predecessor EFIL I1project and continue to serve as a catalyst to support export and real sector growth in Turkey during the EFIL I11implementation period (2005-2010), and beyond using the EFIL I1 and EFIL 111 reflows. To this end, the project will provide medium and long-term working capital and investment finance to Turkishprivate exporting enterprises, at the time when the economy i s showing strong signs o f growth, and export performance i s on the rise-thus increasing the demand for longer term credit, while the financial sector i s still unable to support these trendswith very much neededlonger term funds at a reasonable cost. 14. The secondaryobjectiveo f the loan is further improvement inthe ability o f the Turkish financial sector to provide financial resources to the enterprise sector, through further development o f intermediation by private financial institutions, including banks and leasing companies. The project, through inclusion o f leasing companies inaddition to banks as PFIs,will enable the Bank to continue a dialogue with the leasing sector in Turkey, provide an opportunity to gain more insight into the sector, and enable the Bank to further support its development. Also, the EFIL 111 will seek more diversity o f the financial intermediaries, by including new banks and leasing companies as the PFIs, compared to the EFIL11. 15. The EFIL Iproject financed mostly medium and large exporters, with the average sub- loan being close to US$2.5 million. The inclusion o f leasing companies as a new class o f financial intermediaries in the EFIL I1 facility has insured that more small and medium-sized exporters are reached than if intermediation was done through the banks only. In fact, as o f March 1, 2005 the average lease finance application from the leasing companies under the EFIL I1facility was US$423,000, as opposed to an average loan application size o f US$2.73 million from banks. Overall the average loadlease finance application size under the EFIL I1facility i s US$1.24 million. It i s expected that the EFIL 111, similar to the EFIL 11, will be able to reach a significant amount o f smaller exporters, Le., those with annual revenues typically not exceeding US$3 million, and provide financial sub-leases in the US$250,00~1,000,000 range for acquisition o f productive assets (equipment and machinery for manufacturing and/or service companies) . C. PROJECT COMPONENTS 16. The proposed EFIL I11 project will substantially maintain the design of its predecessor EFIL I1projectwhich is beingsuccessfully implemented.The credit line will be provided to TSKB, with a government guarantee, while TSKB will onlend it (on a wholesale basis) in the form o f subsidiary finance to participating financial intermediaries for further on- lendingto eligible private exporters. The principal design o fEFIL111will be as follows: - TSKB, a privately owned Turkish investment and development bank, will act as the borrower and implementing agency. TSKB i s well suited at this time as the Borrower o f - the Bank loan and for wholesaling it to financial intermediaries; leasing companies, inaddition to banks, will again be included as financial intermediaries under the project. This will continue to support development o f the leasing industry and 8  will allow World Bank funds to reach non-bank customers, primarily smaller exporting companies; and - The loan funds will be provided to the Borrower on standard Bank terms with 16 year maturity (including a 6 year grace period). This would extend the maturity available to the financial intermediaries and borrowing companies and appropriately respond to the increasing stability o f the Turkish economy and lengthening o f the investment planning horizons inthe enterprise sector. 17. The EFIL I11will have a single component a credit line for exporters, and will provide the medium and long-term funds to exporters through two distinct channels, or sub-components: (i)US$165 million and 65 million through commercial banks in the form o f investment or working capital loans, and (ii) US$35 million and 15 million through leasing companies in the form o f lease finance for acquisition o f productive assets (vehicles, machinery and/or equipment).No co-financing arrangements with other international agencies are envisaged. D. LESSONS LEARNED REFLECTEDINTHEPROJECTDESIGN AND 18. The main lesson leamed during the last few years from Bank credit line operations inthe ECA Region and elsewhere i s that the project design should be kept as flexible as possible, with a minimum number o f statutory requirements; e.g. avoiding constraints like minimum sub-loan size, maturity, currency denomination, sub-borrower co-financing requirements, sectoral lending focus, etc., but using sensible financial indicators for the selection of both the PFIs and the sub- borrowedsub-projects in line with established market practices. Restrictive procurement requirements unsuitable for private sector borrowers, and the World Bank's previous currency pool loan features have also proven to be a hindrance to expeditious project implementation, and wherever commercial practices and SCLs were used, these factors ceased to be a bottleneck. Another important lesson learned has been that the most successful formula for high quality and expeditious project implementation i s to combine the Borrower and Implementing Agency functions in one and the same entity ifpossible. Finally, pre-committing financial intermediaries to borrowing a certain part o f a credit line (which involves paying a commitment fee on the pre- committed amount) provides a strong incentive to the intermediaries to be quick and effective in finding and financing eligible sub-projects, and leads to quicker disbursement o fthe Bank loan. 19. Lessons Learned from Previous Credit Line Operations in Turkey: The Implementation Completion Reports (ICRs) for the previous World Bank credit line operations in Turkey indicate that some o f these operations had to be restructured in mid-stream because the initial project design turned out to be too inflexible (e.g., too many requirements interms o f minimum sub-loan size, sub-loan maturity, sub-borrower cofinancing requirements, etc.). The ICRs indicate that, after restructuring, project implementation generally proceeded well. 20. The proposed project design incorporates all o f these lessons leamed, by using TSKB as the borrower and implementing agency for the loan, by the use o f a clear, market-based set o f eligibility criteria for PFIs, sub-borrowers and sub-projects, by the use o f flexible loan terms and suitable private sector procurement practices, and also by use o f formal expressions o f interest from a minimum number o f the PFIs prior to Board Presentation to a specific portion o f the credit line. 9  E. ALTERNATIVES CONSIDERED AND REASONS FOR REJECTION 21. A search for alternative approaches to the project was not necessary in this case, as the EFIL I11is being undertaken as a repeater project, building on the success and structure of the EFIL Iand particularly EFIL I1projects. The borrower in the EFIL I11will again be TSKB (Turkish Industrial Development Bank), same as in EFIL 11. The same set o f development objectives and implementation arrangements as inthe EFIL I1facility will be maintained. Given the absence o f any material changes from the EFIL 11, the EFIL I11qualifies as a repeater project, which will continue to serve the needs o f exporters and PFIs for medium and long-term investment and working capital funds. 111. PROJECT IMPLEMENTATION A. PARTNERSHIP ARRANGEMENTS 22. As part o fbothproject preparation and implementation, the Bank team has built, and will continue to cultivate, close relationships with both national and regional exporters' organizations, the Turkish Eximbank, the Turkish Bankers' Association, and the Turkish Association o f Leasing Companies, with a view to opening and maintaining a dialogue with the project beneficiaries, and to identify, where relevant, policy issues and constraints to further development o f exports as well as o f the leasing industry. In the case o f exporters associations, this dialogue will build on the relationships already developed in the context o f the first two EFILprojects. Relevant policy issues will feed into the Bank's overall sectoral dialogue with the Turkishauthorities. B. INSTITUTIONALAND IMPLEMENTATIONARRANGEMENTS 23. TSKB, a non-deposit taking private investment & development bank owned largely by local commercial banks, will be the borrower and the implementingagency for the project. A separate project implementation unit (PKJ) has been established by TSKB under the supervision o f one o f its executive vice presidents to oversee the implementation o f EFIL 11. The PIU i s staffed with experienced management and staff, and, as the primary project counterpart for the Bank team, will provide the overall administration o f all aspects o f the credit line and required reporting to the Bank. The same PIUwill oversee the implementation o f EFIL111. 24. For the purposes o f EFIL I1 implementation, the PIU has developed a very efficient online interface between itself and the PFIs. The PFIs can apply for sub-project funding online, while the intemal TSKB decision approval process as well as project accounting and information processes are well integrated into the EFIL I1 project management system and are working smoothly. The same tested project management systemwill be used for EFIL I11implementation. 10  c. MONITORINGEVALUATIONOFOUTCOMES/"JLTS AND 25. Inpursuing its major developmental objectives, the project will target an increase inthe access to finance to exporters as measured through an increase in the amount o f aggregate exports o f the financed exporting enterprises, and number o f exporting enterprises benefiting from such improved access. An increase in the development o f financial intermediation in Turkey is an important second development objective, as measured through (i) increase inthe the breadth and depth o f participating financial intermediaries, and (ii) improvement o f the quality o f credit portfolio management. Increase in the volume of transactions o f the participating leasing companies will also be an important target, as it would signal a growing strength o f financial intermediation through leasing which has the potential to reach small exporting enterprises at times overlookedby larger banks. 26. Progress inachieving the development objectives will be measured on the basis o f - Increase in access to finance for exporters measured by the number o f enterprises - and volume of exports supported; Increased depth and breadth o f financial intermediation as measured by the number of additional PFIs (banks and leasing companies) that participate inEFIL I11different from those in EFIL11; and - Improvement o f quality o f credit portfolio management by measuring the level o f debt service and amortization performance o f sub-loans under EFIL I11 of the participating banks and leasing firms. 27. Progress will be monitored through regular reporting by the Borrower/Implementing Agency, and through statutory project supervision missions. It i s envisaged that reporting under the EFIL I11 will be done through quarterly progress reports, with the reports specifically distinguishing project transactions o f the two classes o f financial intermediaries - commercial banks and leasing companies. The Operations Manual describes the details o f the Project reporting. D. SUSTAINABILITY 28. Turkey's past export growth record, as well as the World Bank's own past experience with credit line operations inTurkey, EFIL I1being the most recent one, indicate that the private enterprise sector has the technical and managerial ability to successfully tap export opportunities, provided they have access to appropriate financing (e.g., interms o f pricing and maturity). Thus, expansion o f existing and new export operations that will be financed by the funding to be provided by the proposed EFILI11have a very highlikelihood o f self-sustainability. 29. Additionally, continued use by participating banks o f high-quality loan and sub-borrower analysis requirementsunder EFIL 111, as well as the further development o f the leasing industry as an important source o f longer-term investment finance for smaller exporters, will contribute to strengthening the overall intermediation capacity o f the financial system, which i s likely to be sustained beyond the closing date o f the EFIL 111. 11  30. Finally, by using TSKB - an established investment and development bank - as the Borrower and ImplementingAgency for the project, TSKB's wholesale lending function in the Bank's projects, already well established under the EFIL I1 facility, is likely to become more sophisticated, and therefore more effective in future in intermediating international bilateral and multilateral funding from a multitude o f sources, to the benefit o f the overall Turkish private sector. E. CRITICAL RISKSAND POSSIBLECONTROVERSIALASPECTS 31. EFIL 111potential risks are somewhat lower than those in EFIL 11. With respect to the generic risks e.g., macroeconomic and structural reform risks, as well as potential political instability, these have become less significant since the time o f the EFIL I1preparation in 2003. In December 2004, the EU has formally invited Turkey to start membership negotiations in October 2005 - a widely awaited and highly positive development, which i s bound to further stabilize the markets and make Turkey an increasingly attractive destination for foreign investors. Turkish exports have historically demonstrated their resilience to macroeconomic shocks, and continued to grow in 2004. On the other hand, the public debt i s still large in absolute terms, though it has come down as a percentage o f GNP. The structural reforms, including privatization o f the remaining state banks, have not yet been completed. Even the positive impact o f the invitation for the EU membership negotiations may dissipate if the negotiations present too many roadblocks. Uncertainties on these issues may impact the overall risk environment. 32. With respect to project-specific risks, there are no significant risks observed. TSKB has largely proven itself as very capable in on-lending the EFIL I1 credit line funds and administering the project processes. Leasing companies have become full-fledged participating intermediaries o f the Bank's credit line funds. The Bank has to remain careful incases where the credit line funds are lent to environmentally-risky sub-borrowers, e.g., steel producers. This risk would be mitigated by Bank team visits, to an extent possible, to such potential sub-borrowers before the funds are committed, and by further improvement in the capacity o f TSKB staff to assess the environmental risks o fproposed sub-projects. 12  Risk RiskMinimizationMeasure Generic Risks M The Turkish economy has achieved significant stabilization since the 2001 crisis. The Government has demonstrated its macroeconomic commitment to sustained economic and political stability and andstructural reforms, with the invitation to EU membership negotiations reform risks, serving as an overarching driving factor. Furthermore, the political economy has become much more resilient to negative shocks instability, etc.) since 2001. Turkey's private sector exporters' track record o f resilience to macro-economic instability i s also a strong risk- mitigating factor. However, some macroeconomic and structural reform risks remain that can derail the economic stability and the project environment in future. These are: (i) Large government debt overhang. The net public debt to GNP ratio, although going down, was 63.5% at the end o f 2004 and could be a significant source o f macroeconomic risk in case the external or internal economic environment becomes uncertain-therefore needs to be carefully monitored; (ii)high current account deficit increases the risk o f exchange rate downward adjustment; (iii) tight primary fiscal surpluses still need to be maintained to avoid any future risk o f worsening inflation and government debt scenarios. Delay inthe privatization o f the state-owned banks, because of their balance sheet structure, may cause liquidity risk in times o f externalhntemal uncertainties and need to be constantly monitored. Timely implementation o f the privatization agenda also needs to be pursued to mitigate these risks. Project-specific N The Bank, throughout the last 3-4 years, has maintained a Risks(e.g., close dialog with TSKB, the proposed EFIL I11borrower and participating implementation agency. TSKB has experience in managing intermediaries' foreign credit lines, including those from the World Bank most onlending o f recently being EFIL I1and the Renewable Energy Loan. The funds to non- Bank team has strong confidence inthe financial, institutional, viable export managerial, and technical capacity o f TSKB to undertake the operations, financial liability and administrative burden associated with etc.) Risk Rating - H (High Risk), (Substantial Risk), M (Modest Risk), N (Negligible or Low Risk 13  F. BOARDPRESENTATIONLOAN CONDITIONSAND COVENANTS 33. Board Presentation Conditions: 0 At least two PFIs have beenselected and have submitted an expression o f interest inwriting for participation inEFIL111. 0 The Operations Manual, including the environment guidelines for the sub-loans and leases, has been adopted. 34. Effectiveness Conditions: 0 At least two PFIs have undergone the qualification procedure and have signed subsidiary loan agreements, satisfactory to the Bank. Satisfactory legal opinions on both the Loan, Guarantee and the two Subsidiary Loan Agreements have been received. 35. General Covenants: 0 TSKB to maintain satisfactory financial management systems, including records and accounts, and prepare financial statements satisfactory to the World Bank. Annual project accounts and an IFRS audit o f TSKB's financial statements to be provided within six months o f each year-end during the implementation period (audits to be carried out by independent external auditors in accordance with International Auditing Standards and International Financial Reporting Standards, under terms o freference satisfactory to the World Bank). 0 TSKB to maintain a PIUwith satisfactory staffing and other resources as required for effective project implementation. 0 TSKB to monitor project performance in accordance with the agreed performance monitoring indicators.  IV. APPRAISAL SUMMARY A. ECONOMICAND FINANCIAL ANALYSES 36. NIA B. TECHNICAL 37. NIA C. FIDUCIARY 38. TSKB has worked with the World Bank before and i s very familiar with the Bank's fiduciary requirements related to procurement, disbursements, and applicable safeguards (see Environment in D.5). The Bank team has full confidence in TSKB's ability to diligently follow these requirements. 39. During the last few years, the Turkish authorities have demonstrated a strong commitment to strengthening the financial system by establishing an independent and professional banking regulatory/supervisory institution (BDDK). This commitment and related efforts were encouraged and supported by the Bank through its policy advice and adjustment loans. As a result, the BDDK has established itself as a solid independent regulator, capable o f issuing and enforcing prudential regulations for the banking sector. There is, therefore, no need for detailed prudential guidelines and eligibility criteria for EFIL 111; instead, a single certification by a bank's extemal auditors that a bank i s in general compliance with the Turkish prudential standards for banking operations, as established and promulgated by the BDDK, will be used. Therefore, monitoring o f participating bank eligibility will be simplified and done through: (a) a prudential regulation compliance certificate; and (b) annual audit reports. 40. Leasing companies have not been financial intermediaries in World Bank projects in Turkeyinthe past up to the EFILI1project where USD 85 million o fthe facility was allocated to leasing companies. Leasing companies were an entirely new financial intermediary class with a separate set o f eligibility requirements. Their inclusion in the EFIL I1 proved to be highly beneficial to the outreach o f the EFIL I1 funds to smaller-scale exporters. The following eligibility indicators which were usedinthe EFIL I1facility are proposed to be used inthe EFIL I11facility: a lessor will be duly registered and licensed by the leasing regulator and supervisor; minimum equity capital o f a lessor will be no less than TRY3 million, (approximately US$2.24 million); the total sum o f lease exposures will not exceed 30 times a lessor's equity capital, while the total sum o f exposures to related parties will not exceed 15 times its equity capital; a lessor will have been profitable for at least two out of the last three years o f operations; and 15  - the participating leasing company shall, at the time o f selection and for the duration o f its subsidiary loan agreement with TSKB, for each year-end beginning with year-end 2004, presentan audit report which: Covers two full years o f operations; I s prepared by an intemationally recognized extemal audit firm in accordance with Intemational Auditing Standards and Intemational Financial Reporting Standards (IFRS); and Contains an unqualified audit opinion. 41. Initial and ongoing compliance with the eligibility criteria for the leasing intermediaries will be assessed based on reporting by TSKB to the Bank, including quarterly project implementation reports prepared by TSKB and semi-annual extemal auditor compliance certificates* and annual extemal audit reports o fthe participating leasing companies. D. SOCIAL 42. Private sector exporters are one o f the key stakeholders in this project. The project, through its support o f the manufacturing-for-export sector is, indirectly, supporting employment inTurkey. E. ENVIRONMENT - CATEGORY FI 43. TSKB will be responsible for ensuring that sub-projects financed under the EFIL I11 undergo environmental screening to ensure their conformity with Turkish environmental legislation and regulations and the World Bank's policies and procedures, as set forth in OP/BP 4.01 and other relevant World Bank safeguards. The credit officers already appointed by TSKB to staff the P I U will perform this function. The PIU Operations Manual detailing, inter alia, the World Bank's requirements in respect o f environmental assessment, will be prepared prior to loan negotiations. 44. The PFIs, according to the procedures outlined in the Operations Manual, will undertake the environmental screening o f the sub-loan applications to determine the appropriate environmental risk category for the sub-borrowers/sub-projects. The sub-borrowers will be responsible for carrying out any environmental analysis and for confirming that the proposed sub-projects comply with national environmental guidelines, and for obtaining the necessary clearance from the appropriate licensing authorities. Requirementsin respect o f environmental analysis will also be written into the sub-loan agreements. The World Bank will perform ex-ante review and clearance o f all sub-projects falling in Category 111. Currently, leasing companies inTurkey are licensed and regulated by the Undersecretariat o f the Treasury. With the anticipated enactment o f the new law on financial institutions inthe next couple o f months, the regulatory and supervisory functions vis-a-vis the leasing sector are likely to be transferred to BDDK, the banking regulator. Following suchtransfer, incase BDDK updates the applicable prudential regulations for leasing companies in future, compliance with the updated regulations will be required for eligibility o f leasing companies participating in EFIL 111. 16  F. SAFEGUARD POLICIES 45. Environmental Assessment policies (OP/BP 4.01) will apply to EFIL 111, including sub- projects. The possibility that other World Bank safeguard policies might apply to sub-projects, along with other relevant environmental issues o f sub-borrowers and their sub-projects will be addressed through the sub-loan environmental eligibility assessment. World Bank staff will continue to supervise adherence to Bank and Turkish requirements, learning from the experiences o f EFIL-11. Annex 10 provides further details. It i s not anticipated that the sub- projects under EFIL I11 will trigger OP 4.12 (Involuntary Resettlement) and OP 7.50 (International Waterways). G. READINESS 46. The readiness of the Project for implementation: The completeness and readiness o f the N / A engineering design documents for the first year's activities The completeness and readiness o f the Procurement procedures are detailed inthe procurement documents for the first year's draft Operations Manual agreed with the activities Borrower The availability o f a satisfactory Project Draft Operations Manualhas beenprepared Imdementation Plan and aaeed with the Borrower I Other 1N / A I H. COMPLIANCE 47. The Project complies with all applicable Bank policies. 17  TECHNICAL ANNEXES Annex 1: Country and Sector or ProgramBackground Country and Sector Issues 1. Macroeconomic indicators for Turkey have been improving. Following the 2000- 2001 enterprise and financial sector crises and subsequent economic slump, the Turkish economy has registered a marked improvement in its performance. By the end o f 2004, interest rates on Government securities have fallen to the 18-20 percent range, compared with peaks during the post-crisis period o fwell over 100 percent. The economic recovery has been stronger than expected, with GNP growth for 2004 o f 9.9 percent, well above the initial target o f 5 percent. Inparallel, inflation has fallen substantially. End-2004 CPI inflation was just under 10 percent, below the 12 percent target, and the first single-digit inflation rate inover 30 years. The floating exchange rate regime has been successfully maintained, and an important degree o f exchange rate stability achieved. The current account, however, registered a sizable deficit o f 5.1 percent o f GNP. The positive macroeconomic outcomes have improved the public debt dynamics, with the stock o f net public debt falling by about 7.4 percent o f GNP in2004, to 63.5 percent o f GNP. Fiscal policy i s extremely important in the context o f implicit inflation targeting, and developments are encouraging on this front also. With the primary surplus o f the consolidated public sector reaching 6.5 percent o f GNP at end-2004, there seems to be no more "fiscal dominance" on monetary policy, which helps the Central Bank to turn its overnight lending and borrowing rates into effective monetary policy instruments. In 2005, economic growth i s expected to reach 5%, in part due to the continued strong export performance, while CPI inflation i s expected to decelerate to about 7% by end-year. Based on current trends, the Government's target o f 6.5% primary surplus o f the public sector i s likely to be achieved once again. 2. Turkish exports have been a major contributor to the positive macroeconomic performance. Export growth (Table 4) has been an important economic success story in the recent years. The share o f exports in GNP reached 21.1 percent in 2004. However, in the pre- crisis period exports were particularly hard hit by the combined impact of: (i) slowdown in the growth inTurkey's export markets from an average o f 8.9 percent in 1997 to 5.3 percent in 1998; (ii)disruption inthe previously rapidly growing Russian and CIS markets; (iii) sharp increase the indomestic real interest rates which undermined the competitiveness of Turkish export products in foreign markets; and (iv) the severe credit and liquidity squeeze in Turkey due to non- availability o f reliable short and medium term finance. Consequently, export growth dropped from 13.1 percent in 1997 to 2.7 percent in 1998. The effect o f the major earthquake in 1999 contributed to a further 1.4percent decline in exports that year. 3. Starting in 2000, export growth got back on a positive track, reaching 4.5 percent despite the December financial market crisis. In the aftermath o f the crisis, led by increased competitiveness o f Turkish exports after the Lira devaluation in early 2001 and by increasing market confidence in sustainability o f the crisis resolution measures undertaken by the authorities, export growth jumped to 12.8 percent in 2001 and 15.1 percent in 2002. Post-crisis economic recovery has clearly been export-led. Exports further grew 31 percent in 2003, and 18  have reached $63.1 billion in 2004, posting a growth rate o f 33.5 percent over the 2003 level. Figures demonstrate growth inboth volume and absolute value o f exports (for more statistics on export growth, export loan availability, etc. see Annex 9). Table 4: Turkish Exportsand Importsfor 1999-2004 Year 1999 2000 2001 2002 2003 2004 (billions of US$ % US$ % US$ % US$ % US$ % US$ % US$) Exports 26.6 -1.4 27.8 4.5 31.3 12.8 36.1 15.1 47.3 31 63.1 33.5 Imports 40.7 -11.4 54.5 34 41.4 -24 51.6 24.5 69.3 34.5 97.4 40.5 4. In case of EFIL I sub-borrowers, export performance data over the loan disbursementperiod between 1999-2002 have been very positive.Export figures for the years 1999, 2000, 2001, and 2002 were, respectively, US$ 2, 2.8, 3.1, and 4 billion, much more than the projected figures o f U S $ 0.1, 1.2, 1.7 and 1.9 billion for the same period. This corresponded to annual growth rates o f 40 percent, 11 percent, and 29 percent in the years 2000, 2001, and 2002, respectively. The main reason for this better-than-expected performance was the fact that the majority o f these companies were exporters with established markets. High export volume, increased profit margins and a strong equity base allowed them to sustain and improve profitable business activities, while maintaining a sound financial structure during both the pre- and post- crisis periods. In a few cases o f unsatisfactory performance, the main culprits were: (a) above- optimal financial leverage, (b) a relatively high percentage o f domestic sales within total sales, which were negatively affected by contraction in domestic demand throughout the economic crisis;(c) decreasing profit margins due to domestic competition, and/or decreasing capacity utilization as a result o f problems faced in obtaining working capital financing. Overall, the financial performance o f the majority o f beneficiary EFIL Ienterprises during the EFIL I implementation period can be regarded as satisfactory. The EFIL Ifacility, which was small compared to the size o f the Turkish economy and export oriented enterprises, has nevertheless been very successful in helping exporting companies in a country suffering from a severe crisis to continue and develop their export activities. 5. Medium- and long-term finance to Turkish exporters is, however, still scarce. The banking sector has been restructured to a significant extent after 2001. Inthe banking sector, the emphasis o f the Government's reform efforts during the 1990s was on the development o f a basic legal and regulatory infrastructure to facilitate ease o f entry, and to increase competition and growth. This triggered a rapid expansion o f banking system assets in Turkey during the 1990s, and in spite o f the 1994-95 and 2000-01 banking crises, total system assets in absolute dollar terms has grown 250 per cent from US$51.9 billion in 1994 to US$228 billion as o f end 2004, and also increased substantially as a percentage o f GNP from 39.2% in 1994 to an estimated 76.3% in 2004. The rapid growth in the size o f the banking sector, however, also had some negative consequences. Prudential regulations and enforcement capacity lagged behind, and there was a proliferation o f connected lending and concentration o f exposure and default risks. Lenient loan loss provisioning rules and enforcement allowed banks to understate their credit risks. Large FX open positions and asset/liability mismatches also created foreign currency and interest rate/liquidity risks in addition to credit risks. Additionally, growing public sector borrowing requirements during the years 1994-2001 encouraged banks to shift resources into 19  Government securities that were generating a relatively high-risk free real return. As a result, banks' lending activity declined in real terms. The situation reversed in the latter half o f 2002 and during2003, and lending activity picked up markedly in2004. Banking Sector Development 6. As mentioned above, a combination o f structural weaknesses in the Turkish banking sector, and macroeconomic and political uncertainties caused severe foreign exchange and interest rate shocks causing banking crises in December 2000 and February 2001. Several banks became insolvent and were liquidated as a result o f their large stock o f failed loans and insufficient capital. The total asset size o f the Turkish banking system i s nearly US$229bn, but dollar-denominated values are liable to abrupt changes as the nominal exchange rate realigns. The share o f the top 6 banks intotal assets i s 65%, which indicates an inadequate economic scale and operational volume for the remaining 42 banks. Furthermore, despite the liberal bank entry policy o f the last 25 years, the government i s still a major player in the banking sector with two state-owned banks - Halkbank and Ziraat Bankasi (which are in the process o f privatization) - among the top 6 banks interms o f size. 7. Untilloan demand from real sector companies reaches satisfactory levels, bondportfolio management will continue to shape the asset structure o f the banking sector. As o f end-2004, the volume o f the loan portfolio i s US$72.5 billion with Tier 1 banks owning around 65% o f this figure. On the other hand, in spite o f declining interest rate margins, bond portfolio reached US$92.2 billion in2004; accounting for 40.4% o f total assets. Inshort, T-bills have continued to be a source o f profitability in 2004, although their contribution to the bottom line will be lower with mark-to-market and trading gains forecast to fall further in2005. 8. Thus, there is a need for banks to build an increasing portfolio of loan assets, and a search for competitive sources of longer term funding. This requires a focus on (i) building retail corporate marketing units, specifically targeting SMEs; (ii) credit management and better risk management skills; and (iii)development o f a broad range o f loan products. With lower NpLs, cleaner balance sheets, disposal o f non core assets in a buoyant economy, the banks have sufficient risk capital to focus on building a portfolio o f higher return loan assets. Besides, lower return on government securities going forward, fee income is not expected to contribute to the bottom line in a significant way in the foreseeable future. Hence, profitability based on loan assets will be the main focus going forward. Corporate loans are expected to pick up at an increasing speed inthe next couple of years, and competitive sources o f longer term fundingwill be a key element in achieving success in doing so. Leasing Sector Developments 9. Similar to the predecessor EFIL I1project, leasing companies will again be accepted as financial intermediaries in the EFIL I11 project. The Bank will continue its dialog with the leasing industry- an important non-bank segment o f the financial market with financing options particularly appealing to smaller companies. 20  Figure 3: Turkey Financial Leasing Receivables2000 -2004 500 1 1 2000 2001 2002 2003 2004 -~ _- - -~ - ~~ Source: FIDER(TurkishAssociation of Leasing Companies) 10. According to the Turkish Treasury, there are 93 registered players in the leasing market, o f which 11 were non-deposit taking investment & development banks, 5 special finance institutions and 77 self-standing leasing companies. According to the information obtained from the Turkish Association o f Leasing Companies (FIDER), by the end o f 2004, only 5 o f the non- deposit taking investment & development banks and around 35 o f the self-standing leasing companies are active in the sector in addition to the 5 special finance institutions. Of the 35 currently active leasing companies, 3 are state-owned, 6 are owned by foreigners and 3 are partially foreignjoint ventures. 11. In2003 net leasing receivables of the leasing sector inTurkey increased by 51%inUS$ terms to US$2.2 billion (Figure 3). In T L terms, increase in net leasing receivables was 29% given that Turkish lira appreciated and the US$/TL exchange rate decreased by 15%. In 2004, growth inleasing transactions inthe sector pushed up the consolidated net leasing receivables by 35% to reach almost US$3 billion. In T L terms net leasing receivables increased by 32% in this period. 12. Based on the data from member leasing companies o f FIDER, by the end o f 2004, the total assets o f the sector were US$3.58 billion, indicating a 40% increase from the US$2.57 billion level in 20033. In 2003, 10 largest companies in terms o f asset size held approximately 75% o f the total assets o f the sector. These are at the same time 10 top ranking companies in terms o f new leasing volume and they also realized 75% o f the total new leasingvolume in 2003. 13. According to the Turkish Treasury, total consolidated equity o f the sector was around US$800 million by the end o f 2003. Solvency ratio (equitykotal assets) of the sector increased from its 22% level in 2002 to 27% in 2003. According to the FIDER data concerning the 9 FIDERmember companies' total asset size accounted for 95% o f the total assets o fthe whole sector according to TurkishTreasury data in2002 and 2003. 21  month period o f 2004, total equity of the sector (consisting o f 35 members) reached US$900 million, indicating a 28% equityhotal assets ratio. Net profit of the sector was around US$200 million in 2003, representing a 52% growth inUS$ terms when compared to 2002. Growth rate inthe TL basednetprofit was 50% in2003. The number ofnew leasingtransactions and leasing volume typically fluctuates with GDP growth. Figure4: New LeasingVolume and GDP Growth 1999 2004 - 3,500 12% 3,000 8% 2,500 4% zC .- 2,000 E: 0% s - 1,500 1,000 -4% 500 -8% -12% 1999 2000 2001 2002 2003 2004 New leasingvolume (Left Scale)+GDPGrowth _____ -.. - (Right Scale) ___ ~~~~ ~~ ~ ~~ .. ~ _ _ .- ~ Source: FIDER(Turkish Association o f Leasing Companies)and TSKB ( 2004 GDP) 14. New leasing volume in 2003 grew to US$2.2 billion, indicating a 63% growth relative to 2002 in US$ terms. In 2004, the sector continued to grow where new leasing volume rose by 35% inUS$ terms and reached US$2.9 billion for the whole year. According to FIDER, in2004 share o f manufacturing and service related transactions as a percentage o f total lease volume were 5 1% and 42% respectively. Textiles, food, paper, metal and machinery industries were the five main sectors in the manufacturing area. In the service sector, construction, logistics, telecom, financial services, health services, tourism and transportation vehicles services were the areas with highest lease volume in2004. 22  Figure 5: Breakdown of new leasing volume in terms of equipments concerning 2004 transactions of the sector are as follows: Other 3% Hardware and office equipments 7Q/n Real Estate Transportati vehicles 15% achinery and equipmf!nt 71% 15. The Turkish leasing sector is growing steadily, with straightforward financial leasing being the primary instrument offered. In fact, the existing 1985 Law on Leasing pretty much discourages the other type - operational leasing - by setting a minimumlease term o f 4 years. A new leasing law is being considered by the authorities, which should eliminate this and other constraints, such as ambiguity regarding sale-and-leaseback, sub-leasing and dispute resolution, to allow faster development o f leasing in Turkey by introducing new instruments. According to the changes made in the tax regulations in July 2003, leasing companies record their leasing transactions starting from that date in accordance with the International Accounting Standard 17 (leasing transactions are represented in net leasing receivables instead o f tangible assets and leasing income i s recorded as leasinginterest income inthe income statement). 23  16. Both banking and leasing sectors lack access to term funds. Access by the banking system to medium and long-term funding sources has typically been limited during the past several years due to unfavorable macro-economic circumstances, and became virtually non- existent in the aftermath o f the 2000-01 crises. While market confidence has increased since, there i s certainly no abundance yet o f medium or long term money on the market. All o f the top leasing companies are owned by banks, and suffer from the same funding maturity limitations as their parents. For instance, despite the legally prescribed minimum lease term o f 4 years, the market practice i s to frontload lease payments into the first two years, and keeps the formal lease contract idle for the remainder o f the term. Constant rollover o f short term fundingby the banks i s still the most popular way o f providing term finance to the enterprise sector, which provides the principal rationale for the Bank's involvement by providing medium and long-term funds to exporters via the participating financial intermediaries under the proposed EFIL 111. 24  Annex 2: Major RelatedProjectsFinancedby the Bankand/or Other Agencies 1. The proposed EFIL I11 is a repeater project o f the predecessors EFIL Iand EFIL I1 projects. The first EFIL was implemented during 1999-2003 and was very successful in disbursingnearly the full amount ofthe Loan (US$252.5 million), reaching out to many different exporting industries all across Turkey by financing close to 100 exporting sub-projects, and strengthening the financial sector by having the project PFIs undergo a comprehensive risk management assessment and implement resulting recommendations, even before risk management became an integral part o f the prudential requirementsfor the banks. The EFIL I1i s under implementation and has a highutilization rate. InMarch 2005, US$220 million out o f the total o f US$300 million were committed, andUS$190 million disbursed. 2. Both the first EFIL, EFIL 11, and the proposed EFIL I11are part o f the Bank's multi-year financial sector reform program for Turkey, which seeks to stabilize and support the further development o f the Turkish financial system for the benefit o f the private sector and economic growth. This program combines a series o f programmatic financial sector adjustment loans (some o f which also encompass public sector reform measures) supporting top-down policy reform with investment loans like EFIL I,EFIL 11, and EFIL 111, which facilitate bottom-up interactionwith key players inthe financial sector. The program i s underpinned by several pieces o f Economic and Sector Work, the most recent o f which (Report on Capital Markets and Non- Bank Financial Institutions) has pointed out the importance o f diversifying and deepening the financial system beyond banking. The inclusion o f leasing companies in the proposed EFIL I11 seeks to meet this objective. 25  Annex 3: Results Framework and Monitoring NarrativeSummary Key PerformanceIndicators Monitoring and Critical Assumptions Evaluation Sector-related CAS Goal: (Goalto World Bank Mission) Help meet privatesector financing Continuedimprovementin needs, to enhance private sector Increasedaggregate exports Trade Statistics macro-economicandpolitical competitiveness stability. Project Development Objective: (Objectiveto Goal) To provide mediumand long-term working capitaland investment Export Multiplier: Progressreports Continuationof the current financeto privateexporting preparedby TSKB's floating exchangerateregime enterprises, to continue assisting Incrementalaverage aggregateannual PIU the Turkish exportingsector hurt exports generated (measuredover 3 by the recentglobaldownturn and years for all sub-borrowers)itotal Supervisionmissions domestic financial crises credit line disbursed To increasethe depth andbreadth of financial intermediationas measuredby the number of Range of Financial Intermediaries additionalPFIs (banks and leasing participation: Absence of a major public debt companies) that participateinEFIL / financial sector crisis 111as comparedto EFIL I1 Number of additionalPFIs participating in EFIL 111different from those in EFIL I1 To improvecredit management Sub-loan Performance Indicators: practices in financial intermediationbasedon sub- Decreasing amount of non- borrowercreditworthiness criteria performing sub-loansand leases; Interestand/or principaldefaultsitotal amount of sub-loansand leases disbursed outputs: Credit line Utilization Indicator: I (Outputs to Objective) Provideeffectivesustained Amount of creditline actually Progressreports Good capital adequacyof mediumilongterm finance to disbursediprojectedcredit line preparedby TSKB's TSKB, and effective exporters on a timely basis disbursementon a straight line basis PIU projectmanagementby TSKB Project ComponentdSub- (Components to components: component) Outputs) Credit Line US$305 millionequivalent Progressreports Timely disbursement preparedby TSKB's TSKB to use the existing EFIL I1 PIU PIU for the EFIL I11 implementation, using part of the Supervision missions onlending margin to finance the PIU's oDerating costs 26  Annex 4: Project Description 1. The Third Export Finance Intermediation Loan (EFIL 111) consists o f a single component - financing o f sub-loans and leases under the project intwo tranches o f US$200 million and 80 million. Details are givenbelow. 2. Under the project, the EFIL I11will provide medium and long-term financing for the procurement o f goods and works by private exporters. The inputs could be procured locally or externally on commercially competitive terms and will, therefore, benefit both direct and indirect exporters. 3. Borrower and ImplementingAgency: The Borrower and Implementing Agency for the EFIL I11 will be TSKB, a privately owned investment & development bank, with the Government issuing a guarantee to the World Bank. Turkish laws allow the Government to issue guarantees to private non-deposit taking investment & development banks, although not to regular commercial banks. TSKB will act in the capacity o f a wholesale institution and will onlend the loan funds through a group o f 4-8 private banks and 2-4 leasing companies which will be selected pursuant to criteria agreed between the Borrower and the World Bank (see Annex 6). TSKB will take the credit risk on the banks and leasing companies selected for participation. The participating financial intermediaries in tum will make sub-loans and leases to private exporting enterprises for procurement o f goods and works in order to expand their current export volumes, or in exceptional circumstances to enable them to retain and maintain their current level o f exports. The onlending banks and leasing companies will take the credit risks on the borrowing enterprises. 4. Due Diligence o f TSKB: TSKB was one o f the PFIs in the EFIL Iproject and i s the borrower and the implementingagency for the EFIL I1project. Therefore, it i s well known to the World Bank team through a regular exchange o f views on the implementation o f the EFIL I1and through the reviews o f TSKB's audited reports and other financial reporting required under the EFIL Iand EFIL 11. A review of TSKB's IFRS annual and audit reports for the years [2000- 20041 indicates that TSKB exceeds the minimumBIS risk weighted capital adequacy ratio o f 8 percent and maintains an overall sound financial and operational structure, and i s fit to undertake the financial liability o f the Loan and operational commitments to act as a PIU for the project. 5. Loan Terms: TSKB, based on its own funding mix and anticipated demand o f exporters, has indicated a preference for a dual currency U S Dollar and Euro Fixed Spread Loan (FSL), which it will then on-lend to participating banks and leasing companies for a period o f up to 7 years which will include a grace period o f up to 5 years. Inorder to offset its administrative and implementation costs as well as the credit risks involved, TSKB will charge an on-lending margin to the participating banks and leasing companies o f up to 300 basis points over its cost o f funds under the World Bank loan, depending on the risk profile o f the borrowing intermediary. The subsidiary loans made by TSKB to the participating banks and leasing companies will be denominated and repayable in U S Dollars and Euro. The participating banks and leasing companies are expected to price their sub-loans and leases which may be denominated and repayable inany foreign currency on a commercial basis. 27  6. Selection o f Participating Financial Intermediaries: A preliminary list o f 14 banks and 12 leasing companies has been compiled from the universe o f around 20 private commercial Turkish banks and around 100 private leasing companies using the following pre-screening criteria: 1 For the banks - (i) assets during the last two years to exceed a minimum o f total US$500 million equivalent on average; and (ii)export loans-to-total loans ratios duringeach o fthe last two years (for which data is available) to exceed aminimumo f 10 percent on average. 1 For the leasing companies - (i) lease receivables during the last two years (for total which data are available) to exceed a minimum o f US$50 million equivalent on average; and (ii) new lease volume during the last two years (for which data are available) to exceed a minimumo fUS$30 million equivalent on average. 7. These criteria ensure that only financial intermediaries with an operational history, a viable asset base and an export sector lending focus are selected for further screening. From this group o f banks and leasing companies, a smaller group o f 4-8 banks and 2-4 leasing companies will be selected as final participating financial intermediaries for the EFIL I11by TSKB based on: (i) acceptance by TSKB o f their credit risk, (ii) expression o f interest in participation in their the project, and (iii) following eligibility criteria: the 1 For the banks - (i)general compliance with legal and regulatory requirements applicable to the banking industry, including but not limited to such prudential regulations as minimum BIS risk-weighted capital adequacy ratio, maximum foreign currency exposure limits, maximum large exposure to single and connected clients and maximum insider lending limits, etc., duly certified by the banks' auditors every six months, and (ii)IFRS financial statements audited in accordance with Intemational Standards o f Auditing (ISA) (see Appendix 4.3 - Likely Profile o f PFIs, Pre-Qualification andFinalEligibility Criteria). 1 For the leasing companies - (i)general compliance with legal and regulatory4 requirements applicable to the leasing industry, including but not limited to such regulations as minimum equity capital o f a lessor o f no less than TRY3 million (US$2.24 million at end-2004 exchange rate), the total sum o f lease exposures not exceeding 30 times a lessor's equity capital, and the total sum o f exposures to related parties not exceeding 15 times the equity capital, duly certified by the leasing companies' external auditors every six months, (ii) IFRS financial statements audited in accordance with Intemational Standards of Auditing (ISA) (see Appendix 4.3 - Likely Profile o f PFIs, Pre-Qualification and Final Eligibility Criteria), and (iii) the leasing company should have been profitable for at least two out o f the last three years o f operations. Please see para 40, page 15. 28  8. Eligible sub-borrowers: All private (private ownership more than 50 percent) exporters with foreign exchange earnings, irrespective of their sector, will be eligible for participation as sub-borrowers on a commercial basis. The prospective sub-borrowers will have to prepare and present a complete sub-loan package consisting of TSKB credit application form and such other information which TSKB and the Bank could reasonably request, as well as satisfy the procurement and environmental rules stated as part o f the World Bank loan conditions. The creditworthiness o f the sub-borrowers will be assessed by the PFIs, subject to the minimum requirement that the sub-borrowers maintain a maximum debt equity ratio o f 80:20 and minimum debt service coverage ratio of 1.2:1 (both after receipt of the sub-loan andor lease). The World Bank, in coordination with TSKB, will carry out a prior review o f the first two sub- loan applications o f each o f the participating banks and leasing companies to satisfy itself about the credit analysis process carried out by these financial intermediaries5. For the first two sub-loans with existing PFIs of EFIL 11, the prior review requirements will be waived. However they will apply for newPFIs and for the $5.OM sub-project threshold. 29  Appendix 4.1 Terms and Conditionsfor TSKB (Betweenthe World Bank and TSKB) For TSKI3, the following terms and conditions shall apply: Initial and ongoing compliance with applicable laws and regulations issued by the Turkish authorities, as certified by independent external auditors on an annual basis; For the duration o f the project implementation period, beginning with year-end 2004, submission o f an audit report, that is (i) prepared in accordance with International Auditing Standards and International Financial Reporting Standards; and (ii)has an unqualified audit opinion, except as the World Bank shall otherwise agree; TSKB will onlend the funds under the EFIL I11 to PFIs (selected according to the eligibility criteria agreed with the World Bank) using subsidiary loan agreements. All subsidiary loan agreements are subject to prior review by the World Bank; For the duration o f the project implementation period, maintenance o f the Project Implementation Unit (PW), staffed with qualified personnel, capable to satisfactorily implement all aspects o f the EFIL 111; TSKB will monitor the performance o f the project on a quarterly basis using performance indicators agreed with the World Bank, and will provide the World Bank with quarterly progress reports, giving the details o f the progress made inproject implementation; Timely preparation and submission o f EFIL I11project audit reports in accordance with International Financial Reporting Standards, Intemational Standards o f Auditing, and agreed Financial Management Arrangements (see Annex 6 and Annex 7); and TSKB will receive the funds from the World Bank on a 16 year maturity, at six-month LIBOR or six-month Euribor, plus a fixed spread; TSKB will pay the World Bank a front-end fee of 0.5 percent and an annual commitment fee o f 0.85 percent on undisbursed balances for the first four years, and 0.75 percent thereafter; the commitment fee will be payable with effect from 60 days after loan signing. TSKB will also pay a one-time guarantee fee o f 0.25 percent o f the Loan amount to the TurkishGovernment. 30  Appendix 4.2 Terms and Conditionsof SubsidiaryLoans (Between TSKB and PFIs) The following terms and conditions will apply to the subsidiary loan agreements to be entered into betweenTSKB and PFIs: Initial and continued compliance with the eligibility criteria for PFIs (see Annex 4); U S dollar or Euro denomination; Maturity o f the subsidiary loan o f up to 8 years, with up to 5 years grace; Interest rate o f the cost o f World Bank funds to TSKB plus an on- lending margin reflecting (a) TSKB's administrative costs; and (b) a credit risk margin; One-time front end fee o f 0.5 percent o f the Loan amount, one-time guarantee fee o f 0.25 percent o f the Loan amount, and commitment fee equivalent to the commitment fee payable by TSKB on the World Bank Loan; The funds available to PFIs will depend upon the availability o f funds to TSKB from the World Bank; PFIs will be responsible for ensuring that the sub-borrowers comply with the World Bank's procurement rules for the procurement of goods and works under EFIL I11 sub-loans and leases, applicable Turkish environmental legislation/regulation, as well as the World Bank policy on environmental assessment; and PFIs will provide a full set o f documentation for all sub-loans and leases to TSKB in order to enable TSKB to maintain all project records and make them available for ex-post review by the World Bank or by external auditors as necessary. 31  Appendix 4.3 Terms and Conditionsfor Sub-Borrowers,Sub-projectsand Sub-loans andLeases (BetweenPFIsand Sub-borrowers) The following terms and conditions will apply: For sub-borrowers: 0 Private ownership (defined as more than 50 percent private ownership or private control); 0 Status o f an exporter6; 0 Maximum debtlequity ratio o f 80:20 (after receipt o f the sub-load lease); 0 Sub-borrowers, after receipt o f the sub-loadlease, should generate enough cash during the pay-back period o f the sub-loadlease to maintain a minimumdebt service coverage ratio o f at least 1.2:1;and 0 Certification from the relevant authorities that the sub-borrower and sub-project meet environmental laws and standards in force in Turkey. The World Bank policy on environmental assessment (available inthe Operations Manual for the EFIL I11to be prepared by TSKB's PIU) will also becomplied with. For sub-projects: 0 Sub-projects must be targeted towards the generation o f exports consistent with the sub-borrower's export growth projections; 0 Goods and works on the World Bank's negative list will not be eligible for financing; and 0 Compliance with the World Bank's procurement procedures for the procurement o f goods and works to be financed under EFIL I11 sub- loans and leases. For sub-loans and leases: 0 Sub-loans and leases will be made for the financing o f raw materials, spare parts, plant and equipment, and works, both for working capital as well as investment purposes; 0 Sub-loans and leases will be evaluated in accordance with the PFI's normal project and credit evaluation guidelines and inaddition will be Inaddition to exporting manufacturing firms, some service export companies, such as transportatiodlogistics companies which sell their services to outside Turkey to foreign buyers, will also be eligible to borrow under the EFIL I11facility. 32  evaluated by TSKB using their own credit evaluation guidelines as agreed with the Bank and included inthe Operations Manual; 0 Sub-loans and leasescan be denominated in any foreign currency; 0 Sub-loan and lease pricing and maturity will be determinedby the PFI based on the needs o f the particular sub-borrower and sub-project being financed, with the proviso that the interest rate must at a minimumbe equal to the costs o f World Bank loan funds to the PFI plus an appropriate credit riskmargin; 0 The sum o f sub-loans and leases to any individual sub-borrower or group o f connected sub-borrowers from one or more PFIs will not exceed US$lO million equivalent; 0 For sub-loans and leases larger than US$5 million equivalent and for the first two sub-loans or leases for each PFI irrespective of size, prior review bythe World Bank will be required; and 0 All sub-loans and leases not subject to prior review, can be subject to post review by TSKB or the World Bank inorder to verify compliance with the subsidiary and sub-loan and lease agreement terms. 33  Annex 5: Project Costs (InUS$) Project Component Local Foreign Total US$ j US$ I 200,000,000 80,000,000 200,000,000 ~~ Credit line 80,000,000 Front EndFee 1,005,250 402,050 1,005,250 402,050 Unallocated 44,750 7,950 44,750 7,950 Premia for interest 0 rate caps and Collars Total I 201,050,000 I 80,410,000 I 201,050,000 1 80,410,000 I I I I I Total Baseline Cost Physical Contingencies I - I Price Contingencies I - 1 1 1 I ~ Total Project Cost 201,050,000 80,410,000 201,050,000 80,410,000 *While it is expected that both participating PFIs and sub-borrowers themselves will contribute to the financing of individual sub-projects, the precise amount of such financing to be provided cannot be determined ex ante, as the loan design does not envisage the use of predetermined cofinancing requirements. Instead, PFI maximum exposure to individual sub-borrower limits, debt equity and debt service coverage ratio requirementsfor sub-borrowersand maximum sub-loan and lease limits will drive the amount of cofinancingto be provided. 34  Annex 6: ImplementationArrangements A. Institutionaland ImplementationArrangements 1. TSKB will be the borrower for the EFIL 111, and the Undersecretariat o f Treasury will provide the guarantee to the World Bank on behalf o f the Government o f Turkey. TSKB will also be the implementing agency for the project, and will use the existing EFIL I1 Project Implementation Unit (PIU) within TSKB headed by an Executive Vice President for the implementation o f EFIL 111. The PIU's responsibilities, functions and staffing details are given below. B. On-lendingArrangements 2. TSKB, the Borrower, will wholesale the EFIL I11to around 4-8 private banks and 2-4 leasing companies selected according to a set o f pre-qualification and final eligibility criteria. The on-lending will be carried out by means o f subsidiary loan agreements entered into with the selected banks and leasing companies (privately owned participating Financial Intermediaries - PFIs). The PFIs in tum will make sub-loans and leases to private exporters satisfying a set o f eligibility criteria, according to agreed sub-loan terms and conditions and procurement and environmental guidelines (see Annex 4). TSKB will take the credit risk on the PFIs and the PFIs will take the credit risks on the sub-borrowers. C. ProjectImplementationUnit (PIU) -Responsibilities,Functionsand Staffing 3. Responsibilities. Project coordination and implementation will be done through a PIU within TSKB. The PIU will be responsible for: (i)coordination, communication and public information o f all aspects o f the EFIL I11with the World Bank, the Undersecretariat o f Treasury, PFIs and exporters' organizations; (ii)carrying out the initial and final selection o f the PFIs according to the agreed pre-screening and final eligibility criteria for participating banks and leasing companies; (iii) monitoring o f the performance and the risks associated with the PFIs and periodic reporting to the World Bank based on the PFIs' audited financial statements; (iv) negotiating the terms and conditions o f subsidiary loan agreements with PFIs and entering into such agreements with PFIs on behalf o f TSKB; (v) communicating, the sub-loan terms and conditions including minimum eligibility criteria and procurement and environment guidelines for EFIL 111, to the PFIs; (vi) reviewing the sub-loan applications through prior or post review to ensure that all the sub-loan terms and conditions have been complied with by the PFIs; (vii) submission to the World Bank o f those sub-loan proposals that require prior World Bank approval; and (viii) setting up o f a financial management, accounting and reporting system to handle the information flow betweenthe sub-borrowers, PFIs, TSKB and the World Bank. 4. Functions. Based on the above project responsibilities the functions and tasks o f the PIU have been grouped under three specific areas: (i) Performance and Risk Monitoring o f PFIs; (ii) Credit Operations Management; and (iii) Accounting and Reporting. The task details under each functional group are provided below: 0 Performanceand Risk Monitoringof PFIs: As part of the Performance and Risk Monitoring function, the PIU will carry out the review o f the financial information 35  provided by the PFIs in order to determine their eligibility for initial and final selection and participation in the EFIL I11credit line based on the Eligibility Criteria agreed and coordinated with the World Bank. After the final selection o f the PFIs, and signing o f the subsidiary loan agreements with the PFIs, their continued compliance with the criteria and overall financial performance will be monitored by means o f semi-annual financial information, and complemented by full year-end financial statements, audited by independent external auditors inaccordance with I S A and prepared on the basis o f IFRS. In addition, the PFIs will provide compliance certifications by their external auditors on a semi-annual basis. The objective o f this monitoring will be to evaluate the financial and operational performance o f the PFIs as part o f the credit risk assessment o f the PFIs and their continuing eligibility for participation inthe EFIL 111. 0 Credit Operations: The PIU credit operation sections will provide assistance to the PFIs and sub-borrowers on all aspects o f the terms and conditions and eligibility criteria of the sub-loans and leases under EFIL 111, and will review all the sub-loan applications on a prior or post review basis in order to ensure their compliance with respect to the objectives, criteria and covenants as stated in the subsidiary loan agreements. Indoing this, the PIU in consultation with the World Bank, will prepare an EFIL I11Operations Manual (OM, to be prepared on the basis o f the Operations Manual used in the EFIL I1 project) to explain all the operating procedures and guidelines governing the implementation o f the EFIL 111. The O M will include (i) terms and conditions and eligibility criteria for sub-loans and leases and sub- borrowers; (ii)credit evaluation guidelines for all sub-loans and leases; (iii)the applicable procurement guidelines and the prior review thresholds for sub-loans and leases; (iv) the environment guidelines and checklist for sub-loans and leases; (v) the operational process for the information, documentation, and payments flows; and (vi) the accounting, reporting and auditing requirements as applicable at different levels in the onlending process. The credit operations section o f the PIU will also monitor progress in the utilization o f the EFIL I11 loan funds, monitor the debt servicing performance o f the sub-loans and leasesjointly with the PFIs, collect information on the incremental exports generated by the EFIL I11 in line with the agreed impact performance indicators, and prepare progress reports on these areas, for submission to the World Bank. 0 Accounting and Reporting: The PIU will prepare and maintain the Financial Management System (FMS) required for the accounting and reporting o f all project related activities under the EFIL I11in consultation with the World Bank. The PJU under the supervision o f the Program Manager, will be responsible for: (i)the documentation and recording o f the transactions involving disbursements from the special account; (ii) recording the funds flow to the PFIs; and (iii) recording and all reporting related to preparation o f Financial Monitoring Reports (FMRs) according to the formats agreed with the World Bank. In order to record, monitor and report on the transactions related to the project activities, specific balance sheet and income statement accounts for these transactions will be opened within TSKB's chart o f accounts. The main accounting system will be supplemented by a Management Information System (MIS) specifically designed for EFIL I11and the P I U would be 36  able to generate information about the funds flow in the project at any given time. Entries to the MIS will be done under PIU authorization. The PIU will monitor these transactions and will prepare monthly account summaries inparallel with the monthly accounting cycle within TSKB, and, if requested, send these monthly reports to the World Bank. Through these accounts the PIU will compare the funds flow information with the PFIs and if needed with the sub-borrowers. Periodic reconciliation o f these accounts between TSKB, the PFIs and the World Bank will also be carried out by the PIU. The PIU will furthermore ensure that audits o f the financial statements and compliance certificates are submitted within the periods specified inthe loan agreement and the subsidiary loan agreements. 5. Staffing. The PIU is composed o f TSKB staff. TSKB has appointed its Executive Vice President, Mr. Orhan BeSkok, as the EFIL I11Program Manager. Mr. Begkok (who i s also the Program Manager for the EFILI1facility) will be responsible for the overall project management and coordination with the World Bank, PFIs, the Government, and the exporting sector. In addition, he will be responsible for the creation, appropriate staffing and functioning o f the PIU. Inthis task, the Program Manager, will be assistedby TSKB expert staff, recruited from various divisions o f TSKB. The specific functional responsibilities and related staffing are described in the following paragraphs. TSKB PIUStaff Mr.OrhanBeykok (ExecutiveVicePresident-TechnicalServices) Program Manager o fthe EFIL I11Loan and responsible for: - The coordination, communication and public information o f all aspects o f the EFIL I11 with the World Bank, the Undersecretariat of Treasury, PFIs and exporters' organizations. Mr.BurakAkgiiq (ExecutiveVice President-CorporateMarketingDepartment) Responsible for: - Carrying out the initial and final selection o f the PFIs. - Negotiating the terms and conditions o f the subsidiary loan agreements to be signed with the PFIs. - Enteringinto such agreements with PFIs on behalfo fTSKB. - Communicating the sub loan terms and conditions, including eligibility criteria and procurement and environment guidelines for EFIL 111, to the PFIs. Mr.KorkutUn (DepartmentHead-FinancialAnalysisandEngineering Departments) Responsible for: - Reviewing sub loan applications through prior or post review to ensure that the financial aspects o f all sub loan terms and conditions have been complied with by PFIs. - Monitoring the financial information o f PFIs and their continued compliance with the EFILI11eligibility criteria submission o frequisite reports. 37  - Reviewing sub-loan applications through prior or post review to ensure that the procurement and environmental aspects o f all sub loan terms and conditions have beencomplied with by PFIs. Mr.RefikAlunci(DepartmentHead-EconomicsDepartment) Responsible for: - Submission to the World Bank o f sub loan proposals that require prior World Bank approval. Mrs.CiEi;demIgel (DepartmentHead-OperationsDepartment) Responsible for: Controlling the expenditure documents (invoices etc.) sent by the PFIs and storing them properly. Executing disbursements to the PFIs from the Special Account. Monitoring the Special Account and sending disbursement requests to the World Bank either for replenishment o f the Special Account or reimbursement o f the amounts paidto the PFIs. Preparingmonthly reports related to the Special Account statement. Preparing quarterly reports related to PFIs loan utilization. Monitoring repayments o f PFIs and executing the repayments o f the loan to the World Bank. Collecting information related to the exports generated by EFIL I11from PFIs and submittingthis information to the World Bank. Mrs.EceUna1 (DepartmentHead-FinancialControlDepartment) Responsible for: - Providing information related to the financials o f TSKB. 38  Appendix 6.1 Profileof the Borrower- Turkiye SinaiKalkinmaBankasi(TSKB) A. Introduction 1. TSKB (Turkish IndustrialDevelopmentBank), the proposedborrower and location of the Project ImplementationUnit (PlU) under the EFlL 111Loan, was one of the PFls in the EFIL, Iproject and currently is the Borrower of the EFlL I1 Loan. As such, it is well known to the World Bank team through regular exchange o f vie\\ s on the implementation o f the EFIL Iand EFIL 11, and through reviews o fTSKE3's audited reports and other financial reporting required under the projects. A review o f TSKB's lFRS annual and audit reports for the years 2000-2004 indicates that TSKB exceeds the minimum BIS risk weighted capital adequacy ratio of 8 percent and maintains an overall sound financial and operational structure, and i s fit to undertake the financial liability o f the Loan and operational commitments to act as the PIU for the project. -. 3 Since its foundation in 1950, TSKB has played an active role in every stage of Turkey's economic development, facilitating a number o f "firsts" in the manufacturing industry and the financial sector. TSKB - through its support and extension o f medium-term loans for more than 4000 investment projects - has significantly contributed to the progress and development o f the private sector. Over the past 35 years, the bank also provided financing b y way of participating inthe share capital ofmore than 100 companies. B. Legal Foundation 9 3 . TSKB was established in 1050 with the support o f the World Bank arid the cooperation of the Government. the Central Bank and the leading eonimercial banks of Turkey. TSKB was founded for the purpose o f meeting the following objectives: (i)to provide assistance to private sector enterprises in all sectors o f the economy, with a primary focus on the industrial sector, (ii) to encourage and assist the participation o f private and foreign capital incorporations cstablishcd and to be estahlishcd in Turkey, and (iii) to assist the development o f the capital market i n Turkey. TSKB is the first investment and development bank o f Turkey, and currently one o f several such banks, and enjoys the special status granted to such banks which, among other things, allow-s the banks to rcccive Government guarantees on their borrowings, and to provide lease finance from their own sources. TSKB is a majority privately owned bank. A s an investment &: development bank, 'I'SKB does not accept retail deposits. 'Ihe activities o f TSKB are regulated by the Banks Act o f Turkey and the bank i s supervised by the BDDK. C. CorporateGovernanceand OrganizationStructure 4. Board ofDirectors. The Board of Directors o f TSKB i s responsible for all decisions affecting TSKB's operations. It comprises 11 members, including the Chairman and one Vice- 39  Chairman, and 9 members. The Board includes TSKB's president as one o f its members, and represents the current set o f shareholders: I s Bank Group, 53.30% Akbank Group, 9.66% Vakif Bank, 8.38% Other shareholders, 28.66% 5. Senior Management and StafJ: The President o f TSKB i s assisted by five Executive Vice-presidents, each overseeing one o f the following TSKB functions: Corporate Banking, Technical Services, Treasury & Capital Markets, Financial Control & Operations, and Information Technology & Human Resources. As o f January 2005, TSKB had a staff o f 275, with an average lengtho f service inthe bank o f 9.6 years, and an average age o f 36.1 years. 40   D. Productsand Services 6. Lending. TSKB, as an investment & development bank, maintains the objective to provide the market with medium and long term loans, mostly for the purpose o f investment. In fact, foreign currency-denominated long-term loans dominate the asset side of TSKB's balance sheet. Such long term credit relations require a comprehensive analysis o f the borrowing companies besides a close cooperation with the clients. While providing medium and long term loans to entrepreneurs for their domestic and foreign investments, TSKB also extends short-term working capital loans to meet their financing requirement inthe operating period. Furthermore, the bank provides to its clients all banking services in relation with foreign trade financing. Finally, TSKB also offers financial lease facilities. 7. Over the past several years, TSKB has been consistently providing significant amounts o f medium and long-term lending (Figure 5 - the large increase in 2001 i s partially due to retroactive restatement of TSKB's financials to include SYB which merged with TSKB inMarch 2002). Figure6: TSKB OutstandingLoanVolume, USDmillion 1,200 1,000 800 600 400 200 2000 2001 2002 2003 2004 8. Other Services. Other TSKR sewices include: (i)investment banking services such as IPOs, valuations, MSLAs. privatization consultations, and research, (ii)treasury ojxrations, and (iii) capital market operations and portfolio management. Lending, however, i s TSKB's core business product - in 2004, net fee and commission income accounted for only around 15 percent o f net interest income. 42  lable 5: Other Services by TSKB in 2004 E. Sources of FundingandAsset/LiabilityManagement 9. Funding. TSKB's main sources o f funding are foreign development and commercial bank loans, loans from international financial institutions (IFIS), and small-scale borrowing in international capital markets. As of end-2004, the funds borrowed include borrowings from the European Investment Bank, the Japanese Bank for International Cooperation, Akbank, the World Bank, KfW, Dresdner Bank and other intemational and local banks and IFIs. In2004, TSKB signed a US$50 million subordinated loan agreement with IFC. Funding composition in2004 was as follows: Figure 7: TSKB BalanceSheet -Compositionof Liabilities 100% EquityCapital & 80% Minority 0Other Liabilities 60% 0Securities Issued Fundsraised through 40% Repo's 0FundsBorrowed 20% 0% 2000 2001 2002 2003 2004 __ Source: TSKB. 10. FWmaturity exposure. TSKB has been in constant compliance with the BDDK regulations regarding foreign exchange exposure, and generally maintains a prudently 43  balanced asset/liability mix Interms o f maturity structure. As for maturity structure, TSKB's medium and long-term lending i s funded primarily by medium and long-term borrowings from the intemational commercial and development banks and IFIs, providing for a proper maturity match. In addition, TSKB has strong overall risk management procedures inplace andholds a portfolioofliquid assetsas part o fits liquidityrisk management strategy. F. Asset CompositionandCreditPolicies 11. During the last few years, TSKB increased its share of loans in total assets from 50 percent to close to 60 percent, which i s much higher than the banking system's average 30 per cent in 2004. Medium and long-term loans make up the bulk o f TSKB's lending. The asset composition o f TSKB i s provided below: Figure8: TSIU3 BalanceSheet-Compositionof Assets 100% 80% Other 60% 0FixedAssets 0EquityInvestments 40% LiquidAssets 20% 0Loans 0% 2000 2001 2002 2003 2004 Source: TSKB. 12. Credit Policies. TSKB extends long, medium and short-term loans within the framework o f principles and limits determined by the Board o f Directors. The Board o f Directors approve the credit line and project-financing packages recommended by the Credit Committee. The Credit Committee, formed by the President and the Executive Vice Presidents and attended by the Department Heads o f Loans, Financial Analysis, Economics and Research, Engineeringand Operations discusses the loan application on the basis o f the credit report prepared by TSKB's research team generally formed by an engineer, an economist and a financial analyst from the TSKB staff. The credit report aims at estimating the cost and benefit o f the investment project under evaluation with respect to profitability, economic benefit and undertaker risk. Basically the investment project i s evaluated under economic, technical and financial sub-topics, within a time perspective o f roughly five years. Technical and economic analysis i s carried out by the specialized staff within these fields. The credit report is therefore composed o f these three different analysis integrated and interpreted in a single text by the financial analyst. All decisions regarding lending and collateral are given on the basis o f the credit report. 44  13. TSKB extends loans against collateral. The basic policy conceming collateral is to obtain a mortgage o f first degree on the plant to be set up or to obtain a bank letter o f guarantee. When deemed necessary TSKB resorts to other types o f collateral such as mortgage on property outside the plant, bank letter o f guarantee and personal guarantee. In case o fjoint financing with other financial institutions, a mortgage may be established jointly infavour ofthe institutions concernedor apool sharing agreement providing for proportional claim on the proceeds o f the existingmortgage may be concluded. Sometimes Treasury Bills or Government Bonds issued by the Turkish Republic may also be deposited as collateral. Because of being regarded as the most liquid type o f collateral these Bonds have a positive effect on the capital adequacy ratio requirement just like the bank letter o f guarantee and the mortgage o f first degree. 14. One o f the main objectives o f TSKB i s to ensure the proper use o f its loans. With this objective inview: in the case o f loans to be used for the importation o f goods, disbursements are made exclusively by TSKB; in export and import financing, transactions have been concluded in a manner acceptable to TSKB and in the case o f local currency loans, disbursement will depend on the realization o f conditions laid down previously. Within this framework, the Loans, Operations, Treasury and Technical Services Departments o f TSKB co-operate to observe the proper implementation o f disbursement and collection. The companies financed by TSKB and the sectors they belong to are also followed up periodically. The purpose o f the follow-up is to ensure that the investments are completed in time and conditions set forth are satisfied as well as to identify the problems arising during the implementation and operation stage so as to be able to render assistanceto the companies insolving their problems. 15. It has been a common practice in TSKB to evaluate periodically (once inthree or six months) the financial statements o f the companies in which there's TSKB involvement. Within this framework the credit limitsonce approvedhave beenrevised, raised or cancelled by the Credit Committee especially when the original approval date is earlier than two years. As an independent evaluation, in the credit contracts it is stated that the annual financial statements and accounting records o f the company should be audited by an auditing firm acceptable to TSKB in accordance with the International Auditing Procedures and Principles and results should be deliveredto TSKB during the lifetime o fthe loan. G. CapitalAdequacy,Asset Quality and CapitalBase 16. TSKB maintains a policy o f requiring bank guarantees for part o f its loans to non- bank borrowers. Having bank risk versus company risk on its loan book reduces the capital requirement for TSKB, as exposure to OECD-zone banks is risk-weighted at only 20%, compared to 100% for non-bank borrowers, in calculating its capital adequacy ratio (CAR). At six-monthly intervals starting at end-2002, TSKB has kept its CAR inthe range o f 22.11- 44.14 percent. The CAR as o f December 31, 2004 i s 44 percent. A t the end o f 2004, the TSKB loan book is $1 billion with asset base o f US$1.7 billion. Besides, there is US$174 million utilization from EFIL I1 line o f IBRD. The NPL ratio has significantly decreased from 7.5 percent in 2003 to 4 percent in 2004. This i s mainly due to success in cash collections from rescheduled loans. After application o f BASEL I1regulations for calculation of CAR, TSKB's CAR i s projected to decrease from the current 44 percent to approximately 16 percent still comfortably above the minimumrequirement o f 8 percent. 45  H. EarningsandLiquidity 17. TSKB has beenprofitable for the last few years with the exception o f 2001. In2001, the bank incurred significant losses as a result o f the TL devaluation inthat year resulting in negative net operating income and a net loss for the year. The results have improved considerably beginningthe year 2002. Figure9: TSKB IncomeStatement-Results as YOof Total OperatingIncome 70% -Net Interest 60% Income 50% NetFee& ' 40% Commission 30% Net Operating Income 20% ' Foreign " 10% Exchange GainiLoss ' 0% *Net income _ _ - Source: TSKB Table 6: TSKB -Return on Assets/Return on Equity 2000 2001 2002 2003 2004 ROA 3.21% -5.63% 1.38% 1.37% 3.32% 18. The impact o f the crises i s also visible in the bank's retum-on-assets and return on equity ratios, which both tumed negative in 2001, but recovered in 2002. This experience is inlinewith the experience of other Turkishbanks,which also incurred losses during2001 as a result o f the crisis in that year and the associated extraordinary exchange rate and interest rate volatility, which imposed sizeable losses on almost all banks, bothdirectly and indirectly through the concomitant deterioration inthe banks' loan books. After the 2001 crises and the mergerwith SYB the Bank has regained its profitability and reputation invery short term. As 20.05%, inline with 2000 figures. a result, ROA and ROE, respectively. have improved from -5.63% to 3.32% and -45.55% to 46  Appendix 6.2 Likely Profileof ParticipatingBanksandLeasingCompanies Pre-qualificationand FinalEligibilityCriteria A. TypicalParticipatingBankProfile 1. There were 48 banks in the Turkish banking system at end-December, 2004. These include private commercial banks, state owned banks, foreign banks, and non-deposit taking investment & development banks. Out o f this universe, TSKB has active banking relationship with 36 Turkish banks. In order to determine the level of prudent credit exposure on any one of these banks, TSKB carries out on a semi-annual basis a risk assessment o f these banks by analyzing their financial information including capital adequacy, profitability, and liquidity ratios. However, in the interest o f efficient implementation o f EFIL 111, and following the successful approach used in the first two EFILs, it was agreed that the number o f participating banks are likely to be 4-8. This would enable an amount o f approximately $30-50 million equivalent to be intermediated by each bank and allow the World Bank and TSKB to create the right incentives for the selected banks to focus their management time and effort on timely and efficient implementation o f the EFIL 111. 2. Secondary objective of EFIL I11i s to continue a dialogue with the leading private sector commercial banks and encourage them to improve their financial intermediation skills and volume, by maintaining prudent and rigorous credit appraisal standards and expanding their operations towards increasing the share of credit to the private sector in their balance sheets. 3. Inorder to achieve these objectives, the selected banks shouldhave (i)proven track a record o f lending to exporters, and (ii)a certain `critical mass' in terms o f their balance sheets and, a reasonable level of branch networks. Finally, the participating banks have to demonstrate full and continuous compliance with the technical and prudential standards applicable to their activities, and a clear drive towards increasing lendingto the private sector as a share o f their total assets. 4. The selection o f the participating banks i s therefore being undertaken in two stages: (i) pre-qualification, and (ii) eligibility and selection. The pre-qualification criteria are final listedbelow: 0 The banks should be privately owned, domestically incorporatedcommercial banks; 0 Minimumtotal asset size shouldbe at least US$500 million equivalent, and the banks should have maintained this minimum asset size for each o f the last two years. This would establish that the pre-qualified banks have at least a minimum size o f operations on a consistent basis for two years running; and 0 The pre-qualified banks (as determined by information compiled by TSKJ3) should have a minimum export loans/total loans ratio o f 10percent for the last two years on average for which data i s available. This would establish that the pre-qualified banks have a proven export orientation in their lending operations and maintained this orientation consistently for the last two years. 47  B. Pre-qualified List 5. The pre-qualification process has ledto a list o f 14 banks. Table 7: Banks satisfying the pre-qualification criteria ranked by (i)total assets; and (ii)exportsectorloanshotalassets Banks Annual total assets 2004 Q3 2003 2004 Q3 2003 percent percent US$ million US$ million Akbank 11-9% 11.4% 21,422 21,177 Isbank 14.7% 17.2% 25,056 22,3 10 Garanti 16.0% 20.0% 17,616 16,082 Yapi Kredi 10.5% 13.0% 16,427 15,033 Koqbank 31.8% 31.3% 6,171 5,433 Finansbank 14.5% 14.6% 5,111 4,117 Denizbank 23.9% 30.3% 4,142 3,423 Disbank 35.7% 35.1% 4,688 3,75 5 Oyakbank 17.9% 22.5% 3,996 3,232 Sekerbank 21.1% 26.5% 2,050 1,83 1 TEB 38.3% 47.2% 2,442 2,046 Anadolubank 30.5% 35.8% 1,251 1,122 Altematifbank 32.5% 35.8% 905 839 Tekstilbank 38.8% 41.6% 788 839 Sorirce: Bankers Association of Turkey 6. Final selection of participating banks. The banks to be selected for parti ipation will have to meet the final eligibility criteria mentioned below, be an acceptable credit risk to TSKB, and have expressed interest in participation in the credit line. All the capital based criteria would have to be certified by the banks' external auditors as o f the latest available half-year period. C. General Criteria 7. The participating bank shall remain in general compliance with legal and regulatory requirements applicable to its operations, including but not limited to BDDK-promulgated prudential regulations regarding capital adequacy, large exposures, related lending, and foreign currency exposures, as (re)confinned by the bank's auditors in writing on a semi- annual basis. D. Audit Criteria 8. The participating bank shall, at the time o f selection and for the duration o f its subsidiary loan agreement with TSKB, for each year-end beginning with year-end 2004, present an audit report which: 48  0 Covers two full years o f operations; 0 Is prepared by an intemationally recognized external audit firm in accordance with International Standards o f Auditing and International Financial Reporting Standards (IFRS); and 0 Unless otherwise agreed by the Bank, contains an unqualified audit opinion. E. Typical Participating Leasing Company Profile 9. There are 93 registered leasing companies in Turkey, o f which 11 were non-deposit taking investment & development banks, 5 special finance institutions and 77 self-standing leasing companies. According to the information obtained from the Turkish Association o f Leasing Companies (FIDER), by the end o f 2004, only 5 o f the non-deposit taking investment & development banks and around 35 o f the self-standing leasing companies are active in the sector in addition to the 5 special finance institutions. The total asset size o f the leasing industry was US$2.8 billion as o f end 2003, and increased to US$3.6 billion by the end o f 2004, o f which lease receivables constituted 84 percent. At the end o f 2004, business volume (new leases) o f the industry reached US$2.9 billion, compared to US$2.2 billion for the entire year 2003, suggesting a 35% increase. Total shareholders' equity on September 30, 2004 was US$900 million indicating a 28% solvency ratio. The total assets o f the 10 largest companies together accounted for 75 percent o f the overall industry's assets by the end-2003 and 75 percent o f new business volume in2003, suggestingthe presence o f a large number o f marginal players. 10. It was agreed between the Bank and TSKB that the number o f participating leasing companies i s likely to be 2-4 to enable the EFIL I11 funds to be intermediated most effectively by the strongest industryplayers. This would allow an amount of approximately US$lO-20 million equivalent to be intermediated by each leasing company and enable the World Bank and TSKB to create the right incentives inthe selected companies to focus their management time and effort on timely and efficient implementation o f the EFIL 111. 11. A secondary objective of EFILI11is to continue the dialogue with the leading private leasing companies and build a consensus with them on the best way to improve the leasing environment and the prospects for further development o fthe leasing industryinTurkey. 12. Inorder to achieve these objectives, the selected pre-qualified companies should have (i)acertain `critical mass' interms oftheir leasereceivables, and(ii)provenabilityto a generate new leasing volume. Finally, the leasing companies selected to participate have to demonstrate full and continuous compliance with the laws and regulations applicable to their activities. 13. The selection o f the participating leasing companies has therefore been planned in two stages: (i) pre-qualification, and (ii) eligibility and selection. The pre-qualification final criteria used are listedbelow: 0 The leasingcompanies should be privately owned; 0 Minimum lease receivables should be at least US$50 million equivalent, and the leasing companies should have maintained this size on average for the last two years inorder to establish a minimumsize criteria; and 49  0 The pre-qualified leasing companies should have a minimum new leasing volume o f US$30 million on average for the last two years. This would establish that the pre- qualified leasing companies have a proven track record o f active operations. F. Pre-qualified Short List 14. The pre-qualification process has ledto apreliminary list o f 12 leasingcompanies. Table 8: Leasing companies satisfying the pre-qualification criteria ranked by (i)totalleasereceivables; and(ii)annualvolumeofleasing Name o f Leasing company Paid-in Lease Lease Annual Volume Annual Capital Receivables Receivables of Leasing2003 Volume of 2003 2003 2004 US$ mln. Leasing US$ mln. US$ mln. US$ mln. 2004 US$ Soiirce: 'hrkish 'I-rcasury / FlDEK ('l'urkish Association o F Lcasiiig Companics) G. General Criteria 15. The participating leasing company shall remain in general compliance with legal and regulatory requirements applicable to its operations, as (re)confinned by the leasing company's external auditors inwriting on a semi-annual basis7. H. Operating Criteria 16. The participating leasing company should have been profitable for at least two out o f the last three years o f its operations. I.AuditCriteria 17. The participating leasing company shall, at the time o f selection and for the duration o f its subsidiary loan agreement with TSKB, for each year-end beginning with year-end 2004, present an audit report which: 0 Covers two full years o f operations; 0 I s prepared by an internationally recognized external audit firm in accordance with International Auditing Standards and International Financial Reporting Standards (IFRS);and 0 Unless otherwise agreed with the Bank, contains an unqualified audit opinion. 7See para 40, page 15. 50  Annex 7: FinancialManagement,Audit andDisbursementArrangements A. Project Financial Management Summary of Financial Management Arrangements 1. The task team has conducted an assessment o fthe adequacy o fthe project financial management system at TSKB. The current financial management arrangements for the project are satisfactory to the Bank. 2. Detailed financial management questionnaire i s included inthe project files. A summary o f the conclusions are as follows: I Rating 1. Implementing Entity Satisfactory 2. Funds flow Satisfactory 3. Staffing Satisfactory 4.Accounting Policies and procedures Satisfactory 5. Intemal Audit Satisfactorv 6. ExternalAudit Satisfactory 7.Reporting and Monitoring Satisfactory 8. Information systems Satisfactory OVERALLFMRATING Satisfactorv Country Issues 3. A Country Financial Accountability Assessment for Turkey was carried out in2001. The CFAA report identified some weaknesses inthe Turkishfinancial accountability, inboth the public and the private sector. Main findings in the public sector accountability covered issues like failure to define and control the entirety o f public funds, incomplete audit coverage, weak forces o f public accountability, narrow accounting model and procurement risks. Main findings in the private sector accounting and auditing are the existence o f a regulatory approach where specialized agencies each devise and enforce their and different obligations without adequate coordination and where there i s no common general platform. 4. U S 1 6 5 million and 35 million o f EFIL I11are envisaged to be disbursed through banks. The 1999 Banks Law established the Banking Regulation and Supervision Agency, and among its powers i s the power to determine the accounting and auditing requirements applicable to the banks under its supervision. Banks must submit non-audited monthly prudential returns to the BDDK, and publish audited annual financial statements. Only auditors approved by the BDDK may carry out such audits. All changes in auditor must also be approved, and a change can be imposed where there is dissatisfaction with the performance o f the auditor. The external auditor i s required to report to the BDDKon banks' intemal control and risk management systems, as well as being obliged to report direct to the BDDKwith respect to certain issues which may threaten the going concern nature o fabank. 5. Until the 1999 banking law reforms, the Council of Ministers rather than banking supervisors, were responsible for promulgating requirements in areas such as loan loss 51  provisioning, and these rules were relaxed twice in response to the Asian and Russian financial crises (in February 1998 and August 1999). Requirements with respect to the calculation o f capital adequacy on a consolidated basis, and to disclosures in the areas o f large exposures, connected lending, foreign exchange exposures, interest rate risk exposures, and maturity risk exposures also fell short o f the relevant EU, Base1 Committee and IFRS norms. This served to undermine the quality and relevance o f information provided to regulators and to the market, and has led to weakening the early-warning signals provided by financial statements and to understating the extent o f problems which exist. Since December 1999, efforts were made to strengthen significantly the regulatory and institutional infrastructure for banking regulation (including the creation o f the BDDK), including upgrading o f the relevant financial reporting obligations. In June 2000, the Treasury issued an instruction which brought disclosure rules for banks closer to International Accounting Standards, and in June 2001, the BDDK issued a new Regulation on Chartering and Operations o f Banks, which further enhances public disclosure requirements. 6. The Bank in 1999 has extended the Export Finance Intermediation Loan (EFIL I) to Eximbank where Treasury acted as the guarantor. Eximbank acted as an APEX bank and extended credit lines to Participating Financial Institutions (PFI) for on lending to beneficiary enterprises. At the inception o f EFIL Ithe PFIs were obliged under the terms o f SLAs to remain in compliance with "prudential" ratios which were stricter than those imposed on the banking system by the Turkish bank regulatory authorities (at the time the Turkish Treasury and the Central Bank). As conditionality for FSAL and later PFPSAL the prudential regulations for the Turkish banking system were tightened and inM a y 2001, the SLAs were amended to replace the original "prudential" ratios with those set forth in the (new) banking law and regulations issuedby BDDK. The latter patternwas followed inthe EFIL I1SLAs. 7. The BDDK issued a new comprehensive regulation on accounting standards for banks in July 2002, which brings these standards in line with IFRS. However, the BDDK regulation does not require hll application o f IFRS 27 (consolidation o f subsidiaries), as banks only have to consolidate their financial subsidiaries, while for non-financial subsidiaries separate financial statement disclosure i s mandated. The statements o f such non- financial subsidiaries are not IFRS-based', however, and thus their disclosure will not allow the user to consolidate these with the IFRS-based consolidated statements o f the parent bank and its financial subsidiaries. Also, as the IFRS are subject to change, any such change will necessitate an adjustment o fthe BDDK regulation. 8. The BDDK also issues rules goveming the external audit o f bank financial statements, and only auditors approved by the BDDK may carry out such audits. The "Regulation on Principles for Independent Auditing'' and the "Regulation on Authorization o f the Auditing Institutions and Permanent or Temporary Withdrawal o f their Authorities", both published in the Official Gazette Nr. 24657 on January 31, 2002; these regulations are broadly inline with ISA. 9. TSKB has been assessed for compliance with BDDK prudential regulations by the project team and found to be in compliance. The participating banks are not yet determined however their compliance with BDDK prudential regulations is conditionality for initial and continued eligibility. 6 Only if all non-financial subsidiaries of a bank are listed or publicly held, and only if the CMB requires the use of full IFRS for all listed or publicly held entities, will the financial statements for such non-financial subsidiaries be IFRS- based and allow full consolidation with the IFRS-basedfinancial statements of the parent bank and its financial subsidiaries. 52  10. US$35 million and 15 million o f EFIL I11are envisaged to be disbursed through financial leasing companies inTurkey. Leasing companies inTurkey are subject to Financial Leasing Law enacted in 1985 and the Regulations Dealing with the Establishment and Activities o f Financial Leasing Companies were last amended in 1992. Leasing companies were initially regulated and supervised by the Banking and Foreign Exchange Department o f the Treasury. According to the leasing law, the leasing companies should be joint stock companies with a minimum paid in capital of around US$2.24 million. Total lease transactions o f the companies could not exceed 30 times a leasing companies net worth (15 times for transactions with connected parties). There is not a limit on single party exposure and there is no active supervisionby the Treasury. 11. Quoted leasing companies are subject to the accounting principles published by Capital Markets Board. The changed regulations requiring the application o f IFRS 17, became applicable after July 1, 2003. Therefore due to different accounting policies applied the financial statements o f leasing companies are far from reflecting the real financial positions o f these entities. However due to these inconsistent application o f accounting principles, it i s common practice for leasing companies to have financial statements prepared in accordance with IFRS and audited in accordance with ISA. Eighty percent o f the transaction volume in the leasing industry i s handled by 10 large leasing companies in the sector, and we have been informed that they would all have IFRS financial statements available for the last three years. Therefore our criteria o f initial and continued eligibility will be based on calculations derived from IFRS financial statements. RiskAnalysis 12. A summary o ftherisk assessmentfor the project is as follows Risk Comments Inherent Risk 1. Country Financial Management Risk High Based on CFAA report ~ 2. Project Financial Management Issues Moderate Overall Inherent Risk Moderate Control Risk 1. ImplementingEntity Negligible 2. FundsFlow Negligible 3. Staffing Negligible 4. Accounting Policies and Procedures Negligible 5. Internal Audit Negligible 6. External Audit Negligible 53  Risk Mitigation Strategy 13. Country financial management risk - the CFAA has identified major weaknesses in the Turkish financial accountability, inboth the public, private and the banking sector. These risks together with the developments in the sector after the preparation o f CFAA have been explained in detail in the "Country Issues" section. The project team's assessment o f the banks` compliance with the BDDK prudential regulations showed that the bank i s in compliance with the BDDKprudential regulations. 14. The accounting standards applicable to the banks differ with respect to consolidation from International Financial reporting Standards (IFRS). The financial intermediaries which will manage the credit lines to export companies will submit their IFRS based audited financial statements to the Bank in addition to their audited financial statements prepared in accordance with the BDDK accounting standards. TSKB will bear the credit risk for the loans it extends to the PFIs and the PFIswill bear the credit risk on the credits made available to export companies. Strengths and Weaknesses 15. The significant strengths that provide the basis o f reliance on the project financial management system include: (a) TSKB has been successfully implementing EFIL 11; (b) Disbursementsto the export companies will be made upon submission o f the invoices for the expenditures and TSKB will be responsible for the control o f these invoices inaddition to the PFIs; and (c) Funds will be disbursed through PFIs which will be selected for their financial strength and capacity to appraise and supervise credit lines. 16. There are no significant weaknesses inthe project financial management system. Implementing Entity 17. The loan i s a credit line and the borrower and the implementing entity o f the loan will be TSKB. TSKB will then on-lend to PFIs for lending to exporters. Treasury will be the guarantor o f the loan. EFIL I11is a follow up project and TSKB i s currently implementing EFIL11. 18. TSKB was established in 1950 with the support o f the World Bank and the cooperation o f the Government o f the Republic o f Turkey, Central Bank o f Turkey and leading commercial banks o f Turkey. TSKB has been founded for the purpose o f (i) providing assistance to private sector enterprises in all sectors o f the economy primarily in the industrial sector (ii) encourage and assist the participation o fprivate and foreign capital to incorporations established and to be established in Turkey (iii) assist the development o f to the capital market inTurkey. 19. TSKB's largest shareholder is the I s Bank Group by 53.3 percent. Consolidated financial statements are prepared for I s Bankasi and therefore there i s no consolidation requirement for TSKB. TSKB has internal regulations and manuals for internal control and risk management in compliance with the banking law. 54  20. A project coordination team (PCT) is designated at TSKB under the supervision o f one o f its executive vice presidents to oversee the implementation o f EFIL I1and they will also be responsible for the coordination o f EFIL 111. The staffs currently working on EFILI1 are very experienced and highly qualified. The same staffs will be the primary project counterpart for the Bank team and will provide the overall administration o f all aspects o f the credit line and required reporting to the Bank. 21. The core o f the EFIL I11PFIs will most likely be all or some o f the EFIL I1PFIs, as well as a few other banks and leasing companies. Signing subsidiary loan agreements with two PFIs, which have undergone the qualification process i s an effectiveness condition for the loan. Compliance with the prudential regulations set out by BDDK i s required for continuing eligibility o f TSKB and the PFIs. This will be monitored through (a) prudential regulation compliance certificate and (b) annual audit reports. This certification will be issued by the banks' external auditors. Leasing companies have been financial intermediaries in World Bank projects in Turkey for the first time under the EFIL I1facility. Eligibility indicators have been identified and agreed with TSKB for the leasing companies and TSKB will be responsible for monitoring the continuous compliance o f the leasing companies with the eligibility criteria. 22. The risk associated with the implementing entityis negligible. Funds Flow 23. There will be two special accounts in the name o f TSKB inUSD and in Euro for the project. The Authorized Allocated amount o f the two special accounts will be 10% o f the USD Loan Tranche amount (USD 20,000,000) and 10% o f the Euro Tranche Amount (Euro 8,000,000). The initial amount for USD Tranche Special Account would beU S D 10,000,000 and for Euro Tranche Euro 4,000,000. The full Authorized Allocated amount would be provided once disbursements for USD Tranche reaches USD 40,000,000 and for Euro when the disbursements reach Euro 16,000,000. Funds from the loan will be made available to PFIs following submission o f payment documents (invoices for the goods and works purchased by the export companies) to TSKB. This information will be given to TSKB in electronic form as is done under EFIL I1and TSKB will be responsible for controlling these invoices. 24. In addition to Special Accounts, the Bank may require withdrawals from the Loan Account to be made on the basis o f statements o f expenditure for expenditures for: (a) contracts for goods costing less than $5,000,000 equivalent each; and (b) contracts for works costing less than $5,000,000 equivalent each under such terms and conditions as the Bank shall specify by notice to the Borrower 25. Retroactive Financing. Retroactive financing in an aggregate amount not exceeding $40,000,000, for the USD Tranche and EUR 16,000,000 for the EUR Tranche, may be made in respect o f Sub-loans or the Lease Financing made in accordance with criteria and procedures set forth inthe LoanAgreement and Operational Manualbefore that date but after August 31,2004. 26. The risk associated with funds flow is assessedas negligible. 55  Staffing 27. TSKB has staffs assigned to work on the project. These staffs are highly qualified and have gained experience in EFIL 11. The qualifications and experience o f these staffs are satisfactory to the Bank. 28. The risk associated with staffing i s negligible. Accounting Policies and Procedures 29. The financial management capacity at TSKB i s satisfactory. The Bank has qualified personnel, adequate manuals and guidelines to conduct efficient financial management. The accounting and reporting systems at the bank are geared toward producing statements and information as required by Turkish law and regulations as well as International Accounting Standards. 30. TSKB has developed a web based application, approval and monitoring system for the loans where it acts as an APEX bank. The system i s accessible by the PFIs from the web. The PFIs make their initial application as well as their withdrawal applications from EFIL I1 byusingthe system and are able to monitor the status o f each application on a realtime basis form the web. The system has adequate security levels and i s fully integrated into the management information system o f the bank. The quarterly FMRs for EFIL I1are generated automatically by the system. The system is very efficient and has contributed to the rapid implementation o f EFIL 11.The same systemwill also be used for EFIL111. 31. TSKB has a manual that explains the work flow for EFIL I1and the same manual will be used for EFIL111.The bank provided training to EFIL I1PFIs on the use o f the web based system and has distributed copies o f the manual. The same procedures will be followed for new PFIs inEFIL 111. 32. The risk associated with accountingpolicies and procedures is assessedas negligible. Internal Audit 33. TSKB has internal audit and internal control departments staffed with qualified audit professionals who are capable o f producing audit tasks. The internal auditors have audited transactions in EFIL I1 and they do not have any recommendations relating to the loan. Transactions under EFIL I11will also be subject to internal audit as a part o f banks' credit portfolio audits. 34. The risk associated with internal audit is negligible. Reporting and Monitoring 35. TSKB currently maintains records and ensures appropriate accounting for the funds provided under EFIL I1and same systems will be relied upon for EFIL 111. The formats and contents o f the Financial Monitoring Reports (FMR) will be the same as EFIL 11. The FMR will be prepared quarterly and will be submitted to the Bank no later than 45 days after the endo fthe quarterly period. 56  36. The risk associated with reporting andmonitoring is negligible. Information Systems 37. TSKB has developed a web based application, approval and monitoring system for the loans where it acts as an APEX bank. The systemi s accessible by the PFIs fi-om the web. The PFIs make their initial application as well as their withdrawal applications from EFIL I1 byusing the system and are able to monitor the status o f each application on areal time basis form the web. The system has adequate security levels and i s fully integrated into the management information system o f the bank. The quarterly FMRs for EFIL I1are generated automatically by the system. The system is very efficient and has contributed to the rapid implementation o f EFIL 11.The same system will also be used for EFIL111. 38. The risk associated with information systems is negligible. Supervision Plan 39. During project implementation, the Bank will supervise the project's financial management arrangements in two main ways: (i) review the project's quarterly financial management reports as well as the banks' and project's annual audited financial statements and auditor's management letter; and (ii) duringthe Bank's supervision missions, review the project's financial management and disbursement arrangements (including a review o f a sample o f SOEs and movements on the Special Account) to ensure compliance with the Bank's minimum requirements. As required, a Bank-accredited Financial Management Specialist will assist inthe supervision process. B. Audit 40. Annual and six-monthly (limited review) audits o f TSKB are undertaken on an International Financial Reporting Standards (IFRS) basis in accordance with International Auditing Standards by a reputed international auditing firm. The current auditors o f TSKB are Deloitte and Touche`s member firm in Turkey. The last three years` audit reports (in accordance with IFRS) are reviewedand all were unqualified. Audit o f the EFIL I1financial statements (project balance sheet, sources and uses o f funds and special account statement) are also included in the auditors TOR and audit o f EFIL I11will also be integrated into the auditors TOR. TSKB has been engaging the services o f international auditors for several years and the current auditing arrangements under EFIL I1are satisfactory to the Bank. 41. The PFIs will also submit annual audited accounts to TSKB. It is common practice for the expected PFIs to have their accounts prepared in accordance with International Financial Reporting Standards (IFRS) and audited in accordance with ISA. As the additional PFIs under EFIL I11are not known at this stage the engagement o f auditors for the new ones will not be a specific board condition. There are satisfactory audit arrangements inplace for the PFIs under EFIL 11. 42. The risk associated with EFIL I11is assessedas negligible. 57  Annex 8: Procurement Arrangements A. General 1. The procurement for the proposed project would be carried out inaccordance with the World Bank's "Guidelines: Procurement under IBRD Loans and IDA Credits" dated M a y 2004, and provisions stipulated in the Loan Agreement. The procurement arrangements are described below. 2. Procurement of Goods: Procurement o f goods and related services (installation and maintenance) financed under the proposed project will be according to the World Bank Procurement Guidelines. For contracts below US$5.0 million equivalent, established local private sector commercial practices will be followed in accordance with paragraph 3.12 o f the Procurement Guidelines. Care has to be taken of other relevant factors such as time o f delivery, efficiency and reliability o f the goods and availability o f maintenance facilities and spare parts thereof, and in case o f non-consultant services, o f the quality and competence o f the parties rendering them. Advertising in the local and intemational press will not be mandatory. However, International Competitive Bidding (ICB) would be required for individual contracts o f US$5.O million equivalent and above for goods and related services. All procurement o f goods and related services under contracts equal to or above US$5.0 million equivalent will be subject to the World Bank's prior review. Contracts placed by sub- borrowers on their subsidiary or affiliated companies will not be eligible for financing out o f the Loan. The procurement o f the second hand goods is not eligible for financing out o f the Loan. 3. Procurementof Works. Procurement o f works financed under the proposed project will be according to the World Bank Procurement Guidelines. For civil works estimated to cost less than US$5.O million equivalent per contract, established local private sector commercial practices will be followed in accordance with paragraph 3.12 o f the Procurement Guidelines. For contracts US$5.O million equivalent and above, International Competitive Bidding (ICB) would be required for individual contracts. All ICB contracts for works shall be subject to prior review by the World Bank. Contracts placed by sub-borrowers on their subsidiary or affiliated companies will not be eligible for financing out o f the Loan. B. Assessment of the Agency's Capacity to Implement Procurementand Private Sector ProcurementPracticein Turkey 4. Procurement Capacity Assessment: In case o f procurement under sub-loans and leases, the Participating Financial Intermediaries (PFIs) will be responsible for ensuring that the procurement rules for sub-loans and leases specified below are followed by the sub- borrowers. TSKB will be responsible for reviewing and monitoring the compliance with the procurement rules by the intermediary banks and leasing companies, and their sub-borrowers (beneficiary enterprises). A specialist assigned for the procurement arrangements within the TSKB PIU will be responsible for all procurement oversight for the management o f the project. The PIU will keep the records and copies o f the documents o f the procurements handled through the intermediary banks and leasing companies. The World Bank will conduct regular post reviews o f the sub-projects not requiringa prior review, The PIUwill be 58  responsible for assembling the documentation related to specific procurement transactions from the PFIs and sub-borrowers inorder to facilitate the Bank's reviews. 5. TSKB i s responsible for the implementation o f EFIL I1project, and no procurement problem has been encountered in this project so far. An assessment o f the capacity o f the TSKB to implement procurement actions for the project has been carried out by Salih Kemal Kalyoncu on March 22, 2005. The assessment reviewed the organizational structure for implementing the project and the interaction between the project's staff responsible from the procurement activities. The overall project risk for procurement i s average. 6. Private Sector Procurement Practice in Turkey: In the Country Procurement Assessment Report (CPAR) dated June 2001, it was determined that there are well established commercial practices for the procurement o f goods, works and services by the private sector enterprises, autonomous commercial enterprises and individuals. In case o f goods, the local practice i s to prepare the technical specifications and solicit quotations from the local and/or international market. In case o f medium and large works, the technical specifications are usually prepared by consultant companies and bids are collected from qualified contractors. Minor works are generally tendered on a lump sum basis by collecting bids from a number o f local contractors. When equipment and machinery is needed for expansion o f existing facilities, the purchasers usually prefer proprietary goods from a single source for the sake o f standardization and minimization o f the operation and maintenance cost. Therefore, the local private sector or commercial practices can be considered to be consistent with the World Bank's criteria with respect to economy and efficiency. The general rule in the sector is to procure the least cost goods, works and services consistent with minimumquality requirements. C.Procurement Plan and General Procurement Notice 7. A t the appraisal stage or during the implementation o f the Project, it i s not possible to estimate neither the sub-borrowers nor their procurement requirements. Therefore, it is not possible for the Borrower to develop a Procurement Plan which provides the basis for the procurement methods. Similarly, since the contract sizes and the methods can not be estimated it i s not possible to prepare and publish a General Procurement Notice. It is expected that each sub-borrower will provide a list o f procurements planned under the sub- loan. In case any sub-project includes ICB, special procurement notice will be published in accordance with the Procurement Guidelines. D.Frequency of Procurement Supervision andReview Procedures 8. The Bank will review the procurement arrangements proposed/performed by TSKB in every year, including contract packaging, applicable procedures, and the scheduling o f the procurement processes, for its conformity with Bank Procurement Guidelines, the proposed implementation program and disbursement schedule. (a) Prior Review: The following procurement action and documentation would be subject to Prior Review by the Bank in accordance with the procedures set forth inparagraphs 2 and 3 o f Appendix 1to the Procurement Guidelines. 59  For Contracts awarded through ICB; prior review o f all Bidding Documents, Bid Evaluation Reports, Recommendations o f Contract Award and draft Contract will be conducted. For Contracts awarded through Commercial Practices; prior review o f the first contract will be conducted for each PFI. (b) Post Review: The procurement documents for all other contracts shall be subject to the Bank's post review inaccordance with the procedures set forth inparagraph 5 o f Appendix 1 to the Procurement Guidelines on a random basis, one in five contracts. Post review o f the procurement documents will normally be undertaken during the Bank supervision mission or as the Bank may request to review any particular contracts at any time. In such cases, the TSKB shall provide the Bank for its review the relevant documentation. The post review shall be.conductedby the Bank's Procurement Specialist. Table 9: Thresholds for Procurement Methods and Prior Review (in US$ million equivalent) Procurement Method Expenditure Category Thresholds ICB Commercial Practice 1. Sub-loans and leases Goods 25.0 <5.0 Works 25.O <5.0 Prior Review All First contract contracts for each PFI 60  Annex 9: Turkey's Export Growth, Export Loans and GeneralFX Loan Availability Analysis 1. GDP Growth. GDP (in constant 1987 prices) has fluctuated widely, due to the global crisis o f 1997/1998, and the crises Turkey experienced during the 2000/2001 period. But things seem to have changed since then, and Turkey has grown over 5% annually three years in a row. Current account worries have obviously led the authorities to circumvent domestic demand in 2005, which suggests Turkey is set onto an export-led growth path. Figure10: GDP-Local Currency(constant1987 prices) 60,000 12% 40,000 8% 20,000 00,000 4% + 80,000 0% 2 60,000 8 a -4% 40,000 20,000 -8% 0 -12% 1995 1996 1997 199819992000200120022003 2004 _. 3 Exports as percent of GDP. After the float of the Turkish Lira in 2001, exports/GDP ratio has jumped from 14% to 20%, and in 2004 the estimated exports/GDP ratio stands at 21.5%. Figure11: ExportdGDPDevelopment 450,000,000 25% 400,000,000 $ 350,000,000 20% 300,000,000 .- 250,000,000 3 15% 3 FA 2= 200,000,000 L V 150,000,000 10% & 100,000,000 5% 50,000,000 0 0% 1995199619971998199920002001200220032004 GDP +ExportsiGDP ,- Source: Central Bankof Turkey 61  3. Export Growth. Turkish exports grew from the US$26-28 billion range inthe pre-crisis period to US$36 billion in2002, and continued to grow at a fast pace in 2003 and 2004. Exports summed up to US$63.1 billion in2004. Such a spurt was initially caused by a sharp depreciation of the Turkish Lira, increasing the competitiveness o f Turkey's exports ininternational markets. Also, meager domestic demand led many businesses to reorient their target client segments and rely on exports more than before. For many observers, the appreciation o f the Lira, coupled with an economic slowdown in Turkey's main export destination, Germany, and other trading partners should have brought about a slowdown o f the rate o f export growth. Nothing o f that sort has happened so far, but further Lira appreciations are likely to impede export growth. Figure 12: Turkey's ExportPerformance 70 40 60 35 30 C 50 0 25 * 3 40 z 20 E g 30 15 20 10 5 10 0 0 -5 1999 2000 2001 2002 2003 2004 Exports _ _ +Exportgrowthrate ~ Source: State Institute of Statistics (SIS) 4. Export Credit Costs. The cost o f Turk EXIM's Bank's short-term benchmark credits to exporters has gone down from the highs o f the crisis period. The cost o f locally obtainable medium and long-term credit to exporters, if available at all, i s not as prohibitive as it was inthe recent past. For medium and small enterprises the current rate i s for 6 months LIBOR + 0.75 as regards companies that have a short term export credit insurance scheme and LIBOR+1.25 for uninsured firms. For non-SME loans, the median level i s around LIBOR +1.50. 5. Export and total lending. Banking system loans have grown over the last three years, both in real terms - Le., inflation-adjusted TL and US$ terms. But export & export-guaranteed investment loans' share in total loans has actually diminished. This is basically due to the fact that the TL loan book has grown at a rapidpace, mostly due to consumer credit expansion. 6. During the last three years, the banking system has reduced its direct lending exposure to the public sector. Treasury securities owned by the banks have increased continuously from 2000, almost doubling in US$ terms by 2002, and proving to be the favorite destination for the banks' fi-ee funds. The situation has begun to change in 2003, and the shift towards increasing the loan book gained strength in 2004. All in all, however, the securities portfolio o f the total banking sector still amounts to 54% o f total assets. Loans still have a long way to go in terms o f growth, but the loan book will dominate the securities portfolio as time goes by, making the banking sector's balance sheet composition similar to that found in high- income EUcountries. 62  Figure 13: Export Finance -_-___ __-- 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% 2002 2003 2004 --__ Export & export-guaranteed investment loans / Total loans Export & export-guaranteedinvestmentloans / Total assets I _____ ._ --l 63  Annex 10: Safeguard Policy Issues 1. Environmental Assessment policies o f the Bank will apply to EFIL 111. Environmental issues o f sub-borrowers and their sub-projects will be addressed through the sub-loan environmental eligibility assessment. TSKB will be responsible for ensuring that sub-borrowers and sub-projects financed under the EFIL I11undergo environmental screening to ensure their conformance with Turkish environmental legislation and regulations and the World Bank's policies and procedures, as set forth in OP/BP 4.01 and other relevant World Bank safeguards. The credit officers already appointed by TSKB to staff the PIU will perform this function. The PIU Operations Manual detailing, inter alia, the World Bank's requirements in respect o f environmental assessment, will bepreparedprior to loannegotiations. 2. All sub-loans to be financed under the EFIL I11 should be subjected by PFIs to an environmental review process incorporating the procedures described in section VI o f the project's Operations Manual. The PFIs should use these procedures inreviewing and appraising sub-borrowers/sub-projects, and to inform Beneficiary Enterprises o f environmental requirements for sub-loan appraisal, so that sub-projects can be implemented in an environmentally sound manner. 3. The procedures essentially consist o f Environmental Screening, Environmental Impact Assessment, and Environmental Mitigation where necessary. The Environmental Screening will be carried out by the PFIs at an early stage intheir sub-loan review procedures to determine the appropriate environmental risk category for the sub-borrowers/sub-projects, and may require the contracting o f external expertise. Following screening, an Environmental Impact Assessment (EIA) in line with the environmental classification of the sub-borrower/sub-project will be recommended. The sub-borrowers will be responsible for carrying out any environmental analysis and for confirming that the proposed sub-projects comply with national environmental guidelines, and for obtaining the necessary clearance from the appropriate licensing authorities. Once the analysis i s performed and recommendations incorporated into the sub-project, the PFI will appraise the proposed sub-loan package which would include, where appropriate, an environmental mitigation plan. The implementation o f the mitigationplan will be monitored by the PFI. The overall review process will be monitoredby the Project Implementation Unit (PIU). 4. All sub-borrowers/sub-projects will follow the environmental review process presented schematically below. STEP 1: The sub-borrower prepares an initial sub-project concept. Following informal discussion with the PFI, in which the PFI alerts the sub-borrower o f its environmental assessment requirements, the sub-borrower prepares Part A o f the environmental screening form and includes this with the initial sub-project concept. At this time, it i s the responsibility o f the sub-borrower to initiate discussions with the local environmental authorities (LEA) in order to fulfill any local and national environmental review requirements (such as investment incentive certificate andor other official approval/permits). It will be the responsibility o f the sub-borrower to obtain the appropriate permits and licenses as required by national law in order to facilitate the clearance process with the local LEA. These requirements are considered separate, but parallel, to those presented here and satisfying them i s the responsibility o f the sub-borrower. STEP 2: The PFI screens the sub-project and informs the sub-borrower o f the EIA category prior to appraisal and subsequent follow-up requirements for sub-loan processing. 64  STEP 3: The sub-borrower, or its consultants, submits the environmental analysis (if applicable). The sub-borrower will obtain a positive EIA report, given by the relevant LEA, in conformity with applicable EnvironmentalRegulations for the activities listed inCategories I1and 111. STEP 4: The PFI reviews the environmental analysis that has been submitted and reports its findings to the sub-borrower. The PFI provides its clearance once the analysis i s judged to be satisfactory. STEP 5: The sub-borrower incorporates the recommendations provided in the analysis into the sub-project design and implementation plan, including associated estimated costs. STEP 6: The sub-borrower finalizes the sub-loan application package, including the relevant environmental documentation, and submits it to the PFI for its appraisal. STEP 7: The sub-loan becomes effective upon verification o f the LEA approval and clearance, which can be obtained at any step inthe sub-project preparationcycle. STEP 8: The sub-borrower submits the clearance letter o f the LEA to the PFI. STEP 9: The PFImonitors the implementation o fthe EIA mitigationplan and informs the PlU. 5. Prior and Post-Review-IBRD/PIU. Environmental evaluations and review procedures will be subject to ad-hoc review by the PIU and IBRD supervision missions. The World Bank will perform ex-ante review and clearance o f all sub-projects falling in Category 111. The review of evaluations will ensure that: the work was o f satisfactory quality, community participation took place when appropriate, the appropriate recommendations were made, all documentation was properly filed and recorded, and that the conditions o f approval by the local LEA were met, DuringEFILI11implementation, IBRDmissions will supervise the overall screening process and implementation of environmental recommendations for selected sub-borrowers/sub-projects. The IBRD supervision team will also review, ad-hoc, environmental documentation. Therefore, all this documentation should be kept on file with the PFIs and forwarded to the PIU as needed. 65  Annex 11: Project Processing Seq Tasks I 2005 12005 12010 1 2 3 4 5 6 6 7 8 9 10 66  Annex 12: Documents in the Project File Documents inthe Project files include the following: 0 Articles o f Association o f TSKB e 2000 - 2003 annualreports and audited (KPMG) financial statements o f TSKB e Audited financial statements of potential participating commercial banks: * *****Garanti Bank Yapi Kredi Kocbank Disbank Oyak Bank TEB Bank Audited financial statements o fpotential participating leasing companies: ***** DisLeasing Garanti Leasing Koc Leasing Yapi Kredi Leasing TEB Leasing L a w on the Central Bank o f the Republic of Turkey Banks Act L a w on Leasing and related regulations World Bank study: Non-Bank Financial Institutions and Capital Markets inTurkey EFILProject documents TurkishUndersecretariat o fForeignTrade and other sources: Foreigntrade statistics (6/2003) and other export performance indicators 67  2a? I / c, 3; a .. M rl : w 4 & c i m m  Annex 14: Turkey at a Glance Turkey at a glance 9/20/04 Europe & Lower- POVERTY and SOCIAL Central middle- Turkey Asia income Developmentdiamond` 2003 Population,mid-year (millions) 70.7 473 2,655 Life expectancy GNI per capita (Atlas method, US$) 2,800 2,570 1,480 GNI (Atlas method, US$ btllions) 197.8 1,217 3,934 - Average annual growth, 1997-03 Population ("A) 1.7 0.0 0.9 Labor force (%) 2.3 0.2 1.2 Gross primary Most recent estimate (latestyear available, 1997.03) capita enrollment Poverty (% ofpopulationbelownationalpovertyline) Urban population PA of totalpopulation) 66 63 50 Lifeexpectancyat birth (years) 70 69 69 - , Infantmortality(per 1,000live birtbs) 35 31 32 Child malnutritionPA of childrenunder51 8 11 Access to improvedwater source Access to an improvedwater source (% ofpopulahon) 82 91 81 Illiteracy (x ofpopulationage 151) 14 3 10 Gross primaryenrollment (% of school-agepopulation) 94 103 112 Turkey Male 98 104 113 Lowermiddleincome group Female 91 102 111 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1983 1993 2002 2003 Economic ratios` GDP (US$ billions) 61.5 179.4 183.9 240.4 Gross domestic Investment`GDP 16.3 27.6 21.3 22.8 Exportsof goods and servlces/GDP 12.5 13.7 29.2 27.4 Trade Gross domestic savings/GDP 12.2 21.9 19.8 19.5 Gross nationalsavings/GDP 15.3 24.8 20.8 19.5 1 Currentaccount balance/GDP -3.1 -3.6 -0.8 -2.8 Domestic InterestpaymentsiGDP 2.9 2.2 3.8 3.2 Investment TotaldebtiGDP 33.0 38.2 71.3 61.2 savings Total debt serviceiexports 39.2 31.6 50.7 40.3 Presentvalue of debWGDP 73.1 Presentvalue of debtiexports 234.2 I Indebtedness 1983-93 1993-03 2002 2003 2003-07 (average annualgrowth) GDP 5 0 2 7 7.9 5.8 5.6 Turkey GDP per capita 2 8 0 9 6.2 4.2 4.1 I Lower-middle-incomegroup Exportsof goods andservices 5 9 114 11.1 16.0 5.4 ~~ STRUCTURE of the ECONOMY 1983 1993 2002 2003 ~ Growth of investmentand GDP (%) ("A of GDP) I Agriculture 21.4 16.2 13.0 13.4 Industry 25.0 29.8 23.7 21.9 Manufacturing 16.8 18.3 14.0 13.3 Services 53.6 54.0 63.3 64.7 Privateconsumption 78.4 65.0 66.2 66.9 Generalgovernment cOnsUmptiOn 9.4 13.0 14.0 13.6 I Importsof goods and services 16.6 19.3 30.7 30.7 I GDI +GDP 1983-93 1993-03 2002 2003 I (average annualgrowth) Growthof exportsand imports(%) I Agriculture 1.5 1.o 7.4 -2.4 40 -- Industry 6.7 2.2 5.6 5.0 Manufacturing 6.9 3.0 8.2 8.4 0 Services 4.3 3.0 7.3 6.4 Privateconsumption 4.7 1.9 2.2 6.7 .20 Generalgovernmentconsumption 4.0 3.9 5.4 -2.4 -40 Gross domesticinvestment 7.7 1.o 35.9 20.4 1 I Importsof goods and services 11.4 7.8 15.8 27.1 Exports +Imports Note:2003 data are preliminaryestimates. The diamondsshow four key Indicatorsin the country (in bold)compared with its income-groupaverage. If data are missing,the diamond will be incomolete. 69  Turkey PRICES and GOVERNMENT FINANCE 1983 1993 2002 2003 1 Domestic prices Inflation I :- ("7 change) 1w- Consumer prices 31.4 66.4 44.8 25 2 Implicit GDP deflator 26.3 67.8 44.1 22 5 Government finance 25 (aof GDP,includescurrentgrants) Current revenue .. 19.0 31.2 304 98 99 00 01 02 03 Current budget balance -3.1 -5.1 -5 3 GDP defiator Overall surplusldeficit .... -12.0 -11.9 -10 1 -CPI TRADE 1983 1993 2002 2003 (US5millions) Export and Import levels(US$ mill.) Total exports (fob) 5,905 15,345 40,124 51,206 80000 , Aqriculturaland livestock 1,032 1,044 2,089 2,545 Mining and quarry products 188 233 387 543 60,OW Manufactures 4,685 14,068 33,565 43,912 Total imports [cif) 9,235 29,428 51,554 69,340 40,OW Food 123 969 1,245 2,006 20,ow Fueland energy 3,851 3,903 9,192 11,568 Capitalgoods 2,311 7,499 9,103 11,792 0 Export price index (1995=100) 69 92 75 82 97 98 99 W 01 02 03 Importprice index (1995=100) 100 85 73 83 0Exports .Imports Terms of trade (1995=100) 89 109 102 99 BALANCE of PAYMENTS I 1983 1993 2002 2003 (US$ millions) Currentaccount balance to GDP ("6) Exportsof qoods and services 7.865 26,264 54.907 70,231 Importsof qoods and services 10,118 33,721 55.365 73,760 4 T Resourcebalance -2,253 -7,457 -458 -3,529 Net income -1,430 -2,744 -4,554 -5,427 Net current transfers 1,760 3,768 3.490 2,106 Current account balance -1,923 -6,433 -1,522 -6,850 Financinqitems (net) 2,075 6,741 7,675 10,897 Chanqes in net reserves -152 -308 -6,153 -4.047 1 - 6 1 Memo: Reservesincludinggold (US5 millions) 2,253 17,762 38,051 44.957 Conversion rate (DEC,/ocal/UW 226.0 11,046.7 1,509,471 1,496,668 EXTERNAL DEBT and RESOURCE FLOWS 1983 1993 2002 2003 (US$ millions) Compositionof 2003 debt (US$ mlll.) Total debt outstandingand disbursed 20,324 68,605 131,058 147,035 IBRD 2,336 5,285 5,367 5,214 A 5,214 IDA 184 142 89 83 G' 23 013 B 83 Total debt service 3,138 8,664 29,092 29,172 IBRD 274 1,183 708 728 IDA 4 7 7 7 Compositionof net resourceflows Official grants 98 403 Official creditors 327 -740 224 -1,217 Privatecreditors 139 6,104 6,901 -511 Foreigndirect investment 46 622 863 1,063 Portfolioequity 0 189 -1,183 2,250 F 86,624 World Bank proqram I Commitments 675 207 1,650 0 A iBRD - E -Bilateral Disbursements 486 354 1,031 276 B .IDA D Other muitilateral - F Private - Principalrepayments 115 753 443 502 C IMF - G - Short-term Net flows 371 -399 588 -226 Interest payments 163 437 272 233 Net transfers 208 -836 316 -459 The World Bank Group: This tablewas preparedby country unit staff figures may differ from other World Bank publisheddata. 9120104 70