Argentina - Financial Sector Adjustment Loan

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 15461 IMPLEMENTATION COMPLETION REPORT ARGENTINA FINANCIAL SECTOR ADJUSTMENT LOAN (LOAN 3558-AR) MARCH 19, 1996 Public Sector Modernization and Private Sector Development Division Country Department I Latin America and the Caribbean Regional Office This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY UNIT - Peso 1991 (Since April 1) 1.00 = US$1.00 1992 1.00 = US$1.00 1993 1.00 = US$1.00 1994 1.00 US$1.00 1995 1.00 = US$1.00 FISCAL YEAR January 1 - December 31  FOR OFFICIAL USE ONLY Principal Abbreviations and Acronyms AFJP Administradores de Fondos de Jubilaciones y Pensiones - Pension Fund Administrators BANADE Banco Nacional de Desarrollo - National Development Bank BCRA Banco Central de la Republica Argentina - Argentine Central Bank BHN Banco Hipotecario Nacional - National Housing Bank BNA Banco de la Nacion Argentina - Argentine National Commercial Bank BPBA Banco de la Provincia de Buenos Aires - Bank of the Province ofBuenos Aires CAJA Caja Nacional de Ahorro y Seguro - National Savings and Insurance Bank CNV Conision Nacional de Valores - National Securities Commission DDSR - Debt and Debt Service Reduction DGI Direccion General de Impuestos - National Tax Authority EFF - Extended Fund Facility ESW - Economic and Sector Work FONAVI Fondo Nacional de la Vivienda - National Housing Fund FSAL -Financial Sector Adjustment Loan GDP - Gross Domestic Product IDB - Inter-American Development Bank IFC - International Finance Corporation IMF - International Monetary Fund LIBOR - London Interbank Offered Rate PE - Public Enterprise PERAL - Public Enterprise Reform Adjustment Loan PEREL - Public Enterprise Reform Execution Loan PSRL - Public Sector Reform Loan PSRTAL - Public Sector Reform technical Assistance Loan SECAL - Sector Adjustment Loan SEF Superintendencia de Entidades Financieras - Superintendency of Banks SSMTAL - Social Sector Management Technical Assistance Loan VAT - Value Added Tax This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents mnay not otherwise be disclosed wiLhout World Bank authorization.   FOR OFFICIAL USE ONLY Table of Contents Page No. Preface ............................................... i Evaluation Summary ............................................... ii PART I. Program Implementation Assessment ............................................... I A. Background ...1............................................ B. 1993-94 Performance .............................1.................. C. The Mexico Crisis ............................. 2 D. Program Objectives: Design and Evaluation .................................. 3 E. Achievement of Objectives ............................................... 6 F. Major Factors Affecting the Project . . ............................................. 8 G. Bank Performance ............................................... 8 H. Borrower Performance ............................................... 9 I. Program Sustainability, Assessment of Outcome and Assessment of Outcome ............................. 9 Key Lessons Learned ............................. 9 PART II. Statistical Annex ..1.............................................. PART III. Comments by Borrower and Co-financier ....................................... 20   i IMPLEMENTATION COMPLETION REPORT ARGENTINA FINANCIAL SECTOR ADJUSTMENT LOAN (Loan 3558-AR) Preface 1. This is the Implementation Completion Report (ICR) for the Financial Sector Adjustment Program in Argentina, for which Loan 3558-AR in the amount of US$400 million equivalent was approved on February 16, 1993 and made effective on the same day, a remarkable signal of borrower ownership. The responsible Division Chief and Taskmanager were Messrs. Paul Meo and Stefan Alber, respectively. 2. The loan was fully disbursed about 15 months ahead of the original Closing Date of December 31, 1995. The first tranche was disbursed in March 1993, the second in December 1993, and the third in September 1994. Cofinancing for the project was furnished by the Export-Import Bank of Japan in an amount of US$200 million equivalent. 3. The ICR was prepared by the Public Sector Modernization and Private Sector Development Division and was reviewed by Mr. Orville Grimes, Project Adviser. The borrower and cofinancier provided comments which have been incorporated into the ICR and are reproduced (unedited) in Part III. This ICR is based on file material and on perspectives gained from our continuing involvement in financial sector operations.  I  ii IMPLEMENTATION COMPLETION REPORT ARGENTINA FINANCIAL SECTOR ADJUSTMENT LOAN (Loan No. 3558-AR) Evaluation Summary Introduction 1. This Financial Sector Adjustment Loan (FSAL) was timed to provide another building block in support of Argentina's ambitious structural reform program, which had been launched by the Menem Administration in the early 1990s. The Bank's assistance for structural reforms was built on extensive sectoral studies published as the following reports: Banking Sector Report (1986); Social Sector in Crisis (1988); Tax Policy for Stabilization (1989); Financial Sector Review (1989); Reforms for Price Stability and Growth (1989); Provincial Government Finance (1990); Argentina: Towards a New Federalism (1992); Finance Review (1993), and other sectoral studies of agriculture, industry, energy, transportation, and water services. Reform implementation was then reinforced by a substantial rise in Bank lending such as: Trade Policy Loans in 1987 and 1989; Provincial development and adjustment loans (1990 and 1995); Public Enterprises Reform Adjustment Loans I and II in 1991 and 1993; a Public Sector Reform Loan in 1992; a Debt and Debt Service Reduction Loan in 1993; and a Capital Markets Loan (1994). Further, a series of technical assistance loans complemented adjustment lending and provided continued analytical underpinnings to reforms (for all related loans - see Table 2). Program Objectives 2. The FSAL was designed to consolidate and advance the progress in reforming the financial sector. The success of prior macro and sectoral reforms was predicated on the recovery of private sector investments for which resource mobilization by the banking system represented a major constraint. Decades of high inflation had shrunk the private banking system while encouraging a greater presence of public banks, both federal and provincial. With the strengthened macroeconomic framework, private firms were expanding investments and the FSAL was expected to stimulate the private banking system to increase resource mobilization. Finally, the FSAL was timed to coincide and support Argentina's "Brady Deal," its debt and debt service reduction arrangements.  iii 3. The FSAL's specific objectives were to: (i) reduce the role of the state in the financial sector; (ii) strengthen the banking sector and its supervisory framework; and (iii) provide resources for Argentina's debt and debt service reduction arrangements. To achieve these objectives, the Loan Agreement and Letter of Development Policy required the maintenance of a macroeconomic policy framework consistent with the objectives of the FSAL, and satisfactory progress in carrying out agreed actions described in Part I of Schedule 5 (Second Tranche disbursement conditions) and in Part II of Schedule 5 (Third Tranche disbursement conditions) before each tranche release. Reform progress was predicated on steps already taken in the areas of monetary reform, the new Central Bank charter and restructuring, supervision and regulation of banks, and restructuring of public federal and provincial banks. Implementation Experience and Performance 4. The FSAL's thrust was to bring about major restructuring or closure of the four large federal public banks: the Argentine National Commercial Bank (Banco de la Nacion-BNA), the National Development Bank (Banco Nacional de Desarrollo - BANADE), the National Housing Bank (Banco Hipotecario Nacional - BHN) and the National Savings and Insurance Bank (Caja Nacional de Ahorro y Seguro - CAJA). This was fully achieved. Other FSAL objectives of continuing reforms in the Central Bank, the Superintendency of Banks and provincial banks were also met in a timely manner and the final, third tranche was disbursed on September 2, 1994, well ahead of the original Closing Date of December 31, 1995. Given the progress of institutional strengthening, Argentina's banking system was in a stronger position to withstand and recover from the sharp 1995 shock to its banking system brought about by the Mexican crisis. 5. Furthermore, the "Brady deal" supported by the FSAL, as well as Argentina's major reforms, contributed during 1993 and 1994 to consolidating Argentina's return to foreign credit markets and the subsequent inflows of foreign private financing. 6. The FSAL was designed around reform actions that could be easily monitored. Bank performance and fast-track processing benefited from intensive previous sector work in Argentina, especially in the restructuring of the Central Bank and the major federal public banks. With respect to disbursements, the Bank required the auditing and control procedures on import documentation and debt documents in keeping with Bank guidelines. 7. The borrower was strongly committed to FSAL reforms throughout loan implementation and complied in a satisfactory manner with all loan conditions.  iv Sustainability and Assessment of Outcome 8. The overall outcome of the FSAL is satisfactory as attested by the implementation experience and performance. The major question concerns the longer-term sustainability of an ancillary aspect, namely, a reduced public sector role in deposit insurance and liquidity financing given the financial sector's vulnerability to sudden and abrupt shifts of confidence, a risk clearly discussed in the Memorandum of the President. The 1995 Mexico crisis brought about a sharp drop of confidence, prompting massive deposit withdrawals (especially in weaker private and provincial banks), stretching the capacity of banking supervision and exposing the lender-of-last-resort capacity of the Central Bank under Argentina's Convertibility Plan. However, given the progress of institutional reforms and of banking supervision, the banking and financial sector was better able to weather the crisis and is now well on its way to a recovery. While the Bank and the IMF had tried to encourage more provincial bank reforms when preparing the FSAL--such as more forceful actions by the Superintendency of Banks--the political will had not sufficiently matured at the time of loan preparation. The Mexican crisis quickly turned many provincial banks from financial sources into obligations; this caused provincial governments to forcefully seek Bank support for the privatization of as many as twenty of their banks. A new loan to support this effort (Provincial Bank Privatization, Loan 3878-AR) was approved in May 1995. While the restructuring of federal public banks and Central Bank/Superintendency institutional improvements are unlikely to be reversed in the medium-term, there are ancillary FSAL areas in which the public sector has modified its position and increased its role, such as on deposit insurance and financial assistance by public financial institutions. With Bank assistance, another Trust Fund was created to promote the consolidation of the banking system (Bank Reform Loan, 3926-AR). Lessons Learned 9. The main lesson of the FSAL concerns the value of an early beginning of a policy dialogue on financial sector reforms, of deepening the understanding of policy options and of systematic opinion-building towards a substantial consensus on remedial actions. 10. The second lesson concerns the importance of a continuing and long- standing working relationship with national authorities. The Bank's credibility resulted in quick and substantial agreements on historic institutional changes such as major public bank restructuring, BCRA strengthening, modernization of banking supervision and following-through with Basle-type norms on capital adequacy and loan portfolio classification and provisioning.  v 11. A third important lesson for future operations is that sustainability' of an objective of a reduced public role, such as in areas of deposit insurance and liquidity assistance to the banking system, is not assured despite initial government commitment, in cases where systemic risks threaten the banking system. 12. The fourth lesson is one learned many times before. Adjustment loans should measure reform progress by focusing only on a limited high priority set of actions to which the Government is firmly committed. Fortunately, the FSAL was so focused. 1 Sustainability concerns the probability of a project maintaining the achievements generated in relation to its major objectives. In evaluating sustainability as likely, unlikely, or uncertain, major factors, such as the following, should be taken into account: borrower commitment, policy environment, institution management effectiveness, economic, technical, financial and environmental viability, social impact, local participation and incentives for participants to sustain the project.  -T ' IMPLEMENTATION COMPLETION REPORT ARGENTINA FINANCIAL SECTOR ADJUSTMENT LOAN I. PROGRAM IMPLEMENTATION ASSESSMENT A. Background 1. More than 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 and 1.6 percent in 1995. Output and productivity increases were remarkable until 1995, with annual Gross Domestic Product (GDP) growth averaging 7.7 percent. The GDP fell by an estimated 3.7 percent in 1995 but positive growth is expected to resume in 1996. 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. Economic restructuring with a rigid labor market, however, has resulted in increased unemployment, currently about 16 percent. To deal with problems caused by an initially overvalued exchange rate, the Government has launched a number of microeconomic reforms, particularly in labor legislation, with the aim of reducing labor costs and increasing productivity. 2. The Convertibility Plan was part of a comprehensive reform program at the national level including reforms of the state and financial institutions, privatization, and extensive market liberalization. Central to the Plan was the conversion of the Central Bank into a quasi-currency board; the Argentine peso was linked at par to the US dollar. While fiscal adjustment has occurred at the federal level, provincial fiscal deficits persist, mainly because of the continued inability of 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. B. 1993-94 Performance 3. 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 percent 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  2 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 until 1995. 4. 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. C. The Mexico Crisis 5. Argentina was particularly vulnerable to the events following the surprise Mexican devaluation of December 1994, 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. Indeed, Argentina did not escape the "Tequila" effect; its stock and bond markets suffered precipitous losses, and the Central Bank lost more than US$5 billion of its reserves between December 1994 and end March 1995. 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, a quasi-currency board since 1991, was rigorously constrained in its ability to provide liquidity. 6. With promptness of action--and IMF, IDB and IBRD assistance, the latter providing two new US$500 million adjustment loans supporting provincial bank privatization and private bank consolidation--the banking crisis has subsided and the economy now appears poised for a recovery. Central Bank liquidity lines are  3 now being repaid, the situation of failing banks is being addressed, deposits in the banking system and international reserve levels have reached pre-crisis levels, and the stock market has recovered from its 1995 losses. D. Program Objectives: Design and Evaluation 7. Back in 1993, the FSAL's general objective was to extend Argentina's massive structural reform program to the financial sector. Prior to the FSAL, actual financial sector reforms had progressed only sporadically and partially. While the Bank had strongly encouraged reform in prior years in the context of loan supervision and sector work, the actual restructuring of BNA, BANADE and BHN had not advanced significantly. However, the Central Bank charter was modified in the wake of the 1989 Financial Sector Review, and initial institutional modernization including that of the Superintendency of Banks' was then supported by the Public Sector Reform Loan (3394-AR) and the 1992 Public Sector Reform Technical Assistance Loan (Ln-3362-AR). After the FSAL, financial sector assistance continued with the approval of a Capital Markets Loan in 1994 (Ln-3709-AR) and the Provincial Bank Privatization (Ln- 3878-AR) and the Bank Reform Loan (Ln-3926-AR), both approved in mid- 1995. 8. The central focus of the FSAL was to reduce the participation of federal public banks in the banking system, to further strengthen the Central Bank and the regulatory system. Loan conditionality also required a macroeconomic policy framework consistent with the objectives of the Program (Schedule 1, Sections 5/6(c) to the Loan Agreement). The FSAL reforms were considered essential for the mobilization of external and internal resources needed in unprecedented amounts to finance the backlog of deferred investments and the need of privatized enterprises and sectors. Stimulating the recovery of private sector dynamism and private banking system, on which Argentina's future growth depended, was a major aim of the program. 9. The FSAL's specific objectives included: reducing the public sector's role in the financial system; strengthening bank solvency as well as the supervisory framework; and providing resources for Argentina's debt and debt service restructuring with foreign commercial banks. Some key reforms had been initiated before Board presentation of the FSAL: * Monetary Reforms: liberalization of interest rates, elimination of forced investments and directed credit, and implementation of the new BCRA charter; * Regulatory Framework and Supervision: issuance of banking regulations modeled on the Basle regulations for solvency, minimum capital requirements  4 and preparatory steps for the provisioning and new regulations on external audits; The restructuring of public banks: liquidation of BANADE, preparatory steps for the privatization of CAJA; the limitation of BHN to second-tier operations only, BNA's initial downsizing actions and incipient regulatory reforms affecting the provincial bank sector. 10. The prospect of the FSAL caused authorities to break with past in-action and to accelerate public bank restructuring which had been long considered and which had been supported by the Bank's own technical work, as well as by major consulting studies. For instance, BANADE had been seeking restructuring alternatives but concluded on the basis of a major consulting study, and the Bank's persistent advice, that liquidation was the only alternative. The FSAL accelerated appropriate liquidation steps such as drastic staff and branch reductions. Banco Hipotecario had failed as a.first-tier lending institution on account of poor loan quality, and was seeking a revitalization as second-tier bank. The Federal National Mortgage Administration of the United States provided valuable technical assistance in preparing the ground for a credible second-tier institution and an increasing capacity to securetize its lending. Banco Nacion had suffered from excessive bureaucracy and lack of focus in its major services. With the help of a major consulting effdrt, it narrowed its business to those it had a competitive advantage (agriculture and small business), began significant early retirements and streamlined its organization including the upgrading of its banking technology. 11. The Program's specific conditions were described in Part I of Schedule 5 to the Loan Agreement (Second Tranche disbursement conditions) and in Part II of Schedule 5 (Third Tranche disbursement conditions). They required: (i) The Central Bank - to submit a satisfactory audit of its balance sheet and to introduce a new accounting system; (ii) The Superintendency of Banks (SEF) - to produce evidence that it had inspected virtually all banks operating in the country, and had begun enforcing new capital requirements and provisioning norms for all public and private banks as well as required banks to take remedial action when needed; that regulations had been issued strengthening the external audit requirements of financial institutions in line with the new prudential norms issued by SEF; that regular disclosure of accounting statements of financial institutions had been implemented; and that no rediscount had been provided other than for liquidity purposes; (iii) Provincial Banks -The central bank to provide evidence that it had not provided rediscounts, except for liquidity needs, to provincial banks and  5 that these banks had complied with lending limits to the public sector, and also had adhered to new regulations on reserve requirements; (iv) The National Savings and Insurance Bank (CAJA) to sell the majority of voting shares controlled by the Borrower to entities not owned or controlled, directly or indirectly, by the Borrower; (v) The National Housing Bank (BHN) to implement a new lending policy with no first-tier lending and with second-tier lending to be provided at terms that covered borrowing costs, operating expenses and a positive return on capital. BH-N to design and implement financial performance standards. (vi) The Argentina National Commercial Bank (Banco de la Nacion) - to limit its role in the economy and give priority to private sector lending with emphasis on the small- and medium-size productive sector; and, second, to comply with its reform program, including staff reductions; design and adoption of financial efficiency standards; implementation of a rationalization plan; completion of a study reviewing costs and benefits of providing services to the Government (Government Service Study) and provide an action plan to implement the study's recommendations. 12. To meet the needs of Argentina's debt and debt service reduction program, the FSAL's Loan Agreement also provided that the Borrower use a portion of the proceeds of the Loan for the implementation of the Debt Reduction Plan. Schedule 1 established a Category 2 for a set-aside of loan proceeds of up to US$200 million. A reallocation of the set-aside fund was permitted under the Loan Agreement if deemed appropriate. 13. The Bank had worked closely with the International Monetary Fund (IMF) in the design and supervision of the Bank's adjustment operations, in formulating the country assistance strategy and in carrying out economic and sector work. Early in 1992, the Government reached an agreement with the IF on a three-year program under the Extended Fund Facility (EFF). The main feature was for the Government to achieve a primary surplus before privatization of about 2 percent of GDP to meet debt service obligations without recourse to the inflation tax. Fiscal performance under the EFF was satisfactory during 1992-93, but some programmed targets for the fiscal accounts were not met in 1994. The IMF approved an extension to a fourth year of the Extended Facility (EFF) and increased its amount in March 1995. In September 1995, Argentina drew US$383 million and the IMF review of the third 1995 quarter is under way. Bank and Fund staff consulted each other during the preparation of the FSAL and thereafter. The Fund staff, while supportive of the FSAL, requested Bank staff to attempt to reform the weak provincial banks. While Bank staff agreed with the need for provincial bank reforms, the fact that the provinces were the  6 decision-makers in this area, and the national government had limited influence with them at the time, restricted Bank capacity to include more far-reaching reforms. E. Achievement of Objectives 14. Macroeconomic Policies. The FSAL followed a series of adjustment operations geared to solidify the stability of the Argentine economy and eliminate its chronic macroeconomic imbalances. Macroeconomic results of the package of reform programs have been positive. Inflation dropped substantially (only 1.6 percent in 1995), the public sector deficit was drastically reduced and GDP grew up to the end of 1994. This progress was interrupted by the Mexican crisis in 1995, but economic growth is expected to resume in 1996. 15. Sectoral Policies. The FSAL made reforms happen which had been repeatedly and amply discussed within prior sector work and which had been included in prior lending (adjustment and technical assistance loans). The major prior reforms related to the approval of a radically new Charter of the Central Bank (BCRA) which, on one hand, prohibited BCRA from issuing bonds, paying interest on deposits, lending to financial institutions for other than short-term liquidity purposes, and increasing its holding of Treasury obligations by more than 10 percent a year. Also, the Charter required BCRA to strengthen banking supervision and the enforcement of prudential regulations. After much debate, the Charter had not provided for deposit insurance or direct public assistance in liquidating banks (President Report, para. 92 and Letter of Development Policy, para. 5, Deposit Protection). At least up to the end of 1994, the FSAL had accomplished its broader objectives in the financial sector of: (i) reducing the State's role in the financial system; and (ii) strengthening the banking sector's solvency as well as its supervisory framework were accomplished. Up to the end of 1994, the banking system expanded in terms of assets, deposits, loans and asset quality improved as well. 16. Institutional Reforms. Finally, BANADE was closed; CAJA was privatized; BNA limited its role in the economy and emphasized lending to small- and medium-size private firms; BHN abandoned first-tier operations; and BCRA's operations were strengthened as well. These are significant accomplishments. However, the reduced public sector role in deposit insurance and of BCRA liquidity financing had to be reversed in view of the 1995 banking crisis. The Central Bank provided in 1995 about US$1.6 billion in increased liquidity financing to private and public banks. Also two new government-run Trust Funds were established to assist with the restructuring of provincial and private banks with a targeted capitalization of up to US$3.75 billion and partially financed by two new Bank loans for a total of US$1 billion.  7 17. With respect to the objective of strengthening the banking sector's solvency and the banking supervisory capacity, institutional development has progressed significantly. The Superintendency engaged in a major overhaul and institutional upgrading. Several senior managers were hired, several hundred new inspectors were recruited and trained and supervision policies modemized. Also, the regulatory framework was further enhanced by placing restrictions on affiliated lending and on total lending to any single borrower. Also, reporting requirements were modified for banks to deliver reports on a consolidated basis. While the banks' liquidity has suffered from the Mexican crisis and the consequent massive withdrawal of deposits, Government actions (deposit guarantees, support of consolidations, mergers and liquidations) have been successful in returning the system to pre-crisis levels. The quality of supervision of banks (President's Report, para. 92 and Letter of Development Policy, para. 5, on the Superintendency of Financial Institutions) is much improved with a stronger organization as well as with an improved regulatory system. Indeed, were it not for the 1993/94 actions, training, and institutional strengthening, the Argentine bank supervisory system would very likely not have been able to handle the 1995 crisis. 18. The 1995 banking crisis prompted a major consolidation in the banking system. Thirty-four banks were either absorbed by other banks or liquidated. The total number of banks fell by about 20%, to 134, as of September 1995. The major consolidation took place in the cooperative sector with a reduction of 28 cooperative banks or 74%. The newly formed Bank Consolidation Trust Fund provided financial support for about 13 bank consolidation transactions. Given the pressures of global competition, improvements in banking technology, further consolidations are likely but may take time to materialize. 19. Provincial banks. The limited objectives of complying with the tighter regulations on public sector lending, repayments to BCRA and reserve requirements were achieved. It took the massive liquidity crisis, in the aftermath of Mexico, to overcome earlier political resistance and prompt stronger reforms. The fiscal distress of the provinces, combined with the growing distress of provincial banks, finally forced provincial governments to seek urgent World Bank assistance for their bank's privatization. The privatization of eight provincial banks is now underway, with four privatizations completed and one bank closure finalized. 20. Restructuring of the External Debt. This was an important sub- objective of the loan. A set aside of up to US$200 million in support of the DDSR package with foreign commercial banks was provided under the Loan. This was in addition to a Debt and Debt Service Reduction Loan (1993) for US$450 million. Under the agreement with the commercial banks, all eligible commercial bank debt was restructured; about one-half of Argentina's total public  8 extemal debt. Of the FSAL funds, eventually only US$85 million of the US$200 million were needed to meet the financial requirements of the "Brady Deal." 21. Overall Assessment. The FSAL was well focused, with a specific conditionality appropriately designed for achieving the objectives of the loan and which were easily monitorable. The strong commitment of the Borrower to FSAL reforms was also important in the program's achievements; this was also a contributing factor to the short preparation and execution time for the FSAL program. Substantial compliance with loan conditions was achieved well before the original Closing Date, and tranche disbursements were completed on September 2, 1994. 22. Social Objectives. The FSAL operation had no particular poverty objective; it addressed only banking issues. F. Major Factors Affecting the Project 23. The anticipated bureaucratic lethargy and resistance to reform did not materialize. The authorities, did in fact, move ahead speedier than anticipated. The President's Report did identify the risk of returning to economic instability. As a consequence of the Mexico crisis, this event materialized after project completion in early 1995, and did indeed threaten some accomplishments of the Loan. However the Government acted forcefully to counteract the fiscal deterioration, to seek intemational financial assistance and to stabilize the financial system. While the banking system was shaken severely, it survived and has now recovered. G. Bank Performance 24. The design of the project components supported priority adjustments to which authorities were fully committed: reduction of public sector banking, resource mobilization to the private sector and the soundness and solvency of financial institutions. Furthermore, the operation was consistent with the objectives of the Bank's country assistance strategy. 25. Preparatory work through appraisal required as little as 39 staff weeks, as prior sector analysis and lending helped to put the financial problems into perspective. Potential risks confronting the implementation of the FSAL were correctly identified. 26. Bank supervision missions visited Argentina regularly to monitor progress in implementing the FSAL with three missions absorbing 41 staff weeks. 27. Disbursements took place against imports procured according to Bank procedures and eligibility criteria set forth in the legal documents. Those  9 disbursements related to the set-aside for the DDSR also were properly accounted for all import documentation was audited in a satisfactory manner by Argentina's state auditor. All audits resulted in unqualified opinions. H. Borrower Performance 28. Macroeconomic performance was satisfactory as serious attempts were made to eliminate the public sector deficit and its inflationary financing, which were chronic sources of macroeconomic disequilibria. This commitment remains strong today as proven by the courageous and prompt actions taken to confront to the 1995 Mexico crisis. 27. Financial sector performance was also satisfactory as policies and actions were clearly sensible choices. The Government strongly acted to implement all reforms and complied in a satisfactory manner with program conditions. I. Program Sustainability, Assessment of Outcome and Lessons Learned 28. While institutional changes are considered sustainable, the sustainability of reducing the role of the public sector in the financial sector remains vulnerable to a macroeconomic deterioration and sharp falls in confidence. Should such events re-occur, it is likely that public banks will assume at least temporarily, a heightened role in providing liquidity financing. BNA, in particular, could lead this approach, both because of its size and because of the Central Bank's restrictions under the Convertibility Plan. The rest of the FSAL's public bank restructurings, however, are likely to endure. BANADE is certain to remain closed.2 CAJA is unlikely to be re-nationalized. BHN is not only expected to remain largely a second-tier bank, it is expanding its securitization initiatives as originally hoped. Also, Central Bank and Superintendency reforms are unlikely to be reversed. 29. Assessment of Outcome. The overall rating of the program is satisfactory. It achieved its objectives in a timely manner. 30. Key Lessons Learned. The main lesson of the FSAL concerns the value of an early beginning of a policy dialogue on financial sector reforms, of deepening the understanding of policy options and systematic opinion-building towards a substantial consensus on remedial actions. 31. The second lesson concerns the importance of a continuing and long- standing working relationship with national authorities. The Bank's credibility 2 To alleviate a perceived remaining market failure, the Government created in 1992 the Banco de Inversi6n y Comercio Exterior, S.A. (BICE) as a second-tier bank to lend long-term for investment and foreign trade. BICE remains in the early stages of development and has yet to be fully accepted by the banking community.  10 resulted in quick and substantial agreements on historic institutional changes-- such as major public bank restructuring, BCRA strengthening, modernization of banking supervision and following-through with Basle-type norms on capital adequacy and loan portfolio classification and provisioning. 32. A third important lesson for future operations is that sustainability3 of an objective of a reduced public role, such as in areas of deposit insurance and liquidity assistance to the banking system, is not assured despite initial government commitment, in cases where systemic risks threaten the banking system. 33. The fourth lesson is one learned many times before. Adjustment loans should measure reform progress by focusing only on a limited high priority set of actions to which the Government is firmly committed. Fortunately, the FSAL was so focused. 3Sustainability concerns the probability of a project maintaining the achievements generated in relation to its major objectives. In evaluating sustainability as likely, unlikely, or uncertain, major factors, such as the following, should be taken into account: borrower commitment, policy environment, institution management effectiveness, economic, technical, financial and environmental viability, social impact, local participation and incentives for participants to sustain the project.  I I IMPLEMENTATION COMPLETION REPORT ARGENTINA FINANCLAL SECTOR ADJUSTMENT LOAN I1. STATISTICAL ANNEX Table 1: Summary of Assessments Table 2: Related Bank Loans/Credits Table 3: Project Timetable Table 4: Loan Disbursements: Cumulative Estimated and Actual Table 5: Studies Included in the Project Table 6A: Program Costs Table 6B: Program financing Table 7: Compliance with Legal Covenants Table 8: Bank Resources: Staff Inputs Table 9: Missions  12 Table 1: Summary of Assessments A. Achievement of Substantial Partial Negligible Not applicable objectives Macro policies X Sector policies X Financial objectives X Institutional Development X Physical objectives X Poverty reduction X Gender issues X Other social objectives X Environmental objectives X Public sector management X Private sector management X Other (specify) B. Project sustainability Likely Unlikely Uncertain x C. Bank performance Highly satisfactory Satisfactory Deficient Identification X Preparation assistance X Appraisal X Supervision x D. Borrower Highly satisfactory Satisfactory Deficient performance Preparation X Implementation X Covenant compliance X Operation (if applicable) E. Assessment of 1 Highly Satisfactory Unsatisfactory Highly outcome satisfactory I I unsatisfactory | F ~X IlI  13 Table 2: Related Bank Loans/Credits Loan Purpose Amount Year of Status l ________________________________ ___________________ (US$ million) Approval (12/31/95) I. Banking Sector Loan Banking 400 1987 Canceled 2. Trade Policy I&II Trade reform 500 1987 & Disbursed (Lns 2815 and 2996) 1988 Disbursed 3. Public Enterprise Reform I&fl Privatization of public 300 1991 Disbursed (Lns. 3291 and 3556) entrprises 300 1993 Disbursed 4. Public Sector Reform I Fiscal Revenues and 325 1991 Disbursed (Ln 3394) expenditures, and | _________________________ B C R A 5. Tax Administration I and II Tax administration 6.5 1989 Disbursed Following Operations 20 1992 Undisbursed $2.8 M (Lns 3015 and 3460) . 6. Capital Market Development Capital market 500 1994 Undisbursed (Ln 3709) development 7. Provincial Reform Loan Provincial reforms 300 1995 Second Tranche (Ln 3836) disbursed 8. T.A. Capital Markets (Ln 3710) Improvement of capital 8.5 1994 Undisbursed $7.2 M T.A. Public Sector Reform (Ln 3362) markets 23 1991 Undisbursed $1.0 M 9. Provincial Bank Privatization' Privatization of 500 1995 Second Tranche (Ln 3878) provincial banks. disbursed 10.Bank Reform Loan2 Private bank 500 1995 First Tranche (Ln 3926) restructuring | | disbursed 1/ Approved in May 1995 2/ Approved in July 1995  14 Table 3: Project Timetable Steps in Project Cycle Date Planned Actual Date/or Duration Identification (Initial Executive 1992 Project Summary Preparation 10 months Appraisal July 1992 Negotiations October 19 - 27, 1992 Letter of Development Policy December 8, 1992 (if applicable) l Board Presentation February 16, 1993 Signing February 16, 1993 Effectiveness Feb./March 1993 February 16, 1993 First tranche release March 1993 Second tranche release December 1993 Third tranche release August 1994 Loan closing December 31, 1995 September 31, 1994 Table 4: Loan Disbursements: Cumulative Estimated and Actual (US$ Thousands) FY93 FY94 FY95 Appraisal estimate 205 300 400 Actual 205 300 400 Actual as % of estimate 100% 100% 100% Date of final disbursement 9/02/94  15 Table 5: Studies Included in Project Study Purpose as defined Status Impact of Study at appraisal l 1. Review of BNA's financial Determine costs and benefits Completed Conclusion: BNA does not services rendered to the Borrower of services provided by BNA significantly subsidize the and preparation of action plan to public agencies Government and is not being subsidized Table 6A: Program Costs Appraisal estimate (US$M) Actual (USSM) Item Local Foreign Total Local Foreign Total Costs Costs Costs Costs 1. DDSR]' - 200 200 85 85 2. Import financing - 200 200 - 315 315 Total 400 400 400 400 1/ Debt and debt service reduction Table 6B: Program Financing [ Appraisal estimate (US$M) Actual estimate (US$M) Source Local Foreign Total Local Foreign Total costs costs costs costs IBRD/IDA 400 400 400 400 Cofinancing - 200 200 - 200 200 Total - 600 600 - 600 600  ARGENTINA FINANCIAL SECTOR ADJUSTMENT LOAN Table 7 - Compliance with Legal Covenants Agreement Section Subject Type Present Fulfillment Comments Status Date Schedule 1, 5(c) and 6(c) Macroeconomic policy framework is consistent with the objectives of the 10 C December 1993 Second and third tranche condition program August 1994 Schedule 1, 5(a) Progress achieved by the Borrower in the carrying out of the Program 10 C December 1993 Second and third tranche condition and 6(a) August 1994 Schedule 1, 5(b) Actions described in Part I of Schedule 5 to the Agreement have been taken, 10 C Ongoing Second tranche condition in form and substance satisfactory to the Bank Schedule 5, Part I I. Financial sector reforms underway to continue being implemented 10 C December 1993 Second tranche condition 2. Furnish certified, audited copy of BCRA's balance sheet of December 31, 10 C December 1993 Second tranche condition 1992 3. Confirm that at least 97% of banks operating in the borrower's territory 10 C July 1992 to Second tranche condition have been inspected by SEF or audited by an external auditor acceptable to December 1993 - SEF with opinion on the financial statements consistent with the provisions Ongoing of paragraph 5 below. 4. SEF to initiate remedial action against banks not in compliance with 10 C December 1993 Second tranche condition BCRA's regulations, including but not limited to those relating to minimum 0' capital and portfolio provisioning requirements. 5. Regulations to be issued by BCRA establishing rules to strengthen 10 C December 1993 Second tranche condition external auditing of financial institutions in Argentina. 6. Borrower to confirm that no rediscounts have been provided by BCRA to 10 C December 1993 Second tranche condition provincial banks other than to cover liquidity needs; disclosed the degrees of compliance by the provincial banks and the municipal banks with lending limits to the private sector, as required by BCRA's Communique No. "A" 1932 of February 6, 1992; and disclose the degree of compliance of provincial banks with BCRA's reserve requirements. 7. CAJA's majority of voting shares owned by Borrower shall have been 10 C December 1993 Second tranche condition offered for sale to entities not owned or controlled, directly or indirectly, by the borrower. 8. Borrower to confirm no first-tier lending has been made by BHN in 10 C December 1993 Second tranche condition accordance with law No. 24,143 dated September 23, 1992 and that any financial statements BHN's second-tier lending has been made on terms and conditions that cover completed. the costs of raising funds by BHN, its operating costs and a positive returm Ongoing. on its capital. 9. Borrower to furnish to the Bank the proposed financial performance 10 C December 1993 Second tranche condition standards to be applied by BHN in order to achieve a positive rate of return on its capital.  Agreement Section Subject Type Present FWlfillment Comments Status Date 10. (i) Take all actions necessaiy to ensure that BNA provides on a priority C December 1993 Second tranche condition basis, loans to small and medium size productive firms in accordance with BCRA's definition, and to enterprises engaged in foreign trade; (ii) to define the financial efficiency standards for BNA's operations, and to continue compliance of BNA's reform program as established in the borrower's letter to the Bank. December 1993 11. Furnish to the Bank a certified copy of the audit report referred to in I C Second tranche condition l Section 3.04 (b) (ii) of the Agreement in respect of the financed out of the D proceeds of the First Tranche. Schedule 1, 6(b) Actions described in Part II of Schedule 5 to this Agreement have been 10 C August 1994 Third tranchecondition taken, in forn and substance satisfactory to the Bank. Schedule 5, Part 11 1. The financial sector reforms referred to in the Borrower's letter shall have 10 C August 1994 Third tranche condition been or are being implemented, as the case may be. 2. BCRA shall issue a resolution adopting a new accounting system and 10 C August 1994 Third tranche condition setting a timetable for its implementation. 3. Confirm that at least 97% of banks operating in the Borrower's territory 10 C August 1994 Tbird tranche condition have been (i) inspected by SEF or (ii) audited by an external auditor acceptable to SEF with opinion in the financial statements consistent with the provisions of paragraph 5 below. 4. SEF to initiate remedial actions against banks not in compliance with 10 C August 1994 Third tranche condition BCRA's regulations including but not limited to those relating to minimum capital and portfolio requirements. 5. BCRA shall have disclosed the financial statements of all banks operating 10 C August 1994 Third tranche condition in the territory of the Borrower. 6. Borrower to confirm that no rediscounts have been provided by BCRA to 10 C August 1994 Third tranche condition provincial banks other than to cover liquidity needs; disclosed the degree of compliance of provincial banks and the municipal banks with lending limits to the private sector, as required by BCRA's No. 'A' 1932 of February 6, 1992; and disclose the degree of compliance of provincial banks with BCRA's reserve requirements. 10 C August 1994 Third tranche condition 7. CAJA's majority voting shares owned by the Borrower shall have been sold to entities not owned or controlled, directdy or indirectly, by the Borrower. 10 C August 1994 Third tranche condition 8. Borrower to confinn that no first-tier lending has been made by BHN in accordance with Law No.24.143 dated September 23, 1992 and that BHN's second-tier lending bas been made on terms and conditions that cover the costs of raising funds by BHN, its operation costs and a positive return on its capital. 10 C August 1994 Third tranche condition 9. Borrower shall have implemented the standards referred to in paragraph 9 of Part I of Schedule 5.  Agreement Section Subject | Type | Present Fulfillment | Comments I I Status Datel 10. Actions to be carried out under paragraph 10 of Part I of Schedule 5 10 C August 1994 Tird trnche condition shall have been continued to be duly carried out. 11. The Borrower shall have (i) carried onJy and fumished to the Bank a 10 C August 1994 Third tranche condition study of the review of the financial services rendered by BNA to the Borrower covering an inventory of those services, the determination of the costs and benefits of such services through BNA7s new information on system, and recommnendations on altematives to be followed by BNA in the provision of those services; and (ii) fumish to the Bank an action plan for the implementation of the recommnendations of the study. 12. Provide a certified copy of the audit report referred to in Section 3.04 1 C August 1994 Third tranche condition (b)(ii) of the Agreement in respect of the expenditures financed out of the Second Tranche. ao  19 ARGENTINA FINANCIAL SECTOR ADJUSTMENT LOAN Table 8: Bank Resources: Staff Inputs"/ Stage of Planned Revised Actual project cycle Weeks US$ Weeks US$ Weeks US$ Through appraisal 34 153 38 172.8 38.4 172.8 Appraisal-Board 11 49.5 13 57.6 12.8 57.6 Board-effectiveness ' Supervision 40 181.8 49 218.3 40.7 183.1 Completion 10 45 10 45 11 49.5 TOTAL 95 429.3 110 493.7 104 463.0 1/ Estimated cost in constant FY94 $'000. Based on LA4's staffyear cost. 2/ The loan was approved, signed and made effective on the same date (2/16/93) Table 9: Missions Stage of Month/ Number Specialized Project cycle year of Days in staffskills Performance rating persons field represented l Implementation Development Status objectives Types of problems Through appraisal Preparation 2 12 b,f Mission-March 1992 Pre-Appraisal 4 15 a,b,d,f Mission-April 1992 Appraisal through Appraisal Mission- 4 16 a,d,e,f Board approval July 1992 Board approval l through effectiveness 2l Supervision Ist-May 1993 3 8 a,c,d S HS None 2nd-Oct. 1993 6 7 a,2b,d.f HS HS None 3rd-July 1994 3 2 a,b,e HS HS None Completion 1995 2 a,e HS HS None 1/ Key to specialization: a. Task Manager b. Financial Specialist c. Bank Specialist d. Financial Analyst e. Consultant f Sr. Economist 2/ The loan was approved, signed and become effective on the same date (2/16/93)  - 20 - COMHENTS OF BORROWER/COFINANCIER * I MINISTERJO DE ECQN9Tq A OBRS SERVICIOS PUBLICOS SECRETARIA DE:PRG ACONOMICA D|RECCION NACIONMAL ?ROY QSCON ORGANISMOS .- . 4 j;., . FECBA: .- F ;:.O-..'' PARA: 5i=rJ . % L. i , FAX NO: (aoa) Z.2 3 DE: DIRECCION NACO-AL DE P-'gTCTS CON ORGANISMOS INTERNACONAL : j -, LIC. CARLOS.A. LO?X * . .-.:. - . - - ASU,7TO: !mtomm~ pt2- A prmstrAm 3SQ-4z, R;bcLPAh3TO P3R, =ST_ f<S>C . (P .'-; L 9S fWOTAS -De LoS 2ANCW5: 3CRA-Y B3t6N W < .> EEEC^ alkPiw~~* S . nfIKI. *i . , {q/. / ' .! ;<-i'.. ',.. 4<) .t'' -ii ;'l ;~~~~..~s XL .st Np~I1AL O C'E -' S i . *!,', , _ , ',' . N'. D. ',A.'', ' .;',. .'''ui.a ''re". ." N