Ecuador - Fifth Development Banking Project

Document of V 7 a V The World Bank W +v FOR OFFICIAL USE ONLY Report No. 35,71-EC STAFF APPRAISAL REPORT ECUADOR FIFTH DEVELOPMENT BANKING PROJECT December 23, 1981 Projects Department Latin America and the Caribbean Regional Office This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency amounts are expressed in Ecuadorian Sucres (S/) and US Dollars (US$) December 15, 1981 US$1.00 = S/25 S/1 = US$0.04 S/1,000,000 = US$40,000.00 GLOSSARY OF ABBREVIATIONS AMERAFIN Financiera Inter-Americana S.A. BCE Central Bank of Ecuador BEDE Ecuadorian Development Bank BEV Ecuadorian Housing Bank BNF National Development Bank CAT Tax Credit Certificate CC Coordinating Committee CENDES Industrial Development Center CFN Corporacion Financiera Nacional COFIEC Ecuatoriana de Desarrollo, Compania Financiera CONADE National Development Council ECUFINSA Ecuatoriana de Financiamiento ERR Economic Rate of Return IFS International Financial Statistics FIDASA Financiera del Austro FINANDES Financiera Andina FINANSA Financiera Nacional, S.A. FINANSUR Financiera del Sur FINIBER Financiera Iberoamericana FINEC Financiera Ecuatoriana FRR Financial Rate of Return GOE Government of Ecuador GUAYAQUIL Financiera de Guayaquil IESS Ecuadorian Social Security Institute JM Monetary Council MANABI Financiera de Manabi MICEI Secretary of Industry, Commerce and Integration REPUBLICA Financiera de la Republica Proposed loan The Proposed Fifth Development Banking Project Loan SB Superintendency of Banks SC Superintendency of Companies  FOR OFFICIAL USE ONI ^ ECUADOR STAFF APPRAISAL REPORT FIFTH DEVELOPMENT BANKING PROJECT TABLE OF CONTENTS Page No. I. THE INDUSTRIAL SECTOR A. Manufacturing Sector ........ ................. 1 B. Industrial Policy ...... ............................. 5 Fiscal Incentives . ................................. 5 Export Incentives ....... ..................... 6 Protection ......................................... 6 Exchange Rate ... .................................... 7 Andean Group ........................................ 7 Reform of Industrial Incentives ..................... 8 C. Outlook ............................................. 9 Supply .............................................. 9 Demand .......................................... . 9 II. THE FINANCIAL SYSTEM ........................... ... 11 A. Institutional Structure ............................. 11 B. Regulations ............... 14 C. Financial Savings and Credit ........................ 18 D. Financieras ......................................... 21 Corporacion Financiera Nacional ........ .. ........... 21 Operations ................... .................... 21 Profitability 22 Financial Condition .............................. 23 Private Financieras ................................. 24 E. Issues and Outlook .................................. 25 This report is based on the findings of a mission composed of Messrs. T. Hutcheson, J. Calderon-Rossell, A. Sa Freire and D. Gordon (Consultant) of the Industrial Development and Finance Division, LAC Regional Office which visited Ecuador during March-April and June 1981. 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.  TABLE OF CONTENTS (Continued) Page No. III. THE PROJECT.27 III TH PRJECT .............................................. 2 A. Previous Loans . . .27 B. Objectives ....... ................................... 31 C. Participating Institutions . . .31 D. Technical Assistance Components . . .35 IV. THE LOAN ............. 37 A. Borrower and Terms .. 37 B. Allocation ...... ......... .............. 37 C. Free Limits and ERR ....... ...... ... 37 D. Fees, Interest Rates, and Commissions . .38 E. Subloans and Investments . ....38 F. Disbursements and Procurements . . 39 G. Cofinancing . . ............. 39 H. Project Benefits and Risks . . 39 V. AGREEMENTS AND RECOMMENDATIONS.. 40 ANNEXES 1. Statistical Tables and Charts 2. Terms for Cooperation Between the Superintendency of Banks of Ecuador and the World Bank - Information Systems on Finance Companies 3. Terms for Cooperation Between the Superintendency of Banks of Ecuador and the World Bank - Training, Studies and Improvements Program 4. Terms of Reference - Study of Tariff Protection and Incentives 5. Estimated Schedule of Disbursements 6. Selected Documents and Data Available in the Project File MAP  I. THE INDUSTRIAL SECTOR 1/ 1.01 The emergence of oil production in 1973 and successive increase in petroleum prices have imparted unprecedented dynamism to the Ecuadorian economy. Domestic demand and GDP rose rapidly; GDP growth of 5.3% per annum in 1964-1971 increased to a 1972-1978 average of 10.5%. Later, however, as petroleum exports stabilized and agriculture lagged, GDP growth fell to only 4.8% p.a. in 1979-1980. By 1980 Ecuador had achieved a GDP per capita of almost US$1,000 although the small domestic market and limited export capabilities restricted demand for many products. 1.02 Despite the recent peaking of the petroleum-induced boom, growth perspectives over the medium and long run remain good because of a strong resource base in agriculture, fishing and forestry, abundant labor, and a high investment ratio. But these perspectives can become a reality only if constraints on the use of resources are removed and incentives encourage their efficient use. The government has moved toward this end by raising domestic prices of hydrocarbons--although still to only about one-half of international levels--which could permit more active exploration by CEPE and improve public sector revenues. Additional measures are needed to continue freeing agricultural output from price control. Apparent deficiencies in the industrial protection/incentive system, favoring capital and import intensive industries and hampering export competitiveness, have influenced the authori- ties to plan for a study in depth of the system and possible adjustments, to be carried out with financial and technical assistance from the Bank as discussed in paras 1.17 and 3.21. A. The Manufacturing Sector 1.03 In line with overall economic expansion, manufacturing 2/ real growth averaged 10.6% p.a. in 1972-1978 and in 1979-1980 slowed somewhat to 7.8% p.a. By 1980 manufacturing's share of GDP in current prices was about 16%, having first fallen with the rapid expansion of the petroleum share in the mid-1970s, slowly recovered through 1978 and then fallen again (Table 1.1). This share is smaller than for other middle income countries or for neighboring Latin American countries, in part because of the extraordinary share of petroleum in GDP. The ability of manufacturing to have kept even roughly abreast of the petroleum-fired growth of the 1970s is remarkable, however, reflecting a stable political and institutional framework, expansive macroeconomic policies and generous incentives. 1/ This section is based in large part on the Ecuador Economic Development Issues. Report No. 3723-EC, December 14, 1981. 2/ "Manufacturing" in this report will consistently exclude petroleum refining.  TABLE 1.I ECUADOR - MANUFACTURING VALUE ADDED 1972-1980 1972 1973 1974 1975 1976 1977 1978 1979 1980 SI million at current prices Total 8,763 10,828 14,292 17,209 22,926 29,784 34,729 39,248 44,696 Food, Beverages & Tobacco 4,203 4,988 6,551 7,682 10,730 13,000 17,601 Textiles & Clothing 1,816 2,216 2,838 3,749 4,654 6,362 6,758 Wood & Wood Products 478 615 953 1,030 1,307 1,637 1,804 Paper & Printing 504 589 767 1,050 1,399 1,490 1,568 Non-Metallic Minerals and Base Metals 839 1,029 1,485 1,769 2,198 3,029 3,604 n.a. n.a. Metro Products, Machinery Transport Equipment & Others 279 523 724 815 1,197 1,066 1,309 Chemicals 6 Products (excluding petroleum refining) 664 868 974 1,114 1,441 1,901 . 2,085 As percentages Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Food, Beverages & Tobacco 48.0 46.1 45.8 44.6 46.8 47.9 50.7 Textiles & Clothing 20.7 20.5 19.9 21.8 20.3 21.4 19.5 Wood & Wood Products 5.5 5.7 6.7 6.0 5.7 5.5 5.2 Paper S Printing . 5.8 5.4 5.4 6.1 6.1 5.0 4.5 Non-Metallic Minerals and Base MIetals 9.6 9.5 10.4 10.3 9.6 10.2 10.3 n.a. n.a. Metal Products, Machinery, Transport Equipment & Others 3.2 4.8 5.1 4.7 5.2 3.6 3.8 Chemicals & Products (excluding petroleum refining) 7.6 8.0 6.8 6.5 6.3 6.4 6.0 Manufacturing as % of GDP 18.7 17.4 15.4 15.9 17.2. 18.3 18.3 16.9 15.7 GDP 46,859 62,229 92,763 107,740 132,913 162,378 188,968 231,719 284,428 Source: Banco Central del Ecuador Input/Output Analysis.  -3- 1.04 Although the most recent figures are not available, it is estimated that most subsectors shared rather equally in this growth, so that little structural change is evident at the broad subsectoral level. Manufacturing is still dominated by consumer goods, which accounted for about 60% of output, employment and investment (Tables 1.1 and 1.2). The share of intermediate goods industries declined in spite of a small but significant gain in the metal products and equipment sectors, mainly due to electrical appliance and vehicle assembly. The structural stability was due probably to the generalized protection from imports and tax incentives, not discriminating among subsectors which allowed manufacturers freely to respond to rising domestic demand; there is so far little prima facie evidence of large scale expansion of highly inefficient activities. The preponderance of Ecuador's manufacturing remains in domestic materials transformation--cocoa, coffee and fish processing, sugar refining, textiles, cement and wood products. Table 1.2 (Units in %, data from 1977) Metal Products Consumer Goods Intermediate Goods & Equipment Employment 58.0 35.0 7.0 Value added 58.6 33.0 8.4 Investment 59.7 35.9 4.4 1.05 In the two decades ending in 1970 Ecuador's manufacturing sector underwent a rapid change from being basically workshop-based 1/ to being organized in formal factories; output and employment in workshop firms were essentially static. Since 1970 the formal sector firms have continued rapid growth, but the output of workshops has resumed growing, albeit more slowly than other firms. By 1978 the share of output from workshops was only 20% but these provided 70% of the 321,000 jobs in the manufacturing sector. Of the formal sector firms, those in the smallest category having from seven to twenty workers, have grown fastest in output, employment, and productivity. 1.06 Compared with 100,000 or so workshops, the formal industrial sector comprises only some 1,700 production units, employing an average of 50 persons each. Only 11 factories in 1977 had more than 500 employees--five of them in food processing, three in metal products and machinery, two in textiles and one in cement. Two hundred firms had more than 100 employees, and accounted for 60 percent of the gross value of output, 67 percent of value added and 74 percent of new investment in the formal sector in 1977. Because of import protection, the local market for many manufactured products is controlled by two or three large enterprises. A 1970 survey indicated that in most industries, 1/ Defined for statistical purposes as firms having fewer than seven employees.  -4- except for textiles, up to three firms controlled 50-95 percent of the domestic market. 1/ This situation had not substantially changed by 1980. Large industrial groups' also have direct links-common directors and major share- . holdings--with banks and financial institutions, large agricultural enterprises, :t wholesale and retail. trade and the media. 1.07 The location of formal manufacturing industry is concentrated in the provinces around Guayaquil (Guayas) and Quito (Pichincha), which in 1977 contributed respectively 40 and 39 percent of total employment and 46 and 35 percent of value added. Guayas accountedJfor the major share of food, paper and chemical industries while Pichincha provided the bulk of employment and value added in textiles, wood products, metal products, machinery and equipment. These proportions had not changed greatly since 1967 and indicate that govern- ment incentives to decentralization have so far had quite limited effect. 1.08 Notwithstanding its relatively rapid growth the manufacturing sector was unable to expand employment opportunities in pace with the growth of the labor force during 1970-1978; over these years the manufacturing share in total employment remained-around 12.6%. The renewed growth of workshop production may increase somewhat the employment share. 1.09 After rising by an average of 1.5% p.a. in real terms in 1970-1978, minimum compensation 2/ jumped 30% in 1979 and 77% in 1980 because of legislated increases in the minimum wage. 3/ This sharp increase in labor costs was heightened by a legislative reduction of 9% in the work week, to forty hours. These labor costs--now among the highest in Latin America relative to Ecuador's level of industrialization and per capita income (Table 1.3)--militate against employment creation, tend further to increase the already high cost per job in the manufacturing sector and aggravate the bias stemming from capital subsidiz- ing elements in Ecuador's industrial policy (para 1.10). 1/ Junta de Planificacion. 2/ Minimum wages plus fringe benefits. 3/ The increases mandated for workshops and small formal sector firms were lower, improving somewhat their competitive position.  -5- TABLE 1.3 Minimum Wages and Manufacturing's Share of GDP in Selected Latin America & Caribbean Countries Minimum Monthly Wage Annual Minimum Wage/ Manufacturing's in Manufacturing 1/ Per Capita GDP 2/ Share of GDP Argentina 441 2.3 36.5 Mexico 180 1.4 27.7 Venezuela 175 .7 16.3 Trinidad & Tobago 166 .6 14.2 Ecuador 200 2.3 17.9 Dominican Republic lOO 1.2 19.5 Colombia 92 1.1 20.1 Chile 91 .6 20.4 Peru 90 1.5 25.6 1/ US Dollars in November 1980 at official exchange rate. Monthly minimum x 12 / 1979 GDP per capita from World Bank Atlas (1980). B. Industrial Policy 1.10 Fiscal incentives under the Industrial Promotion Law consist of exemptions from duties on imported machinery, spare parts and other inputs not produced in Ecuador, and from numerous minor taxes. Firms may also deduct from taxable income amounts invested in qualifying new projects. The Law is administered by an Interministerial Committee for which the Ministry of Industry, Commerce and Integration provides staff. Firms receiving benefits under the Law are expected to use domestic inputs to the maximum extent possible and can in turn expect quantitative limits on competing imports to guarantee their market. Although a low price for the goods to be produced is one of the criteria for granting of benefits, this cannot easily be moni- tored after the project is in operation. The exemption from duties accorded to imported capital goods accentuates the employment disincentive duc to minimum wage legislation. Among industries benefiting from the Law the invest- ment cost per job was US$47,310 in 1979 before the latest jump in wages. Although the figures in Table 1.4 derive from initial estimates and are not subsequently confirmed, they are in line with those from the annual manufactur- ing surveys, rising from US$22,310 in 1967 to US$46,020 in 1977 which however, represent an increase in real terms over the decade.  Table 1.4 Comparative Estimates of Cost per Job (US$ thousands) Date of Cost per Job Cost per Job Type of Activity Estimate (current prices) (1980 prices) Third Development Banking Loan 19I76-77 50.0 66.6 Industrial Development Law Firms 19.79 47.3 52.0 Formal Manufacturing 1977 46.0 61.3 Total Economy 1978 23.3 27.8 Fourth Loan 1979-80 39.2 41.1 Fourth Loan, Export Projects 1979-80 7.1. 7.4 1.11 Export incentives in the form of negotiable tax credit certificates (CAT) used to be granted on the basis of the increase over the previous year's exports. The subsidy rate, moreover, was related to the absolute value of exports, thus discriminating against small or first-time exporters. In July 1979, these defects were corrected partially. The incentive is now given on the total amount exported, at a rate that rises with the proportion of value added so as to give a 15%-20% subsidy to value added in exporting. Exporters have duty-free access to imported inputs but the administration of this benefit is cumbersome. Export incentives could be further improved by exclud- ing from benefits products, such as processed cocoa, whose effective protection is high because domestic raw materials are subject to an export tax and those which enter duty-free into other countries of the Andean Group. Exporters also receive credit at highly consessional rates (4-8% in Sucres); the credit subsidy, amounting roughly to an additional 6% of export value, should be re-examined. 1.12 In spite of incentives, manufactured export performance has been disappointing on the whole. Excepting refined petroleum products and processed coffee and cocoa, manufactured exports increased only 15% p.a. in nominal terms, only about 4% p.a. in real terms, during 1974-80. Preliminary data show a further slowdown in 1981. Items such as fish products, wood products, and various food items, all transformations of Ecuador's agricultural and fishing resources, have increased by almost 40% p.a., however, and now make up 15% of manufactured exports. If export and other incentives are adjusted to allow Ecuador's comparative advantage to be realized, exports of these and similar products should continue to do well. Export projects tend to be more labor intensive than other manufacturing investments as exemplified by projects financed under the Fourth Loan (Table 1.4). Greater success in exporting manu- factures would, thus, contribute to employment creation. 1.13 Protection to encourage import substitution industries is based on several criteria including the protected manufacturer's capacity to supply the local market, production costs, and profit margins, as perceived at the outset of the project. Protection mainly takes the form of high import tariffs--up to 170 percent on consumer goods and zero to 30 percent on raw materials,  -7- machinery and eql.-rment. "Inessential" and luxury goods are subject to a 30 percent ad valorem surcharge. "Inessential" and "semi-essential" goods imports are also subject to prior import deposit requirements of 10 or 30 percent, respectively, of CIF value; passenger vehicles and certain other products require prior deposits of 50 percent; incentive legislation exempts certain sfnns from prior import deposits. In addition most imports are subject to a 1 percent tax on CIF value. Some 250 items, mainly "essential imports", require prior ministerial authorization before import licenses are granted. Absolute protection in the form of import prohibition is given to some products. Although licenses are required for all imports, quantitative restrictions actually apply to few imports. 1.14 The combination of duties, surcharges and taxes purports to give some local products effective protection of 200 percent and more. However, local prices for many consumer goods are less out of line with international (specifically US) prices than the apparent levels of protection would suggest. In November 1980, retail prices for several categories--footwear, clothing, plastic housewares, certain cosmetics and pharmaceuticals--were comparable (at the official exchange rate) to those for similar items in the US 1/. The largest differentials were for consumer durables such as motorbicycles and refrigerators (60-70 percent above the US price for similar models) and motorcars. A number of factors have helped to prevent local manufacturing or assembly plants from overexploiting their protected position, notably competi- tion from traditional local wage goods industries and illegal imports. 1.15 Exchange rate stability has favored investment in the manufacturing sector. But as the real exchange rate vis-a-vis the US dollar has fallen (appreciated) by 24% since 1971, imports have become gradually cheaper in rela- tion to actual or potential local alternatives. This has hampered particularly the production of those capital goods and intermediate inputs imported duty free under the Industrial Incentive Law. Likewise, the fall in the real exchange rate has made export manufacturing less profitable and reinforced the tendency to concentrate on the protected domestic market. Industrial policy reforms should encompass an appropriate combination of adjustments in the real exchange rate, in the level and structure of import protection, and in export subsidies. 1.16 As a founding member of the Andean Group, Ecuador expected sizable advantages from its association, few of which have been realized. Ecuador's former trade surplus with the Group has shifted to a small deficit; its Andean exports fell after 1976 and now make up only 5% of total exports. Under industrial programming for the Group, Ecuador was assigned production of items such as petrochemicals and vehicles that are highly capital intensive, and for which an efficient scale of output may be too large even for the five countries combined. Because of doubtful commercial prospects, such projects have to be government sponsored. Recently, however, some other Andean countries have come to favor deemphasizing programmed allocation among members of subsectors or product lines, and relying more on intra-Group competition behind a lower common external tariff. Ecuador could benefit from this latter approach. 1/ Sears, Roebuck & Co., East Coast drug stores, car and motorbicycle dealers, excluding local sales tax.  -8- 1.17 Reform of Industrial Incentives. Various criticisms of the current industrial incentive system have been raised within Ecuador. It is alleged that: (a) the sacrifice of public revenues may have been more than was necessary to achieve given results; 1/ (b) the incentives have probably biased the choice of activities to which new investment has been directed, giving excessive stimulation to final consumer products relative to producer goods and exports; and (c) relatively capital-intensive and import-intensive products and techniques of production have been favored, to the detriment of employment creation. These concerns are shared by the government and the Bank. The government has proposed draft revisions in the Industrial Promotion Law which would effect marginal improvements but recognizes that further changes in the Law and other incentives may be desirable. Consequently, under the proposed Loan, the Bank would provide financial and technical assistance for a study of industrial protection and incentives to be undertaken by the government with the help of local and foreign consultants (see para. 3.21 and Annex IV). Identification of changes in incentivies to reduce or even to eliminate the biases against job creation would be an important goal of the study. 1.18 Because incentives and other factors can give a false impression of the economic benefits of investment projects, financieras in Ecuador using Bank funds have long been, and would continue, calculating economic rates of return (ERR) on larger subprojects. 2/ Estimating border prices for the subproject's output (usually the single most critical parameter in an ERR analysis) is difficult where the output is subject to prohibitive tariffs or quantitative import restrictions as is common in Ecuador. Moreover, while ERR calculations may exclude "absolutely" inefficient subprojects, they cannot ensure choice of an optimal combination of factors of production. Hence, pending more fundamental reforms to reduce distortions, financieras will be required in their appraisals of larger subprojects: (a) to supply specific information on their method of estimating the border price in cases where imports are effectively banned; and (b) to take specific account of employment creation effects and of whether and to what extent more labor- intensive technologies were considered kpara. 3.06). Nevertheless the ability of a financiera to influence these choices is limited so long as prices remain distorted. 1/ The cost of fiscal incentives to industry has risen rapidly in recent years. According to one estimate, it was equivalent to 25% of 1979 non-petroleum budget revenue. Investment tax credits accounted for one half of uncollected revenues, import duty exemptions and export subsidies to manufactured products for a further 25% and 12%, respectively. 2/ Ecuadorian financieras were the first in the Bank to begin calculating ERRs.  -9- 1.19 The technical assistance to be provided under the Loan (para 3.20) would be designed inter alia to help the financieras, particularly the new ones, improve their subproject analysis to identify the effects of distorted relative prices. The inclusion in a significant way of 11 new financieras should help to distribute Bank funds among a larger number of firms and to finance projects that are smaller than those financed by CFN and COFIEC. More financing of smaller firms and subprojects should help to reduce the average cost per job in subprojects financed by the Fifth Development Banking Loan. C. Outlook 1.20 The manufacturing sector has considerable potential to contribute to growth of output and employment in coming years if new investment is channelled into activities that make good use of Ecuador's human and raw material resources. The government's strategy calls for industry to become the leading sector as oil exports decline. Although the government is committed in principle to several large projects of doubtful benefit, their early implementation is unlikely, given the country economic stringencies and uncertainty as to the future of the Andean Group. 1.21 Supply, problems have slowed and distorted industrial growth. The availability of raw materials for agroindustries, for example, has been hampered by price controls; by the patterns of land ownership; deficiencies in storage, refrigeration and transport facilities (both roads and vehicles); and lack of quality control, packaging materials, credit and technical assistance. Consequently, investment in a sector where Ecuador has an apparent comparative advantage has lagged, while industries relying on supplies of readily imported inputs grew rapidly. Although in overall terms there is abundant labor, in formal industries its cost has risen faster than productivity. On the other hand, the relative price of capital has declined, due to concessional interest rates, the decline in the real exchange rate, import duty exemptions on machinery, and equipment and tax incentives. 1.22 On the demand side the best prospects seem to lie in breaking out of the constricted internal market for consumer goods for high income groups. Faster development of Ecuador's agricultural, forestry, and fishing sectors would generate demands for low-cost wage goods, with rising purchasing power in those sectors, and also open opportunities for forward and backward linkages. Export markets, particularly outside the Andean Group, are practically untouched. Building on a good resource base, there are manufactured export possibilities in fruit and vegetable processing, natural colorants (e.g. bixin), essential oils, spices, pesticides, medicinal extracts, wood products, fibers, specialized pulp and paper, and fish, shrimp and lobster processing. Cultivation of shrimp (mainly for export) in artificial ponds is expanding rapidly. Several financieras have high expectations of using significant amounts of Bank and other funds for those subprojects and for the forward and backward linkages they open up. 1.23 Growth of GDP is expected to continue decelerating to less than 4% p.a. (para 1.01); manufacturing should continue to outpace other sectors, although not to the same degree as in 1979 and 1980. Industrial growth of even 4% p.a. would generate substantial needs for additional investment. Aggregate  -- 10( - industrial investment estimates are almost impossible because of a deficient data base, but a reasonable estimate would be the import of capital goods for industry in 1979, which exceeded US$567 million on a sharp upward trend. Taking into account both the real growth of this base, and international price increases, at 4% p.a. and 8.5% p.a. respectively, industrial investment could average about US$850 million per year in the 1982-83 period. As presently conceived about 14% of this total, of which the Bank portion would be about 3.5% (Table 1.5), would be financed under the proposed project. TABLE 1.5 Projected Industrial Investment 1982-83 (US$ millions) Proposed Source Project Other Total Multilateral Institutions 59 a/ 40 99 Financieras' domestic resources 1/ 39 39 Cofinancing Commercial banks 40-50 - 40-50 Sponsors, suppliers, export financing agencies, etc. 102-92 80 182-172 Total investment associated with financiera projects 240 120 360 Total Industrial Investment 1,700 1,700 1,700 a/ Proposed Loan. 1.24 The proposed Loan would help to finance around US$240 million in total investment in 1982-83. If, because of a higher proportion of export projects (para. 3.05), the cost per job can be reduced from the average level for the Fourth Loan (US$41,100) to US$30,000 in spite of the increased labor costs, approximately 8,000 jobs could be created in the two-year period. This would represent about 22.7% of the jobs needed for manufacturing to keep pace with the labor force that is growing at 3.4% p.a. 1/ See para 3.16.  - 11 - Il The Financial System 1/ A. Institutional Structure 2.01 The financial system in Ecuador has the following components: the monetary autho3riies - the Junta Monetaria (JM) and the Central Bank of Ecuador (BCE); the supervisory institutions-Superintendency of Banks (SB) and Superintendency of Companies (SC); 3 government-owned banks and 29 private commercial banks; the government-owned financiera, Corporacion Financiera Nacional (CFN)), and 12 private financieras; 11 mutual savings associations; numerous credit unions; 24 insurance companies; the Ecuadorian Social Security Institute (IESS); 21 foreign exchange houses; 2 securities exchanges; 4 warehousing firms; 4 leasing companies; and the Ecuadoriaa Institute of Educational Loans and Fellowships. While financial institutions are concen- trated in the Guayas and Pichincha provinces, the network of branches and agencies, especially of banks, cover most of the country's towns and larger villages. Although economic activity in Guayas province has demanded and received substantial amounts of credit, Quito remains the major financial center, mainly due to the location there of BCE and most government functions. 2.02 The monetary and financial policies of Ecuador are established by the JM and executed by BCE. JM comprises 11 members: the Chairman, appointed by the President of the Republic; the Ministers of Finance, of Industry, Commerce and Integration, of Agriculture, and of Natural Resources and Energy; a representative of the National Development Council (CONADE), and representa- tives of the two regional Chambers of Industry and Commerce and of commer- cial banks; the General Manager of BCE and the Superintendent of Banks. BCE, established in 1927, is charged with administering the JM's monetary and financial policy decisions. 2.03 The SB, an autonomous entity directed by a Superintendent appointed by the National Chamber of Representatives, has been developing into an effective institution for supervising the operations of the financial system. In-house training programs have been developed for SB staff, who are well- motivated and eager to learn. Recently a Manual of Inspection has been developed by the SB with the assistance of the Center of Latinamerican Monetary Studies and the U.S. Comptroller of the Currency. The Manual covers most of the relevant aspects of financial institutions examination, including organiza- tional and management issues, and it has been used for training purposes in the Dominican Republic, Panama and Nicaragua. The Superintendency of Banks would actively participate in the implementation of the Bank project particu- larly for supervision of financieras (para 3.19). Technical assistance would be provided in the project for the Superintendency, both for training purposes and to develop systems and studies (para. 2.38 and 2.39 and Annex 3). While the SB supervises most operations of the organized financial system, the 1/ The discussion in this section is based on current prices. While the official inflation rate in 1980 was reported around 12.8%, it is estimated that it may have been at least two points higher.  - 12 - Superintendency of Companies, established in 1964, is responsible for over- seeing the operations of the two securities exchanges; securities-related operations are still very limited (paras. 2.10), but IFC is currently helping the SC in its efforts to develop the capital market, in particular trading in stocks. 2.04 Apart from BCE, the National Development Bank (BNF) is the largest of the Government-owned financial institutions, accounting for 7.1% of total extension of credit in 1980 (Annex 1, Table 1) and for 10.8% of the total credit outstanding from all financial institutions (Annex 1, Table 2). Most of BNF's credit operations are in agriculture and livestock (77%), while operations in the industrial sector, imainly small scale enterprises, accounted for 14% (Annex 1, Table 3). Since the i975 oil boom, however, lack of additional resources and capitalization restricted BNF's portfolio growth (12% p.a.) to less than half that of all financial institutions (Annex 1, Table 2). Also owned by the Government, and with 4.2% of the 1980 credit portfolio of all financial institutions (Annex 1, Table 2), the Ecuadorian Housing Bank (BEV) mainly provides credit to the housing sector. BEVs credit operations have been subject to fluctuations (Annex 1, Table 1), roughly parallelled by those of the 11 mutual savings associations. Established in 1979, the Ecuadorian Development Bank (BEDE) mainly serves government institutions and programs; it has an initial paid-in capital of around S/2,200 million. In 1980 BED's operations amounted to S/a 2,598.5 million, and are expected to increase substantially in future. Completing the array of government-owned financial institutions is the Corporacion Financiera Nacional, which is the largest financiera of the country (paras 2.25-2.31) with 5.6% of the 1980 credit portfolio of all financial institutions (Annex 1, Table 2). CFN's portfolio growth matched the overall credit expansion, at about 34% p.a., from 1975 to 1977, but in 1978-80 it fell off sharply to about 5% p.a. as against some 25% p.a. for the financial sector as a whole. CFN operations (para. 2.25 and Annex 1, Table 3) concentrate in the industrial sector and export-related operations. 2.05 The private banking sector accounts for about 67% of the 1980 credit portfolio and a similar share of the credits granted in that year (Annex 1, Tables 1 and 2). Bank loans, with average maturity of 11.3 months, have the most diversified range of applications among the financial intermediaries. The commercial sector absorbed around 45% of private bank credits in 1980 (Annex 1, Table 3) and industry about 27%; the remaining fourth went to agriculture and other purposes, including construction and consumer finance. Since 1975 the portfolios of banks have been growing at an average of 31% p.a., roughly paralleling the amount of credit extension by all financial institutions but advancing more rapidly than the aggregate from a 1978 trough. The growth of bank lending has been made possible by the increase in demand deposits and by credits from BCE. Ecuadorian banks predominate, only 4 of the 29 private banks being foreign bank subsidiaries. New entrants and more aggresive competition for deposits and clients have been challenging the dominance of the oldest established banks,  - 13 - 2.06 The financieras (Section D) have consistently, since 1974, experienced a faster growth of their credit portfolios than those of other financial institu- tions (Annex 1, Table 2). CFN expanded its operations very rapidly in the earlier years of this period, but slowed after 1977, while the private finan- cieras continued to maintain a growth rate of about 50% p.a. through 1980. This was sustained by expansion of the private financieras' capital base by about 56% p.a. and by credit extended from BCE. COFIEC was joined by nine other private financieras during this peiods. 1/ By the end of 1980 the private financieras' credit portfolio was 8.3% of the total for all financial insti- tutions, exceeding that of CFN, and their credit volume was 20.4% of the total (Annex 1, Table 1). Financieras' high proportion of credit volume relative to aggregate portfolio is due to the mostly short-term maturity of their credits, around 9.2 months. The private financieras operate mainly in the industrial sector, which absorbed 52.9% of the total volume of credit in 1980 (Annex 1, Table 3), preponderantly to finance working capital. About 15% of their credits went to agriculture, 6.9% to trading activities and the remaining 24.8% to other sectors, mainly construction and services. In the last two years, some of the private financieras have been expanding operations in the agriculture sector, in part due to the availability of CBE credits through the rediscount of Development Bonds and to their participation in Bank agricultural credits. 2.07 Mutual Saving Associations also substantially increased their credit during the 1970s, outpacing other institutions through 1975 but slowing to an average of 23% p.a. in 1978-80. The initial growth rate of Mutual Associations was from a low level of balances in the early 1970s, and was due to the financial assistance provided by BEV and an aggressive mobilization strategy based on the offer of mortgage loans to depositors. After 1972 no new Associa- tions were formed, and in 1979 four of the eleven institutions held around 82% of the total Mutual Savings portfolio. The Associations are not allowed to issue bonds or financial certificates. Individual deposits are still very small, an average of S/16,500 (US$660) per associate, while the average loan has been S/381,000 (USS$15,200) - allowing one mortgage loan per 23 associates. In 1980, the credit volume of Mutual Saving Associations was only 0.9% while credit balances were 4.5% of the system total (Annex 1, Tables 1 and 2). 2.08 One-third of the 24 private insurance firms currently operating in the country are branches of foreign companies, the rest Ecuadorian. Besides insurance protection, they provide small amounts of credit to their clients; in 1979 this amounted only to around US$1.5 million. In the same year insurance company investments in securities, both debt instruments and shares, amounted to S/773 million, equivalent to about 8% of the debt securities outstanding at the time (Annex 1, Table 4). More significant in this regard is the Social Security Institute (IESS) which provides credit to the govern- ment sector and to lESS affiliates, mainly for housing. By 1979 IESS held more than S/6,500 million in mortgage bonds and loans to its affiliates. IESS constitutes the principal organized market for mortgage bonds of commer- cial banks (holding 75% of those outstanding) and is thus able strongly to influence their prices and yields. In future, the expansion of medical assistance to its affiliates, and consequent increased claims on its resources, together with the financing needs of the public sector will reduce IESS participation in the mortgage bond market. 1/ Two more financieras were formed in 1981.  '- 14s - 2.09 The 21 foreign exchange houses, small and profitable institutions, had in 1979 total assets of around S/200 million. Their transactions, amounting to about S/16,000 million, were mainly (about 93%) in US Dollars and US Dollar travellers checks. Other specialized institutions include four warehousing firms, mainly providing depository services and storage/distribution facilities; on a minor scale, they also provide short-term financing operations with merchandise guarantees. In 1979 total assets of the warehousing firms were around S/358 million, and the volume of merchandise deposited about S/2,200 million. IECE is an institution providing loans for educational purposes; in 1979 its total assets were around S/93 million. 2.10 Transactions on the securities exchanges in Quito and Guayaquil were around S/9,608 million in 1980, almost equally divided between the two; 81% of the transactions were in government and BCE securities (55% were BCE's Bonos de Estabilizacion Monetaria), the remainder mostly in mortgage bonds, with insignificant trading (0.2%) in stocks. The 1979 volume of transactions represented 72.5% of the debt securities outstanding. However, for stabilization bonds the trading volume was four times the amounts outstand- ing, mainly due to the short (30 to 180 day) maturity of the bonds; on the other hand, only 18% of mortgage bonds, were traded and trading represented only 64% of the increase in mortgaLge bonds. These statistics suggest that not all new issues are negotiated in the exchanges, while the organized secondary market remains very limited. The latter deficiency is a major handicap to savings mobilization through issuance of debt securities. 2.11 Finally, the rigidity of the interest rate structure (para. 2.14) and the unsatisfied demand for credit contributed to the establishment of small finance companies, outside the traditional financiera pattern and the control of monetary authorities, to provide consumer credit and finance machinery for industry and agriculture. It is estimated that by 1978 these institutions had around S/150 million (US$6 million) in their portfolio - the equivalent of around 0.2% of total credit balances of the financial system - 65% financing industrial and agricultural machinery and buildings, the remainder used for acquisition of cars and trucks and travel expenditures. The growth of these companies occurresd mainly in 1975 and was reduced to 18% p.a. in the 1976-1978 period. Monetary authorities are currently studying ways to control these marginal finance companies. B. Regulations 2.12 JM and BCE's main policy instruments, used regularly to control the growth of monetary aggregates and the operation of financial institutions, are: (a) reserve requirements, currently 26% on demand deposits, and 10% of Mutual Savings Associations' deposits (in 1980, however, a liquidity shortage reduced actual bank reserves to 23.7% and those of Mutual Savings Associations to 8.2%); (b) portfolio growth ceilings imposed on an ad hoc basis for banks, and recently for a short time on financieras as well;  - 15 - (c) open market and credit operations to stabilize the growth of monetary aggregates; (d) interest rate ceilings and commissions (para. 2.14); and (e) control of foreign exchange operations (para. 2.13) and management of international reserves. In addition, JM and BCE have established minimum capital requirements for financial institutions (basically S/20 million for banks and SilO million for financieras); a maximum leverage position (debt-to-equity ratio of 15 times for banks and 10 times for financieras); and maximum claims on a single borrower (less than 10% of equity of banks and less than 25% of financieras' equity). BCE has direct control over a substantial share of the country's financial savings, which it allocates among the various lending institutions and objects of credit (para. 2.22). 2.13 Denominating loans in foreign currencies is prohibited except when they originate from international transactions. This has encourage the growth of guarantees financed from foreign bank credit lines by Ecuadorian financial institutions (para. 2.24). In these operations customers pay higher interest rates and are exposed to foreign exchange risks, but thereby obtain substantial supplementary resources. 2.14 Interest Rate Structure: Traditionally, interest policy has consisted of fixed rates supplemented by commissions. The basic rates vary with the maturity and nature of operations, and by credit programs and institutions (Table 2.1). The fixed rate structure, not subject to variation in response to availability of loanable funds and usually lower than market equilibrium rates, has resulted in credit rationing and encouraged emergence of an unorganized market (para. 2.11) at higher rates. The interest ceilings also have tended to discourage investors from holding debt instruments and lenders from intermediation through conventional institutions (para. 2.20). Thus, in general these policies have been detrimental to an efficiently functioning financial system, and to competition among financial institutions, in partic- ular financieras, given the fixing of spreads. The rigid interest rate structure, combined with a fixed US/Sucre exchange rate could encourage capital flight; through 1980 there was little evidence of this - the inter- national reserves both of BCE and of the whole banking system increasing during 1975-1980, at 28.4% and 29.4% p.a. respectively, reaching 36% in 1979-1980 - but early 1981 saw substantial outflows, occasioned in part by the hostilities with Peru and interest rate differentials.  - 16._ Table 2.1: Maximum AnnLual Interest Rates and Commissions (p.a.) on Some Operations. (as of March 18, 1981) Mutual Savings Private Private Associations Operations BNF Banks CFN Financieras and RHV I. Lending: - 12% 12% 12% - Operations with maturity of: less than 360 days 12% 12% 12% 12% 12% 361 - 540 days a/ 13% >13% 13% 13% 13% 541 days - 2 years 14% 14% 14% 14% 14% more than 2 years 15% 15% 15% 15% 15% Financial Funds Mechanism b/ 9% 9% 9% 9% - FOPEX - - 6% - - Against future exports 8 8 - 8 8 (sui generis) II. Central Bank: Advances and rediscounts c/ - - - 8% - Industry 4% d/ 7% 7% - - FOPEX - - 2% - - Against future exports (sui f.4% 4% - 4% generis) Financial Funds Mechanism rediscounts 3% 3% 3% 3% - III. Borrowing: Savings - 8% - - 9% Deposits with a maturity of: 31-180 days - 9% - - 10% 181 360 days - 10% - 11% 361-540 days - 11% - - 12X 541 days - 2 years - 12% - - 13% more than 2 years - 13% - - 14% Mortgage bonds - 15% - - - Financial certificates with a maturity of: 270-360 days - - 10% 102 361-540 days - - 11% 11% 541 days - 2 years - - 12% 122 aore than 2 years - - 13% 13% General and specific guarantee bonds - - 15% 15% IV. Commissions on selected operations a. Loans for agriculture, mining, fishery, industry end tourism with maturity of: 4-7 years iZ 1% 1% 1% 1%1/ (3-10 yrs) more than 7 years 22 2% 2% 2% 2% (> 10 yrs) b. For mortgage lending based (1.5% more than (a) except that - on mortgage bonds or maturities start at 3 years) general guarantee bonds c. Guarantees - 4% 4% 4% Source: BCE and SB. a/ For loans with maturity more than 360 dlays, except those with a maturity of five years or more and where there are partial repayments, the interest rate applied will corres- pond to that of the maturity of the corresponding amortization. b/ Includes specific programs in agricultture, livestock, agribusiness, small industry and tourism. c/ For operations outside Quito and Guayacquil, the interest rates are 2% less for private banks and 1% less for BNF. d/ Small Industry. a/ Housing.  2.15 On March 18, 1981, after lengthy discussion among its members, JM adjusted the interest rates for borrowing and lending operations, including commissions. 1/ The regulations are subject to different interpretations, and doubts have been expressed about the v&lIdity of some aspects that may contra- vene basic laws, but the main rates and commissions, as adjusted, are shown in Table 2.1. The maxilmum nominal intereat rate for lending is 15% p.a. for operations with maturity more than 2 years. Adding allowable commissions the official effective lending rate on medium- and loing-term loan is 16-17%, and 17.5-18.5% when the lending operations are financed by bonds. This represents an increase of 2 percentage points from the previous rates for loans of 5 years maturity, and 1 percentage point for those above 5 years. Bonds are sold at discount to improve their yield to holders. On March 31, 1981, mortgage bonds with maturities varying from 2 to 10 years were still nominally yielding between 13.5% and 15.5% p.a., (11.1% and 12.7% after tax) and tax exempt stabilization bonds were yielding between 8.6% and 12% with maturities ranging from 30 to 180 days. On June 21, 1981, however, the government issued 5-year bonds bearing a 15% coupon. The inflation rate last year was officially around 13%, and is currently estimated at perhaps 15% p.a.; hence the current government borrowings are at a rate marginally positive in real terms. However, their effect on resource mobilization efforts by banks and financieras could be very damaging since the new bonds' tax-free yield equals the recently in- creased maximum rate for mortgage bonds, interest on which is subject to tax; the latter could presumably be sold only at steep discounts the cost of which would have to be passed on to borrowers. If the government expects the financieras to mobilize significant amounts of long term resources, it should accord parity in tax treatment as well as in interest rates to these institutions' issues. 2.16 The March 1981 adjustments in the interest rate structure did not change the 4% p.a. commission allowed for guarantees and for lending operations originating from letters of credit, leaving financieras higher margins for such operations than for loans. However, they are not permitted to write guarantees in excess of 4.5 times their equity and letter of credit loans in excess of 3.5 times, whereas other loans may be made up to a total of 10 times equity. Thus once a financieras has reached its legal limits (as is the case for most of them) it can further expand its operations only as its equity capital is increased; and the added leeway gained thereby has a multiplier of 10 if used for loans but only 4.5 for guarantees and 3.5 for letter of credit loans. Still, up to this lower limit the financial incentives favor such opera- tions over lending financed from bonds and the proposed Loan. 2.17 Another of the rate adjustments puts financieras into competion with banks for funds under fixed term contracts for deposit above 270 days maturity. The issuance of bonds, nominally of long term, with a repurchase agreement that effectively make them payab,e on demand, is now greatly restricted; this practice resulted in a mismatch in the structure of assets and liabilities oL at least one financiera. However, given the virtual absence of secondary markets (para. 2e10)), the prospective response of investors to future security issues under the new regulations is still uncertain. 1/ See para 3.09 for Bank's limited role irn these changes.  - 18 - 2.18 It is still too early to determine the effect of the March 1981 regulations. Some Ecuadorian investors consider that they simply reflect the actual market yields. Others consider that more basic reforms in the system, going beyond mere adjustment of permitted interest rates, will be necessary for substantially more ample and reliable mobilization of resources for investment (paras. 2.22 and 2.37). However, the Government considers that more basic reforms of interest rates at this time would involve a major political risk. Nevertheless, some of the current limitations of the interest rate structure are recognized. The review of the effect of the March 1981 regulations could lead to additional reforms. During loan administration the behavior of the financial system, in particular regarding resource mobilization for long term lending, will be reviewed to determine whether further measures may be required (para 4.07). C. Financial Savings and Credit 2.19 During the period 1975-1980, after the inception of the oil boom, the total of financial savings (including net deposits of the government) was growing faster (at 27.4% p.a.) than the average growth rate of the economy (21.4% p.a.) (Table 2.2 and Annex 1, Table 4). The growth of net government deposits (52.3% p.a.), largely resulting from oil revenues, was a major factor; they increased from 2.7% of all financial resources made available to the financial system in 1976 to 9.2% in 1980. Non-specified liabilities and equity of financial institutions also increased their share of total financial savings, contributing strongly to the growth of the system. These increases were spurred by the attractive return on investment in financial institutions, especially banks and some financieras, vis-a-vis other financial instruments. Financieras experienced the most dramatic gains in capital, with an average growth rate of 56% p.a. during 1975-1980, while that for banks was 32.9% p.a. The share of private capital in total financial savings reached 10.4% at the end of 1980, up from 7% in 1976.  Table 2.2: GDP, Financial and Real Saving (SI million, current prices) Percentage of Real Saving Real Saving Increments of as a Ratio of Intermediated Year GDP Financial Financial Real Percentage of Financial in the Financial gavings Savings Saving b/ GDP Savings to GDP System B C A B C D E F = A G=D 1975 107740 34065 21818 20.3 0.316 1976 132913 47616 13551 29767 22.4 0.358 45.5 1977 162378 62116 14500 37656 23.2 0.383 38.5 1978 188968 71630 9514 42905 22.7 0.379 22.2 1979 231719 88676 17046 58058 25.1 0.383 29.4 1980 284428 114126 25450 65974 23.2 0.401 38.6 Average growth rate per year 1975 - 1980 Average during the period 21.4% 27.4% - 24.8% 22.8% 0.37% 34.8% Source: BCE and SB a/ From Annex l, Table 4. I/ Gross Domestic Saving.  - 20 - 2.20 The expansion of stabilization bonds also was rapid (34.4% p.a.) but from a low base, so that their 1980 share in total financial savings was still only 1.3% in 1980.. The growth rate for debt securities other than stabilization bonds was lower, roughly 20% p.a., their share in total financial savings declining from about 12% to under 10%. This lower growth rate has been due in part to interest rate controls that resulted in portfolio shifts from debt instruments into higher yielding investments-e.g. shares of financial institutions whichr in 1980 yielded an average of 26% for banks, ranging up to 60%; and 18%'for financieras, writh some close to 27%. Such shares are also more marketable than bonds, except stabilization bonds. The growth rate of savings and time deposits (19.6% p.a.) has also been lower than average and by 1980 their share of all financial savings had fallen to 14.4%; the share of currency in circulation aLnd demand deposits was also reduced, to 39.2%. This may have resulted from arnti-inflationary monetary restrictions that limited the growth of the commercial banks' portfolio, the slackening of overall economic growth, and the more attractive returns from real estate and shares of financial institutions. 2.21 The ratio of financial savings, including government deposits, to GDP at around 37% shows (Table 2.2) a still low level of intermediation and financial development relative to other Latin American countries (Annex 1, Table 5). Only about 34.8% of real savings (Table 2.2) are intermediated through the financial markets. This is further reflected in the fact that loans from non-related parties to firms reporting to the Superintendency of Companies are only about 38% of their total assets, which suggests that financing needs of the corporate sector are still met substantially from internal sources. On the other hand, the proportion of real saving to GDP (22.8%) is around the average for middle income and industrialized countries. Even if the share of real saving does not rise substantially, there is consid- erable scope for increased intermediation and improved efficiency and effec- tiveness in the financial markets. 2.22 BCE's predominant role in the operations of the financial system is due in part to the large share of financial savings under its control, around 45% in 1980, (Annex 1, Table 4). Although a substantial portion (over 20%) of these resources are net government deposits, most come from the financial sector largely in the form of required reserves. BCE reallocates these funds by transfer through designated financial institutions for specified purposes - to commerce 32.7%, industry 33.9%, agriculture 15.3% and other sectors 18.1% in 1980 (Annex 1, Table 3). It is questionable whether this method of directed allocation oE credit resources makes optimal use of them, in particular the agricultural sector seems relatively disfavored. Certainly it hampers the development and efficiency of financial intermedia- tion. In the future BCE might better devote its efforts and resources to promoting secondary markets for financial instruments and to more consistent policies for controlling inflation. 2.23 The savings made available to the organized financial system allowed it to finance around S/86 billion of credit operations in 1980 with about S/100 billion in credit balances (Annex 1, Tables 1 and 2). The credit balances of all the system grew at an average rate of about 28% p.a. during 1975-1980 (slightly faster than financial savings), roughly the same rate as  21 - in the previous 5 year period. Credit volume grew at a slightly lower rate (26%) due to a slight lengthening of maturities. Still the average maturity of credits remains short (11 months) reflecting the short-term character of resources and credit requirements of the commercial sector. While private bank credit has had about the same average maturity as that of the financial system as a whole, private financieras have engaged mainly in shorter term operations averaging around 9 months. Contributing factors are the low margins that can be earned on long term resources; the ready availability of BCE funds; the absence of secondary markets to enhance the liquidity of debt instruments, the fact that private firms are accustomed to finance their long-term needs internally or through rollover of short-term loans; and the unattractiveness of yields on long-term debt instruments relative to equities and real estate. Future growth of long-term resource availability depends on making suitable financial instruments attractive to investors - inter alia by introducing more flexibility in interest rate policy, promoting secondary markets and adjusting tax and other incentives. 2.24 Contingent operations are an important addition to the credit balances shown in Annex 1, Table 2, which amounted to S/33,461.8 million in 1980, 33% of the total; of which 76.3% of all guarantees were by private banks and 23.2% by financieras (including CFN); 60% consisted of guarantees financed by foreign banks through short and medium term credit lines. Thus, in addition to the credit portfolio of the entire financial system, at least a further 20% equiva- lent entered the economy financed by foreign sources with Ecuadorian guarantees. For private banks contingent operations amounted to the equivalent of 38% of their credit balances, and for CFN and private financieras 15% and 80% respec- tively. Private financieras, therefore, are heavily dependent on foreign banks, and to a lesser extent on BCE for their resources. D. Financieras Corporacion Financiera Nacional (CFN) 2.25 CFN, Ecuador's oldest and largest financiera, is wholly owned by the government but mainly finances the private industrial sector. In its day-to-day operations it enjoys considerable autonomy but its Board of Directors, seven of whom are Ministers of State, sets overall policy. CFN is headed by a General Manager, who exercises authority through a strong management structure consisting of an Assistant General Manager and departmental and divisional managers. The last three years have been difficult ones for CFN, which has responded by attempting to consolidate its activities. Thus it has sharply reduced the growth rate of both assets and staff, drastically curtailing the expansionary trend of 1974-77 (Annex 1, Table 6); its share of total assets of financieras has dropped correspondingly. 2.26 Operations. CFN's loan portfolio, the largest component of total assets, has remained roughly constant in real terms since 1978. Its term structure and funding have been shifting to a pattern somewhat more like other financieras. In the last two years, CFN has dropped the practice, long of concern to the Bank, of partially funding long-term, fixed rate Sucre loans with  -- 22 - floating rate foreign exchange borrowiLngs. In order to reduce losses (para. 2.29) it has been making more use of BCE resources and has increased short term lending. Nevertheless, long term lending remains its principal activity. Resources available to CFN for this purpose would be reinforced under the proposed loan by access to Bank funds and to cofinancing, and by increased mobilization of domestic savings. To the latter end, the government has agreed to ensure CFN's access to loca:L and foreign sources of financing. 2.27 Equity investments, CFN's second most important line, have been growing more rapidly than total portfolio, due mainly to government pressures that CFN's management has not successfully resisted. Many of these investments are, at best, financially precarious (AZTRA and Selva Alegre) and some (e.g. Ecuasider and Coordinauto, companies to organize a steel mill and automobile manufacture) seem dubious from the economic viewpoint as well. None of the new investments, however, are in violation of the Fourth Loan covenant limiting exposure in a single firm, 1/ which has probably had a restraining effect. CFN's management needs to screen equity investment proposals more carefully and firmly reject those that do not have sufficient possibilities of return to justify the risk. 2.28 Although it charged less than market rates until recently, CFN has not been able to increase its guarantee and letter of credit business, whose volume in real terms has fallen 23% in the last 3 years. In part this reflects a failure to market these facilities aggreasively. Clients express reluctance to accept "expensive" resources from CFN (although they accept them from other financieras) believing that CFN should provide "cheap" money. Also, CFN's internal procedures for dealing with guarantees handicap it in relation to private financieras. CFN is attempting to overcome these problems and expects to make much greater use of guarantees and letters of credit in the future. 2.29 Profitability. CFN's rate of return on equity declined steadily from 1975 through 1979, when it lost US$2.6 million equivalent (Annex 1, Table 7). Its gross spread fell mainly because the cost of its foreign commercial borrowings rose faster than the yield on its portfolio, the latter being affected by the unprofitable investments in AZTRA and Selva Alegre (para. 2.27). Large provisions for possible loan and investment portfolio losses also imposed a drain on profits. Losses of US$6.0 million were initially forecast for 1980, but several circumstances resulted in a small profit. First, CFN negotiated larger credit lines, with attractive margins, from BCE, and increased the efficiency and volume of its use of BCE resources for FOPEX, a line of subsidized export financing. Second, CFN reduced its foreign exchange obligations, and fortunately several of the semestral interest rate fixings fell during the mid-1980 trough in interest rates. Third, CFN increased its commissions on guarantees and letters of credit from 1% to 2% p.a., and in June 1981 to 3-4% p.a., approximating market levels as required by earlier agreement with the Bank. Finally, the average interest rate on its long term 1/ The investment in AZTRA occurred before the Fourth Loan covenant.  - 23 - loan portfolio is gradually rising as old, 12% loans are being replaced with 14-16% loans. The new interest rates established in March 1981, up to 17% p.a., will contribute to a further rise in portfolio yield but could be more than offset by a corresponding rise in interest expense. A solution to the AZTRA and Selva Alegre problems (para. 2.31) should dramatically improve CFN's profitability, both by raising its return on assets and by eliminating the need for extra-ordinarily large provisions against loss. Nevertheless, to achieve the minimal goal of protecting the real value of its equity CFN will have: (a) further to increase gross margins by continuing to charge full market rates for its financial services; (b) emphasize profitable lines of activity; (c) continue close control of administrative costs; (d) increase its leverage; and (e) improve its financial management. To help CFN design and implement a computer-based accounting, budgeting, and financial information system US$100,000 in technical assistance would be provided to CFN in these areas. 2.30 Financial Condition. The two major threats to CFN's financial condition identified at the time of the Fourth Loan were its exposure to foreign exchange risk on external borrowings and its investments in large, unprofitable public sector enterprises (AZTRA and Selva Alegre). CFN agreed to prepare programs acceptable to the Bank to deal with these problems. In both cases the CFN proposals were inadequate; however, they helped to define the issues and to reduce CFN's consequent foreign exchange exposure from US$130.8 million in 1978 to US$114.6 million in 1980 - which, at 1.5 times CFN's equity, is still excessive. One of the technical assistance components of proposed loan could help carry out a study of possible means to minimize CFN's (and other financieras') exchange risk problems (Annex 3). Under the Fourth Loan the government agreed to reimburse CFN for foreign exchange losses arising from past, but not new, foreign borrowing. This agreement is carried over into the proposed loan. CNF has agreed to a freeze on further borrowing from foreign sources which exposes it to sub- stantial foreign exchange risk. 2.31 CFN has made provisions from its own earnings equal to almost 10% of its equity holdings of AZTRA and Selva Alegre which amount to almost US$37.0 million, but any definitive solution of this issue must come from the government. The problems of the two companies derive in large part from controlled prices for sugar and cement, and from political interference in management. The government understands the causes and is seeking a fundamental solution which would restore both companies to profitability and eventually permit their sale to private investors. The Bank strongly encourages such a solution but has also stressed the view that pending its achievement CFN should be relieved of the financial burden of these two investments. The substantial price increases for sugar and cement undertaken by the government could facilitate the sale of the two firms. CFN would also receive US$20.0 million to enable it to make an adequate provision for these investments, pending their sale. Final agreement on the timing of this transfer were reached at negotiations. On its part CFN will undertake a review with its auditors to determine if all US$20.0 million or more or less should be added to its provisions for loss. To help prevent similar problems the government agreed in the future to limit CFN's exposure to a single firm to 10% of its equity except when adequately protected from the additional risk by a mechanism satisfactory to the Bank. Finally, CFN agreed to annually establish adequate provisions in a manner satisfactory to the Bank and take into account the opinions of the auditors.  - 24 - - ivate Financieras 2.32 The private financieras are among the most important sources of institutional finance to the industrial sector, accounting in 1980 for over 35% of credits to that sector (Annex 1, Table 3). Most of the financieras are based in the two main industrial and commercial centers, Quito and Guayaquil, while FIDASA has its headquarters in Cuenca. 1/ The recently established MANABI and FINANSUR focus on the regions around Manta and Machala respectively. Headquartered in Quito, COFIEC, FINIBER, FINANSA, and FINANDES have about 65% of total assets and contingent operations of all private financieras. The largest and most mature institution, COFIEC, controls around 33% of all private financieras' assets and contingent operations. 2/ The second largest private financiera is FINANSA with 17%, while FINIBER and FINANDES have 10% and 5% respectively. The Guayaquil group - GUAYAQUIL, ECUFINSA, FINANSUR, AMERAFIN - have 16%, 10%, 3% and 3% respectively, of total assets and contin- gencies of private financieras. FIDASA in Cuenca and MANABI in Manta 3/ are the smallest of the private financieras, each with less than 2% of total assets and contingencies (Annex 1, Table 8). 2.33 Along with CFN, private financieras basically provide credit to the industrial sector (Annex 1, Table 2) 78% of which is for working capital. Recently, however, they have been expanding their credits to the agricultural sector. Since mid-1982 they have become very active in the Bank's SSI Loan, having used about 75% of the resources thus far committed. Only COFIEC and FINANSA have equity investments, around 2% of their total assets and contingent operations. COFIEC also has provided significantly more direct credit with maturities longer than one year (19.2% of total assets and contingent operations) than the other financieras. FINANSA has the largest portion of its portfolio in contingent operations (54%), while MANABI and FIDASA have only limited contingent operations probably due to the lack of foreign bank financing. MANABI and FIDASA have also a relatively high liquid position, due in part to their less aggressive strategy. FINIBER is probably the most aggressive and fastest growing of all the private financieras, followed by GUAYAQUIL and ECUFINSA. The growth of FINANSA has been slow in the last year, partly due to some liquidity constraints and a major change in its shareholders. With new management ECUFINSA is revamping its lending strategy. MANABI's strategy calls for expansions in such secondary cities as Manta, Loja, and Riobamba. Recently formed FINANSUR, AMERAFIN, FINEC, and REPUBLICA are still looking for a particular niche in the the market. Among the latest additions, FINANSUR seems the most aggressive; FINANDES and FIDASA have grown least rapidly. 2.34 As regards borrowing operations, only COFIEC and FINANSA have issued a limited amount of bonds and only COFIEC has issued financial certificates. 1/ See Glossary for full names of the financieras. 2/ CFN, however, has assets about 1.6 times larger than COFIEC. Headquartered in Quito, it has offices in all principal cities of the country. 3/ Officially headquartered in Manta, MANABI's principal office is located in Quito. Still more recently formed, and just initiating operations, are FINEC in Quito and REPUBLICA in Guayaquil.  - 25 - Some financieeas have also issued development bonds, which are basically discounts with BCE and therefore are not considered debt securities. COFIEC, and to some extent MANABI, are the only financieras with a substantial proportion of loan resources with maturities above one year. Contingent opera- tions, rediscounts, acceptances, and letters of credit in aggregate make up most of the liabilities of financieras. COFIEC, FINIBER, FINANSA, GUAYAQUIL and ECUFINSA are already at or close to the legal debt-to-equity ratio (10:1). The newest financieras, together with FIDASA, have not yet been able to obtain foreign banks support that would enable them to increase their leverage position. FIDASA's location in Cuenca isolates it from visits of foreign banks representa- tives. Moreover, it has no predominant private group among its sponsors - its major shareholder, with about 25% of equity, is CFN - which tends to make it less aggressive. With the exception of COFIEC, and to some extent FIDASA, most of the private financieras have played an insignificant role in mobilizing domestic resources except through their own equity. Their resources are provided overwhelmingly by BCE and foreign banks (Annex 1, Table 9). 2.35 The management organization of most private financieras is small and very simple, usually revolving around a few key professionals with experience drawn from COFIEC and CFN. Their management information systems, except for COFIEC and FINIBER, are in process of development. Most of the professionals working in the financieras are schooled in international banking operations and commercial banking-type analysis, although the top manager and/or a few at middle level have some experience in project appraisals. Only COFIEC has a full project analysis department, while FINANSA, ECUFINSA, FIDASA, GUAYAQUIL, and MANABI have at least one officer working on project appraisal. Most financieras expect to increase their medium and long term operations and propose to build up their project appraisal capabilities. All operate under Policy Statements acceptable to the Bank or would adopt such Statements as a condition of participation in the proposed loan. 2.36 Most of the financieras work with tight liquid resources; the overall current ratio is around 1.3 for the oldest financieras and about 1.8 for the new ones. All private financieras except COFIEC finance part of their loan portfolio from equity. COFIEC uses part of its equity and some liabilities to finance equity investments and real estate holdings. The profitability of financieras has been lower than that of banks, due to their fast growing capitalization. In 1980, excluding MANABI which was starting operations, the private financieras earned an average return on equity around 18% with a range of 6-27%, the newest at the lower end of the scale (Annex 1, Table 10). Account- ing conventions make the actual average interest earned and cost of funds difficult to ascertain precisely, but it is estimated that their average gross spread is around 3.5 to 4.0%. Administrative expenses including taxes and provisions for losses are roughly 2.2% of total assets and contingencies. E. Issues and Outlook 2.37 The financial system of Ecuador has been growing inadequately given the expansion of the economy, in a period of relative political sta- bility. The efficiency of the system in allocating resources needs to be  - 26 - improved, in spite of recent reforms, through allowing greater scope for market forces in interest rate policy, the promotion of secondary markets for financial (especially debt) instruments and revision of policies throughout the economy that may discourage securities investments. The predominant role of BCE in credit allocation should be de-emphasized, and it should r,ive more attention to creating and strengthening secondary markets for financial instruments, fostering competition among financial institutions and expanding their role as investment bankers. So long as secondary markets are lacking the effects of a market-oriented interest rate policy may be limited. With real savings approximating the share of GDP found iLn other middle-income and industrialized countries, the most promising means of- increasing financial savings, in particular debt securities, would be through portfolio shifts by investors from non-financial to financial assets. The share of real saving of the economy going into financial savings, i.e. intermediation, would have to be increased. Dialogue between the Bank and the monetary authorities on these issues would occur in the context, inter alia, of the interest rate review provided for in the proposed loan (para 4.07). 2.38 The financieras remain important channels and allocators of resources to the industrial sector. However, their intermediation function is still very limited, mainly as a result of the market constraints noted above. The conditions for access to resources under the proposed loan (para 3.16) would provide an additional incentive for resource mobilization. Although the top managers of financieras are generally experienced and able professionals, project appraisal capabilities need to be developed further. The advisory services in project appraisal methodology and practices, proposed to be financed under the Loan, should help to further this end (para 3.20). The average level of profitability of all the private financieras, depressed by those recently established and by the continuous rapid capitalization of most of them, still is acceptable; and the more aggressive and efficient financieras are showing attractive profits. Their earning potential, given current monetary policies, is still high. Further development of management control systems and improved financial programming would increase their efficiency. The technical assistance programs through the Superintendency of Banks (Annex 3) may help to train financieras' financial managers and improve their opera- tional effectiveness, especially in follow-up of subproject implementation; certainly it should strengthen the supervisory capabilities of the Super- intendency's own staff. Bank staff are already assisting the SB in carrying- out the training program. 2.39 Improvements to the data base and statistics of the financial system, the accounting and auditing practices of financial institutions, and other operational practices of financieras need to be examined, A program of studies and development of information systems (Annex 3) has been confirmed. during negotiations. Bank staff are already assisting the SB in planning the particular studies to be included in the program and preparing terms of reference; as usual the Bank would comment on results of the studies and means of implementing their findings.  - 27 - III. THE PROJECT A. Previous Loans 3.01 Since 1971 the Bank has made four loans to Ecuador for development banking projects, using financieras as intermediaries, for a total of US$86.0 million. Only CFN and COFIEC participated in the first two of these loans; in the third and fourth, other more recently formed financieras participated to a limited extent. A further loan designed specifically to reach smaller clients (SSEs) has recently become effective and is being committed rapidly; a second SSE project will be appraised in early FY1982. 1/ The Fourth Loan was fully committed in December 1980; fifty percent of the Fourth Loan amount was disbursed by July 1981, only 10 months after effectiveness. 3.02 Eight new financieras (in addition to CFN and COFIEC) were reviewed for participation under the Fourth Loan and six were found eligible to participate. 2/ Because of vigorous demand it became apparent that the entire loan might be committed by COFIEC and CFN before the new financieras could act. Therefore the government requested and the Bank agreed to reserve US$7.0 million for new financieras until December 1980, on a first-come, first- served basis. Three of the new financieras committed these funds for nine subprojects, including one particularly labor-intensive fish export venture. The inclusion of the new financieras, one of the purposes of the Fourth Loan, contributed to the achievement of other objectives as well - e.g., broadening of the aggregate clientele, and increased attention to the need of smaller firms and more backward regions. 3.03 The characteristics of subloans financed under the first three loans were summarized in the SAR for the Fourth Loan (Report No. 24146-EC, dated May 31, 1979--Tables 9 and 10 of Annex 4). A revised tabulation for the Third Loan--including the final commitments made under it, several by the newer financieras as well as by CFN--is shown in Table 3.1, together with comparative data for 41 subprojects approved under the Fourth Loan. The data of Table 3.1 are based on subproject appraisal estimates made by the financieras; it is still too early to assess actual results. The appraisals were, however, reviewed in the Bank--especially those for subloans exceeding the free limit--and were considered generally reasonable. 1/ Eligible intermediaries under the SSE loan 1879-EC comprise commercial banks as well as the financieras, with the latter using about 75% of the amounts committed to date. 2/ The major factor impeding the other financieras was their inability or unwillingness to commit themselves to raise the proportion of medium and long term operations in their portfolios to at least 20% by December 1981.  - 28 - Table 3.1 COMNMILISON OF SUBPROJECTS FINANCED UNDER THIRD ANlD FOURTH DEVELOPMENT BANKING LOANS (Units, IJS$ millions, and Percent) Third Loan Fourth Loan No. No. $ _ By subloan size .4 0.25 14 3.20 12.2 13 1.93 5.6 0.25 - 0.50 7 3.38 12.9 6 2.42 7.1 0.50 - 1.0 2 1.66 6.3 10 6.66 19.6 1.0 - 3.0 6 10.72 40.9 12 22.99 67.6 '73.0 2 7.23 27.6 - - - 31 26.19 100.0 41 34.00 100.0 By subsector Food processing 2 0.67 2.6 7 3.44 10.1 Wood products 2 1.96 7.5 1 3.00 8.8 Textiles, clothing, footwear 9 14.79 56.5 7 6.66 19.6 Non-metallic mineral 4 3.22 12.3 7 5.65 16.6 Metal products 5 2.01 7.7 8 6.71 19.7 Paper 2 1.86 7.1 - - - Chemicals, plastics, rubber 5 1.58 6.0 9 7.92 23.3 Others 1 0.10 9.4 2 0.61 1.8 31 26.19 100.0 41 34.00 100.0 By type of firm New 9 8.49 32.4 12 8.94 26.3 Existing 32 17.70 67.6 29 25.06 74.7 31 36.19 100.0 41 34.00 100.0 By destination of output Export 2 0.76 2.9 5 2.62 7.7 Domestic and mixed 29 25.43 97.2 36 31.38 92.3 31 26.19 100.0 41 34.00 100.0 By economic rate of return < 20 2 0.92 4.0 10 8.72 31.6 20 - 30 6 13.52 59.0 12 12.16 44.1 7 30 L1 8.47 37.0 5 6.70 24.3 not available :L2 3.27 - 14 6.42 - :31 26.19 100.0 41 34.00 100.0 Total Project Cost (1980 prices) 177.3 21 145.05 Average Project Cost (1980 prices) 5.9 -1/ 3.54 Financed by Bank Funds (%) 19.2 24.6 Average Cost per Job (1980 prices) 0.066 0.041 1/ Percentage 2/ Based only on 30 subprojects.  - 29 - 3.04 The commitments under all four loans are for a diversity of industrial subsectors, but with a concentration in textiles, clothing and leather goods through the Third Loan. 1/ Metal products manufacture has received an important proportion of the first two loans and of the fourth, little of the third, while the share accorded to chemical/plastic industries rose progressively, to 23.3% of the Fourth Loan. 3.05 The averages for size of subloan, for total subproject cost and investment per job are all substantially lower in Fourth Loan commitments than in the Third. This is doubtless due in part to the US$3 million limit on maximum use of Bank funds by a single firm that was set for the Fourth Loan. It may also reflect participation in the loan by some of the newer financieras; subloans presented by them, as a group, under the Third Loan were much smaller, and under the Fourth Loan somewhat smaller, than those of COFIEC and (especially) CFN. However, the Fourth Loan cost per job, at a US$41,000 average, is still high relative to Ecuador's per capita income and savings. 2/ The share of export production subprojects, in which the projected investment per job was only about one-seventh of that in import-substitution industries, also increased from the Third to the Fourth Loan, from a low base percentage. Because export projects tend to be more labor intensive 'para. 1.12) US$20.0 million of the pro- posed loan would be reserved for subproject-8 exporting more than 50% of their gross output. 3.06 Some deficiencies in ERR calculations have come to light. In order to remedy them and to improve the analysis, the following adjustments will be made in implementation of the Fifth Loan: (a) financieras will provide a special explanation of the method of estimating border prices of important subproject inputs or outputs whenever they are subject to quantitative import restriction or tariffs greater than 25%; (b) financieras will spell out the procedures used on each subproject for procurement, and explain the extent to which consideration is given to more labor-intensive technological alternatives; (c) because of inflation the limit below which ERR analysis will be required would be raised from US$150,000 to US$300,000 for Bank- financed subprojects and from US$500,000 to US$1,000,000 on other subprojects regardless of the source of funds, with no ERR required for pure working capital loans (non-Bank); and (d) technical assistance (para 3.20) will be provided to the finan- cieras, particularly the new ones, in making financial and economic analyses of projects. 1/ These categories were consistently preponderant recipients of Bank funds prior to the Fourth Loan, accounting for 37.1% of commitments under the first two and 56.5% under the Third. Their Fourth Loan share, within the 41 subprojects analyzed, is 19.6%. 2/ By comparison, however, projects receiving benefits under Ecuador's Industrial Development Law have an average cost per job of US$61,300.  - 3C - 3.07 Permanent working capital made up about 15% of total project costs, under the Fourth Loan. About 51% of total cost consisted of foreign exchange of which the Bank financed about half. The financieras' own funds, other financial institutions and project sponsors contributed over US$100 million to complement the US$40 million Bank loan. The magnitude of the mobilization of complementary resources puts into perspective the relative failure to achieve the specific goals of resource mobilization through the financieras that the Fourth Loan aimed at (para 3.09). 3.08 While the trends of labor/capital utilization and of export orientation are encouraging, financiera credits under the Fourth Loan have still supported mainly a rather capital-intensive import-substituting segment of industry. Loan 1879-EC targetted specifically at SSEs offsets this bias to some extent and early results are very encouraging. Nevertheless, the typical estimates of ERR have been high, mostly well over 20% albeit lower for Fourth than for Third Loan subprojects--still with only one under 15%. In most cases the projected finarcial return (FRR) exceeds the ERR, as a result of the industrial protection/incentive system. 3.09 Progress in resource mobilization and in dialogue on financial reforms fell far short of the objectives of the Fourth Loan. Under the Fourth Loan the BCE and the Bank were to have discussed financial reforms through a series of studies to be conducted by BCE's Capital Market Study Unit. This unit was caught up in a general reorganization of BCE and was assigned data gathering and reporting tasks. Consequently, studies were not conducted according to a timetable and under terms of reference agreed with the Bank as expected. The Bank did see and comment on some unofficial proposals that led up to the 1981 changes (para 2.15). The lack of earlier and more far reaching reforms is the main reason for the difficulties that these financieras had in issuing bonds and certificates to the public. Under the proposed loan, a review of interest rates and other conditions bearing on the financieras' ability to mobilize resources would be conducted before more than half of the proposed loan could be committed (paras 2.18, 2.37 and 4.07). 3.10 Under the Fourth Loan, as in the proposed loan, the financieras had to mobilize complementing resources to use Bank funds according to a matching formula. Because the increase in the equity of both the private financieras and CFN was more than expected, the institutions had less need to issue bonds and certificates, Furthermore, deve:Lopment bonds sold to BCE were not fore- seen and had not been excluded from the matching formula. The formula did explicitly exclude bonds with repurchase agreements; the exclusion would be maintained in proposed loan and only mobilization of funds from the public would qualify in the matching formula (para 3.16).  31 - B. Obectives 3.11 The proposed Fifth Loan seeks to build on the accomplishments and experience of the four earlier loans, sharpening their focus toward the following objectives: (a) in the light of actual experience following the March 1981 adiustment of interest rates, to maintain progress toward an interest regime more flexible and responsive to market influences; (b) to increase over the longer term the strength, diversity and efficiency of the Ecuadorian capital market by encouraging the issuance and purchase of longer term debt instruments (specifically those of the financieras) and the creation of an effective secondary market for such investments; (c) to encourage greater initiative, reach, and competition by financieras through broader participation of the newer, smaller, and (to some extent) dispersed ones; (d) to strengthen institutional capabilities for loan appraisal and supervision, collection and organization of data, exchange risk management, etc. through technical assistance components; and (e) to analyze the existent system of industrial protection/ incentives, identify anomalies and sources of inefficiency and provide a basis for its rationalization -- through a study in depth of effective protection/subsidies and their cumulative impact, whose foreign costs would be financed from the Loan. 3.12 The foregoing objectives have been discussed extensively with the government, which expresses full concurrence with all except (a); the monetary authorities are not yet persuaded that the advantages of a freer interest rate regime would outweigh possible strains and risks, but they stress that the March 1981 adjustment is an initial step and test and that they are willing to consider further measures if and as market reaction and international interest rate tendencies may indicate the need to do so. C. Participating Institutions 3.13 The characteristics of CFN and of the growing number of private financieras are summarized in paras 2.25 to 2.36, and in Annex 1, Tables 6-10. For easy reference in this report, and with no invidious connotations, they are classified into three groups on the basis of their prior participation (or eligibility) in Bank loans, as follows: Group I - participants throughout, from the First Loan -- CFN and COFIEC  - 32 - Group II - additional participants eligible under the Fourth Loan -- FINANSA, ECUFINSA, FINANSUR, FIDASA, FINIBER and MANABI Group III - financieras not participating in the Fourth Loan but potentially eligible to participate in the proposed loan -- GUAYAQUIL, AMERAFIN, ANDINA, FINEC, and REPUBLICA 3.14 CFN and COFIEC, given their large size and long familiarity with Bank requirements relative to other financieras, will almost certainly use the bulk of Bank funds under the proposed loan. However, as the other financieras have increased in number and grown in size and experience, it is expected and intended that their percentage share in the Fifth Loan will be substantially greater than under the Third and Fourth--when it amounted to 10.3% and 18.0%, respectively. In order to avoid their being preempted in the early life of the loan, 25% of the Loan amount will be reserved for Group II and III financieras--in shares roughly proportional to their respective capital and reserves as of June 30, 1981, but with some weighting in favor of the smaller ones--for a period of one year from Loan effectiveness, subject to their fulfilling the conditions of participation specified in paras 3.15-3.16, and to the normal requirements of project and appraisal quality. CFN and COFIEC would be in competition from the start, on a first-come, first-served basis, for the remaining 75% of the Loan; the others would also compete for the unallocated share once they had exhausted their initial allotments; and all could compete for any unused allotments after expiry of the first year. This should serve to maintain a competitive spirit and stimulus, while providing a modest "infant financiera" protection. Conditions of Participation 3.15 Participation in the Fourth Loan by the Group II financieras was conditioned on the following: (a) paid-in capital at :Least US$2.0 million equivalent; (b) a portfolio contain:Lng at least five medium and long-term operations; and (c) a total debt/equity ratio of no more than 7 to 1, later relaxed to 8.5 to 1, subject to review for financieras desiring to orient themselves more strongly toward medium- and long-term operations. 1/ Subsequently, the condition under (b) was altered to require that participat- ing financieras develop a program by which at least 20% of total portfolio would consist of medium- or long-term operations by the end of 1981. While aiming at this goal, most of the Group II financieras have continued to engage mainly in short-term guarantee operations financed by foreign banks, which are relatively favored by the interest structure. Under the proposed loan the 1/ A debt/equity ratio of 10 to I was agreed for the most mature Group II financiera.  - 33 - targets summarized above, as amended, would be maintained for Group II and III prospects, with the target date for Group I-I to achieve a 20% share for medium/long-term operations set at DecermDer 31, 1982. Also, for continuing eligibility under the fifth and subsequent Bank loans, Group II and III financieras would have to raise this share to 30% after two years from its initial target date. COFIEC and CFN would have to maintain 50% of their portfolios in medium- and long-term operations. No financiera would be able to make additional commitments of Bank funds while in default on those targets. Each financiera would sign a Subsidiary Loan Agreement with BCE providing for, inter alia: (a) a total debt/equity ratio of no more than lO to 1 in accordance with Ecuadorean banking laws; (b) provisions for loss equal to at least 1% of its total portfolio; and (c) a limitation, equal to twice its equity, on aggregate exposure to stockholders owning more than 1% each of the shares of the financiera. Close supervision by the Superintendency of Banks will help to ensure that a prudent financial structure is maintained (para 3.19). 3.16 The objectives sought by the government and the Bank with regard to resource mobilization will require a strong inducement for the financieras to make vigorous and imaginative efforts to tap the medium/long term market and genuinely to test the quantum of resources potentially available and the interest rates (or discounts) renuired to elicit a good response. Each financiera's use of Bank funds will therefore be contingent on its mobilization of domestic medium or long term resources in the following proportions: Resulting Entitlements to Type of Domestic Resources Bank Funds (a) borrowings with maturity of over 3 years - 0.2 times (b) certificates with maturity of 6 months to 3 years - 0.4 times (c) bonds with maturity of over 3 years or more up to 7 years, and intermediation of shares - 0.8 times (d) incremental equity - 0.5 times (e) bonds with maturity over 7 years or more - 2.0 times (f) underwriting of shares of enterprises - 0.6 times All increments to equity and amounts outstanding of bonds and certificates (except when sold directly to public financial institutions) with maturities of 18 months or more, made since December 31, 1981, will count in accordance with the above scale. To encourage capi tal market development, the under- writing of shares of enterprises would be counted in the resource mobilization efforts of financieras. Based on past experience and outlook approximately US$118 million could be mobilized in connection with the Fifth Project (Table 3.2).  34 - Table 3.2 Financieras Resource Mobilization and Use of Bank Funds (millions of US Dollars) Mobilized by Use of Bank Funds Private Private CFN Financieras Total CFN Financieras Total Equity 30 42 72 15 21 36 Long-term Bonds - 3 3 - 6 6 Internal Borrowing 20 - 20 4 - 4 Medium-term Bonds and Underwriting 7 3 10 6 2 8 Certificates 10 3 13 4 1 5 Total 67 51 118 29 30 59 3.17 The project appraisal capabilities of CFN and COFIEC have developed over several years experience, although CFN showed signs of recent deterioration probably resulting from increased turnover and loss of staff. The Group II financieras have performed fairly well in this regard under the Third and Fourth Loans, although unevenly; and some, at least, are in need of improvement in more sophisticated analysis such as ERR calculations. The Bank has little basis so far for assessing the capabilities of Group III financieras. For the proposed loan, in view of the increases in prices since 1979, the free limits for CFN and COFIEC will be increased to US$ 2 million for each from the previous US$1.5 million and US$1.25 million, respectively; and those for the Group II financieras to US$350,000 (from US$250,000). The Group III financieras would be required to submit the first: two projects for Bank approval and, if the appraisals prove satisfactory, the same US$350,000 free limit would be set for them; otherwise, they would continue to submit all projects for advance approval until their appraisals measure up to standard. They would be encour- aged to use the services of the Resident Advisor to be located in the Ministry of Finance (para 3.20).  - 35 - D. Technical Assistance Components 3.18 The Fifth Loan would include four technical assistance elements: (a) reinforcement of the supervisory and data collection capabilities of the Superintendency of Banks (SB); (b) advisory services to financieras, management and staff on the requirements, methodology and specific problems of subproject appraisal; (c) an in-depth study of industrial incentive measures and their consequences; and (d) strengthening of CFN's accounting and budgeting systems. 3.19 The SB has a generally well-designed Manual and program for super- vision of financial institutions. It has agreed to extend or intensify its supervision of financieras and reporting thereon, insofar as may be necessary to meet the Bank's requirements, (Annex 2). SB has requested Bank assistance, and modest funding from the proposed loan, for a training program to upgrade the capabilities of their inspection staff; Bank staff are already assisting the SB in carrying out the training program. Consultancy funds would also be made available to SB for studies to help improve the system of data collection and reporting and the management of foreign exchange risks (Annex 3). During negotiations these agreements were confirmed. 3.20 The financieras are under generally competent direction but most of their staff members have a background of conventional banking and money market operations, rather than long-term project financing--although some have had training and experience with CFN or COFIEC. Appraisals so far received from the newer institutions, while creditable on the whole, are of uneven quality; and some have not been able to make any timely submissions. As their projects increase in size and complexity, moreover, the appraisals are likely to become more difficult and elaborate, and to require more refinements, such as ERR calculations. It is not feasible for the Bank to undertake an institution building and staff training effort in relation to the 11 newer financieras comparable to that previously devoted to CFN end COFIEC; it would greatly overburden staff resources. It has therefore been agreed with the Ecuadorian authorities and the several financieras that a small portion of the proposed loan will be earmarked to finance the employment by the Ministry of Finance, of a well-qualified advisor experienced in project appraisal methodology (and insofar as possible in other aspects of development banking), to be resident in Quito for an initial period of two years, to carry out the following functions: (a) on request, usually by a financiera but occasionally also by the Bank, to assist financiera staff in completing or refining their analysis of subprojects, in identifying informational gaps or methodological anomalies, etc., with a view to improving the quality of appraisals and submissions;  - 36 - (b) to visit individual financieras (especially those less experi- enced) from time to time to review with them the subprojects they have under analysis, discuss any difficulties encountered and advise on means of solving them, apprise them of any superior methodologies or data sources; etc; (c) to help organize and conduct programs of training for new project appraisal staff for the financieras, seminars on related subjects of common interest, etc; and (d) on occasion to give similar assistance, as needed, in the preparation of financial projections and other operational problems. 3.21 It has been agreed that the government will carry out, with the help of consultants, an analytical study of export promotion and other incen- tives measures that operate in EcuaLdor, with a view to proposing reforms conducive to better use of resources and trade strategy. The study would be carried out by a group in MICEIT's Centro de Desarrollo Industrial (CENDES) and partially financed from funds earmaLrked under the proposed loan. Bank staff assisted the government in preparing the terms of reference; the Bank would assist in the design of methodology and choice of an expatriate expert to organize and guide the development of the MICEI study. It would be supervised by a Coordinating Committee (CC) comprising the principal Ecuadorian agencies concerned, under the chairmanship of the Vice-Minister of Industry. Ecuadorian consultants would undertake by far the major part of the data collection and analysis, and be responsible for the study's conclusions and recommendations-- although the Bank would review them and comment at several stages. On com- pletion, the government would agree with the Bank on a set of proposed actions to be taken on the basis of the study and a timetable for carrying them out. Definite terms of reference for the study were confirmed during negotiations and a timetable for completion and subsequent agreement on policy actions are included in the Loan Agreement. 3.22 It is proposed that the following amounts be earmarked, within the Fifth Loan, for the technical assistance components summarized above: Resident Advisor (2 years) US$200,000 Superintendency of Banks Training and Studies (3.5 person-years of foreign consultants) 350,000 Industrial Protection/Incentives Study (16 months of expatriate consultants' services) 150,000 CFN Accounting and Budgeting Systems 100,000 Unallocated 200,000 US$1,000,000 Commitments for these purposes would be reviewed well before the closing date, and any uncommitted balance reprogrammed for subproject financing.  - 37 - IV. THE LOAN A. Borrower and Terms 4.01 The proposed loan of US$60.0 million to the Republic of Ecuador would be channelled through BCE, the government's fiscal agent: Part A, US$59.0 million equivalent to eligible financieras; and Part B, US$1 million to various government agencies to finance technical assistance. Part A funds would be made available to industrial and related enterprises for financing the direct foreign exchange costs of investments in physical assets and associated permanent working capital through either loans or equity investments. Part A of the proposed loan would be repayable within 15 years on an amortiza- tion schedule corresponding to the composite of subloans or (for investments) to a schedule agreed ad hoc. Part B would be repaid on a fixed amortization schedule of 15 years. Up to US$6.0 million could be used for expenditures on agreed subprojects or technical assistance occurring after July 31, 1981. The terminal date for submission of subprojects would be December 31, 1984. In the light of prior experience with similar projects the closing date for disbursements has been established at December 31, 1986. B. Allocation 4.02 Part A of the proposed loan would be allocated to the respective financieras on a first-come, first-served basis, up to the maximum amount each could commit in proportion to its mobilization of domestic resources from the public (para 3.16). A total of USS15.0 million, however, would be reserved for financieras other than COFIEC and CFN, in shares specified for each, for a period of one year from effectiveness (para 3.14). The formula for matching Bank funds to domestic resource mobilization would be reviewed with the review of interest rates (para 4.07), and adjusted if necessary after exchanging views with the Borrower. C. Free Limits and ERR 4.03 The following free limits would assure Bank review of a reasonable proportion of subprojects from each institutions and afford the Bank the opportunity to conduct a dialogue with the financieras concerning appraisal techniques. Financieras Free Limit (US$ thousand) CFN and COFIEC 2,000 Other financieras (after receipt of two satisfactory appraisals from those in Group III) 350 An economic rate of return (ERR) would be calculated in all subproject receiving more than US$300,000 in Bank funds or more than US$1.0 million in other medium and long term funds.  - 3;8 - 4.04 With a view to encouraging special attention to export-oriented production, a sum of US$20.0 million will be reserved for projects that are expected to export 50% or more of their incremental gross output (para 3.05). Therefore, financieras in their subproject appraisals would clearly identify export and non-export subprojects and would be able to commit no more than US$39.0 million for the latter. D. Fees, Interest Rates, and Commissions 4.05 The Government of Ecuador, through BCE, would charge a fee of 2.9% for assuming the risk of borrowing in the currencies of the Bank's currency pool at an assumed 11.6% p.a. and on:Lending to the financieras in Sucres at 15% p.a. including a 0.5% p.a. administration fee for BCE. These terms would be reflected in a Subsidiary Loan Agreemnent between BCE and each financiera, the signing of which would be a condition of disbursement to any financiera. 4.06 Interest rates to subborrowers would be set at the nominal legal maximum of 15% p.a. plus the commissLons of 2.5% or 3.5% p.a. (equal to the commissions allowed for loans financed through long term bonds) depending on the subloan's original final maturity. On this basis, the typical subloan of 7 or more years would bear an effective interest rate of 18.5% p.a. At the inflation rate of 11.2% p.a. of 1978-80, and even at the higher rate of 15% p.a. projected for 1981-83, the proposed interest rate to subborrowers would be significantly positive in real terms. However, the indicated margins of 2.5-3.5% could prove insufficient to sustain the financieras' lending activity, given the larger spreads on other operations. 1/ 4.07 Because of lack of experience with the new interest rates and commissions, and the possibility that, notwithstanding the changes, financieras might be unable to mobilize significant resources from the public, the Bank and government will review, not later than December 31, 1982 or before commit- ment of more than US$30.0 million of the loan, the situation with respect to interest rates, spreads and other important factors bearing on long term resource mobilization and lending. Further commitment of the loan would be contingent on agreement between the government and the Bank that the interest regime and other policy measures would be conducive to efficient use of the loan and mobilization of long term resources by the financieras. E. Subloans and Investments 4.08 The financieras would set subloan terms according to the financial requirements of the individual subprojects, provided that the final maturity of any subloan fall no later than 15 years from loan signing. Financieras could also use Bank funds for investments in share capital of subprojects and would repay these funds to the Bank within 15 years of loan signing according to an agreed schedule. Because of the high nominal interest rate, amortization schedules of subloans providing for gradually increasing payments of principal plus interest would be permitted. When a subloan is partially financed by cofinancing resources (para 4.10), the amortization schedule of the Bank subloan could be adjusted to facilitate the shorter maturity of the cofinanced 1/ In the event that interest ratet policies are revised (para 4.07), the above conditions will be modified accordingly.  - 39 - loan, while providing for gradually increasing payments of principal plus interest on the combined amortization schedules. To prevent undue concentra- tion of Bank financing, no firm or group of related firms would be able to borrow or receive investments of more than US$3.0 million in Proposed Loan funds or more than US$4.0 million from the proposed and previous Bank loans. F. Disbursement and Procurement 4.09 Procurement would follow the standard practice for previous Develop- ment Banking Loans in Ecuador. The basic procurement decision is made by the subborrower; individual procurement contracts seldom exceed US$250,000. The firm typically compares several alternatives for each important item following normal business practice. The financiera would check this procedure to ensure that the goods and services being procured are technically adequate and reasonably priced. Under the proposed loan the financiera would spell out in the subproject appraisal the steps toward these ends it and the subborrower had taken. Dis- bursements would be made for 100% of the direct foreign exchange costs of the financieras' subloans and would be fully documented. Disbursements under the technical assistance components would be for 100% of foreign expenditures. Loan documentation establishs clearly the obligation of BCE when dealing with the financieras to make all conversions between Sucres and the currencies disbursed by the Bank at rates of exchange that fully protect the financieras from the exchange risk on Bank funds. G. Cofinancing 4.10 Conversations by the Bank with the financieras and international (foreign) commercial banks (FCBs) have taken place to the end of arranging cofinancing for the proposed loan to meet the project's need for additional resources (para 1.23). Although the cofinancing arrangements are still un- certain, it appears that one or more banks would be prepared to lead a consortium to provide US$40.0 -US$50.0 million at medium term maturity and standard LIBOR terms. Because financieras are prohibited from lending in foreign exchange, cofinancing funds would be lent by the FCB directly to the subborrower with a financiera's guarantee. The FCB would negotiate with each financiera the maximum amount of cofinancing funds each could use and its cost. Some financieras using Bank funds might not choose or be chosen to use FCB funds. The Bank and FCB would agree to exchange information on the subprojects and financieras. Cofinancing funds would be used only for subprojects approved by the FCB and, unless the FCB otherwise agreed, for subprojects partially financed by the Bank. The financiera would evaluate these subprojects as they do others and, taking into account the assets to be financed and the financial strength of the subborrower, make up a specific package of Bank and FCB funds. On Bank approval of the subloan the FCB would immediately disburse its portion. No cross default clause is contemplated as the borrowers from the Bank Loan and the FCB are distinct. Nor would the government be asked to absorb either the credit risk or foreign exchange risk on the FCB's portion of subproject financing; the latter risk would remain with the subborrowers.  - 40 - H. Project Benefits and Risks 4.11 A principal benefit anticipated from this project will be oppor- tunities for continuing an increasingly informed dialogue with the government on (a) means to bring about more effective mobilization of domestic resources including interest rate policies (paras 2.37 and 4.07); and (b) industrial policy reforms on the basis of the projected study of protection and incentives (para 3.20 and Annex 4). It is expected that the requirement that financieras mobilize set amounts of matching resources as a condition of access to Bank funds will serve both as an inducement and as a test of market potential and of the adequacy of financial policies to facilitate resource mobilization. 4.12 A further benefit of the project will stem from the participation of a much more numerous and varied group of private financieras. This should enhance competition, resource mobilization efforts, and access to credit for smaller firms or those in outlying regions. The provision of advisory assistance in project appraisal and related matters should strengthen the technical and analytical capabilities of the newer financieras, while the proposed reinforce- ment of the SB should improve the effectiveness of supervision and reporting with respect to all of them. Cofinancing associated with the proposed loan would mark the first time the financieras had obtained 8 year funds from a commercial bank. Moreover the cofinancing technique being pioneered in the proposed loan may find application elsewhere. 4.13 The government has taken steps to make AZTRA and Selva Alegra profit- able and to contribute US$20.0 million to CFN according to an agreed timetable. 4.14 The economic benefits of the proposed project would be similar to those of the four previous Bank loarLs. Approximately 60 subprojects with an average use of Bank funds of around US$1 million each would be financed with an average ERR of over 20% (para 3.08). Most subprojects continue to be in the resource-based food, beverage, textile, and forest products subsectors. Although few import substituting subprojects would have very low cost/job levels for workers directly employed, they would create added employment through both backward and forward linkages. Because export projects are more labor intensive one third of loan funds are so earmarked. Based on experience and the expected increase in the proportion of export projects, Bank funds would be used to help finance arouncd US$240 million in total investment and create around 8,000 jobs. 4.15 The main potential risk is that market conditions and investor psychology may effectively preclude the financieras from mobilizing medium- and long-term funds on the scale reqiuired to match Bank funds according to the formula (para 3.16) or that the cost of money so mobilized may be unacceptably high for borrowers. Such results would call for intensive consultation with the government and the financieras, to try to devise remedial measures.  - 41 - V. AGREEMENTS AND RECOMMENDATIONS 5.01 During negotiations agreements have been reached or confirmed on the following-- (a) With the government, on: (i) a mid-loan review, jointly with the Bank of experience under the March 1981 interest rate regime (or subsequent adjustments) as it bears on domestic resource mobilization, and of whether further rate modifications or policy changes may be needed (paras 3.09 and 4.07); (ii) terms of reference, administrative and funding arrangements, and a timetable for a study of industrial protection/incentives including provision for discussing the results with the Bank and carrying out an agreed upon program of reforms (para 3.21); (iii) terms of reference for SB's supervision and reporting responsibilities with respect to financiera operations, and administrative and funding arrangements for technical and training assistance to the SB in support of these responsibilities (paras 2.38 and 3.19, and Annexes 2 and 3); (vi) fee to be charged through BCE for absorbing the foreign exchange risk (para 4.05); and (v) other terms and conditions of the proposed loan (paras 4.01 to 4.09). (b) With the government and CFN, on: (i) arrangements for relieving CFN of the financial burden of AZTRA and Selva Alegre, make adequate provisions and a timetable for transferring the required funds (para 2.31); (ii) ensuring CFN's access to local and foreign sources of financing (para 2.26); (iii) continuing reimbursement of CFN's foreign exchange losses and a freeze on further borrowing which exposes CFN to substantial exchange risk (para 2.30); (iv) technical assistance in CFN's accounting, budgeting, and financial information systems (para 2.29); and (v) limitation on CFN's exposure to a single firm (para 2.31).  - 42 - (c) With the government and the financieras, on: (i) conditions for the financieras' eligibility to participate in. the Proposed Loan (para 3.15); (ii) the requirement for all financieras to mobilize domestic resources in amounts proportional to their use of Bank funds, and the formula for matching (para 3.16); (iii) the temporary preallocation of part of the Loan for Group II and Group III financieras (para 3.14), and reservation of US$20.0 million to finance export production projects (para 4.04); and (iv) terms of reference and administrative and funding arrangements for the services of an advisor on development banking/project appraisal (para 3.20). (d) With the financieras, on: (i) debt/equity, other financial covenants, and free limit conditions (paras 3.15 and 3.17); and (ii) upgrading of subproject evaluation (para 3.06). 5.02 The following would be condition of Loan effectiveness: Signing of a Fiscal Administration Agreement, satisfactory to the Bank, between the Borrower and BCE. 5.03 The following would be conditions of disbursement: (a) to any financiera: signing of its Subsidiary Loan Agreement with the Central Bank (para 4.05); and (b) to any financiera that has not previously participated in Bank loans: adoption of a Policy Statement satisfactory to the Bank (para. 2.35). Recommendation 5.04 With the above agreements, the proposed project would constitute a suitable basis for a Bank loan of US$60.0 million to the Republic of Ecuador on the terms and conditions shown in Chapter IV.  ECVAOOR STAFF APPRAISAL REPORT FIFT9 DEVELOPMENT BAN INC PROTECT Credit WoIme by Fi-tnieta' Tsn-i-uet-en (8/ meillfon) lonnlrorion 1970 1971 1972 1973 L974 1975 1976 1977 1978 1979 1990 Nttional Development Bank 677.5 762.8 807.8 1,507.6 3,640.6 4,000.1 4,578.7 4,734.2 4,331.9 5,059.1 6,094.2 ECoodorian noelna Bank 11.0 19.4 99.4 70.0 144.6 387.3 368.1 904.8 1,147.9 979.4 534.9 Tnt-l Offinial Banks .ennllnB Central Bank and BDE) 688.5 782.2 907.2 577.6 3,785.2 4,387.4 4 946.8 5,639.0 5.479.8 6 038 5 6.629.1 Total Prie-ts Banka a. 8,076.8 9,120.4 10,590.6 12,948.2 15,723.4 19,159.3 24,067.4 29,662.5 33,053.5 42,357.7 58,520.1 TCLa1 Banks 8.76543 9,90236 1 9 1425 15fL6 23,546.7 29.014.2 35,301.5 3B,533.3 _4E,396.2 65.149.2 CFN 617.0 403.0 498.0 515.0 1,405.0 1,198.0 2,320.0 2,202.0 2,509.1 2,865.9 2,657.0 PrIv-te FPnanr. ere c/ 358.9 444 4 633.4 830.5 1,305.5 1,438.4 2,435.1 5,073.6 7,947.2 11,006.6 17,535.1 lotal Pinan-i-ras 89759 847.4 1,131.4 13455 2710.5 236.4 755 1 7,275.6 10,346.7 13,872.5 20,192.1 Mtne-l Savings Aa...iati-oo 42.0 93.0 179.0 209.0 323.0 462.8 585.4 743.8 901.8 1,076.4 809.3 Total Credit Voue 9_783.2 10,843.0 121 082 80 3 22,542.1 26,645.9 34 35447 43.320.9 49,781.8 63,345.1 86,150.6 Central Bank d/ 3,181.1 2,762.1 3,091.9 3,095.8 6,189.8 10,029.0 13,015.8 17,745.3 21,994.7 31,708.1 47,834.5 Snortea: SB and CFN. INotea:a/ Inclode, the Bank of Coopera-l-es. b/ Indostrial Ioans, exclading export credit and apeni.1 Ioans, c/ Boring 1970-1975 there et- only one pye- fn .in.n.iera (COFIEC). d/ OCetoal Bank Ct.edit iS h ..neled through 1th-r flis.n.al inesituins. r ig..res do eat iselude gosrantee operations, e.empt ia ele ease of Fisaanee-es cad -redit grted by IESS ts its affilietea, -ad BDE, thith etaata to S/. 2,508.5 illien in 1980.  - 44 - ANNEX 1 ECUADOR Chart 1 STAFF APPRAISAL REPORT FIFTH DEVELOPMENT BANKING PROJECT S/million Financial Institutions Credit Volume ee, oee - - TOTAL OFFICIAL BANKS (a) TOTAL PRIVATE BANKS (b) -- CFN -- PRIVATE FINANCIERAS / 50. 8001 0-- MUTUAL SAVINGS ASSOC. .---- CENTRAL BANK 40, 000/1 30,0008 X, 20. 000-/,, 1~ 7 71 720 73 74 'S 78 7 8 ,.S' //~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ , / ~~~~~~~~~~~~~~~ 0~~~~~~~~~~~ -; .~~~~~~~~~~~~~~~~~~~~~~ 70 71 72 73 - 74 75 76 77 78 79 81a~~~~~~~~~~  ECUADOR STAFF APPRAISAL REPORT FIFTH DEVELOPMENT bANKING PROJECT Credit Balances by Financial Institutinn a/ (S/ million) 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 National Develop-ent BRnk 1,352 1,477 1,687 2,394 4,498 6,202 7,671 9,100 9,897 9,241 10,932 Ecuadrian Houning BRnk 359 354 429 478 632 984 1,362 2,131 3,144 3,893 4,237 Total Official Banks (excludinR Central Bank -nd BED) 1,711 1_831 2.116 2,872 5138 7.186 9.033 13_041 13.134 15,169 Total Private Banks 5 437350 9,767 13,769 17.383 _4,691 33,080 38 710 49,907 67,556 Total BRaks 7.141 7,996 9,466 12,639 18899 24569 33.724 44.311 51,751 63,041 82,725 CFN 762 650 769 891 1,435 1,897 2,906 4,471 5,145 5,380 5,626 Priva-t Financieran c/ 248 242 341 432 779 1120 1,534 2,246 3,747 5.567 8,337 Total Financieras 1.010 892 1,110 1,323 2,214 3,017 4_440 6,717 8,886 10,947 13_663 Mutual Ravings A-.icletion. 181 268 344 550 908 1,355 1,832 2,470 3,191 4,037 4,571 Total Credit Bal.n.es 8,332 9 156 1 22.021 28,941 39_996 53_498 6 78.025 100,959 Centr-l Bank d/ 1,686 1,714 1,622 1,913 3,994 6,448 9,073 11,932 14,938 20,442 26,744 a/ Elndi.g contingent operations. BED and credit granted by IR88 to it. affiliates. b/ 1neluding the Brnco de Ceoperativas. o/ Doring 1970-1975 thera -as only on. privete financiera (COFIEC). d/ Central Bank credit in channelled throngh other financial institntions.  - 46 - ANNEX 1 ECUADOR Chart 2 STAFF APPRAISAL REPORT FIFTH DEVELOPMENT BANKING PROJECT Financial Institutions Credit Balances S/million 80, 000- ~~ TOTAL OFFICIAL BANKS (a) - TOTAL PRIVATE BANKS (b) -CFN 70, 000 - - PRIVATE FINANCIERAS --- MUTUAL SAVINGS ASSOC. ---- CENTRAL BANJK /1 60,,000 A 40,000- / (b) 30, 00 0 - 20, 000 -// : ,. 1 0,8000L 0 73 7, 72 73 74 75 78 77 78 79 80  ECUADOR STAFF APPRAISAL REPORT FIFTH DEVELOPMENT BANKING PROJECT Dintribhtion of Credit by Institution -nd Sector a! 1980 (S/ million) Percent- Percent- Percent- Percent- Agri- Percent- Percent- Percent- Percent- Percent- Percent- age of age Ins. age f ge Ins. culture age of age Ins. age of age Inn. age of age Inn. Sec, per Sec- Sec. per Sn & live- Sec. per in Sec. Per in Dec. per in Inetitution CoS-erce Int. b/ tnc c/ Industrv Inst. Dector stock Ist. Sector Other d/ Inst, Sector Total Inst. Sector National Develop. BRak 55C.8 1.8 9.0 821.2 3.1 13.5 4,663.3 35.1 76.5 58.9 0.4 1.0 6,094.2 7.1 100.0 EcUAdorian Hoosing Bank - - - - - - - - - 534.9 e/ 3.2 100.0 534.9 0.6 100.0 Total Officiel Rsnk6 (excloding Ce-traE Bank and RUE) 550,8 1.8 8.3 821.2 3.1 12.4 4,663.3 35.1 70.3 593.8 3.6 9.0 6,629.1 7.7 100.0 Total Priv-te Benks f/ 26,423.5. 88.2 45.2 15,479,6 58.5 26.5 5,911.3 44.5 10.1 10,705.7 65.0 18.3 58,520.1 67.9 100.0 Total Bsnks 26,974.3 90,1 41.4 16,300.8 61.6 25.0 10,574.6 79.7 16.2 11,299.5 68.6 17.3 65,149.2 75.6 100.0 . CFN 1,769.7 yi/ 5.9 66.6 887.3 3.4 33.4 - - - - - - 2,657.0 3.1 100.0 Private i..ancieras 1,209.8 4.0 6.9 9,278.2 35.1 52.9 2,695.1 20.3 15.4 4,352.0 26.4 24.8 17,535.1 20.4 100.0 Total Fin-ocieran 2,979.5 9.9 14.8 10,165.5 38.4 50.3 2,695.1 20.3 13.3 4,352.0 26.4 21.6 20,192.1 23.4 100.0 Mutual Sa-ings lent. - - - - - - - - - 809.3 4.9 100.0 809.3 0.9 100.0 Total Credit Volume 29,953.8 100.0 34.8 26,466.3 100.0 30.7 13,269.7 100,0 15.4 16,460.8 10D.0 19.1 86,150.6 100.0 100.0 Central Bank hi 15,635.0 52.2 32.7 16,206.0 61.2 33.9 7,325.7 55.2 15.3 8,667,8 52.7 18.1 47,834.5 55.5 100.0 Doucces: SB and CFN a F Figurns do not include guiarantee operations except in the cane of Financ.e.is, and credit granted by IESS to its affiliates, and BDE wI,ch ano-nto S/2,598.5 million Ic 1980. b/ Percentage of credit of the sector per in-titutio-. c/ Percentage of credit of the in-titution in the Rector. d/ Includes fishery, coeetructon, and other loans not cl.soified elsewhere. e/ Moatly for houaing. f/ Includes BRnk of Cooperatives. h/ Central Bank credit is chaoneled through other financial instituti.on.  ECUADOR STAFF APPRAISAL REPORT FIFTiI DEVELOPMENT BANKING PROJECT FiwAsncial Savings Bank and Non-bank Fiinancial Intermediaries (Balances at End of Period) (Millions of Sucres) Average growth rate per year 19701974 7 1975 7. 1976