Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-6612-AR REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED BANK REFORM LOAN IN AN AMOUNT EQUIVALENT TO US$500 MILLION TO THE ARGENTINE REPUBLIC JUNE 29, 1995 Public Sector Modernization and Private Sector Development Division Country Department I Latin America and the Caribbean Region This document has a restricted distribution and may be used bv recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS Currency Unit - Peso (Arg$) EXCHANGE RATE Arg$1 = US$1 FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS BCRA = Central Bank (Banco Central de la Reptiblica Argentina) BCTF = Bank Capitalization Trust Fund BHN = National Mortgage Bank (Banco Hipotecario Nacional) BICE = Investment and Trade Bank (Banco de Inversi6n y Comercio Exterior) BNA = Banco de la Naci6n Argentina CAMEL = Capital, Asset Quality, Management, Earnings and Liquidity CAS = Country Assistance Facility CIF = Cost, Insurance and Freight CNV = National Securities Commission (Comisi6n Nacional de Valores) CPI = Consumer Price Index EFF = Extended Fund Facility FSAL = Financial Sector Adjustment Loan GAAP Generally Accepted Accounting Principles GDP = Gross Domestic Product IDB = Inter-American Development Bank IMF = International Monetary Fund LFE = Law of Financial Entities MERCOSUR Southern Cone Trade Bloc (Mercado del Cono Sur) NYFed = Federal Reserve Bank of New York OCC = Office of the Comptroller of the Currency OPP = Operating Principles and Procedures P/E = Price/Earnings Ratio PYMES = Small and Medium Enterprises (Pequenias y Medianas Empresas) RWA Risk-Weighted Assets SEDESA = Deposit Insurance Corporation (Seguro de Dep6sitos Sociedad An6nima) SEF Superintendency of Financial Entities (Superintendencia de Entidades Financieras) SOE = Statement of Expenditures VAT = Value-Added Tax WPI = Wholesale Price Index FOR OFFICIAL USE ONLY ARGENTINA BANK REFORM LOAN TABLE OF CONTENTS Page No. I. THE ECONOMIC SETTING ...... .............. 1 A. Economic Context .................... 1 B. Recent Perfornance .................... 2 C. The Mexico Crisis .................... 3 II. THE FINANCIAL SECTOR ...... .............. 5 A. Background .......... 5 1. Structure of the Banking System ....... ............ 5 2. Resource Mobilization and Interest Rates ..... ........ 6 3. Adjustment of Commercial Banks ...... ............ 6 4. Bank Regulation ............................. 7 5. Supervision ............................. 7 B. The Recent Financial Crisis ........ ........... 8 1. Deposits .................. 9 2. Stock and Bond Markets .................. 10 3. Deposit and Lending Rates ................... 11 4. Failed Institutions ........ . ................... 11 5. Government Response to the Crisis ................. 12 6. Deposit Insurance ............................ 13 7. Future Structure of Banking ................... 13 C. Capitalization and Consolidation of Private Banks ..... ........ 14 1. Capitalization of Banks ........................ 14 2. Consolidation of Private Banks .................... 14 3. Selective Restructuring of Banks ................... 16 4. Liquidation ................................ 17 D. The Governnent's Distress and Failure Resolution Policies ..... 17 1. Corrective Actions by the Superintendency ............ 17 2. Resolution of Illiquidity or Insolvency ..... .......... 18 3. Liquidity Assistance . ......................... 18 4. Suspension .............................. 18 5. Revocation of License and Liquidation ..... .......... 18 6. Loss Allocation ............................. 18 This Report is based on the findings of a mission that visiLed Argentina in April 1995. Mission members included Messrs. D. Leipziger and M. Carrizosa (Mission Leaders), H. Shah (Sr. Financial Sector Economist), D. Scott (Sr. Financial System Specialist); M. Slough (Sr. Financial Specialist), R. Toro (Lawyer), S. Silverberg (Consultant) and Messrs. A. de Juan and G. Caprio (Peer Reviewers). Ms. C. Bernard. Mr. 0. Grimes and Mr. G. T. Nankani are the responsible Division Chief. Projects Adviser, and Department Director respectively, and Mrs. C. Coss is responsible for its processing. This document has a restricted distribution and may be used by recipients only in the performance of their official dutics. Its contents may not otherwise be disclosed without World Bank authorization. E. Restructuring with BCTF Financing .................... . 21 III. THE PROPOSED LOAN ................................ 24 A. Background .................................... 24 1. Past Bank Involvement ......................... 24 2. The Bank's Response to the Current Crisis ............ 24 B. Loan Objectives ................................. 25 C. Loan Description ................................ 25 D. Loan Conditions ......... ........................ 28 E. Disbursement, Procurement, Accounting, and Auditing ... ...... 31 F. Loan Supervision ................................ 32 G. Risks, Benefits, and Social and Environmental Impacts .... ..... 32 1. Risks ................................... 32 2. Benefits ................................. . 33 3. Social Impact . . . . . . . . . . . . . . . . . . . . . . .34. . . . . . .34 4. Environmental Impact . . . . . . . . . .. . . . . . . . . . . .. . .34 IV. RECOMMENDATION ................ 34 ANNEXES A. Status of Bank Loans .............................. 35 B. Status of IFC Investments .......................... . 36 C. Policy Matrix . . . . . . . . . . . . . . . . .3.8.. . . . . . . . . . . ... . .38 D. Key Macroeconomic Indicators. . .. 39 E. Key Financial Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . .40 F. Operating Principles and Procedures Governing BCTF Assistan for Acquisition or Merger .......................... . 44 G. Argentine Banking System Statistics .................... . 46 H. Mergers and Acquisitions Among Argentine Private Banks ..... . . 53 I. BCRA Prudential Regulations ......... . . . .. . . . .. . . . . . . 54 J. Banking Supervision Procedures . ....... . . . . . . . . . . . . . . .59 K. Summary of Differences Between BCRA Accounting Rules for Banks, Argentina GAAP and United States GAAP ...... . . . . . . . . . . . 64 L. Central Bank Restructuring, Closure, and Transfer Provisions .... . 66 M. Financing Needs for Private Bank Restructuring ...... . . . . . . . . 71 N. The Bank Capitalization Trust Fund ....... . . . . . . . . . . . . . . 74 0. The Legal Provisions of the Deposit Insurance System ..... . . . . . 76 P. Liquidity, Capitalization, and Classification of Private Banks ..... . 80 Q. Illustrative Components for Institutional Development Plan ..... . . 88 R. Draft Letter of Development Policy .................... . 90 MAP: IBRD No. 26842 ARGENTINA BANK REFORM LOAN Loan and Program Summary Borrower: The Argentine Republic Beneficiaries: Private Commercial Banks Amount: US$500 million Terms: The loan is proposed to be a fixed rate single currency loan in US dollars, with a maturity of up to fifteen years. Each semester's disbursements would have a maturity of 12 years from the rate fixing date, including 3 years' grace. The interest payment dates are August 15 and February 15, with the first expected rate fixing rate on August 15, 1995. Objectives: The purpose of the loan is to provide balance of payments support to the Argentine Republic in the aftermath of the regional crisis that has abruptly curtailed the country's access to foreign capital. At the same time the loan will support the Government's ambitious bank reform program. That program has the following principal objectives: (i) to hasten the process of consolidation of a fragmented private banking sector; (ii) to improve the financial structure of a distressed banking sector in the context of acquisitions, mergers and restructurings, and (iii) to contribute to the restoration of confidence in the banking system. Description: A fast disbursing loan is proposed. The loan would disburse in three equal tranches in accordance with conditions noted in the Policy Matrix (Annex C). Counterpart funds would be made available to the Bank Capitalization Trust Fund. Release of the second and third tranches would also require the achievement of US$167 million of transactions by the Trust Fund in accordance with principles agreed between the Government of Argentina and the Bank (Annex F). Benefits and Risks: Project benefits include the restoration of confidence in the private banking sector, which has been badly battered by the events following the Mexico crisis which resulted in a massive outflow of deposits. While the situation has now stabilized, many banks are in financial difficulty. The new failure resolution approach being adopted by the Government, and the Bank Capitalization Trust Fund operation that the project helps finance offers the opportunity for an orderly consolidation process. The vehicles are recapitalization and refinancing for banks willing to accept the requirements of this Trust Fund. The borrower expects the US dollar single currency loan terms to facilitate improved debt management, and the fixed interest rate to protect against possible market interest rate increases after the loan is fully disbursed. The principal risk to the project remains macroeconomic, insofar as the economic situation in Mexico, and, more generally, Latin America remains unsettled and the Argentine economy continues to be vulnerable. This could result in a further loss of confidence, a deeper economic crisis, and a renewal of deposit flight. To the extent that the financial sector can be strengthened by recently announced government measures, including a stronger failure resolution mechanism, that risk can be and has been effectively lowered. Macroeconomic risks have been reduced by the adoption of a very strong fiscal program, aimed at producing a sizeable surplus this year, and by continued prudent and effective economic management. The other project risk is a deterioration in the integrity of the distressed bank resolution framework. This risk is being addressed by the authorities through significant changes in legislation, a clear commitment to improve the quality of banking supervision, and the creation of the Bank Capitalization Trust Fund to facilitate the restructuring of the banking system. Poverty Category: Not applicable Estimated Disbursement: The loan would be disbursed in three equal amounts against import documentation, and the counterpart proceeds will be used by the Bank Capitalization Trust Fund. Disbursements would be conditioned upon a satisfactory macroeconomic performance and financial sector policies to be described in the Letter of Development Policy, satisfactory operation of the Trust Fund, and, for the Second and Third Tranches, the achievement of at least US$167 million in eligible transactions. These transactions will be subject to ex-post review in accordance with agreed benchmark criteria. Schedule of Disbursements: US million US million Bank FY 96 97 Annual 167 333 Cumulative 167 500 Financing Plan: US million World Bank 500 Argentine Government 2J000 2,500 Rate of Return: Not applicable Project Number: AR-PA-40904 REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED BANK REFORM LOAN TO THE ARGENTINE REPUBLIC IN AN AMOUNT EQUAL TO US$500 MILLION 1. I submit for your approval the following report and recommendation on a proposed adjustment loan to the Argentine Republic to support private bank reform to the Argentine Republic for the amount equal to US$500 million, with the aim of consolidating and strengthening the financial sector. The loan would be a fixed rate single currency loan in US dollars, with a maturity of up to 15 years. I. THE ECONOMIC SETTING A. Economic Context 2. Four years have passed since Argentina, emerging from the severe economic crisis of 1989-90, adopted the Convertibility Plan in April 1991. This innovative plan restructured Argentina's economic landscape. From extreme hyperinflation, the country moved relatively quickly to an annual inflation rate of 3.9 percent in 1994. Output and productivity increases have been remarkable for the last four years, with Gross Domestic Product (GDP) growth averaging 7.7 percent. The initial consumption-led boom has matured into a healthy pattern of investment and export-led growth. Privatization of state assets has been far-reaching, and much more successful than expected. As a result of the economic recovery, poverty levels have declined significantly, although economic restructuring with a rigid labor market has resulted in increased unemployment, about 12 percent of the labor force by late 1994. To deal with problems caused by an initially overvalued exchange rate, the Government launched a number of microeconomic reforms, particularly in labor legislation, with the aim of reducing labor costs and increasing productivity. The result, plus exchange rate developments in Brazil, have allowed export expansion to be strong in recent years and to underpin growth. 3. The Convertibility Plan was part of a comprehensive reform program at the national levelP' including reforms of the state and financial institutions, privatization, and extensive market liberalization. While fiscal adjustment has occurred at the federal level, provincial fiscal deficits persist, mainly because of the continued inability of 1/ Past Bank support for this program has entailed various operations in support of financial sector adjustment, capital market development, privatization, and modernization of the public sector. provincial governments to contain current expenditures and sufficiently increase their own-source revenues. The combined fiscal deficit of the provinces was equal to 0.7 percent of GDP in 1994. In this context, public provincial banks were extremely vulnerable, as they could obtain no relief from provincial governments. This has allowed the Government to move forcefully, with World Bank assistance, to privatize and/or liquidate the great majority of the provincial banks. On May 4, 1995, the Bank approved a Provincial Bank Privatization Loan (Ln. 3878-AR) in the amount of US$500 million equivalent. B. Recent Performance 4. With the dynamic evolution of the economy, demonstrated by a shift in consumption to export-and investment-led growth, GDP in 1993 and 1994 grew by 6 and 7.1 percent, respectively. Gross fixed investment reached 20 percent in 1994, associated with increased national and foreign savings. Exports, which were affected by declining international prices in 1992-93, rose by 20 percent in 1994, with manufactured goods exports exhibiting particular buoyancy, growing at an average of 27 percent in 1993-94. Better international prices for grains and improved economic conditions in Brazil contributed to export growth. In 1994, imports grew at the fast pace of 27 percent. Imports of capital goods led the expansion, indicative of the acceleration in investment and the restructuring of the economy. Financing trade and current account deficits was not difficult, given Argentina's improved access to international financial markets during 1993 and 1994. During the first two months of 1995, exports rose by 35 percent, while imports remained approximately at the previous year's level. 5. With the increased accumulation of international reserves, and the reduction in bank reserve requirements earlier in 1993, monetary aggregates expanded at a fast pace. Bank credit also grew at a fast rate, reflecting the sub-par, but rapidly improving, monetization of the economy. Interest rates on peso deposits declined from 25 percent in December 1992 to 9 percent by early December 1994, just before the Mexico crisis began. Interest rate spreads, although also declining, remained high, indicative of the continued segmentation and shallowness of the financial system. Towards the end of 1994, approximately half of Argentina's financial assets were dollar-denominated, and interest rates and spreads on dollars were much lower than those for peso-denominated assets. Continued capital inflows sustained the growth in aggregate demand. Liquid international reserves at end-November 1994 stood at US$14.5 billion, a significant increase since the end of 1992. Nevertheless, the general rise in dollar interest rates, which started in early 1994, produced a deceleration in reserve accumulation and credit expansion in the first three quarters of 1994. The government's fiscal position remained prudent, however, with rough balance in its consolidated accounts achieved in 1994. The Government remains committed to maintaining a sound macroeconomic framework, as described in the Letter of Development Policy (Annex R). -3- C. The Mexico Crisis 6. Argentina was particularly vulnerable to the events in Mexico due to its relatively heavy reliance on foreign capital inflows (financing in 1994 an estimated current account deficit of 3.6 percent of GDP), the inflexibility of its exchange rate regime, and the need for a strong financial system under the Convertibility Plan. Compared to Mexico, however, Argentina enjoyed several advantages: (a) its current account deficit was less than half that of Mexico; (b) it had stable political and economic leadership; (c) its level of international reserves remained high; (d) public debt maturities were not concentrated in the short-term spectrum of the market; and (e) many of its structural reforms--privatization, governmental reform, domestic market liberalization, and foreign investment--were deeper. Nevertheless, Argentina could not escape the effects of Mexico. Its stock and bond markets suffered precipitous losses, and, given its exchange rate system, the Central Bank lost more than US$5 billion of its reserves between December 1994 and end March 1995. 7. Partly generated by memories of past confiscations of deposits, the disruption of The Mexican economy triggered a banking crisis. Loss of confidence led depositors to withdraw a total of about US$8 billion from the banking system, thereby causing a major liquidity crisis. As a result, interest rates increased to levels unprecedented since the onset of the Convertibility Plan, and in March 1995, the banking system was on the brink of a fatal run on deposits. The Central Bank, converted into a currency board in 1991, was rigorously constrained in its ability to provide liquidity. 8. The Government reacted forcefully to the crisis. During February and March 1995, it took courageous measures to reestablish a fiscal surplus by cutting expenditures on, inter alia, export subsidies, public sector wages, and social security expenditures, while raising Value-Added Tax (VAT) rates and other taxes and eliminating many tax exemptions. These measures are expected to yield some US$6.3 billion, about 2 percent of GDP, during the remainder of 1995. Swift action by Congress in approving unpalatable emergency measures added to their credibility. The Government intends to maintain strong macroeconomic management under an IMF-EFF program, which was extended to June 3, 1996, with an increased amount of US$2.4 billion. 9. As the Government announced these measures in mid-March 1995, it also assembled an international financial package of approximately US$11 billion in support of the Convertibility Plan. About US$5.4 billion would come from the IMF, the Inter- American Development Bank (IDB), and the World Bank; with an additional US$800 million from the Eximbank of Japan; over US$2 billion from two large bond issues; and US$2.4 billion is expected from projected asset sales. As a result, by early April 1995 financial markets showed signs of stabilization and recovery, and appear to have become firmer. Not only did the authorities react firmly to the crisis on the eve of - 4 - presidential elections by suspending insolvent banks, but they have also received strong political support in Congress, where financial reform legislation was approved swiftly and the mechanism for crisis resolution was rapidly put into place. 10. The Mexican crisis brought to light important lessons for Argentina. It highlighted the extent of the economy's reliance on volatile capital flows; revealed the need for a strong financial system, given the Central Bank's limited lender of last resort capabilities; reemphasized the need to sustain the credibility of the economic program; and clearly illustrated the difficulties of a fixed exchange system in times of generalized crisis. The Government's forceful and rapid reaction to the crisis has reduced concerns about future domestic policies, but the external environment remains uncertain. Although the initially strong negative reaction of financial markets to the Mexican crisis has been partially abated, a clear reluctance to renew significant flows of capital towards emerging markets remains, particularly flows to Latin America. Moreover, there continues to be a general lack of market discrimination between countries in the region. Even under an optimistic scenario, in which the principal countries affected by the crisis adopt appropriate economic policy measures to reestablish credibility in the eyes of international investors, access to international financial markets may only be slowly reestablished, and capital inflows are likely to remain well below those observed in previous years for quite some time. 11. If international capital market access remains narrowly constrained, which appears to be the case, net capital inflows, even with the enhanced assistance of multilateral organizations, may be barely positive in 1995. This compares to capital inflows of US$10.5 billion in 1994. The net result will be severe import compression in 1995 with import levels at least 10 percent lower in real terms (compared to 1994), and a severely reduced current account deficit of possibly 1.2 percent of GDP, approximately one third of the deficit in 1994. In this scenario, the bulk of capital inflows will come from official sources. Furthermore, to achieve this adjustment in the external accounts, economic activity would decelerate sharply, an unfortunate outcome in light of the already high rates of unemployment. 12. The recent Country Assistance Strategy (CAS) (Report No 14278-AR), discussed at the Board on May 4, 1995, highlighted the very low growth prospects for 1995 resulting from the strong fiscal program necessitated by the crisis. This heightened level of economic uncertainty has put further stress on financial markets and has retarded the return to normal asset values in the banking system. Although the inflow of IMF resources has aided in the restoration of reserve levels, Central Bank reserves are at least 20 percent below their pre-crisis level and the system is still vulnerable to ebbs in confidence. The need for balance of payments support is noted in the CAS (see paras. 46-47), and quick disbursing assistance to the Government's program of bank reform is fully consistent with those circumstances. II. THE FINANCIAL SECTOR A. Background 13. Structure of the Banking System. Argentina's financial sector consists chiefly of commercial banks. This is a result of Argentina's Law of Financial Entities (LFE) which allows banks to extend a full scope of financial services. Of a total of 203 financial institutions existing in December 1994, 168 were commercial banks which accounted for 98 percent of total financial sector assets. The remaining 35 banks were finance companies or savings institutions that do not offer checking account services. As of April 15, 1995 the number of commercial banks had shrunk to 140, owing to 15 mergers, principally among the cooperative and regional retail banks. The banking system as of that date included three federal public banks (Banco de la Naci6n Argentina (BNA), Banco Hipotecario Nacional (BHN), and Banco de Inversi6n y Comercio Exterior (BICE), 29 provincial/municipal banks (three of which have been privatized); 57 national private banks (including the formerly federal Caja Nacional de Ahorro y Seguros, privatized in 1992), 31 foreign private banks, and 20 cooperative banks. Table 1 below indicates the share in total assets, loans, and deposits of the banks. Overall, private banks (including cooperatives) accounted for about 55 percent of total assets, and 59 percent of total deposits as of February 1995. The 10 largest private banks21, each with assets over US$1 billion, accounted for between 28 and 30 percent, respectively, of total assets, loans and deposits (Annex G provides bank-level detail). Table 1: Breakdown of Total Assets, Loans and Deposits as of 2/28/95 (%) | Type of Bank Total Assets Loans Deposits . ;~~1. Federal 21.2 18.8 14.9 Provincial/Municipal 22.1 22.9 24.7| National Private 30.7 31.8 32.1 Foreign 16.9 17.0 17.9 Cooperatives 7.4 8.2 9.4 Sub-Total B:aks 98.3 98.7 99.0 FXinance Companies 1.5 1.1 0.8 Credit Unions 0.2 0.2 _ _ 0.2 Total System 1O0~~~~~~~G 100.0 .100.0 2/ These are: Galicia, Rio, Frances, Cr6dito Argentino, Roberts, Quilmes (domestic) and Citibank, Boston, Deutsche and BN Lavoro (foreign). - 6 - 14. Resource Mobilization and Interest Rates. Until 1990, financial deepening in Argentina decreased as a result of declining confidence in the domestic currency and other financial assets. Successive episodes of hyperinflation and outright asset confiscations in the early 1980s and later in 1990 discouraged investors and depositors from holding domestic financial assets. Since 1990, the Government has sought to increase mobilization of financial resources and thereby contain the cost of capital to meet the anticipated expansion of demand. Macroeconomic stabilization and growth policies were very successful in increasing resource mobilization, at least until the end of 1994. With greater interest rate stability and higher growth, currency and bank deposits increased from an average of 5 percent of GDP in 1990 to 19 percent in 1994 (see Figure 1 and Annex E). The policies were further successful in increasing corporate equity and bond issues. Corporations, including commercial banks, raised an impressive US$9.9 billion in equity issues and registered US$6.5 billion in bond issues during 1990-1993. Finally, increased resource mobilization reduced lending rates (Figure 2), from 52 percent at the onset of the Convertibility Plan in April 1991 to 23 percent in November 1994 (see Annex E). 15. Adjustment of Commercial Banks. Macroeconomic stabilization, financial sector policies, and improved regulation and supervision encouraged banks to become more efficient. First, the Convertibility Law established a firm constraint on the Central Bank's capacity to extend credit to commercial banks. The constraint on BCRA lending chiefly affected public banks, where financing declined from about 160 percent of deposits in 1990 to zero in 1994. Central Bank financing of private banks amounted to only 5 percent of deposits in 1990 and declined to zero in 1992. The constraint on the Central Bank lending was the chief condition persuading public banks to adjust and privatize"'. The provincial authorities could no longer afford to own loss-making banks when their own budgets were severely strained and bail-out financing from the Central Bank was no longer available. 16. Second, as a result, stabilization increased the capacity of commercial banks to mobilize deposits and bonds, and reduced reserve requirements (to 43 percent) increased their lending capacity. The increased intermediation capacity permitted banks to reap economies of scale. Furthermore, with lower inflation and increased availability of credit, intermediation spreads declined, from an average of 27 percent per year in April 1991, to 11 percent per year in November 1994; this decline in spreads put competitive pressure on banks to reduce costs. With increased resource mobilization and competitive pressure, financial sector productivity (the ratio of sector 3/ The Federal Government has privatized a major national bank, the Caja Nacional de Ahorro y Seguros, sold with support from the Bank's Financial Sector Adjustment Loan (FSAL, Ln. 3558-AR), and liquidated the Banco Nacional de Desarrollo, also supported by the Bank's FSAL. Provincial governments are slowly following suit; with one provincial bank (La Rioja) liquidated and three others (Chaco, Corrientes, and Entre Rios) privatized, and with more to be liquidated/privatized under support from the Bank's Provincial Bank Privatization Loan (Ln. 3878-AR) approved on May 4, 1995. GDP to employment) increased by 180 percent between 1990 and 1994 and operational costs declined from 13 percent of total assets in 1990 to 8 percent in 1994#'. 17. Consolidation in the banking system, which proceeded at a fast pace following the financial crisis of the early 1980s, slowed after 1990. Following a decline from a high of 214 banks (35 public and 179 private) in 1980 to 165 (33 public and 132 private) in March 1991, the number of banks stabilized. Nevertheless, the larger institutions gained in market share. As discussed below, as a result of lower deposit growth since 1994, the pace of commercial bank consolidation has resumed and is expected to continue during the foreseeable future, stimulated further by the flight to quality of deposits during the recent crisis. 18. Bank Regulation. Prudential regulations of the BCRA cover: (i) capital adequacy and minimum capital requirements; (b) reserve requirements; (c) loan classification and loan-loss provisioning; (d) operations with affiliated companies; (e) consolidation; (f) internal and external auditing; and (g) diversification of credit risk (see Annex I). Minimum capital requirements for commercial banks are subject to risk ratings based on normal CAMEL criteria. Minimum capital requirements were set at 11.5 percent of risk-weighted assets (adjusted by the CAMEL-based risk rating) as of January 1995. These include a minimum of about 8 percent of risk-weighted assets in tier one (equity) capital. Portfolio classification has been changed from a classification system based primarily on guarantees to one reflecting a borrower's financial situation and repayment capacity. Provisioning requirements are determiined both by portfolio quality and by the guarantee arrangements. Details on loan classification and provisioning are given in Annex I. As of December 1994 the sub-normal portfolios in public and private banks were 33 percent and 10.3 percent, respectively. 19. Supervision. Together with the improvement in prudential regulation, enforcement capacity is being strengthened steadily. The Superintendency of Financial Entities (SEF)'s capabilities have been improved during the 1990s under support from the Bank's Public Sector Reform Technical Assistance Loan (Ln. 3362-AR)) and Financial Sector Adjustment Loan (Ln. 3558-AR)), and through technical assistance and training from the Federal Reserve Bank of New York (NYFed) and the US Office of the Comptroller and the Currency (OCC). SEF now has a staff of around 500. The staffing of the Supervision Division was increased as of July 1994 from 160 to approximately 300, organized into six on-site inspection groups specializing in different types of financial institutions (see Annex J for a full description of the enhanced supervision program which is now in effect). The managers of these inspection groups were hired through an executive search from international accounting firms and are being paid competitive salaries. One hundred and ten newly trained bank examiners who were hired out of 2,000 applicants in 1994 replaced 100 retiring examiners. 4/ The Argentina: Capital Markets Report, dated December 1994, contains a fuller discussion of these issues. (Report No. 12963-AR) 20. About 84 financial institutions have undergone full inspections during the past nine months, and off-site surveillance of all banks is undertaken monthly. On-site inspections include a CAMEL rating of the institution, which is used for determining capital requirements and will be used for assessing deposit insurance fees. Despite the increased burden placed by the need to monitor troubled institutions as a result of the crisis, SEF expects to complete examination of all institutions by September 1995. The capacity of the Superintendency to react to crisis situations has improved significantly, although no regulatory agency could have coped with the large, systemic crisis of the first quarter of 19955'. As of March 1995 the financial situation of troubled financial institutions was being monitored daily by a new reporting and analysis division, with the help of upgraded information systems and following reporting requirements noted in Attachment 1 to Annex J. The crisis has uncovered the offshore activities of several banks and SEF is now requiring consolidated balance sheets on a line by line basis. B. The Recent Financial Crisis 21. Private banks in Argentina may be divided into five groups: (i) large domestic retail banks with a national network; (ii) foreign banks; (iii) wholesale banks; (iv) cooperative banks; and (v) regional retail banks. These are listed in Annex G, Table 6 and described in more detail in Annex P. The recent liquidity crisis has not only reduced the deposits of the entire banking system and caused interest rates to rise sharply, but has led to a significant change in the composition of deposits, liquidity and assets among the various groups of banks. In essence, the large domestic banks and foreign banks have gained market share at the expense of the wholesale banks, cooperative banks and regional retail banks. 22. The current financial crisis began in late November 1994 with the bankruptcy of a small but trusted non-bank trader (ArgenBonex). An increasingly weak bond market and the recognition of the high gearing of security traders led commercial banks to finally cut credit to broker-dealers. These actions further softened the bond market. The problem was greatly exacerbated after the December 20, 1994 devaluation in Mexico with the massive withdrawal of foreign investors from Argentina and elsewhere. The resulting losses sharply weakened the wholesale banks that had a significant inventory of government securities. Banco Extrader, a small wholesale bank, failed soon after the Mexican crisis. The wholesale banks typically had only one branch, no retail deposit network, and relied primarily on corporate, inter-bank and institutional deposits. Concerns about their solvency and liquidity led to rapid 5/ Although the regulation and inspection procedures have improved considerably in recent years, significant improvements in enforcement are still needed. Some of the more important problems are well-disguised insider lending, and continued accrual of interest of non-performing loans. To improve assessments of systemic portfolio quality, classifications of individual borrowers are being compiled and standardized across banks. Borrowers from banks having liquidity problems are being analyzed to detect insider lending. - 9 - withdrawal of corporate and institutional deposits, sharp cuts in their interbank lines, and withdrawal of their deposits from provincial banks. Table 2: Recent Developments in the Argentine Banking Sector 11/30/94 12/20/94 12/31/94 1/31/95 2/28/95 3/31/95 4/15/95 Deposits in Commercial Banks (million) Pesos 23,833 24,498 22,750 21,979 21,034 17,679 18,610 Non Pesos 24,039 24,625 24,427 24,802 24,501 23,575 22,836 Liquidity in the Banking System (million) Cash 2,941 2,950 3,061 2,932 2,750 2,300 2,300 Balances with other Banks 1,788 n/a 1,509 1,398 n/a n/a n/a Balances with BCRA 1,113 n/a 1,091 1,200 1,350 1,950 2,000 Marketable Government Securities 3,548 n/a 3,048 2,942 n/a n/a n/a Deposit Rates (% p.a.): Peso 3 month 8.4 10.0 11.1 12.0 13.0 21.0 22.5 6 month 8.4 9.3 9.6 9.9 14.0 20.5 20.0 Deposit Rates (% p.a.): US$ 3 month 6.0 6.0 6.3 6.5 7.0 11.0 11.4 6 month 6.0 7.4 7.3 6.8 7.7 10.0 10.9 Weighted Average Lending Rates (% p.a.) Peso 21.0 25.0 35.0 40.0 45.0 60.0 60.0 US$ 16.0 18.0 22.0 28.0 30.0 45.0 45.0 Prime Rates (% p.a.) Peso 10.2 11.8 19.0 18.0 24.0 28.0 26.0 US$ 8.5 9.3 12.0 12.0 15.0 21.0 20.0 Overdraft Rates (% p.a.) Peso 25.0 35.0 35.0 45.0 45.0 65.0 65.0 International Reserves of BCRA 14,318 n/a 15,663 13,792 13,077 10,197 11,685 (US$ million) Merval Index 526 516 460 435 323 382 426 23. The structural conditions of the banking sector--no deposit insurance, absence of a significant lender of last resort, the ready conversion of pesos into dollars at parity, and ease of capital movements--as well as the memories (para. 14) of many previous financial crises -- fueled a mini-run on deposits and a flight to quality among many depositors in the system. Simultaneously, interbank market access shrank down to 10 top private sector banks and the interbank rate increased sharply, pushing several solvent but illiquid institutions to the brink of failure. 24. Deposits. Deposits in the Argentine financial system stood at US$49.1 billion on December 20, 1994 and dropped 16 percent to US$41.3 billion by end March 1995. Not surprisingly, peso deposits fell faster, by 24 percent, accounting for some US$6.9 - 10 - billion out of the total deposit losses of US$7.9 billion since December 20. Dollar deposits fell about 7 percent over the same period, mainly in the month of March. Annex E shows recent trends in deposits, loans and the M4/GDP ratio, all of which indicate similar developments (also see Figure 1). Figure 1 RATIO OF LOANS AND BROAD MONEY TO GDP 1991- 1995 19. D% 19.12% eo~~~~~~ ow- TTIO%01 1 16. 20%14i'llll .1 0 % 14.0%II IIIII 6 0X 7mi i l f4T I l l i XI g I m I II m I 0 II I II * 12.0% 7.0% 1991 1993 1995 1992 1994 Year anc IAMnth 0 M4/GDP t Pank Loaan/GDP Source: Central Bank Data 25. Until February 1995, the biggest losers were the wholesale banks, with deposit losses of over 70 percent and an insurmountable crisis of confidence. Many other banks also suffered deposit withdrawals too large and too rapid to survive. Provincial banks lost about 40 percent of their deposits; cooperatives lost one-third. Foreign banks lost some overseas deposits but gained local deposits. Private retail banks lost about 21 percent of their deposits. However, the ten leading private banks gained market shares in deposits. Thus, the relative positions of different banks have been dramatically transformed, and the process of consolidation has been accelerated. 26. Stock and Bond Markets. Prices and trading volumes dropped sharply, while volatility increased dramatically. The Merval index (the stock price index at the Buenos Aires Stock Exchange) dropped from 516 on December 20, 1994 to 323 by end-February 1995, but recovered to 426 by April 15, 1995. The bottom, around 320, was reached in late February 1995. At that point, the index had fallen about 38 - 11 - percent since the Mexico crisis, and currently is still around 18 percent below the pre- crisis level. The market Price/Earnings (PE) ratio which was 18.3 in November 1994 fell to about 12 at the end of February 1995. The trading volume in Buenos Aires Stock Exchange ran around US$12 to 13 billion monthly prior to December 1994, and has steadily fallen to around US$1.5 billion monthly by late April 1995. No new equity or eurobond issue, and only one 90-day local commercial paper placement, has occurred since December 20, 1994. While several placements (up to US$1 billion worth) of negotiable obligations are in the process of Comisi6n Nacional de Valores (CNV) approval and preparation, it is unlikely that new issuance will occur any time soon. With the trading volumes unusually low and volatility extremely high, most issuance and even ordinary portfolio management decisions are in limbo. 27. The prices of Government securities fell sharply due to the crisis as well as generally rising interest rates. As a result, their secondary market yields have risen significantly. In addition, the fragmented structure and varying liquidity of different government securities have greatly amplified the differences between their secondary market yields, which now range from 15-30 percent per year. Both the prevalence of such yields in government paper and the absence of any discernible interest rate benchmark contribute to a significant rise in the interest rate on commercial loans. 28. Deposit and Lending Rates. Deposit and lending rates increased markedly in response to strong demand and low liquidity (see Figure 2). The loss of deposits, together with continuing liquidity and solvency problems, have made the banks very conservative in new lending. While the prime corporations have not faced the worst credit crunch, credit to Pequefias y Medianas Empresas (PYMES) has been sharply curtailed. The closure of or contraction in activities of cooperatives and provincial banks has also further constrained credit to PYMES. The sharp reduction in credit and the high rates are both bound to result in a deterioration in portfolio quality, which can be fully reflected only over a period of time. 29. Failed Institutions. By late April 1995, two banks were in liquidation, and five others and four financial companies were in a 30-day suspension period (cf. paras. 47- 48 on the suspension and liquidation process). Only Banco Finansur reopened following an acceptable restructuring plan. As many as 46 private banks are possible merger or acquisition candidates. Two new banks have been formed as mergers of eight and seven cooperatives, respectively (see Annex H for details). Other typical mergers include absorption of a cooperative bank by regional or other cooperative banks, mergers between small regional retail banks and the stronger wholesale banks, and acquisition of regional banks by the larger national banks seeking increased presence in a particular region. Finally, many wholesale banks are being liquidated and are continuing to sell their assets in order to repay their liabilities. - 12 - Figure 2 EFFECTIVE DEPOSIT AND LENDING RATES AnnuaIrzed F%tog 1991-1995 100 D% 90.0% ll. 0% 70.0% 50. 0% 50.D% 40.0% - ------ 30.0% 20.0% 1992 1994 1993 1995 Yoar and Month o PQ8O DLposlt Rate + Pe5n Lending Pate Source: Data from Central Bank and Carta Econ6mica 30. Government Response to the Crisis. Faced with this situation, the Government struggled to provide liquidity. This effort included: (i) an initial "club" of five private banks in early January 1995 each contributing about US$50 million to purchase illiquid wholesale bank portfolios; and (ii) a transfer of 2 percent or about US$870 million of the banks' reserves at the Central Bank into a special account with the Banco de la Naci6n Argentina (BNA). BNA, acting as agent for and on instructions from the Central Bank, lent the funds to wholesale and provincial banks at 16 percent p.a. against collateral of bank assets and in some cases personal guarantees of the owners. These funds were quickly exhausted. In February 1995, the Trust Fund for Privatization was established to handle the workout of provincial banks. 31. The Central Bank's capacity to act as a lender of last resort is constrained by the Convertibility Law which requires it to limit its monetary liabilities below its international reserves. As of April 1994, BCRA provided US$1.8 billion in extraordinary liquidity assistance to all banks.O' Banks met further liquidity needs through lower reserves requirements (about US$1.7 billion) and by exercising their right to borrow a part of their required reserves (about US$1.3 billion), currently set at 6/ Private banks received US$1,165 million of this amount. This is in addition to the BNA safety net lending of US$468 million, which was financed by the more liquid private banks themselves. - 13 - 32 percent. The Central Bank's charter was amended to allow it to extend the maturity of its liquidity rediscounts, thereby enabling it to lend for terms beyond 60 days and above the previous ceiling of the net worth of a bank. However, under the restriction of the Convertibility Law, BCRA has little capacity at present to provide further liquidity. With available liquidity in the system virtually exhausted, and the increasing likelihood that the extraordinary liquidity advances to many banks may not be repaid, the government established a Bank Capitalization Trust Fund (BCTF) to handle the recapitalization/restructuring of distressed banks (see Annex N). 32. Deposit Insurance. In April 1995, the Government created a limited deposit insurance scheme, effective April 17, to help restore confidence in a deposit system badly shattered by the events of early 1995 (see Annex 0 for details). Deposits with maturities of less than 90 days are insured up to US$10,000. A further US$10,000 insurance is provided for deposits exceeding 90 days maturity (total insurance on these deposits is US$20,000 minus any claims on deposits below a 90-day maturity). These insured amounts include the first right of claim that deposits of up to US$5,000 have on the reserves of a failing bank. For term deposits, the new insurance applied to new deposits after April 18, 1995. The insurer, a privately financed Deposit Insurance Fund, would cover nearly 100,000 holders of fixed-term accounts, plus a large majority of savings and current accounts, totalling about US$10 billion, or a quarter of deposits. The fund will be financed by contributions from the banks. The fund is likely to reverse the decline in small deposits, but less likely to encourage the return of institutional deposits. The role of deposit insurance in the loss allocation process is described in paras. 49-54. 33. Future Structure of Banking. The long overdue trend towards consolidation started before December 1994, and has accelerated considerably since then. The profile of the sector is likely to change. First, the ongoing strain on provincial finances and the poor financial situation of provincial banks will trigger further privatization or closures of these banks. Most wholesale banks with a single branch and limited retail depositor base are likely targets for take overs. The cooperative banks have several weaknesses: highly regional and poorly diversified portfolios, strong affiliation with specific clientele which weakens their portfolio, high costs, and inadequate capacity to raise capital. These cooperative banks are therefore merging/disappearing quicky and are already down to 20 by end April 1995 from 39 in August 1994. The smaller private banks also lack economies of scale and loyalty of depositors, and face higher cost of attracting deposits. They would be forced to either merge or be acquired. 34. If the authorities continue to implement the prudential norms forcefully, the number of Argentine banks in the coming five years may be halved from about 160 at the beginning of 1995. The surviving banks may comprise 30 foreign banks, 5 to 10 cooperative banks, 5 to 10 provincial/federal banks, 5 wholesale banks, a dozen or more first-tier private banks with national branch networks and about 20 second-tier banks with smaller national, or multi-provincial presence. Such consolidation will still - 14 - leave Argentina with proportionately many more banks than in Mexico, Chile or Brazil, and thus is not likely to reduce competition substantially. The two largest public banks would have control of one third of the market share, and two or more foreign banks would operate with a significant retail franchise. The retrenchment would force the banks to cut costs, rationalize their branch networks and introduce better technology. However, at present only about six of the banks are publicly listed, and progress in terms of greater public shareholding, reduction of family controls and professionalization of top management will take longer. C. Capitalization and Consolidation of Private Banks 35. Capitalization of Banks. To shed light on possible acquisition and merger prospects, private domestic banks in Argentina, including cooperative banks, were independently classified into five groups (A, BI, B2, B3 and C), using 14 rating parameters measuring, inter alia, liquidity, solvency, capital adequacy, portfolio quality and provisioning, profitability and operational efficiency. The detailed methodology used for this exercise is described in Annex P. Figures 3 and 4 indicate the distribution of private national banks and their assets by category. Banks in categories A and B1, are clearly the most capable of acquiring weak banks, although some banks in category B2 may also be suitable candidates for acquiring other banks or being major merger candidates. Categories B3 and C contain most of the banks that are under BCRA assistance and intensive surveillance. 36. The capital shortfall in the domestic private banking system has been estimated by comparing the figures for actual capital with those required by BCRA and making adjustments for shortfalls between actual loan-loss provisioning and the classification of the banks' loan portfolios according to the latest BCRA prudential regulations. The likely capital shortfall is discussed in para. 66 and in greater detail in Annex M in the context of anticipated acquisitions and mergers. 37. Consolidation of Private Banks. The recent crisis has accentuated the fragility of Argentina's smaller banks, and is likely to accelerate a process of consolidation which was already underway. The changes in the BCRA Charter and banking legislation will strengthen BCRA's role in orchestrating acquisitions and mergers. From a capital viewpoint, the ten largest private banks would be best placed to act as acquiring banks in merger transactions. The regional banks are widely perceived to be overstaffed and inefficient, so an acquiring bank would branches and reduce staff substantially to achieve economies of scale. Some large banks are undertaking acquisitions, including acquisitions of selected assets and branches of regional banks. The more likely acquirers are intermediate-size banks wishing to increase market share. Overall, it is estimated that there is a possible set of 40 banks (rated A, B1 or B2) - 15 - Figure 3 PRIVATE NATIONAL BANKS Distribution by RatIng - February 1995 30 28 _ _ _ _ _ 26 24 ___ 22 20 ___ 14 12 _ _ _ 10 8 6 4 2 0 A Ratlng Cntegory Nujrber of Bnkls Source: Mission estimates. Includes cooperative banks Figure 4 PRIVATE NATIONAL BANKS SharQ of Assets - FPbrudry 1995 45 O% 40.0% 35. 0% 30. 0% 25 0 15. 0% ___ ___ 1D.D0% 5.D% 83 Rntlng Category Share of A5sets Source: Mission estimates. Includes cooperative banks. - 16 - that could contribute to the consolidation process by either acquiring or merging with other banks. A small number of banks may also be capable of restructuring themselves with BCTF assistance. 38. One problem foreseen by potential acquiring banks is that immediately following the takeover many of the acquired bank's depositors could withdraw their deposits. This phenomenon is likely to occur because many of the smaller regional and cooperative banks in the interior have been limiting or scheduling withdrawals. Only after a period would deposits recover--and this would most likely occur if a larger bank with a good name acquires the smaller bank. In the interim, the merged bank could well suffer from liquidity difficulties. For this reason, the acquired bank would have to be free of existing short term debts to the BCRA and BNA for past liquidity assistance. The BCTF will therefore extend loans to refinance these obligations in the context of consolidation transactions that restitute the liquidity and capital adequacy of the acquired or consolidating banks. 39. Mergers between the medium and small cooperative banks and regional retail banks are more likely because they can strengthen themselves through economies of scale and increased market power. However, such transactions--over ten of which have occurred during the last six months--run the risk that merging several relatively weak banks without strong management or upgrading staff and systems could merely create larger weak banks. To prevent a failed merger SEF will require, that merging banks redress shortfalls in capital requirements, that management is suitable, and that the merged entity has a strong business base. 40. In order to facilitate merger and acquisition program, the BCTF will provide financial assistance. Acquiring banks will be offered access to subordinated convertible loans from the Trust Fund to help meet tier two capital shortfalls in the acquired bank(s) after deducting increased loan-loss provisions and other asset write-downs. Such assistance should be subject to the acquiring bank meeting or exceeding tier one (i.e., equity) capital requirements. The large, acquiring banks should be able to maintain the required ratio of 2 to 1 between equity capital and tier two capital (subordinated debt) without additional equity injections. The same will not necessarily be true of mergers between smaller and medium sized banks, which may have to seek new capital from their shareholders in addition to the debt provided by the Trust Fund. 41. Selective Restructuring of Banks. In some cases, SEF can recommend to BCTF that a bank be considered for restructuring, without undergoing a merger or an acquisition. These cases will tend to be few, but where they exist, the eligibility requirements will be strict with respect to the initial level of tier one capital. If BCTF provides assistance in the form of subordinated loans, which count as tier two capital, such assistance will only be given on a matching basis with additional ownership capital. Moreover, the treated bank will agree to undergo an institutional diagnosis and to prepare a business and institutional development plan which the SEF can monitor. - 17 - As with all banks receiving BCTF financing, the emerging bank will meet all prudential capital requirements and will be free of regulatory forbearance. 42. Liquidation. The Government is understandably concerned about the occurrence of a large number of bank liquidations which could negatively affect depositor and investor confidence in the Argentine financial system. Nevertheless it is likely that there will be a number of smaller retail banks and wholesale banks which will not find acquisition or merger partners. These banks probably belong to category C in Figures 3 and 4. For some of these banks the eventual solution will be orderly liquidation, with settlement of insured depositors' claims by the new deposit insurance scheme, purchases of selected assets by interested banks (either with or without matching liabilities) and the disposal of the residual balance sheet by a liquidator. It will be in the interest of creditors that the residual balance sheet be as small as possible, given the protracted delays and the legal fees involved in a court-administered settlement. Two banks have recently started liquidation procedures. D. The Government's Distress and Failure Resolution Procedures 43. The focus of Argentine distress resolution policies is: (i) early identification of problems, (ii) a set of remedies related closely to the severity of the problem and the degree of cooperation of existing managers/owners, and (iii) minimization of court- ordered liquidation which a time-consuming and costly process. Broadly the process can be divided in two stages. In the first stage, SEF holds the primary responsibility for identifying problems from its routine oversight procedures and resolving them through administrative remedies. In the second stage, in which the problems are more acute, BCRA would attempt to resolve them through liquidity support; suspension of the operations of a bank; recapitalization, merger, or acquisition; or liquidation of the institution. 44. Corrective Actions by the Superintendency. The Superintendency monitors compliance with prudential norms (see Annexes I and J for details of prudential norms and supervision) from daily and monthly reports, off-site examinations, and annual external auditors' reports.7' The largest 120 banks are subject to a full annual on-site inspection and the remaining smaller 80 banks and finance companies are subject to a similar inspection every 18 months. The banks which have received extraordinary borrowings from the BCRA are subject to considerable on-site inspection and even daily monitoring (see Annex J, Attachment 1 for the format of such daily reporting). In April, some 80 banks were subject to daily reporting. The steps that SEF can take to deal with problems identified in the course of monitoring are explained in Box A below. 7/ The audit must give an opinion on compliance with the Central Bank's prudential requirements. The Central Bank can disqualify and levy fines on auditors that fail to report a bank's non-compliance. - 18 - 45. Resolution of Illiquidity or Insolvency. More serious cases of insolvency or illiquidity are dealt with as follows. Entities requiring such consideration are identified either: (i) by one of the six specialized Inspection Groups when the corrective actions described above do not rectify the problems; (ii) based on information provided the Groups for Follow-up or Coordination or Financial System Analysis; or (iii) when an entity requests extraordinary or repeated liquidity assistance from the BCRA. At this point, BCRA may either provide liquidity assistance or suspend the bank's operations. 46. Liquidity Assistance. BCRA evaluates requests for liquidity assistance on the basis of deposits lost, amount of assistance requested, additional funding needs based on projected cashflows, and guarantees and collateral offered. Until February 28, 1995, such liquidity assistance was available for a maximum of 30 days extendable to 60 days, and up to the net worth of the institution. Since then, Law 24,485 (see Annex L) has amended the Charter of the Central Bank, to offer "extraordinary" assistance beyond these ceilings. Apart from other collateral BCRA may request, the law requires that liquidity advances be guaranteed by a controlling packet of shares. 47. Suspension. If a bank is found to be in need of significant recapitalization, merger or acquisition, or liquidation, it is placed in "suspension" for a period of 30 to 90 days to protect it from the creditors and to permit time for a workout. Suspension may be invoked by the Superintendent, with the approval of the Chairman of the Board of BCRA, or may be requested by the bank concerned (see Annex L). During suspension, if the bank can present a plan for rehabilitation (typically recapitalization with merger, acquisition or other changes in ownership) acceptable to BCRA, suspension is removed and normal operations are resumed. 48. Revocation of License and Liquidation. If an acceptable plan is not produced, the bank's license is revoked and the bank will be liquidated. Prior to license revocation, the Central Bank is now authorized (Article 35 bis of the Law of Financial Entities (LFE)) to perform any required segregation of assets and liabilities and sell the institution or sell a part of its assets and a corresponding amount of senior liabilities, with the remaining liabilities to be repaid under administrative liquidation or bankruptcy procedures. 49. Loss Allocaton. Where asset values of a suspended bank exceed its deposit liabilities, but not total liabilities, the Central Bank can now divide the bank's assets and liabilities so that an acquiring bank assumes all deposit liabilities and a comparable amount of unencumbered good assets. (Where liabilities are secured, creditors would have access to the value of the collateral up to the amount of their claim.) The remaining assets and unsecured, non-deposit liabilities (which have a lower creditor priority than deposits) would then be transferred to the courts for liquidation. 50. In those cases where the asset values of the suspended bank are less than deposit liabilities, the Central Bank may still be able to effect a transaction in which the assets - 19 - BOX A Problem Resolution by the Superintendency 1. The six Inspection Groups of the Superintendency apply the following four types of remedies: change of management, changes in banking practices, increased capitalization by existing shareholders, and administrative fines and restraints. Normally, these remedies would be exhausted before considering extraordinary financial assistance from BCRA, suspension, or revocation of operating license. 2. Memorandum of Intent and Understanding. The Memorandum is a formal agreement between the Directors of the non-complying bank and the SEF. It specifies the actions and time-tables to correct infractions of law, regulations, or to improve the financial strength of the entity. It is used when the problems do not pose an immediate threat to the entity or its stakeholder, and the management is cooperating in their resolution. The Memorandum is not a legally binding contract, but non-compliance with it results in more serious actions. 3. Plan for Regularization and Improvement. While similar in content to the Memorandum, the Plan is a legally enforceable instrument provided for under the Law of Financial Entities (Article 34) and the Charter of the Central Bank (Article 46). BCRA requires that the Plan be disclosed publicly. 4. Cease and Desist Order. Under Article 47 of the Central Bank Charter, the SEF can issue a cease and desist order against a bank or its staff which are in violations of the law, regulation, or a Plan for Regularization or which are engaged in improper banking practices. Cease and Desist orders are issued when the SEF judges the management unwilling or unable to implement corrective measures prescribed. All cease and desist orders must be made public. 5. Disqualification. The Law of Financial Entities permits SEF to disqualify a person from managing a financial entity for grave violations of the law, pursuit of rash banking practices or personal gain, and violations of cease and desist orders, if such conduct can harm the solvency of the entity, stability of the system or the interest of depositors. 6. Fines. BCRA can also impose fines on entities and persons for violations of law, regulations, administrative orders or conditions imposed, or for imprudent banking practices. - 20 - and a reduced depositor claim are transferred to an acquiring bank. This would require an agreement whereby depositors would accept less than the full present value of their claim. The Central Bank is now authorized to approve these agreements with depositors so that their claims would be covered by the estimated value of the bank's assets. This might involve a proportionate reduction in depositor claims, the substitution of a long-term instrument for a portion of depositor claims, or some other arrangement whereby a portion of depositor recovery is based on the successful collection of troubled assets by the acquiring bank. In such a transaction the deposit insurer would cover losses that would otherwise be borne by insured depositors, and the insurer would assume any additional recovery claims that might be available to insured depositors. 51. In most such cases, it will be advantageous for uninsured depositors and the deposit insurer to accept some potential loss in order to avoid liquidation, the delays in recovery that would accompany liquidation, and the likelihood of a lower present value recovery in liquidation. In those cases where a satisfactory compromise does not develop or where there is no interested acquirer, the asset collections and eventual distribution to creditors would be handled through the liquidation process. Insured depositors would be paid by the deposit insurer, to the extent the insurer has funds, and the deposit insurer and uninsured depositors would have an equivalent claim on recoveries that would come ahead of the claims of unsecured non-deposit creditors. 52. Where the liabilities of suspended banks exceed their assets, losses will be borne first by shareholders and next by unsecured general creditors. Where assets are insufficient to cover deposits, the deposit insurer will make insured depositors whole, to the extent it has available funds. Losses that would accrue to depositors would be shared on a pro rata basis between uninsured depositors and the deposit insurer. It should be noted that each depositor has a priority claim of up to US$5,000 on the reserve balances of the failing bank at the Central Bank. To the extent that such funds are present, they will reduce the required outlay and (to some degree) potential loss of the deposit insurer. Since the Deposit Insurance Fund has an interest in the outcome of negotiations with regard to the transfer of deposit liabilities to an acquiring bank, it needs to be included in those deliberations. 53. In sum, when the assets of a failing bank are inadequate to cover all liabilities, the shareholders are first to lose and the remaining creditors are paid according to the following order of priorities-: (i) up to US$5,000 to depositors from the bank's reserve with BCRA; 8/ A discussion and some workout examples of partitioning of assets and loss allocations under different scenarios are set out in Annex 0. - 21 - (ii) secured creditors up to the amount of their security (any shortfall to be claimed pari passu with unsecured creditors under (v) below); (iii) depositors pari passu with the deposit insurer (by right of subrogation) for any claims paid; (iv) BCRA; and (v) unsecured general creditors (including labor and tax claims). 54. This bank resolution mechanism was sorely tested in response to the recent liquidity crisis triggered by the disruption of Mexico's economy. The mechanism has worked, insofar as five banks have already been suspended and three more are in the process of liquidation. Nevertheless, it was not designed to deal with a systemic breakdown of confidence. For this reason and in light of the severity of the current crisis, an additional mechanism was added to aid the resolution process. E. Restructuring with BCTF Financing 55. Law 24,485 significantly increases the authority and capacity of BCRA to deal with distressed banks by permitting it to divide assets and liabilities for this purpose. Simultaneously, the creation of the Bank Capitalization Trust Fund (BCTF) has considerably augmented the capacity of the authorities to finance the merger or acquisitions necessary for distress resolution. This Fund will be financed by an amount equivalent to US$2.0 billion from the proceeds of the Argentina bonds recently issued by the Government and would also received the counterpart funds (US$500 million) from the proposed Bank loan. BCTF would extend medium-term loans to the qualified acquiring banks or investors, to qualified merging banks, or to qualifying banks sufficiently capitalized to be considered for restructuring and willing to undergo an institutional diagnostic and follow-up plan. Under the proposed loan, the Government has agreed with the Bank on the use of the BCTF's resources as governed by the Operating Principles and Procedures of BCTF, agreed with the Bank. These principles are summarized below. Operatine Principles and Procedures Governing BCTF Assistance for Acquisition or Merger * BCTF is established to facilitate and finance an orderly transfer of assets and liabilities from weak banks to financially and managerially strong banks. It will provide no financing without a strong prospect of the bank's recovery. - 22 - * BCTF will provide financing for acquisition of weak banks, or their segregated assets and liabilities as determined by Article 35 bis of the of Law Financial Entities on behalf of the Central Bank. BCTF will not purchase or hold the same on its own account, except in exercise of its collateral rights. * Typically, BCTF will finance acquisitions of banks that have received extraordinary liquidity assistance from BCRA or BNA and are rated 4 or 5. * If necessary, BCRA request the audit of the bank to be sold prior to BCTF financing, by an auditor acceptable to BCRA. Such an audit shall be requested for the sale of whole or part of a suspended bank, on the basis of Article 35 bis of the LFE. The auditor will offer an opinion concerning the fair market value of the assets and liabilities to be sold and will certify that insiders are not treated in a preferential manner. - To ensure financially sound and well-managed entities after acquisition or merger, the acquiring banks must have a current rating of 1 or 2 and comply with capital adequacy and liquidity requirements. In the case of mergers, a bank rated 3 can be considered provided BCRA submits evidence to verify the level of tier one capital, capital adequacy in light of current asset values, the strength of management, and the business viability of the merger entities. The Superintendency will assess and verify that (i) the acquiring bank has the financial and managerial capacity to undertake the transaction successfully, (ii) the financial risks to BCTF of the transaction are acceptable, and (iii) the managers and principal owners of the acquiring/merged entity meet the "fit and proper" qualifications. Any 3-rated bank will submit a business development plan within 60 days of receiving Trust Fund resources. * The BCTF may also undertake financing in the context of restructurings, provided that the bank is eligible by virtue of having (a) minimum tier 1 capital requirements, (b) adequate management and business base, and (c) agreeing to undertake an institutional diagnostic of its difficulties. In receiving BCTF financing, the bank will have verified that it meets all capital adequacy requirements without counting BCTF financing, that BCTF funding will be matched one for one by new ownership capital, and that it is willing to comply with an Institutional Development Plan to be monitored by the SEF. BCTF loans for restructuring will not exceed 10 percent of the volume of resources available to the Fund. * Recapitalization (subordinated) loans will not exceed 25 percent of the risk-weighted assets (RWA) for assets being acquired, 15 percent of - 23 - RWA for assets involved in the case of a merger, or 10 percent of RWA for assets of a restructured bank. BCTF's secured loans will not exceed the amount of outstanding loans from or on behalf of the BCRA. BCTF assistance will require banks to repay all such extraordinary loans in the terms agreed with BCRA. * BCTF financed transactions will use competitive and transparent procedures for qualified bidders. * BCTF will only finance an acquirer in a qualifying acquisition or merger transaction through either subordinated loans of 8 years maturity (meeting tier two capital definition) and/or secured loans of up to 3 years. BCTF will determine the type of each loan and their maturities, to ensure viability of the merged entity, and keep subordinated loans to the minimum possible. BCTF will not provide direct equity/preferred capital; however, both kind of loans may be convertible to equity at terms fixed by BCTF. All refinancing of BCRA or BNA extraordinary assistance will be done in conjunction with transactions described in these principles. * To prevent continued dependence of acquiring/merging bank(s) on official support, the restructuring plan will be adequately financed. BCTF will obtain an opinion from the Superintendency that the consolidated post-acquisition/merger bank can satisfy the normal prudential regulations for capital adequacy, provisioning, portfolio classification, liquidity, and interconnected lending. 3 Loans will be denominated in US dollars with an interest rate for merger and acquisition recapitalization loans equal to at least the World Bank rate plus a spread of 0.5-1.0 percent per year and for other recapitalization loans and all refinancing loans equal to the cost of Argentina bonds plus a spread of 0.5-1.0 percent per year. * The BCTF may on a case-by-case basis consider other transactions which meet BCTF objectives, but these will require prior review by the World Bank, and will in aggregate volume not exceed 5 percent of the resources of the BCTF. - 24 - III. THE PROPOSED LOAN A. Background 56. Past Bank Involvement. The Bank has been actively engaged in the reform of the Argentine financial sector since 1986. The dialogue intensified with the advent of the Menem administration in 1989, when the Bank assisted the Government in drafting the new Central Bank charter, developing organizational plans for the Superintendency of Banks, and designing action plans for the reform of public banks. In the context of this overall framework, the Government proceeded to institute major reforms during the subsequent five years, supported by a series of Bank operations. Under the Public Sector Reform Technical Assistance Loan (Ln. 3362-AR), major reforms were carried out in both the Central Bank and the Superintendency in areas of training of staff, accounting, information systems, and organizational improvements. With the Financial Sector Adjustment Loan (Ln. 3558-AR), approved in 1993, the Bank continued to support reforms of the public banks, principally the national development bank, the housing bank, and the national savings and insurance bank, and to strengthen the regulatory environment. 57. Over the past year the Bank has continued its dialogue with the Government in the context of its Capital Markets Study (No. 12963-AR), which identified, inter alia, two major problems in the banking sector: (a) the need to radically restructure, privatize or liquidate loss-making provincial banks; and (b) the need for a consolidation and strengthening of a relatively fragmented private banking sector. In the last six months, both outcomes have emerged. Due to weaknesses in provincial public finances, and precipitated by the Mexican aftershock, provincial public banks came under unsustainable pressure. Although the Bank had already planned to deal with some provinces in the context of the Provincial Reform Loan (Ln. 3836-AR), approved in early 1995, the urgency of the situation and the political opportunity afforded by the crisis to privatize provincial banks led to rapid preparation of the Provincial Bank Privatization Loan, approved by the Board on May 4, 1995. 58. The Bank's Response to the Current Crisis. In the aftermath of the Mexico crisis, the Government has struggled to maintain confidence in the financial system, despite major losses in deposits from the system and an exhaustion of its very limited lender-of-last-resort (LOLR) capacity. The Bank announced its intention to provide an additional US$1.3 billion of quick- disbursing assistance as part of a multilateral effort involving the IMF, IDB, and the World Bank. The Eximbank Bank of Japan was also quick to respond with a loan of US$800 million. This coordinated action aims to augment rapidly official sources of capital in light of the abrupt cutoff of private flows following the Mexican financial crisis and the resulting urgent need for balance of payments support. The IMF is providing new funds equivalent to US$2.4 billion and the IDB is matching the Bank's level of additional assistance. These funds are to be provided as part of a strong program of fiscal strengthening that the Government had - 25 - already announced in the aftermath of Mexico and has further reinforced in the context of the Fund program. 59. In the framework of these measures, the Government of Argentina has requested the assistance of the Bank in helping to support its program of banking reform. The Government quickly established a Bank Capitalization Trust Fund to enable it to deal with distressed banks and facilitate acquisitions and mergers in a manner that allows failed or irretrievably weakened banks to exit the system without triggering a systemic crisis of confidence. The Government is committed to financing the BCTF with an amount equal to some US$2.0 billion9'. As part of loan preparation, the Bank has provided advice in the areas of bank restructuring, failure resolution, and deposit insurance. The Government's commitment to designing an improved failure resolution system is also seen in its solicitation of advice from experts in the field and the high priority attached to the establishment of a limited deposit insurance system. The Government continues to value Bank involvement in assessing any future institutional needs of the Superintendency. B. Loan Objectives 60. The purpose of the loan is to provide balance of payments support to the Argentine Republic in the aftermath of the regional crisis that has abruptly curtailed the country's access to foreign capital. The foreign exchange is needed to help reduce the severity of inevitable import compression now underway in Argentina. The country's dependence on official flows has increased dramatically in 1995 and these sources will account for the bulk of capital inflows. 61. At the same time, the loan will support the Government's ambitious program of bank reform. That program has the following principal objectives: (a) to hasten the process of consolidation of a fragmented private banking sector; (b) to improve the financial structure of a distressed banking sector by encouraging acquisitions, mergers, and restructurings; and (c) to contribute to the restoration of confidence in the banking system. C. Loan Description 62. A fast-disbursing fixed rate US dollars single currency loan of US$500 million is proposed. The loan would have a repayment period of up to 15 years; and each 9/ The Government successfully sold US$1.0 billion of domestic and US$1.0 billion of foreign bonds to help finance BCTF. The bonds carry 3 year maturities and are priced over LIBOR. - 26 - semester's disbursements would have a maturity of 12 years from the rate fixing date, including 3 years' grace. The Government of Argentina is eligible for single currency loans as it has no unconverted VLR82 loans. The proposed US$500 million loan represents (35.7 percent) of the FY96 lending program for Argentina of (US$1.4 billion). The loan would disburse in three tranches in accordance with conditions noted in the Policy Matrix (Annex C) and in the subsequent section detailing Loan Conditions. The Borrower is the Argentine Republic and the implementing agencies are the Ministry of Economy and Public Works and Services and the Central Bank of Argentina. Counterpart funds would be made available to the Bank Capitalization Trust Fund and assurances to that effect are reflected in the Loan Agreement. All three tranches would be disbursed in accordance with policy conditions; however, the second and third tranches would also require the achievement of a specified level of US$167 million of eligible Trust Fund recapitalization transactions in accordance with principles agreed between the Government of Argentina and the Bank (Annex F). The Borrower has requested that the loan be a fixed-rate US dollar single currency loan. 63. Counterpart funds will be used by the BCTF for recapitalization and debt refinancing of liabilities in order to render a bank receiving BCTF assistance fully able to meet all prudential capital requirements. Financing will be provided in accordance with principles agreed with the Bank for three possible kinds of transactions: (a) acquisitions by qualified banks of weaker or distressed banks or acquisitions of parts of insolvent banks which have undergone BCRA suspension and procedures of article 35 bis of the LFE; (b) mergers among qualified banks where at least the dominant merger partner is rated "3" on the CAMEL rating or its functional equivalent and has the managerial capacity and capital adequacy to undertake the transaction; or (c) a restructuring of a bank, deemed by the SEF to have fully adequate tier one capital, willing to both match any BCTF subordinated loans dollar-for-dollar with new ownership capital, and follow an institutional development plan to improve its management and operations (Annex Q). 64. Trust Fund loans will be two types: (i) subordinated (convertible) loans of a maturity of at least 5 years in an amount up to 10 percent (in the case of restructurings), 15 percent (in the case of mergers), and 25 percent (in the case of acquisitions of the risk-weighted assets involved in the transaction, all or part of which will constitute tier two capital; and (b) secured loans of up to 3 years maturity of an amount not to exceed the outstanding rediscounts and advances to the distressed bank from or on behalf of the Central Bank. The recapitalization limits are set to provide greater incentives for consolidation transactions. In addition, an overall cap of 10 percent of total BCTF resources has been set on financing of restructurings. 65. The Operating Principles place ex-ante restrictions on the financial conditions of banks to be assisted by the Fund in the context of acquisitions, mergers, or restructurings (see para. 55). However, regardless of transaction, however all banks receiving BCTF assistance must fully meet prudential capital and other BCRA - 27 - requirements. The Government has agreed that any forbearance granted to a bank will be extremely limited and time-bound and will not relate to capital adequacy. Audits are required for all transactions (see Annex K on Argentina is generally accepted accounting principles); the BCRA has already instituted a system for selecting external auditors for all suspended banks. The Trust Fund is expected to denominate its loans in US dollars, charging a rate which corresponds to its borrowing costs plus a spread to cover the operational costs of the Trust Fund. 66. Potential demand for financing of acquisitions/mergers is difficult to predict. At the peak of the crisis, some 80 private financial institutions (banks, finance companies, and savings and loan associations) with assets valued at US$14 billion were recipients of extraordinary liquidity assistance and many of these are still candidates for recapitalization, acquisition or merger. On the basis of data received from the Central Bank, and using the assumptions described in more detail in Annex M, the banking sector's potential demand for funds is estimated to be in the range of US$2.0 to 2.5 billion. This includes about US$1.6 billion of refinancing of Central Bank advances as well as US$350 to 870 million to meet identified or potential capital or provisioning shortfalls. For only those banks currently being assisted by the BCRA, total potential demand for financing is more likely to be in the US$1.8 to 2.1 billion range, using conservative estimates. Some of this demand--the tier one equity requirements--could be met by the acquiring banks themselves. Trust Fund resources are authorized to total US$2.0 billion, reflecting the proceeds of domestic and foreign bond that will be in place by July 1995 (the "Argentina bonds" placed among domestic and foreign investors), and the proceeds of the proposed Bank loan of US$500 million. Thus, the Bank would provide a maximum 20 percent of Trust Fund resources. 67. Any transaction not meeting the agreed rules and procedures of the BCTF would be subject to the Bank's prior review, as to its consistency with the objectives of the program. At the time of second and third tranche release, the Bank would make an assessment of whether those transactions that have not met the agreed rules and procedures undermine achievement of the objectives of the program. Such transactions would not be included in the amounts required for release of the second and third tranches (para. 72(b)) and are subject to limitation. 68. A central tenet of the proposed operation is SEF's progress on bank supervision, as part of the Government's program of financial sector strengthening and reform (described in the Government's Letter of Development Policy in Annex R). Further progress in bank supervision will be monitored on the basis of a diagnostic review and development plan to be agreed with the Government before release of the second tranche. The development plan will focus on supervision policy, the supervision process, regulatory reports, off-site supervision, and human resources development. Satisfactory performance with respect to the agreed action plan will be a condition of third tranche release. In addition, a loan condition provides for Central Bank implementation of enhanced surveillance standards, including full on-site inspections of - 28 - banks on an annual basis for the larger institutions and every 18 months for foreign and small banks, monthly off-site surveillance of all banks, and at least continuous monitoring of banks receiving extraordinary liquidity assistance from the Central Bank. Finally, under the operating procedures governing BCTF assistance, assisted banks with a BCRA rating of 3 will be subject to enhanced surveillance, including full bi- annual inspections that include an assessment of progress with respect to their development and restructuring programs. 69. The Bank needs to closely monitor the impact of the bank crisis resolution mechanism on the overall health of the banking system. Under current policies, the Central Bank should limit forbearance of capital requirements and should refrain from renewals of extraordinary liquidity assistance. Under the proposed condition, the Bank would review the capital position of commercial banks and the extension of Central Bank liquidity loans and determine whether the Central Bank's failure resolution policies are being effectively implemented. A positive review would be required for release of the loan's second and third tranches (para. 72(e)) D. Loan Conditions 70. Signature of a Letter of Development Policy (see Annex R) would be a Board condition. As detailed in the Policy Matrix (Annex C), release of all three tranches would be subject to compliance with the following conditions: (a) maintenance of sound macroeconomic policies that are consistent with and comply with the policy objectives and programs as described in the Letter of Development Policy (Annex R); and (b) continued adherence to a program of financial sector strengthening and reform, as described in the Letter of Development Policy (Annex R). 71. The following actions will need to be taken for loan effectiveness: (a) the Operating Principles and Procedures of the Fund, agreed with the Bank, have become effective and have been used for at least one eligible transaction; (b) at least US$167 million has been provided to the Trust Fund; (c) the Central Bank is implementing its crisis resolution procedures in accordance with recent changes in its Charter, program objectives, and policies described in the Letter of Development Policy (Annex R); and (d) the enhanced surveillance and inspection schedule is in effect. - 29 - 72. For Second and Third Tranche releases, the following additional conditions will apply: (a) the Trust Fund is operating in accordance with the agreed Operating Principles and Procedures, and the Bank is satisfied on the basis of an evaluation of transactions that its objectives are being achieved; (b) The Trust Fund has received adequate funding to carry out its mission, and its resources amount to no less than US$501 million (second tranche) and US$834 million (third tranche); (c) the Trust Fund will have issued subordinated debt instruments, as defined in para. 64, in an amount of at least US$167 million in the context of eligible transactions, and these transactions will have been deemed satisfactory according to agreed performance benchmarks (Box B), subject to the agreed maxima per transaction for the purpose of tranche release calculation (Box C); (d) No more than 10 percent of BCTF resources received will have been used for eligible restructuring transactions and the exceptions limit will have been enforced; (e) the Bank has received an acceptable annual financial audit review of the Trust Fund; (f) the Deposit Insurance scheme is receiving contributions as required and is functioning as designed; (g) the BCRA continues to satisfactorily implement its crisis resolution procedures (in accordance with relevant provisions of its charter, the reforms of the Law of Financial Entities and relevant decrees, as described in Annex L) in the judgment of the Bank on the basis of information provided on outstanding liquidity lines, forbearance of any prudential regulations, and suspensions and banks subject to provisions 35 bis of the LFE; (h) enhanced surveillance and inspection procedures as defined in para. 68 are being maintained and a report acceptable to the Bank has been submitted indicating the profile of Bank classification and implementation of agreed inspection schedules; (i) for second tranche release, the BCRA will have agreed on an Action Plan for the SEF based on a joint assessment with the Bank, and for - 30 - third tranche, satisfactory progress will have been made in implementing that Plan. BOX B EX-POST REVIEW BENCHMARKS (Applicable to Transactions under Trust Fund Support) SATISFACTORY RESOLUTION UNSATISFACTORY RESOLUTION I. A. BCRA certifies that bank meets I. Bank does not meet capital adequacy normal capital and liquidity and liquidity requirements and continues requirements. to receive forbearance on these requirements six months after transaction. B. Last full inspection performed according to agreed schedule. II. Bank is receiving any extraordinary liquidity assistance from BCRA. C. Bank has not received extraordinary assistance from the III. Bank has not been subject to a full Central Bank. inspection according to schedule. II. Bank has been placed under procedures of Article 35b of Law of Financial Entities. BOX C TRANSACTION CALCULATION FOR PURPOSE OF SECOND AND THRD TRANCHE RELEASE MAXIMUM MAXIMUM CREDIT PER CREDIT PER TRANSACTION TYPE TRANSACTION TYPE PER TRANCHE Acquisition $60 million No limit Merger $40 million No limit Restructuring $20 million $60 million * In reaching a level of $167 million, all transaction must meet all benchmark performance criteria noted in Box B. * In lieu of transaction, the Government may request the substitution of up of $50 million (total) in loans to the Deposit Insurance Fund, if, in its judgment, that improves the crisis resolution capacity of the system (see Annex 0 on the details of the pay-in schedule). - 31 - E. Disbursement, Procurement, Accounting, and Auditing 73. The loan proceeds would be used to finance the CIF cost of general imports, except those on the Bank's standard negative list. The following procedures will be apply to procure these imports: (i) goods (and associated services) imported by public and private sector entities and valued at US$10 million equivalent or more per contract would be procured using simplified ICB procedures, employing Bank-issued standard bidding documents. Contracts above this threshold would be subject to the Bank's prior review; (ii) imports valued at less than US$10 million equivalent per contract would be procured (a) by public sector entities in accordance with the applicable public procurement procedures and (b) by private sector entities, in accordance with established commercial practices. These procedures and practices have been reviewed and found acceptable by the Bank. Retroactive financing would be allowed for goods (and associated services) imported up to four months prior to loan signing, up to a maximum of US$100 million. 74. Counterpart funds are to be used by the Trust Fund (as described in paras. 62 and 62) to finance eligible transactions in accordance with agreed procedures. Transactions will be considered eligible once the Government has accepted and put into effect the Operating Principles and Procedures (Annex F). 75. Calculations based on reasonable assumptions as to the speed and cost of the anticipated transactions are consistent with the disbursement of the second tranche by July 1996 and the third tranche a year later, although the volume of transactions could well be more rapid. The first tranche is expected to be disbursed upon effectiveness of the loan. Disbursement of the second and third tranches will require, inter alia, the execution of US$167 million in eligible transactions under the Trust Fund, as defined in the loan agreement and in Annex F. 76. The Central Bank will submit disbursement applications to the Bank and will maintain separate records and accounts. Disbursement requests will be based on customs certificates, a procedure which was reviewed by the Bank and found to be satisfactory. Withdrawal applications documented by customs certificates will be made against Statements of Expenditures (SOEs) for contracts above US$10,000 but below US$10 million. 77. An audit report on the import documentation submitted, to be carried out by independent auditors acceptable to the Bank, would be contracted within 30 days and submitted to the Bank within 60 days after disbursement of each tranche. Audit reports would give an opinion with respect to SOEs prepared by the Central Bank. Receipt of a satisfactory audit report of the prior tranche would be a condition of subsequent tranche release. The loan Closing Date would be D.ecember 31, 1997. - 32 - F. Loan Supervision 78. Loan supervision will follow the principles of the Bank's new supervision strategy, with appropriate use of resources in the field. Loan supervision will take the form of monitoring Argentina's new system of supervision and distress resolution for the private banking system. In addition to an ex- post review of Trust Fund transaction, for purposes of tranche release, annual audit reviews of the Trust Fund's operations are required. Close contact will be maintained with the Federal Reserve Bank of New York, which is providing technical assistance to the Superintendency of Banks in the areas of supervision and prudential regulation. The Bank and the government will retain the option to either redesign or augment the existing Technical Assistance Loan for Capital Markets Development (Loan 3710-AR), should the need for additional technical assistance become necessary (see para. 68). Loan supervision will include review of the policies and operations of the Central Bank as they affect the use of the proceeds of the loan. Detailed reporting requirements have been established to enable the Bank to effectively supervise this project. G. Risks, Benefits, and Social and Environmental Impacts Risks 79. The principal risk to the operation remains macroeconomic, insofar as the economic situation in Mexico, and Latin America more generally, remains unsettled and the Argentine economy continues to be vulnerable. This could result in a further loss of confidence, a deeper economic crisis, and a renewal of deposit flight. Insofar as this risk is embedded in regional risk, it cannot be mitigated by changes in the proposed program; however, to the extent that the financial sector can be strengthened by recently announced government measures, including a stronger failure resolution mechanism and the introduction of limited deposit insurance, that risk can and has been effectively lowered. Macroeconomic risks have been reduced by the adoption of a very strong fiscal program, aimed at producing a sizeable surplus this year, and by continued prudent and effective economic management. 80. Several risks nevertheless remain. The first is that recent improvements in the quality of supervision would not be sustained. The quality and timeliness of supervision are central to the early identification of distressed banks and to judgments that need to be made on the quality of bank management. Recent supervisory policy changes are encouraging, but implementation of these reforms must be effectively maintained. Second, closure/liquidation needs to remain a credible option and the BCRA must use its new powers of Article 35 bis of the LFE to deal with insolvency. Although there is the risk that political considerations will impede regulators, this has not proven to be the case with recent bank suspensions. A third risk is that the Trust Fund's loans will not be repaid, namely, that transactions eventually fail, and the Government is forced to bear an additional fiscal burden. Strict Trust Fund rules - 33 - mitigate but do not eliminate this risk. At a maximum, the potential fiscal burden of the Fund is less than 1 percent of GDP. Another risk is that the Trust Fund would either run out of funds or suffer a maturity mismatch on its subordinated debt if those loans total more than the Bank loan. In either event, Government must be prepared to either secure additional official financing or seek further international bond financing. A final risk of the operation is that the process of bank closures and acquisitions will result in a further loss of confidence, but this risk must be borne if the system is to be worked out. Benefits 81. The program supports an improved mechanism for resolving the condition of distressed banks. This mechanism has been designed by the Argentine Government, with material input from discussions with Bank staff in the course of project preparation. Specifically, the operating rules of the Trust Fund were determined and agreed through these discussions. In addition, tranche release conditions refer to the adequacy of liquidity policy (within the constraints imposed by the Convertibility Law), bank supervision, and funding of deposit insurance. These agreements will strengthen implementation of the Government's bank distress resolution policies. 82. It is expected that the banking system will be stronger as a result of the program. The key forces to achieve this result include the further consolidation of Argentina's fragmented banking system and stronger surveillance and enforcement of prudential regulations. Although the banking system will not be fully protected against future shocks--an inherent risk of the convertibility system--the policies introduced by the Government provide for quicker and more effective Central Bank intervention to handle failing banks and minimize their adverse impact on confidence. 83. In sum, the program benefits include the restoration of confidence in the private banking sector, which has been badly battered by the events following the Mexico crisis and massive outflow of deposits. While the situation has now stabilized, many banks are in financial difficulty and the Trust Fund operation that the project helps finance offers, along with the new powers granted the BCRA to dismantle and send banks for liquidation, a viable approach to insolvency. Moreover, as the Trust will effectively broker mergers and acquisitions to remove weak or insolvent banks from the system, a more orderly consolidation process can be managed. As part of the debt restructuring of acquired bank liabilities, the Central Bank will be repaid its overdue loans, which is important for the health of the BCRA and its normal operations. The new failure resolution approach being adopted by the Government, and continuation of recent significant improvements in supervision are important issues associated with this project. The ultimate aim is a stronger and more efficient banking sector. 84. Finally, the project will have a financial benefit to Argentina. Argentina expects the US dollar single currency loan terms to facilitate improved debt - 34 - management and the fixed interest rate to protect against possible market interest rate increases after the loan is fully disbursed. Social Impact 85. The most likely social cost of consolidation of the banking system is a short term loss in employment. Most employment losses during 1991 to 1994 took place in public banks, as these banks downsized, restructured or privatized. In contrast, employment in private banks increased during the same period, and increased resource mobilization expanded the banking business. With the slowdown in the growth of deposits and the resulting consolidation of private banks, some short term employment losses can be anticipated. These losses come at a time of a downturn in aggregate economic activity and sluggish overall employment growth, and highlight the importance of the Government's social safety net program being supported by a parallel Bank operation. Environmental Impact 86. There are no expected environmental impacts associated with this project. IV. RECOMMENDATION 87. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and would be consistent with the approved guidelines for Bank support. I recommend that the Executive Directors approve it. James D. Wolfensohn President Attachments Washington, D.C. June 29, 1995 - 35 - ANNEX A THE STATUS OF BANK GROUP OPERATIONS IN ARGENTINA STATEMENT OF BANK LOANS (as of March 31. 1995) (US$ million) Loan Ficsd AMOUNT (loss UNOISSURSED Number Year Borrowor Purpose cancellations) Fully disbursed loans (421 5,033.3 0.0 of which SALISECAUDebt Reduction loans: 2676 1 986 Argentine Agriulture Sector 350 0 2815 1987 Argentin Trade Policy 496.0 2996 1989 Argentinr Trad Police 11 300.0 3291 1991 Argentina Public Enterprics Reform 300.0 3394 1992 Argentina Public Sector Reform 325.0 3555 1993 Argntino 00SR Support 460.0 3558 1993 Argentina Finncial Sector Adjustment 400.0 2641 1986 Argentina Water Supply 44.8 8.5 2864 1987 Argenti Power Oiatribution 276.0 84.9 2920 1988 Argentina Municipal Development 120.0 10.1 2984 1989 Argentina Social Sector 28.0 0.1 3280 1991 Argentina Provincial Development 200.0 141.1 3281 1991 Argentina Wate Supply 100.0 92.8 3292 t991 Argentina PEREL 23.0 1.3 3297 1991 Argentina Agricultural Services 33.5 13.9 3342 1991 Argentina Pub Sectr Reform T.A. 23.0 7.9 3460 1992 Argentina Tax Administration II 20.0 4.6 3520 1993 Argentina Yacyruta II 300.0 28.1 3521 1993,, Argentina Flood Rehab 170.0 62.7 0369 1993 Argentind Pub EntapriAe Rof II 300.0 0.03 3611 1993 Argentina Road Maintenance & Rehab 340.0 245.68 3643 1994 Argentina Matel & Child Health 100.0 86.4 3709 11 1994 Argentina Capitl Markets 600.0 500.0 3710 1994 Argentina Capital Markets TA 8.5 7.8 3794 21 1995 Argentina Secondary Education I 190.0 190.0 *383d 1996 Airdea Provincial Reform 300.0 240.0 3860 2t 1996 Argentina Municipal Development I 210.0 210.0 TOTAL 8,320.0 ot which has boen repaid 2481 .8 TOTAL NOW OUTSTANDING 6,838.2 AMOUNT SOLD 12.8 of which has been repaid 12.8 TOTAL NOW HELD BY BANK AND IDA 6,825.4 TOTAL UNDISBURSED 1 936 0 *1bi SECAL. SAL or O et Reduedon Loan It Not yet effective 2t Not yet signed. IOApr-BS - 36 - STATEMENT OF IFC INVESTMENTSANEB as a March 31, 1995 (USS Millions) Oniginr l Gross Cormmitme-nts Hold Hold by Undisbursd FistI Year IFC If C Partiai- t7y Parttici- (Ineluding Committe Obligor Type at Business Loan Equity pants- Tobta IFC pasf Pwrticip-nts; 1 9o(lgs Acindar S.A. Steel Products 27S94 - 20.73 48.57 25.00 _ 5.sa t 960 ai Papolbra Rio Parana S.A. Pulp and Pacer 3.00 _ _ 3.00 _ _ 1961 a/ Fad sS.A. Motor Veh. & Accessories 1.23 - 0.28 1.50 1982 a/ Pasa SAIC Petrochemicals 3.C5 - _ 3.CS - - 1965n2 ai Colulosa Argentina Pulp anas Paper 8.25 - 4.25 t 2.50 I 989 a/ EditoralCodexS.A. Prinbng and Publishing 5.00 1.o0 0540 7.00 - -- I 9eWi7 al Daimirn Siderea SAIC (ran anoSteei 14.75 - 2.25 i7.00 1971/73 a/ Calera Avelan da S.A. Cement 5.50 - - 5.50 t197'7/8418ttl88 Alp rgatas SAIC Textiles anti Shoes 62.93 5 C0 38.50 1 C4.4.3 34.22 29.00 1977185 a/ Soy-xS.A. Food and Food Process 21.00 - _ 21.00 1978/81/lSV/87193/94 Juan Minotb S.A. Cement 54.00 _ 67.50 t115 50 9.51 9.29 1978/85/87188S19 ar MassuhSA. Pulp and Papwr 25o85 5.25 3-00 32.90 19791SVJS7192 a/lIpakoS.A. Petroehemicals 21.00 1.15 9.00 31.15 19791S31S4 al Alpssea S-A Food &Food Proceass 5.20 1.51 - e.81 1984/88 Petroquimica Cuyo SA. Chmricals &Petrochem. 21.00 4.00 21.09 48609 3;52 4.25 1986 a/ AtanorS.A. Chemicals 7.00 1.00 - 3.00 I 986 Pop..Sadie r CaprtalMarkets - 0.05 _ 0.05 0.05 19aoJS7 Sadicar Capita lMarkets - 2.00 - 2.00 0.43 19Soa ROB-Cattorini Genea r tanutacturing - - - a.00 0.1Sa - I 9Se ROB-Benvenuto Food &agribusiness - - _ 0.0 - - I 9ft R0OB-eBoldt Timber. pulp &Paper - - - 0.00 - - - 19gSt ROB-CIave Plast General manufacturing - - - 0.00 I19So ROB-Cuyo Genwa manufacturing - - - 0.0 - - 1988 ROIB-GaverSante Industrr41 services - - - 00 , gae ROB-Klaukol Cement - - - 0.0 zo- 1 988 ROB-Labalcor Food a agrnbusines - - _ 0.0 - - t986 R0O3-Longvie Genrwa manutacturmng - - - 0.00 0.90 1986 ROIB-Pilar General manufacturing - - - 0.00 0.19 I 986 RO8-SudaLm ricana Industrisli equipment - - - 0.00 0.21 I 988 ROB-St.Ursula Food &argribusiness - - _ 0.0 - - 198a ROB-Stani Food &agribusin*ss - - - eoo - - I 986 ROB-Tags Industral servires - - _ 0.00 1 980 R08-D4rio 7Tmber. pulp & paxper - - _ 0.00 0 09 - - 1988 ROIB-Piedra Mining - - -
Группа Всемирного банка · President's Report
Argentina - Bank Reform Loan Project
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