Transcript of meeting of the Executive Directors of the Bank, held on Tuesday, July 25, 1995

STRICTLY CONFIDENTIAL nm 1 NM INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION Tuesday, July 25, ·1995 Washington, D.C. The meeting of the Executive Directors was convened at 10:07 a.m. in the Board Room, 700 Eighteenth Street, N . W., Washington, D. C., Mr. James D. Wolfensohn, Chairman, presiding. MI LLER REPORTING COMPANY, INC . 507 C Street, N. E . Washington, D. C. 20002 (2 0 2 ) 546 - 6666 STRICTLY CONFIDENTIAL nm 2 C O N T E N T S 2 Proposed Loan - Argentina (Bank Reform Loan) 31 Mr. Jimenez 36 Ms. Cordeiro @]) Mr. Autheman 46- Mr. Evans 48 Mr. Rahman 51 3 Projects Processed Under Streamlined Procedure: 61 (a) Proposed Loan - Argentina (Mining Development Technical Assistance Project) MILLER REPORTING COMPANY, INC. 507 C Street, N.E. Washington, D.C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nm 31 The major item of business is a proposed for Bank Reform in Argentina. And Mr. Hardy, I think, who is the Assistant Director of the Western Hemisphere Department of the IMF, is here. I am happy to see you. Thank you for being here. Mr. Leipziger of the Latin American and Caribbean Region will introduce the proposal. Mr. Leipziger. I should note, by the way, that Messrs. Gerber and Legg and Mrs. Herfkens have circulated their statements in advance and I am grateful for those. MR. LEIPZIGER: Thank you, Mr. Chairman. Mr. Chairman, Members of the Board: I have the pleasure today of presenting the second adjustment operation designed and prepared to respond to the balance of payments and structural difficulties affecting Argentina in the aftermath of the Mexican crisis. The impact of this shock on the Argentine MILLER REPORTING COMPANY, INC . 507 C Street, N.E. Washington, D.C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nm 32 financial sector was particularly severe, with sudden shifts in deposits to stronger banks and a net flight of deposits reaching 16 percent of the total in the nation's banks moving out in a period of less than three months. Such a systemic shock would cripple many banking systems. Faced with this crisis, the government acted courageously to shore up the fiscal accounts, to provide whatever limited liquidity it could muster, given its currency board system, and to stick with convertibility despite reserve losses of at least $5 billion. The government was quick to establish two special trust funds, one to handle the privatization of provincial banks and another to finance the restructuring of distressed private banks. The government requested the assistance of the World Bank in both actions, in part because the Bank had identified the provincial banking problem and the fragmented private banking sector as priorities for reform earlier on. The crisis now made both areas o f reform indispensable. The provincial bank pr i vatization loan , approved by the Board on May 4th of this year, addressed the first o f these two priorities and the loan presented for your consideration today addresses the second. MILLER REPORTING COM PANY, I NC . 50 7 C Street, N. E . Washington , D. C. 2000 2 ( 2 0 2) 5 4 6 - 6666 STRICTLY CONFIDENTIAL nm 33 The World Bank's overall strategy towards Argentina was extensively discussed at the May 4th meeting on the CAS, country strategy. This operation is fully consistent with that strategy. In this operation, the Bank has moved from initial discussions with the government to this Board date in a total of four months. In the process, we benefitted greatly from the excellent cooperation of the authorities. The proposed loan offers the government the opportunity to continue consolidating and strengthening the private banking sector by encouraging acquisitions, mergers, and restructuring, while at the same time invigorating the process of supe rvision and impl e menting its improved c r is i s resolution procedures. The loan is not without risks, however. Much of the success of the capita lization trust fund will hinge on t he ab i lity of government to act prudently but forcefully i n the process of triage, whi l e mai ntaining confidence in the banking system and in the peso. Recent signs point to a r e newal in domesti c c onfide nc e ; in fa c t, depos i ts in the banking sec t or increas ed by about $2 billion between mid-May and mid-June a s s ome de pos it s clearly are r e t urn i ng to t he sys t em ; MI LLER REPORTING COMPANY, I NC . 50 7 C Street, N . E . Wash i ngton, D.C. 20002 (2 0 2) 546 - 6666 STRICTLY CONFIDENTIAL nm 34 however, Argentina's access to international sources of finance has been slowed by the general wariness towards renewed investment in Latin America. In response to the statements distributed by Mrs. Herfkens and Mr. Gerber, I can add the following observations. With respect to the point on possible earlier responses to banking system weaknesses, I would like to · point out that the government had raised capital adequacy requirements to 11.5 percent, considerably above the normal Basel level of 8, and had adopted camel based ratings and enhanced supervision procedures in the last year. Although there were structural weaknesses, the reality of the situation is that the externally induced crisis of confidence caused by the Mexican situation was difficult to arrest with Argentina's very limited lender of last resort capacity. For the future, we are placing significant weight on the banking supervision function to strengthen the resiliency of the system and also in the creation of the limited deposit insurance system funded by the private banks themselves. Concerning the impact of bank consolidation on access to credit by small and medi um enterprises and rural MI LLER REPORTI NG COMPANY, INC. 507 C Street , N .E . Washingt on , D .C. 2000 2 (2 02 ) 54 6 - 66 6 6 STRICTLY CONFIDENTIAL nm 35 credit seekers another issue raised by both Mrs. Herfkens and Mr. Gerber we don't believe that these markets will necessarily be underserved as big banks Banco de la Nacion, Banco Galicia, for example -- have extensive branch networks and provincial banks, once privatized, will also serve these markets. These small and medium enterprises will also benefit from the overall reforms of the financial sector, which I think need to take place. Moreover, the government is well aware of this problem, although some SME access may continue to be difficult, especially in light of the current recession in Argentina. In response to Mr. Legg's statement received this morning, we agree whole-heartedly with the importance of economic and sector work. Our December 1994 grey cover capital markets report, sent to the government in August 1994 and discussed with them in October 1994, addressed the problems of the banks. On the point that Mr. Le gg raised of not r e lying excessively on supervision, Argentina has made it clear, and this is clearly differe nt from Mexico, that shareholders and depositors can and will lose in fa ile d banks and that governme nt does not inte nd large b a ilout o f private b a nks. MILLER REPORTI NG COMPANY, INC . 507 C Sc reet , N.E. Wa s hington , D. C . 2 000 2 ( 2 0 2 ) 5 46- 6666 STRICTLY CONFIDENTIAL nm 36 In conclusion, the proposed loan is an adjustment loan with major conditionality in the areas of supervision, crisis resolution, and most importantly the operation of the trust fund itself. In this respect, it is a loan designed to accomplish a number of objectives, and to do so in a way which is both timely and responsive to the current requirements in Argentina. As such, we believe it merits your support. Thank you. MR. WOLFENSOHN: Thank you very much for that introductory statement. We only have one person on the list and he wants to speak fifth. [Laughter. ] MR. WOLFENSOHN: So, if four of you could pretend to speak, we could h e ar from Mr. Rahman. But if there are any who would like to speak before him, I would be delighted to have that indication . Yes. MR . JIMENEZ; Thank you, Mr. Chairman. We are pleased to support this vital operation fo r the financial st r engt hening o f the Argent ine f inancial MILLER REPORTING COMPANY, I NC . 50 7 C Street, N.E . Washington , D . C. 2000 2 (202 ) 546-6666 STRICTLY CONFIDENTIAL nm 37 system. In the aftermath of the financial turbulence at the beginning of the year in the Latin American Region, the Argentine financial system suffers serious consequences as we just heard from the administration. The Argentine Government should be commended on their quick response in taking the necessary steps to restore confidence in their financial system and to create instruments to deal with it, namely the Bank Capitalization Fund and the privately-financed Deposit Insurance Fund. All of this was made in the midst of an electoral year. The government helped open discussions of the nation's problems and implemented tough but necessary measures. The Argentine authorities deserve recognition for their decision to remain committed in maintaining a sound macroeconomic framework, as described in Minister Cavallo's letters in the documents. The Bank has been involved in the reforms of the Argentine financial system since 1986, and also we have to congratulate them because they responded quickly putting together this operation in just three months. We notice today that about 50 percent of the fund s that were withdrawn from the banks in the wake of the crisis have returned as an indication of renewed confidence in the MI LLER REPORTI NG COM PANY , I NC. 507 C Street, N.E. Was hi ngton, D. C. 20002 (202) 546 - 6666 STRICTLY CONFIDENTIAL nm 38 financial system of Argentina. The quick erosion of the financial sector, particularly in this case, underlines the fragility of any financial system in any economy trying to open up into the global system. One of the basic lessons of the Argentine and the Mexican crisis is the need of all countries to set up a strong and firm financial system, protected with early mechanisms of defense against rapid and predicted movements of capital flows, especially short-term capital to maintain depositors' confidence and market trust. In this area, Mr. Chairman, the World Bank and its institutions has a lot to contribute to every country in Latin America especially. I think that this is one of areas in which Bank involvement is urgently needed to assist the member countries to decrease fragility and minimize pervasive effect of volatility of global capital flows. Any financial system should have proper mechanisms in place to diminish external shocks and manage properly finan c ial risk. I have, Mr. Chairman, two requests for comment from the administration. Number one, wi th t hi s ope ration we will have three MILLER REPORT ING COMPANY, I NC. 507 C St r eet , N. E . Washi ngto n , D.C. 20002 (202) 546 - 6666 STRICTLY CONFIDENTIAL nm 39 financial loans to Argentina, the one that we are dealing with now and the May 16th approval of the provincial banks. At the beginning of the year we had the capital market development loans. All three involved complex problems requiring close monitoring, special attention and supervision in their implementation, especially the impact of the bank crisis revolution mechanism on the world health of the banking system. Does the Bank have enough staff in the field to perform this complex task to ensure that r isk can be detected ahead of time? A good briefing regarding the strategy that the administration plans to follow regar ding this monitori ng we would like to hear from you. Number two, it is objective that one of the di f ficult i es that the Latin American economies nowadays faces with r egard to the outs i de investors is the profound lack of market discrimination by the financial markets . They do not discriminate which country it is happening in and what is the e f fect on the other countries. I wonde r in o r der t o s t art findi ng a s olution t o these kind of problems if the IFC could not get more invo lve d to put toget her i n p art nership with t h e pri v ate MILLER REPORTING COMPANY , I NC. 507 C Street, N. E. Was hington , D.C. 2000 2 ( 2 02 ) 54 6 - 5666 STRICTLY CONFIDENTIAL nm 40 sector some kind of rating mechanisms for the market itself that will rate financial institutions, especially banks, a recognized rating mechanism that would alert the market ahead of time. The purpose would be to assist markets to police themselves within a framework of proper regulations. A rating agency can help attain the goal of assisting the Deposit Insurance Agency that we just see in this document can assist local shareholders, the bank itself to have early voices of alert to minimize the risk of the market. For example, we have noticed in the document under consideration today that a local consulting firm was chosen to help with the bank classification, as shown in the graph on page 15. You classify the banks according to ratings. They may also fulfill the role of these rating mechanisms in the market of independent professional bodies, the same way that they do in the developed countries. I mean, a kind of early warning system that continues rating the banks and time-helping instruments to maintain quality portfolio and to maintain this kind of alertness, as I said before. These kind of agencies can avoid sudden breakdowns of confidence in the banking syst e m. MILLER REPORTI NG COMPANY, INC. 507 C Street , N.E . Washi ng ton, D. C . 20002 ( 202) 546 - 6666 STRICTLY CONFIDENTIAL nm 41 I wonder if the staff while on their mission had detected the need for this kind of mechanism in the countries that they have worked, especially in the new countries trying to open up. Now back to the Argentine financial system, I trust that the measures taken by the Argentine Government are further evidence that the Latin American reform process is alive and well again in momentum. I also hope that the consolidation with the weaker banks with the strong one will result in a whole firmer financial system than the one we have now. Thank you, Mr. Chairman. MR. WOLFENSOHN: Thank you, Mr. Jimenez. We are, of course, very actively involved on banking reform or banking support throughout the continent. And your question as to personnel is very appropriate and I will ask my colleagues later to speak to it on the issue of a rating system. That is pretty tough when the Central Bank itsel f has some difficulties, and I can see the need for it . But, I once worked in Australia in terms of trying to set up a rating system in an environment which was far more developed t han this one. And I think a s a ma tt er o f pol i cy we wo uld MILLER REPORTING COMPANY, I NC . 507 C Street , N. E . Washington, D . C. 200 02 (2 0 2) 546 - 6666 STRICTLY CONFIDENTIAL nm 42 need to be pretty careful whether we put ourselves out front to do the rating on the banks, although it is something that perhaps IFC can look at but it has a close identification with us, and we take on a certain responsibility then if it is a World Bank endorsed rating system when you may not have all the information that is available. It would be wonderful to have an advanced system that was bullet-proof but whether we could do it or not is something I will refer to my colleagues and maybe they will be more optimistic than I am. Ms. Cordeiro. MS. CORDEIRO: Sorry. Your appeal to have some other speakers did not work. I was not planning to be so early. But, let me make brief comments because I think that we had an opportunity recently to discuss at length the Arge ntina case. And this loan is, in fact, consistent with the strategy that we have discussed and approved, and it goes in the right direction. It basically is supporting the government efforts in the aftermath of the Mexican crisis and is trying to mitigate the repercussions on other regional economies. And I think all of us recognize the quick and appropriate respons e o f the government, a s we ll as the ability o f the MI LLER REPORTI NG COMPANY, I NC . 5 0 7 C S t reet , N . E . Was hington, D.C. 2 0 002 ( 202) 54 6 - 6666 STRICTLY CONFIDENTIAL nm 43 Bank on a timely response. In our view, the banking sector is, in fact, the core of our strategy and it is a priority for the Government of Argentina. And I think it is rightly so. As you started saying, it is in fact the best way to get the signals to get the system working. But, I think this crisis is also a n opportunity for Argentina. If the reforms and the changes are deep enough, the sector may come out stronger to the benefit of the entire economy. So, there is an element of risk but we believe that the challenge element is a positive one and it is strong enough. We have to recognize that the banking sector is, in fact, burdened by non-performing loans, bank assets are deteriorating, bank deposits are declining, even if we have been told that some of the r ecent information goes the other way. But I think that we are fac i ng some risks and I think the loan does what it can do bes t in t he current situation. Basically the loan assists the Bank Capitalization Trust Fund that is going to finance transactions, mergers a nd a cqu isit ions bas ica l ly within the pri v a t e sector through MILLER REPORTING COM PANY, I NC. 5 07 C St reet , N.E . Washington, D . C . 2 00 02 ( 202) 54 6- 6666 STRICTLY CONFIDENTIAL nm 44 medium-term loans. The financial needs at best have been estimated in the range of $2 billion to $2-1/2 billion. IBRD is providing 500 and the government will have to provide through the bond issuance the remaining $2 billion. So, the question that comes to mind is: How is this operation going to work? Or, in other words, what are the risks of this operation? In our view, we see basically three types of risks. The first one is what I would call a regional risk. If the regional crisis remains unsettled, the operation may not be sufficient to restore confidence and improve the sector structure. This is the risk well acknowledged in the document but that we can only partially mitigate it by the design of the operation. It is the nature of the risk that makes it so. The s e cond risk -- and I think it is of a d i fferent nature, is a domestic risk -- i s the quality o f transaction risks. Those are basically market transactions . So, the expectation is that they will be economically sens i ble. I think that here t he loan, in fa ct , has one feature that might help to achieve this. I t is a p r econdition to acce s s to the Trust Fund financing , which is MI LLER REPORTING COMPANY, INC. 507 C St r eet, N.E . Washington , D . C . 20002 (202) 546 - 6666 STRICTLY CONFIDENTIAL nm 45 only banks with a solid financial status can access these funds. And I think this is a very important prerequisite that the Capitalization Fund demands. I must say here that we are grateful for the broad array of information that the documentation provides us with all the details, how the banks are rated. I mean, it is a very rich set of documents and views in this report. The third risk I think is one is more difficult at this stage to judge. It is the one that comes from the weakest segment of the banking system. Since mergers and acquisitions will not cover the entire sector, there is still a high possibility that several smaller banks will have to be closed down or liquidated. And that is my question: What will be the government's attitude vis-a - vis this possible event? Are the safeguards now in place sufficient to reassure depositors? What can be the confidence impact of such closures? And this impact might be very regi onalized. We know the deposit insurance scheme is not yet working. That will be an additional safeguard, but we would like to h e ar staff comments how this risk is going to b e mitigated. MILLER REPORTI NG COM PANY, INC. 5 0 7 C Street, N . E . Wash ington , D.C . 20002 (202) 5 46 - 6666 STRICTLY CONFIDENTIAL nm 46 And I think here is where we see a very close link with this loan and your recent impressions from the visit regarding how the effects on the ground will be felt if some of these smaller banks are closed and depositors don't feel confident and they will keep moving deposits out of the banking system. Thank you, Mr. Chairman. MR. WOLFENSOHN: Thank you, Ms. Cordeiro. Mr. Autheman . MR. AUTHEMAN: Thank you, Mr. Chairman. I approve of this proposal. I think it is well designed. I have thr ee questions. First, when will the l oan and the t r ust fund be effective? The report mentioned three conditions for effectiveness. I have this question because it seems t o me the soone r wi ll be the better. Second, is the funding of the trust f und adequate? Annex A gives an estimation of the financing needs for private bank restructuring based on a February assessment and whi ch is mostly a conso l idat i on of the Cent r al Bank liquidity advances plus a whole e stimate bad loans and capital requirements. Betwee n Fe bruar y and now, sev eral thi ngs happened MI LLER REPORTI NG COMPANY , I NC. 5 07 C St reet , N.E . Washington, o.c. 20002 ( 202) 546 -66 6 6 STRICTLY CONFIDENTIAL nm 47 in Argentina. Some go in the positive direction. The government appears to be successful in its stabilization effort. Others go in the negative direction. The extent of a recession may be deeper than estimated initially and, accordingly, bad loans may be more important in the short term. So, how is the Bank going to review these estimates with the government and how confident are you that they are still up to date? However, this is not my main point because one can estimate that if the funding appeared to be short, the government may be able in the future to replenish this fund at a time where it will have regained access to capital markets. My final point is about the terms of the funding. Ar e t hey adequa te? This will not be a market operation. There will be losses and how are they going to be covered? I understand that the Bank loan will be relent by the government to a trust fund under market terms. What is happe ning with the other finances? And who is going to cover the losses now? Because I do not expect an appropriate l y c a pi t alized bank t o be r e ady to buy badly capitalized or MILLER REPORT ING COMPANY, INC . 507 C SLreet , N.E . Washington, D . C . 20002 ( 2 0 2) 546-6666 STRICTLY CONFIDENTIAL nm 48 distressed banks without a significant discount. So, how is the loss involved in this operation going to be covered? Thank you. MR. WOLFENSOHN: Thank you for those questions, and my colleagues will seek to answer them. Mr. Evans and then Mr. Rahman, who will come in as number five. Mr. Evans. MR. EVANS: Thank you, Mr. Chairman. Just harking back to the earlier item, I welcomed your statement and hope you will continue to keep us in touch with your visits and the conclusions you draw from them. I think it is appropriate, as Eveline Herfkens has pointed out in her statement, to draw some conclusions from the past here. And I think that she is right in saying that the weaknesses of the banking system could have been addressed at an earlier stage both by the authorities and by the Bank. I think she is also right in drawing attention to the enormous importance of having a strong financial system. And I think that is a lesson from 1995, which we in the Bank and indee d in the Fund are rightly drawing. MILLER REPORT ING COMPANY, I NC . 50 7 C St reet , N . E . Washington, D . C. 20002 (202) 546 - 6666 STRICTLY CONFIDENTIAL nm 49 Now, this loan will be planned to be in three tranches, repayable over fifteen years. It will take a little time to get going. Mr. Autheman has asked for that to happen speedily, and he wonders whether the sources available in the trust fund are actually large enough. I have a question which goes in the opposite sense. Staff I think are right to emphasize that only sufficiently strong institutions should take over the weaker banks and staff consider the number of sufficiently strong banks would in theory be able to take over the smaller banks. But, I wonder how far the demand in fact will exist. I mean, is there a possibility that the larger and stronger banks may prefer to go organically, to some extent, rather than through acquisition? The balance sheet may become more attractive because of the trust fund -- there is only one element in restructuring, and other factors that might seek to dissuade larger banks from acquisitions. So, it seems to me there is obviously some risk the Fund will not be called upon to the extent staff expect. If so, then clearly this has an implication for liquidation procedures whi ch I think wo uld n eed to be tightened as this MI LLER REPORTI NG COMPANY, I NC. 507 C Street, N. E . Washington, D.C . 20002 (202) 546 - 6666 STRICTLY CONFIDENTIAL nm 50 could be a more effective vehicle for the rationalization of the banking sector. I would welcome staff's comments on that. I agree with Mr. Gerber's comments that the quality of loan portfolios is likely to remain a source of concern and should require continued attention. I think that reinforces your own concern, Mr. Chairman, that the Bank needs to spend more time following up on loans after approval and after they become effective. I think that that is true in this case. The staff note in their view the key risk to the whole program is macroeconomic. I think, in fact, the macroeconomic and financial risks are intertwined quite closely. I mean, clearly, the crisis in March was exacerbated by the weaknesses of the financial sector. So, strengthening the bank should do quite a lot to reduce the overall macroeconomic risk. I also agree with the points in Mr. Legg's note circulated this morning and in the belief, Mr. Chairman, that this loan will be more effective than some others in the past. I give it my support . Thank you. MR. WOLFENSOHN: Thank you very much indeed, Mr. MILLER REPORTI NG COMPANY , INC . 5 07 C S tree t, N.E. Wa shington , D. C . 20002 (2 02) 54 6 - 6 6 66 STRICTLY CONFIDENTIAL nm 51 Evans. Mr. Rahman. MR. RAHMAN: Thank you, Mr. Chairman. Mr. Chairman, I would like to thank you for your tour impression and bringing out the core points faced by the countries that you have visited. I will refer to these later on. As this Chair has noted during the Board discussion of the Mexico financial sector development loan, it is good to see the Bank responding quickly to a crisis in a member country and expeditiously address it. As we have all noted earlier, this document is a good pointer to the risk and uncertainty associated with exclusive or excessive reliance on private foreign capital flows without sufficient institutional preparation and strengthening in the recipient country. Lastly, it is also a pointer to the continued and perhaps increasing role that the World Bank and other MDBs need to play to augment resources for growth and development in developing countries. Mr. Chairman, in the light of these gen eral observations, we welcome this loan. We particularly welcome the increased use of the new product, namely single currency MILLER REPORTING COMPANY, INC. 5 07 C Street, N.E . Washington , D.C. 20002 ( 2 02) 5 4 6-6666 STRICTLY CONFIDENTIAL nm 52 loan, as desired by the borrower. As has been pointed out by many speakers and Mrs. Herfkens in her circulated statement, this is not the first loan to Argentina in this sector. The consolidation and recapitalization of the banking sector in Argentina proposed in this loan will be taken up in the wake of the improvement, in the prudency regulation and steps to strengthen enforcement capacity steadily. The previous financial sector loan and technical assistance have improved considerably the capability of the superintendency of financial entities. But, obviously, as the recent crisis pointed out, much more and probably the harder part remains to be done. This loan as a good response will harmonize the short-term and long-term measures needed. In this connection, Mr. President, I congratulate you for your going into the deep insight to the problems of these countries. Particularly you mentioned about the rural credit. I wonder how these banking sector reforms proposed in the banks is going to affect the rural credit. Here many small banks will be merged or cooperative banks will go int o liquidation. How far this is going to affect the rural e conomy a nd rural credit is not clear to me. I would MILLER REPORTING COMPANY, INC . 507 C Street, N . E. Wa shi ngton , D.C . 20002 (202) 546 - 6666 STRICTLY CONFIDENTIAL nm 53 appreciate if the Bank staff could give some clarification on this point. I also fully share with Mrs. Herfkens and Mr. Gerber on the issue of employment and the close supervision of this project. Thank you, Mr. Chairman. I thank the staff for bringing out a good project here. MR. WOLFENSOHN: Thank you very much, Mr. Rahman. I think this is an appropriate time to ask staff to respond and then, if there are any othe r further observations the Board would like to make, they could make them later. Mr. Nankani. MR. NANKANI: Thank you, Mr. Chairman. I will make two comments and then pass the rest on to Mr. Le ipzige r to handle. Basically, we would like to say very much that we are in full agreement with t he points made by many Directors about the need for very careful supervision of this and othe r financial sector loans. And we are planning a presence in the resident mi ssion to assist with this process, in addition to the attention that the region and FRS (Phoneti c) will joint ly be g ivi ng to the s e oper ations . MILLER REPORTING COMPANY, I NC. 5 07 C Street , N . E . Washington , D.C. 20002 ( 202) 546 - 6666 STRICTLY CONFIDENTIAL nm 54 I would also mention that tremendous progress has been made in Argentina over the last two years in strengthening the supervision system, and they have a twinning arrangement with the Federal Reserve of New York, and we also have a technical assistance loan that will allow us to, as we supervise these loans, include additional resources for strengthening supervision. On the rating system, I cannot add anything to what you have said, Mr. Chairman. I think it is obviously a very important issue but I find that we mi ght not be the best to undertake this function. With respect to the weaknesses of the financial sector and whether these could have been a ddressed earlie r, I think there has been ample recognition on the part of the government, as well as ourselves , about the financial system in Argentina and, while major strides were made between 1991 and 1994 in reforming the system, it was r e cognized both b y government and the Bank in the capital markets report that we discussed with the authorities last year that additional reforms were n e ede d. And these are now being undertaken, a d mittedl y under the impetus of the post-Mexico situation. If I may, I would l i ke to r equest Mr . Leipziger t o MILLER REPORTING COMPANY , INC. 507 C Street, N.E . Was hington , D .C . 2 00 02 ( 2 0 2) 5 4 6 - 666 6 STRICTLY CONFIDENTIAL nm 55 deal with the other issues, particularly confidence of depositors, the effectiveness date, the funding adequacy, loss coverage and rural credit. MR. LEIPZIGER: Yes. On the questions that Ms. Cordeiro asked, I think she has identified the risks properly. The risk to the quality of transactions I think is the predominant risk we tried without prejudging the market to put some conditions on the operations of the fund as to who can buy banks and who can merge, et cetera . And there is an extensive list of the preconditions for access to trust fund resources, which we hope mitigates that risk but doesn't eliminate the possibility of a bad transaction. On the third risk that you indicated, the confidence element related to closing banks, at the moment at least thr ee banks have been l i quidated. Ther e are another seven under suspension and another s e ven that are being warned that they are getting close to suspension . So, I think the a uthor i ti e s are moving we ll in this area. Obviously, there is a tradeoff between being too toug h a nd b e ing t oo leni e n t. The De posit I nsuran ce Fund is MI LLER RE PORTING COMPANY, I NC. 507 C Street, N.E . Wa s hington, D.C. 20002 ( 202 ) 546 - 6666 STRICTLY CONFIDENTIAL nm 56 in existence. It just has a slow pay-in period, although the banks can be requested to accelerate their contributions to that fund by up to a year, which would give it resources in the range of $200 million or so. I think there are cases where the depositors will be taking losses. In some cases, they are being asked to convert some of their longer-term deposits into equity in a bank, for example. But, you are quite right that the process of triage has to be handled carefully if you don't want to increase the flight of deposits. It is also true that the majority of returning deposits we understand are going into the stronger banks, and that is a rather natural phenomenon. And we think the trend of consolidation is inevitable. On Mr. Autheman's questions, the effectiveness of the loan, we are hoping for an early effectiveness. I mean, the trust fund is basically set up and the rules, some of them have been issued and others will be issued shortly. So, we are talking, I think, of e f fectiveness within a matter of weeks once the remaining conditions are met, which is basically publishing the rules and doing at least one transaction that meets our requirements. There are about a half a doz e n t r a ns a c t ions in t h e MILLER REPORTI NG COMPANY, I NC. 5 0 7 C St r eec, N. E. Wash ington , D.C . 2000 2 (202) 5 4 6 - 6666 STRICTLY CONFIDENTIAL nm 57 works, a few mergers, a few acquisitions, and we think it will be effective soon. On the funding adequacy, you are right, our estimates are February. It is not clear if we did them today we would be any better able to estimate demand. You are quite right that the aspects that have changed since our mission are played both ways, positively and negatively. Recession is deeper than we had thought it was going to be. On the other hand, the return of deposits has happened relatively faster than we thought it would be. I think our estimates still in terms of the capital requirements, which were in the $350 million to $80 0 million range, are still valid. The amount of money required to refinance the extraordinary liquidity assistance I think is less than what we had anticipated, because at its peak there were about 70 banks r eceiving at l e ast $1.6 billion in extraordinary liquidity assistance . Many of these banks have now begun to repay this assistance . So, that is an overestimate, I would think. In ter ms of who b e ars the losses, I thi nk we do in the report indicate the loss indication mechanism. And, as I said, the shareholders will be hit in the first instance, but depos i tor s are al s o a t r isk s i nce the d eposi t insurance MI LLER RE PORTING COMPANY, I NC . 50 7 C Street , N . E . Was hin gton, D.C . 2 0 002 (202) 546 - 6666 STRICTLY CONFIDENTIAL nm 58 covers only a very limited amount, up to $10,000 demand deposits and $10,000 of longer-term deposits. So, there will be some losses for banks that close. Mr. Evans questioned what the real demand, particularly by larger banks, to purchase and acquire banks. I think you are quite right that the larger banks have options. They can open branches on their own. They don't need necessarily to be purchasing banks. The stronger banks that we have spoken to -- and that is only by necessity when one only speaks to a handful of the larger banks and it may not be reflective of the medium-sized banks that wish to grow, and I think that is a logical place for demand to exist -- the larger banks, you are right, at the moment would prefer to sit back, but they have also indicated that it is a matter of price, so that the bank that is sold may not be sold in its entirety. The Central Bank now has the possibility to segregate assets and liabilities and may well be able to sell deposits and matching assets at an attractive price. Also, some depositors may be required to take losses prior to be acquired by another bank. So, I think the proof of the pudding will be, once the trus t fund is in MI LLER REPORTING COMPANY , INC. 507 C Stree t , N . E. Washington, O.C. 20002 ( 2 0 2) 546-6666 STRICTLY CONFIDENTIAL nm 59 operation, to see what demand occurs. You asked about the liquidation option, the liquidation option is viable. The reason why it is generally avoided is that by throwing the bank liquidation into the courts, it takes a very long time, and there are very few winners, except for the lawyers perhaps. So, the Central Bank will try its best through these various means to use liquidation as a threat but eventually to try and place, very much the way it is done i n the U.S. or in other banking systems, the majority of deposits with a stronger bank. You asked a question, sir, about the monitoring of the loan portfolio. I think as part of our condi tiona l ity for the second and third tranche, we do have the means for monitoring how the Central Bank is implementing its supervision policies and its crisis r esolution policies. I don't thi nk I need to comment on your observation on the link between macro and finance, which is clearly the major idiosyncracy, if you will, of Argentina, p a rticular ly given its convertibility. The last question, Mr. Rahman asked about the rural credit, which was also referred to in some of the sta teme nt s tha t were r eleased. MILLER REPORTING COMPANY, INC . 507 C St reet, N . E. Washington , D . C. 20002 ( 202) 54 6 - 66 6 6 STRICTLY CONFIDENTIAL nm 60 Many of the rural banks are essentially cooperatives and rather than go out of business, there has been a rash of mergers of these rural co-ops. The big issue for the supervisors is to make sure that the merging bank, if it is a combination of six little banks, is not a weak larger co-op rather than six small weak co-ops. But, I think that, given that proviso, the rural banks have not been disappearing in that sense. Nevertheless, I think there is an equity issue in the banking system. Clearly, the banks would prefer the prime customers, and there may be some issues of market access in rural areas which we need to look at. But, at the moment, coming out of this crisis, that is not the number one priority. I think the number one priority was to stabilize the banking sector, which was close to defeat at the end of Febr uary and early March. But, I think we are aware of the issue and the government is clearly aware of the equity issue on access. MR. WOLFENSOHN: I think it will be a s well, give n the number of comments that have been raise d on this, t hat we should indicate when we tell the government that this has been approved by the Boar d, that t hi s is a n i s sue o f conce rn MILLER REPORT ING COMPANY, INC . 5 07 C Street , N . E. Washington, D.C. 2 000 2 (2 0 2 ) 546-6666 STRICTLY CONFIDENTIAL nm 61 by the Board, and it may be something that from time to time we can come back and inform the Board of the steps that have been taken. I think it would be useful to convey to them the sentiment of the Board, and we will do that, and we will monitor it accordingly. You are welcome if you have other comments, but if there are no further comments, then I would approve this loan on the terms proposed, then move speedily to the project approvals under streamlined procedure, which are Mining Development Technical Assistance Project of $30 million to Argentina and a credit for technical assistance to Azerbaijan. These documents have been distributed and, in the absence of objection, the loan and the credit will be approved. MILLER REPORTING COMPANY, INC. 507 C Street, N.E. Washington, D.C. 20002 (202) 546-6666