Argentina - Capital Market Development Project (Backstop Facility)

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 18045 IMPLEMENTATION COMPLETION REPORT ARGENTINA CAPITAL MARKET DEVELOPMENT PROJECT (BAC.KSTOP FACILITY) (LOAN 3709-AR) June 23, 1998 Finance, Private Sector & Infrastructure Country Management Unit 7 Latin America and the Caribbean Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit = Argentinean Peso EXCHANGE RATE US$1.00 Dollar= 1 Peso WEIGHTS AND MEASURES Metric System GOVERNMENT OF ARGENTINA FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS BANADE Banco Nacional de Desarrollo BF Backstop Fund BICE Banco de Inversion y Comercio Exterior CMDP Capital Market Development Project FIL Financial Internediary Loan FSD Financial Sector Department IBRD International Bank for Reconstruction and Development ICR Implementation Completion Report IFC International Finance Corporation GDP Gross Domestic Product GOA Government of Argentina R&D Research and Development Vice President . Shahid Javed Burki Country Management Unit Director Myrna Alexander Sector Management Unit Director Danny Leipziger Task Manager . Stefan Alber  FOR OFFICIAL USE ONLY IMPLEMENTATION COMPLETION REPORT ARGENTINA: CAPITAL MARKET DEVELOPMENT PROJECT (BAC]KSTOP FACILITY) (LOAN 3709-AR) TABLE OF CONTENTS Page No. Preface Part I: Project Implementation Assessment - Evaluation Summary A. INTRODUCTION ...............iii B. PROJECT OBJECTIVES ............................. , iii C. ACHIEVEMENTS OF OBJECTIVES ............................. iv D. MAJOR FACTORS AFFECTING THE PROJECT ........................... ................................................ iv E. PROJECT SUSTAINABILITY ............................................................................ v F. BANK PERFORMANCE ........................................................................... v G. BORROWER PERFORMANCE ............................................................................ v H. ASSESSMENT OF OUTCOME ............................................................................ v I. LEssoNs .................................................................................................................. v Implementation Experience and Results A. BACKGROUND ............................................................................1 B. LOAN OBJECTIVES ........................................................................... . 4 C. ACHIEVEMENT OF OBJECTIVES ............................................................................ 7 D. IMPLEMENTATION RECORD AND MAJOR F ACTORS AFFECTING THE PROJECT . ............................................. 8 D. I The Time Factor ................................................................. 9 D.2 The Design Factor ................................................................. 15 D.2. I The Knowledge Base ........................................................................... 15 D.2.2 Borrower Ownership ............................................................................ 18 D.2.3 Design Features ............................................................................ 20 E. PROJECT SUSTAINABILITY ............................................................................ 24 F. BANK PERFORMANCE ............................................................................ 25 G. BORROWER PERFORMANCE ............................................................................ 25 H. ASSESSMENT OF OUTCOME ............................................................................. 26 Part H: Statistical Annex TABLE 1: LOAN DISBURSEMENTS: CUIMULATIVE ESTIMATED AND ACTUAL ............. .................. 30 TABLE 2: PROJECT TIMETABLE .............................................................. 30 TABLE 3: BANK RESOURCES: STAFF I'NPUTS ..................... ......................................... 31 TABLE 4: RELATED BANK LOANS/CREDITS .............................................................. 31 TABLE 5: MISSIONS .............................................................. 32 TABLE 6: STATUS OFLEGAL COVENA'NTS .............................................................. 33 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.  ii IMPLEMENTAITION COMPLETION REPORT ARGENTINA CAPITAL MARKET DEVELOPMENT PROJECT (BACKSTOP FACILITY) (LOAN 3709-AR) PART I. PROJECT IAMPLEMENTATION ASSESSMENT IREFACE 1. This is the Implementation Completion report (ICR) for the Capital Market Development Project in Argentina, for which Loan 3709-AR in the amount of $500 million was approved March 1, 1994, and became effective August 31, 1995. The Loan was canceled on March 17, 1997. Disbursements amounted to $106.35 million, or about 21% of the loan. 2 The ICR was prepared by Mr. Richard Webb (consultant). Because of the exceptionally innovative character of this operation and large loan size, a more extensive evaluation is being presented. 3. Preparation of the ICR was begun three months after cancellation, during June 1997. It is based on information in the project files, and on discussions carried out in Buenos Aires during October 1997 and April 1998 with the implementation authority--the Banco de Inversion y Comercio Exterior (BICE)--Ministry of Finance, and Central Bank officials, discussions in New York with Salomon Brothers during November 1997, as well as discussions with Bank and IFC officials. The Borrower reviewed this ICR and had no further comments.  iii EVALUATION SUMMARY AL. INTRODUCTION 1. The Capital Market Developrnent Project (CMDP) was primarily designed to accelerate capital market development in Argentina to meet growing investment needs. The principal instrument for this purpose was to be a Backstop Fund (BF) that would be established in a Government-owned, second-tier bank, the Banco de Inversion y Comercio Exterior (BICE). The analysis underlying this project was that recent macroeconomic and reform measures had succeeded in stabilizing the economy and that policy priorities had turned to the recovery of investment and economic growth. Stabilization accompanied by financial sector reforms appeared to provide the basis for successful intervention in the area of capital markets. In addition, a maj or obstacle to growth was identified in the weak financial system and, in particular, th,e absence of private sector savings and investment instruments with maturities longer than a few months. B. PROJECT OBJECTIVES 2. The principal objective of the project as stated in the President's Report was to encourage the holding of medium and long term securities by private investors and bankers and longer term lending by prime-rated commercial banks. This was to be achieved by improving market confidence and ensuring liquidity to creditworthy banks in the event of market developments that raised or caused spikes in domestic interest rates. These purposes would be achieved principally through the operations of the BF. The BF would encourage prime-rated commercial banks to issue medium term bonds and lend long term for productive investments, by selling commitments to purchase such bonds in the event that issuing banks were unable to roll them over. Fund operations were to be targeted to assist small- and medium size businesses in particular. 3. A complementary purpose was to reinforce and consolidate ongoing financial reform through loan conditionalities. These included freely determined interest rates, the removal of existing interest rate subsidies, and strengthened capital market regulation, supervision and enforcement. The project would also contribute to financial recovery by promoting or inducing the development of other elements of capital market infrastructure, such as the use of standardized debt securities and national credit rating agencies.  iv 4. Beyond these capital market objectives the loan was motivated by two more considerations. One was the high priority attached by the Bank to the support of Argentina's model economic reform program that, as stated in the President's memorandum, had brought price stability and economic growth "unknown for several decades." A second consideration was internal: the project concept was considered to be exceptionally innovative and, potentially, to open a needed door to private-sector and financial-sector lending. C. ACHIEVEMENTS OF OBJECTIVES 5. The Loan failed to meet its principal capital market objective. A combination of delays, both during the preparation and implementation phases, inappropriate design and weak Borrower ownership frustrated its intended contribution to capital market development. The back-stopping intervention to encourage longer maturities was small, brief and swamped by other market developments, principally the 1995 Tequila effect. Via the announcement effect, the Loan did however support the continuation of Argentina's model economic program, the most successful in decades. Financial sector reform continued but a causal connection to this Loan cannot be established. D. MAJOR FACTORS AFFECTING THE PROJECT 6. The main determinants of project outcome were delays and interruptions, design cum unsuitability of Bank procedures, and weak Borrower ownership. 7. Originally targeted for Board approval in 1992, a series of slow-downs and set backs delayed Board approval until 1994 and effectiveness until 1995. From conception to cancellation in 1997, there were seven occasions when project advance was slowed, halted, or even forced to the drawing board, in each case of between four to eight months. Meanwhile, market conditions evolved rapidly and unpredictably ever more reducing the odds of success. Although progress was made in making Bank procedures more flexible, the remaining rigidities affected the timeliness of this highly market sensitive operation. 8. The second reason for vulnerability was that the specialized, narrow and rigidly defined product offerred by the Back-Stop facility was ill suited for a rapidly moving, even volatile market. Insufficient awareness and foresight in bond market developments and little prior experience in back-stopping even outside the Bank were contributing factors. 9. The final reason was weak Borrower ownership. Many officials of the Government remained skeptical about the value of public support to back-stop prime-rate commercial banks, about the long-term beneficial capital market effects and the actual functioning of the Back-Stop Fund. The Borrower up to this day still prefers directed lines of credit, especially for the small business sector. All this translated into slow processing of the Loan and the resulting obscurity of the back-stopping arrangements as perceived by the market.  v E. PROJECT SUSTAINABILITY 10. No sustainability can be claimed as only three back-stopping transactions were in fact carried out. As a result of the Loan cancellation, the Backstop Fund is under liquidation. F. BANK PERFORMANCE 11. Performance was admirable in terms of executive energy, creativity and timeliness. Bank procedures were also made more flexible. Weighing all factors, Bank performance was however deficient in underestimating the risks of low Borrower commitment. Another deficiency can be attributed to the Bank in having been the lead designer of a product ill- suited to high market sensitivity. G. BORROWER PERFORMANCE 12. The Borrower should have been transparent and articulate in its low enthusiasm for the Backstop Facility. Inevitably, the resulting managerial inertia caused the Backstop product to remain obscure dooming wide market acceptance. H. ASSESSMENT OF OUTCOME 13. Project performance was unsat:isfactory, not having met the fundamental capital market objectives. 1. LESSONS 14. First Lesson. The Bank should be wary of projects which require radical changes to Bank procedures and policies, decision agility and which are to meet the requirements of the fast-moving capital market. 15. When it recommended cancellation of the BF the Bank explained: "Unfortunately, the market seemed little prepared for such a facility, and from the first it lacked the agility required of a private-sector facility."' That statement can also be seen as an admission of the Bank's own participation in entrepreneurial failure. It was the Bank that from the beginning took lead-ownership of the project, defining details of product design and implementation and not able to free the entrepreneurial requirements of the facility of its internal approval procedures and policy agenda. It was the Bank that did underestimate the pitfalls of a "little prepared market" and that, in its implementation, had itself lacked the agility required of a private-sector facility. 16. The Bank was aware of the entrepreneurial nature of this Project. And it had a strategy for coping with that need: BICE was to be privatized, a Salomon Brothers type of institution was to be involved, and substantial assistance was to be provided by market- 1 Letter from Gobind Nankani to Alberto Remigio Abad and Eugenio Pendas, February 27, 1997.  vi experienced FSD staff. Argentine managerial performance was perhaps the most frequent issue raised by supervision visits. What the Bank failed to see was: (a) the inherent conflict between market agility and its own institutional culture, and (b) the extent to which, in decision after decision, it would impose the latter-its own procedural and policy priorities--over the requirements of good market performance. 17. The BF experience suggests how future Bank performance with projects that require "private-sector agility" could be improved. The first recommendation is that all market-related expertise in and outside the Bank be used to create more awareness of the demands of the market. In the BF case, the odds of success were reduced by an entirely avoidable falling-out between the Region and the IFC. The upshot was that a pool of market-experienced staff with a track record in capital market transactions-including concurrent IFC projects in Argentina--was perversely unavailable to contribute to the project. 2 18. The second need is for decision-making space, not business advice. FSD officials who were involved with the BF brought private sector experience to the job, tracked the BF's interface with the market, and provided many initiatives that helped to make the backstop more market-friendly. But FSD officials were not empowered to make BF-related decisions. Even minor modifications in backstop pricing or terms of access, for instance, had to be taken by officials who must weigh each technical recommendation against the competing requirements of required administrative behavior. In addition to consuming time, the decision process is biased against departures from established practice, i.e. against entrepreneurship. If the Bank is to engage in projects that require market-responsiveness, a condition should be a clear, ex ante definition of decision boundaries, and a corresponding delegation of decision-making authority so that, within those bounds, market results can be pursued relentlessly. 19. Second Lesson. A second lesson is the risk of a reluctant Borrower. The shallow interest in the BF concept never strengthened and the desire for a directed credit line was never abandoned. Very few GOA officials came ever to understand the CMDP. From conception through cancellation the leadership for the project was seen to be in the Bank's hands. The GOA twice took the initiative, but in both cases it was, in essence, to propose an abandoning of the longer-term, market-developing and maturity-lengthening functions of the backstop in favor of a short-term, liquidity-providing role. This occurred during the Tequila crisis in early 1995, when the Bank partially accommodated the GOA by easing the terms of access to the backstop. And it happened again just prior to cancellation, when the GOA proposed a "restructuring" of the loan that would have melded its funds into a larger, liquidity-providing reserve fund. 20. Low borrower ownership had its most visible cost in the inertia of BF management. In addition, one can speculate that some of the delays-policy disputes and processing 2 The IFC funded an effort to develop securitization expertise in a commercial bank.  vii time--that plagued implementation would have been shortened if the GOA had strongly supported the BF concept. 21. Third Lesson. A third lesson concerns the pitfalls associated with the Bank's use of a loan to carry out developmental research and development. 22. The resulting innovative excitement had two blinding effects. One was that borrower's interests did not receive the priority that they deserved-and were paying for. A second was that technical enthusiasm over the loan probably interfered with the detachment required in a project appraisal. 23. From the beginning the BF became and remained a top priority project. This attitude was already present in 1992 when novelty was still only a matter of engaging in capital market development, including a still-vague idea of a contingency component. The crystallization of the backstop idea in the first weeks of 1993 greatly increased the sense of enthusiasm and urgency. Paradoxically, the series of delays that frustrated implementation probably only increased the determination to push ahead at the expense of building more expertise. Moreover, technical puzzles, such as the pricing method, absorbed much of the effort put into preparation, crowding out work on more mundane issues of business management.  IMPLEMENTATION EXPERIENCE AND RESULTS A. BACKGROUND 1. The Capital Market Development Project (CMDP) to Argentina for the amount of US$500 million was approved by the ]3oard on March 1, 1994 and canceled on March 17, 1997 after a short, three-year life. In terms of its operational existence, the period was even briefer: the Backstop Fund (BF) created by this loan--its principal purpose--was in operation for only one year. This was lbecause the Loan did not become effective until August 1995 and because activity was interrupted in August 1996 to carry out a First Project Review, an interruption that proved permanent.3 During the twelve months of operation, the project's core activity--the issuance of backstop commitments to commercial banks--totaled $200 million. 2. The project was also unusual in its innovative character: it set precedents for contingency lending and for Bank disbursements against the procurement of bonds; and it became a lesson in the procurement of specialized financial services and in the pricing of financial products. Breaking new ground, however, was time-consuming. And the cost of delay was high. As it designed and reclesigned the loan, the Bank kept falling behind a rapidly moving capital market. 3. This loan has given rise to widely different views regarding the soundness of its project concept, the particular features of the project design, the justification for its cancellation, and its ultimate value for the Borrower and for the Bank. Considering the special features of the project, the following discussion departs somewhat from the standard format for Implementation Completion Reports. Greater attention is given to the project background, to changes in circumstances and priorities over the project cycle-- with the help of a detailed chronology (Table l)--and to a discussion of possible lessons. 4. At the time of project formulaition, during 1992-93, Argentina was emerging from a period of financial mismanagement and instability. Inflation had been protracted and had climbed to hyperinLflation levels. The real exchange rate had fluctuated widely. One consequence vvas extreme demonetization. By 1990, M2 had fallen to 5 percent of GDP, loan tenors were measured in weeks or days, and no 3 BF operations were actually interrupted in March 1996, when the fourth auction of BF commitrnents failed to elicit any bids, prompting the Bank to begin a re-examination of the project even before a formal "First Project Review" had been triggered by the volume of commitments.  2 bonds were being issued. Banking system credit to the private sector, squeezed by the flight of liquidity and by heavy government borrowing, had become insignificant. 5. From this low point in late 1990 rapid recovery began to take place following drastic stabilization and reform measures. Stabilization was anchored on a 1991 Currency Convertibility Law that, in effect, converted the Central Bank into a Currency Board, and on fiscal measures that turned a large deficit into a surplus. Other reforms were also energetic and comprehensive, including privatization, trade, and financial policies. The pace of financial recovery over the period of project formulation and approval is evident in the growth of M3 (adjusted to include foreign currency deposits in the domestic banking system). This rose from $15.0 billion in September 1991, shortly before the first pre- appraisal mission for this project, to $52.0 billion in March 1994, the time of Board approval. And over approximately the same period, the banking system's ability to extend loans (in dollars and pesos) increased from the equivalent of $4.8 billion in April 1991, to approximately $36.2 billion as of October 31, 1994.4 6. World Bank lending to Argentina followed a parallel cycle. Over the five-year period that preceded the initiation of this project, Bank lending averaged only $180 million 5 per year. Certainly, the country's inability to carry out stabilization measures was an obstacle to lending at the time. The extent of withdrawal may also have reflected the failure of a controversial effort by the Bank to support reform during 1988. That year, the Bank provided four fast-disbursing loans for a total of $1.25 billion, although the rapid breakdown of the reform program led to the cancellation of about half that amount. Lending was then almost entirely interrupted during two years, from late 1988 through late 1990. Cautious support began in December 1990, with new loans totaling $ 1.0 billion through August 1992. By late 1992, the strength of government commitment and success of its reform program had become evident. The Bank shifted to a position of vigorous assistance. Lending rose sharply. During the twelve months prior to Board approval of this project, that is between September 1992 and August 1993, the Bank made seven loans to Argentina for a total of $ 2.0 billion, including a $400 million Financial Sector Adjustment loan. 7. By late 1993 the view was developing in the Bank that adjustment was nearing completion and that Argentina was entering, instead, a phase of reform consolidation. Government of Argentina (GOA) priorities were moving from stabilization-related measures, including an initial, critical need for external financial support, to what came to be thought of as "second stage" reforms. These targeted institutional and policy changes that were considered important to underpin fiscal and monetary discipline and to restore 4 Felipe de la Balze, Remaking the Argentine Economy (NY: Council of Foreign Relations, 1995) pp. 77-78 and Table IO, p. 181. 5 From mid-1987 to September 1992. The figure does not include two loans that were canceled shortly after approval.  3 investment and growth. Attention shifted in particular to institutional change, productivity, and resource mobilization. 8. The CMDP loan was caught up by the change of priorities. Starting out in 1991-92 principally as an adjustment loan, by the time of Board approval in 1994 it had evolved into an institutional development prc.ect. The President's Memorandum spoke of a "post- adjustment phase in Argentina," that, it said, meant "more emphasis on investment lending," and "greater demands on the institutional capacity of the Governent." Gross investment was already rising rapidly, from 15.0 percent of GDP during 1990-91, to 19.6 percent in 1992 and 20.0 percent in 1993, and projections were that substantial additional investment would be needed to meet backlogs in infrastructure and in productive capacity. Funding requirements, savings capacity, and financial sector capacity became key issues. In this new policy context, the proposed loan was targeted, above all, to the problem of resource mobilization for accelerated growth. The CMDP loan became a tool "to help Argentina meet a growing investment demand."6 9. The emergence of capital market development as a priority in Argentina coincided with a renewed interest by the Bank in financial sector lending. The failure of many financial intermediary loans (FIL)--mostly to support onlending by local development banks--had prompted the Bank into adopting a more severe policy for the sector, with less 7 tolerance for departures from market prices or for interest rate subsidies. The consequence was a slowdown in such lending, and a search for new project formulas. In that context, the CMDP loan caught the Bank's attention as an innovative, more market and private sector oriented approach to financial sector lending. 10. The context for the CMDP project included a broad program of financial reform that was being supported by other Bank loans. Reform began in 1990-91 with measures that deregulated and opened the finanicial sector to greater competition. Subsequent measures carried out between 1990 and 1994 included the privatization of govemment banks, closure of Banco Nacional de Desarrollo (BANADE), suppression of the govermnentr monopoly on reinsurance, deregulation of broker commissions, elimination of taxes on financial transactions and eclualization of tax treatment on government and on private sector corporate bonds and commercial paper, simplification of requirements for the issuance of new financial producits, and privatization of the social security pension fund. Interest rate subsidies were phased down and made transparent in the budget. Bank support for financial sector reform was provided through four loans, including the CMDP and a parallel Capital Market Development Technical Assistance Loan (Loan 3710-AR-- US$8.5 million). Two other Bank loans, the January 1993 Debt Reduction and Debt Service loan ($450 million) and the February 1993 Financial Sector Adjustment Loan ($400 million), included conditions that bore on financial sector reform. 6 Argentina. Capital Market Development Loan- Staff Appraisal Report. September 17, 1993. Report No. 12328-AR, p. ii. 7 The new poticy was forcefully outlined and supported in the August 19S9 report by the Task Force on Financial Sector Operations (chaired by Fred Levy).  4 B. LOAN OBJECTIVES 11. This loan had several objectives, though some were more explicit than others. According to the President's Memorandum, the proposed operation: "aims to accelerate capital market development to help Argentina meet growing investment demand." More specifically, it said, the objective "is to encourage the holding of medium and long term securities by investors and bankers and longer term lending by prime-rated commercial banks." But other objectives became evident in the course of design and implementation. The loan also sought to further general policy reform in Argentina, to provide country support when credibility and liquidity were in critical need, and, in parallel to its contribution to Argentina, to develop an "innovative" new lending instrument for the Bank. 12. Medium and long term financing were needed for the recovery of investment and productive activity in Argentina. Yet, as the decade opened, term lending, in dollars as well as pesos, had virtually disappeared. The CMDP set out to help close the gap between the demand and need for productive investment and the domestic supply of medium and long term financing. The idea of targeting "outer maturities" had appeared in the first Staff Appraisal Report prepared in mid-1 992 when the Bank began to identify a capital markets project. At that stage, the project concept consisted of a standard FIL to fund onlending by financial intermediaries. The FIL idea was eventually dropped, while the maturity objective was retained and sharpened in succeeding appraisals. The President's Report (February 1994) stated that the project objective was "to encourage the holding of medium and long term securities by investors and bankers and longer term lending by prime-rated commercial banks". 13. If the lengthening of maturities was the operational target, the Loan also had a broader institutional objective. It was expected that the operation of the BF, supported by ''an international financial institution with a proven successful record," would further that objective in several ways. It would help to strengthen local capital market institutions, such as national credit rating agencies, bring about the development of standardized debt securities, and generally develop institutional skills and capacities within the capital market. Through the creation of the BF and through its capacity-building externalities, the loan was to become, in a fuller sense, an institutional development project. Instead of providing funds from abroad to help meet domestic investment needs, like most Bank projects, the Loan set out to help Argentina strengthen its domestic capacity to mobilize long-term savings and investment. 14. The Loan was also intended to further the reform process through its agreed policy conditions. These included macroeconomic stability, freely detennined interest rates, the removal of existing interest rate subsidies, and strengthened capital market regulation, supervision and enforcement. Some of these reforms were to receive added support  5 through the Capital Market Technical Assistance Project approved shortly before this Loan. 15. The particular mechanism for extending maturities was to be an institutional innovation, a "Backstop Fund" (BF), especially created for the purpose. Endowed by the loan, the Fund would, in effect, act as a guarantor or safety net for banks that were willing to lend at longer terms while having to fund themselves at shorter terms. The BF would cover the resulting maturity mismatch by selling commitments to purchase bonds that banks were unable to refinance at maiturity. The risk covered would extend only to refinancing difficulties caused by market-wide events, not by a drop in credit rating or other bank-specific event. The President's report was clear with respect to the ultimate purpose of the loan--an increase in the supply of long term funding for productive investment. For that reason, the right to exercise BF purchase commitments was to be conditioned on evidence that a participating bank had in fact increased its long term portfolio by an amount equal to the BF bond purchase commitment. 16. The BF was to be located in Banco de Inversion y Comercio Exterior (BICE), a government-owned financial institution created in 1992. Another option considered at an early stage of project design was to work through an existing financial institution with a track record in capital market work, and ideally, in underwriting or guarantees. Government-owned banks, however, lacked that experience and were in any case slated for disappearance, while private institutions were almost equally thin in terms of capital market capacities and moreover posed a conflict of interest issue.9 The Bank's solution was to develop the required institutional capacity from scratch through the creation of a project implementation unit, the BF. 17. Yet, the choice of BICE was at odds with the Bank's preference for a private sector home for the BF, a leaning that stemrned from still-fresh memories of the dismal record of state-owned financial intermediaries iin Argentina. It also owed something to the emphasis that was being given to financial market privatization at the time. In fact, the initial proposal to use BICE, which the GOA favored, was based on the GOA's stated intention to privatize BICE by selling all or a majority of its shares to private owners. 18. When the privatization of BICE was delayed and then abandoned by the GOA despite strong insistence by the Bank,the Bank proceeded with what it considered a decidedly second-best institutional arrangement. At the same time, the decision to retain government ownership of BICE strengthened the argument for dropping the original credit line idea in favor a formula less vulnerable to the managerial pitfalls of state ownership. 8 President's Report to the Board on a Proposed Capital Market Technical Assistance Project (CMTAP) to the Argentine Republic, Report No. 6193-AR, January 19, 1994. 9 As of April 1994, 4 banks were federally-owned and 30 owned by provincial or municipal governments. 10 As late as January 1993, a meeting of regional and FSD staff concluded that "we would consider BICE only if its development and management improves and if it is successfully privatized." Memorandum from Donna Dowsett- Coirolo to Shahid Husain, January 25, 1993.  6 The BF appeared to meet that need, since, with the guidance of a "reputable intemational institution" acting as financial manager, BICE could be limited to a "fairly innocuous role" as "trustee/administrator." It remained a paradox of the project that it created a direct government intervention in financial markets at a moment when both the GOA and the Bank were pushing for an across-the-board withdrawal of the state from those markets. 19. Beyond the direct, project-related objectives, the Bank had two, broader motivations for the loan. One was the country support argument. This took on an exceptional importance during the period of project design and approval: at stake was a model economic reform program and what seemed to be an historic opportunity to break out of a deep rut of macroeconomic failure. The President's memorandum stated that the program had brought price stability and economic growth "unknown for several decades" in Argentina."1 The Bank perceived a bold and high-payoff economic program that, however, needed time, further reform, and visible extemnal support to become credible and consolidated. It was a moment of enthusiastic recommitment to the country by the Bank, following a period of withdrawal. 20. The Bank's visible endorsement, as a way to build market confidence for the country's economic program, was at all times a major, though mostly unstated purpose of the loan. But the weight attached to this objective was not constant. From 1991 through 1994 it diminished pari passu with recovery in the country's financial circumstances and market image. At the end of 1994 it suddenly resurfaced with the "Tequila effect"-when the collapse of Mexico's currency caused a massive withdrawal of funds from the Argentine banking systenL The GOA requested a renegotiation of the loan terms to permit more rapid disbursement, and the loan was amended wiffi that objective. 21. The amendments amounted to a temporary setting aside of the original, main purpose of the Loan--to develop long-term lending and medium term bond issues by commercial banks. The new priority was expressed in an understanding reached with GOA authorities in March 1995. It was agreed that: "the banking situation remains fragile because of the loss of deposits," and that, with respect to disbursements, "speed was of the essence." The Board must have understood this rationale but it was not made explicit in the formal justification. Instead, the argument for amendment was the need to accommodate the tightening of the market. In the context of 1995, the BF would have found no takers without a loosening of its terms. 22. A second, general motivation was enthusiasm for the innovative character of the loan. Because it would disburse only in the event of market disturbances that interfered with bond refinancing, the loan was in effect a contingency operation. Though it was often referred to as a guarantee, and though it was approved as a standard loan, it was in fact a novel type of operation. The particular form of the contingency arrangement-the backstop- II MemorandumandRecommendationofthePresidentto theExecutiveDirectors,Februy4, 1994,ReportNo.P- 6161-AR, p.2.  7 -was entirely new to the Bank. 12 Indeed, though the concept was borrowed from the private sector, experience with its application even outside the Bank was limited.13 23. Novelty came to be seen as an advantage, a reason in itself for the loan. As a project concept, the BF seemed to provide the Bank with a solution to two internal, institutional goals. It offered a way to reestablish financial sector lending, and more generally, to develop IBRD sector-capacity in the capital markets field and complement IFC capital market transactions. At the same time, it would help the Bank increase its support for the private sector. Timing contributed to the enthusiasm: project design coincided with the creation of the Financial Sector Department (FSD), which became substantially involved in the project's design and implementation. In a way, the project became an experiment, a piece of Rcsearch and Development (R&D) by the Bank. An official of the new Department argued for the project saying, "This may not work, but if it does, it opens a lot of possibilities for us. Even beyond Argentina. That's why I am so militant ... no matter what the risk of falling flat on one's face is. C. ACHIEVEMENT OF OBJECTIVES 24. The BF project failed to achieve most of its objectives. A combination of implementation delays and inappropriate design combined to frustrate its intended contribution to capital market development in Argentina. As already noted, implementation was delayed, the loan eventually canceled, and its operational life-measu'red by the time during which the BF was actively offering to purchase backstop commitments from commercial banks-lasted about one year. So short an existence, by itself, precluded a significant contribution to its primary objective--the encouragement of medium and long term borrowing and lending for investment-and in that sense the loan was clearly unsuccessful.'S 25. The backstopping intervention in financial markets to encourage longer maturities was small, brief and swamped by other market developments working in the same direction. The objective was in any case partly surrendered in 1995, when amendments opened the fund to use as a source ol liquidity, weakening its insurance leverage on longer term lending and bond issuing. 12 Staff disagreed on whether the backstop should be called a "guarantee." Against the recommendation of FRP, the region preferred the term "investment loan" because a guarantee operation would have made it harder to insist on policy conditions and on operational involvement. 13 During the process of loan design the backstop was described as an old idea but currently applied mainly in the Japanese debenture market, and limited, moreover, to tenors shorter than those planned for the BF. Memorandum Jean-Francois Rischard to Carlos Bertao, F'eb 8, 1993. 14 Memorandum, J-F. Rischard to C. Bertao, February 8, 1993. 15 In addition, the BF does not appear to have; left any progeny: there seems to be no institutional development in Argentina that could be imiputed to the backstop idea.  8 26. The "tutorial" impact on capital market institutions sought by the loan was equally frustrated. As an institution the BF did not rise to develop the expertise and managerial capacity to live up to the challenge posed by financial market dynamics. It failed to develop respect in the market. The arms-length contribution of visiting Bank and Salomon Brothers officials did not substitute for the day-to-day institutional and professional leadership that had been expected from the BF. 27. One benefit to Argentina can be claimed by the BF, though it was unrelated to the loan's original intent. The US$200 million in BF transactions during 1995 and 1996 provided liquidity and market support to four medium-size and relatively well-rated banks during the post-Tequila period. The corresponding loan disbursements that followed provided Argentina, in turn, with foreign exchange at a time when the country was seeking to buttress its capacity to defend a fixed exchange rate. 28. A second benefit is closely related to the former. Independently of the actual use or non-use made of the funds, the Bank's approval of the US$500 million BF loan probably added a degree of reinforcement to the credibility of the GOA economic reform program in late 1993 and early 1994. 29. Those liquidity and program-endorsing benefits are intangible and cannot easily be valued. In financial terms, the BF operations ended with net benefits.'6 30. It is even more difficult to assess the innovative contribution of the CMDP. The Loan has opened the door for the consideration of contingency lending by the Bank. It has also created a precedent for disbursement against the procurement of bonds. These rulings are especially helpful to the Bank's financial sector work. But the experience with such new operations is too recent for evaluation and one cannot assume that greater lending flexibility by the Bank is necessarily an institutional gain nor an advantage to borrowers. Indeed, the few attempts at contingency lending made thus far, including the BF, suggest that the concept is demanding in terms of agility in implementation, a feature that is likely to constrain its applicability. D. IMPLEMENTATION RECORD AND MAJOR FACTORS AFFECTING THE PROJECT 31. To help readers follow the complex implementation record of this project, a chronology is provided in Table 1. The following discussion of implementation is organized in terms of two main determinants of the eventual outcome--timeliness and design. 16 The December 31, 1997 balance sheet of the Backstop Fund showed a net worth of about US$2.2 million after allowance for unpaid interest to the Bank. The government's total capital investment in the Fund, made in November 1994, amounted to only US$ 12,000. The overall profit was the result of operating revenues from fees and interest on backstop operations, and of capital gains realized from sales of its back-stopped bond holdings. Revenues thus exceeded the costs incurred by the Bank loan and in the operation of the Facility, including fees to Salomon Brothers. Backstop Fund Sociedad Anonima, Estados Contables Especiales al 31 de Diciembre de 1997, Price Waterhouse and Co.  9 D.1 The Time Factor 32. The readiest explanation for the unsatisfactory outcome can be found in delays and interruptions incurred during the formulation, implementation and operation of this project. Originally targeted for Board approval in late 1992 and for operation in early 1993, a series of slowdowns and setbacks delayed Board approval until March 1994 and the opening for business until August 1995. Comparable two- to three-year delays are not unusual in Bank projects. Extra time is often taken to negotiate loan conditions or to perfect technical details. The costs of delay can often be absorbed by a project, and sometimes prove a worthwhile investment. But in the case of the CMDP, slippage greatly reduced the odds of success. 33. There were three reasons. First, interruptions were numerous; over the five-and-a- half year project lifetime--from conception in 1991 to cancellation in early 1997--seven occasions can be counted when project-advance was slowed, halted, or even forced to return to the drawing board, in each case for periods of between four and eight months. Implementation took on a stop-go character that undermined commitment and momentum. Frequent re-starting and redesign mulliplied the administrative cost and gradually eroded conviction and effort applied to the project by both Bank and Borrower. (See Box).  10 Interruptions during Preparation, Implementation and Operation Five months (Aug-Dec 1992). Bank tried unsuccessfully to condition loan on the privatization of BICE and on restriction of BICE lending to private borrowers only. Six months (Jan-Jun 1993). Project is redesigned. Reasons: (i) GOA refusal to privatize BICE; (ii) reduced need for adjustment aid by Argentina; (iii) Bank's new interest in capital markets and in private sector, reinforced by creation of FSD. Four months (Mar-Jul 1994). Immediately after approval in March, Bank sees breach of a policy condition (new interest subsidies). Result: a four-month Bank-GOA debate. Five months (Jul-Nov 1994). After agreement on interest subsidies was reached in July, loan signing was delayed another five months as GOA proceeded with what Bank saw as unjustifiable slowness to complete the legal processing of loan documents. The Bank used this period, however, to perfect the prospective BF product. Eight months (Jan-Aug 1995). Tequila crisis leads to a seven-month process of loan redesign, including Board amendment. Overlaps with a six-month legal tussle over the procurement of Salomon Brothers as financial manager. Four months (Mar-Jun 1996). "Time out" called to review disappointing performance of BF after only six months of market operations. The offer of backstop commitments through auctions is interrupted. Several modifications discussed, including a change from periodic auction to continuous offer, and an improved standard contract for the purchase of BF commitments (called the "Master Facility" agreement). Six months (Aug 1996-to cancellation) A conditionality device that had been built into the loan-tranching-triggered an overall project review, interrupting the recently re-started operations. After considering a major reformulation of the project, the loan, instead, was canceled.  I1 34. Second, the CMDP was aiming at a moving target. The market conditions that the CMDP was meant to correct evolved rapidly and unpredictably. Over 1991-1994 the level and variety of financial activity recovered with unexpected speed, measured by financial indicators and by the growing sophistication and institutional development of private financial markets. The recovery included the two specific targets of the BF loan--expansion of the bond market and increased availability of medium term paper and credit.17 Deposit rates fell from 62% in 1991 and 17 0/o in 1992 to 11% in 1993 and 8% in 1994. 18Maturity remained very short though medium term corporate issues and foreign placements were growing rapidly. 35. The situation changed again i n early 1995, this time abruptly, in the wake of the currency collapse in Mexico. Through the first semester of that year, the "Tequila effect" brought a state of financial emergency. M3 (including dollar deposits) fell 12.0% in the first quarter and 1.1 % in the second. 'Interbank money rates jumped from 7.5% in November 1994 to 20.1% in March 1994 before subsiding to 6.6% in July. Bond issuing came to a halt, and recovered more slowly. The second half of 1995 through early 1997 was a period of renewed though less dramatic recovery and financial growth. The CMDP goal of providing a financial instrument that would be priced and structured at market terms was tantamount to shooting at a fast-moving target, and, with a high risk of continually falling behind. 36. The third reason for vulnerability to slippage was that the specialized, narrow and rigidly defined product offered by the BF was ill suited to a rapidly moving, even volatile market. This aspect of the project is discussed in more detail below (Section on "The Design Factor"). An agile, client-oriented market operator would have been hard put to adapt the pricing and other terms of a backstopping product to such market conditions. For the Bank's cumbersome, market-insensitive and goal-ridden operational style, the challenge proved too great. 37. The following chronological account examines the causes and effects of slippage in greater detail. 38. The first delay arose out of a policy disagreement. The momentum established by an initial November 1991 mission an.d a September 1992 Staff Appraisal Report19 was checked when the GOA backtracked on its intention to privatize BICE. The project was held up through the Fall of 1992 as the Bank pressed for a privately-owned BICE. The consequence of this disagreement and of the Bank's insistence carried on beyond 1992 since it helped to justify a decision taken in January 1993 to reformulate the project: one of 18 IFS, January 1997, p. 213. 19 Staff Appraisal Report, Argentina, Capital Market Development Loan, September 25, 1992.  12 the objectives of reformulation was to finesse the problem of continuing government ownership. 20 39. If the Bank was adamant on privatization, it seemed justified by a past of deplorable experience with state financial institutions in Argentina, and, more directly, by the inherently private sector nature of the capital markets project that was being developed.21 First Boston had already been retained to prepare the prospective privatization and propose guidelines for what was to be a project run by and for the private sector. Yet the Bank's refusal to back down on privatization also had a subjective element. The extravagant swing in Argentine policies and economic performance had produced very high expectations in the Bank and now became a reason for raising the bar when it came to policy orthodoxy. Its very promise as a model performer-in the Bank's eyes--meant that Argentina would be subjected to the highest policy standards. 40. The privatization issue entered into the Bank-IFC relationship in an ironic way. The Bank viewed itself as going to lengths, even risking the loan, on the issue. Yet that position did not satisfy the IFC, for whom continuing government involvement in Argentina's financial sector, and doubts that promises to privatize would be fulfilled were a reason for unenthusiastic participation, and in the end, for its withdrawal.22 41. By December 1992, the passage of time and changing economic circumstances came together with the unsolved frustration over BICE to precipitate a major overhaul of the project. Reformulation and renegotiations took almost fifteen months, up to Board approval in March 1994. A time-consuming, new Staff Appraisal Report was prepared. For some six months privatization continued to be sought, using a proposed co-financing partnership with the IDB (who had planned to add $200 million to the Bank's $300 million) as a means of joint leverage, before the effort--and the cofinancing--was abandoned. As mentioned, that failure became one reason for reformulation: it strengthened the argument for the contingency and backstop concepts, under which market constraints would help to discipline the government. 42. Time brought other reasons for reformulation. The need for adjustment assistance had diminished, policy reform had moved ahead--with help from other Bank loans 23--and 20 At a meeting held in December 1992 the Bank began to discuss alternative ideas for the project. Complete withdrawal was considered "politically infeasible." Memorandum S. Alber to P. Meo, December 15 1992. 21 Its original designation had been "private sector development loan." 22 The Bank and the IFC were at odds over the project already by mid-1992, exchanging written complaints. and each suggesting that the other was not seeking cooperation. Soon after, the IFC decided to abstain from either direct participation or from open criticism, limiting its attendance in project meetings to token representation by junior staff Other reasons were undoubtedly in play: with the CMDP the Bank was venturing into capital market development, a field long occupied by the IFC at least in terms of transactions: at the same time, the project enjoyed strong support from senior Bank staff. making it difficult for the IFC to object. 23 The December 1992 decision to redesign the loan Bank closely followed the beginning of a lending surge: $450 million for Yacreta II (September 1992). $170 million for Flood Rehabilitation (September 1992). S450 million for Debt and Debt Service Reduction(January 1993), $300 million for Public Enterprise Reform 11 (January 1993),  13 financial deepening was proceedingl apace. And, within the Bank, the interest in capital market development had grown. Institutional development and longer maturities became the goals of the loan. 43. A few weeks after Board approval, the loan was suddenly stalled again. In the Bank's view, a key loan condition had been breached: the government's budget proposal announced that month--in the Bank's view--created new interest subsidies, in direct contradiction to an understanding with GOA, an understanding, moreover, which had been stressed during the staff presentation to the Board. Bank-GOA negotiations on this issue carried on for four months. The GOA disputed the "newness" of the budgeted subsidies and saw them as a minor political accommodation in the context of a sweeping pro-market program. This view of the matter came to be accepted by the Bank, which eventually agreed to proceed with the loan. 44. The interruption caused by the interest subsidy issue, between March and July 1994, was immediately followed by a five-month period of slow loan processing by GOA authorities. By now, an element of self-fulfillment was reinforcing the slippage. Delay had been blunting the cutting edge nature of the project. While the Bank struggled to launch the BF, capital markets had been developing on their own. The advances included securitization, corporate and commercial bank bond issuing and longer term lending. As its relevance dwindled, the Loan lost policy and administrative priority in GOA plans. The legal paperwork needed for loan signature dragged out over the second semester of 1994, putting even further distance between the loan's design and the market context.24 Heretofore, the GOA had chafed at delays that resulted from Bank insistence on policy conditions and project reformulation. From July to November it was the GOA that--in the Bank's estimate--was unnecessarily slow in processing the loan. 45. The Loan was finally signed in November 1994. The contract specified conditions for the backstop--pricing, eligibility for purchase and for use, auction procedure-which reflected the assessment of capital mrarket conditions made several quarters earlier. Yet 25 market conditions had evolved substantially through late 1993 and all of 1994. By November 1994, the developmental assumptions underlying the project were becoming anachronistic. Still, the Loan had been signed and there would be scope for adjustments once it began to operate. $400 million for Financial Sector Adjustment (February 1993), $340 million for Road Maintenance and Rehabilitation (June 1993). 24 The slowdown may have been, in part, the deliberate achievement of GOA opponents of the loan, whose voice grew as the original, confidence-building argument for the loan receded. Opponents had argued as early as 1992- 93 that Argentina's capital markets would recover quickly on their own, making the BF project unnecessary. 25 "The level of activity and rate of change taking place in the market has been extraordinary. Since early in the calendar year, access to the international caLpital markets has developed very quickly. Offers of tenor and price (spread) seem to be lengthening and declining by the week." Irving Kuczynski to Daniel Adams, Back-to-Office Report, November 1 1993.  14 46. At this point the tables were turned. For two or more years the market had been moving ahead of the CMDP. Now, barely weeks after signing, the market collapsed as a consequence of the Mexican crisis of December 1994, and the BF, with its medium-term bond issuing and term-lending goals, found itself ahead of the market. Liquidity drained out of the financial system, institutions failed, interest rates jumped and maturities shortened. 47. The 1993 reformulation of the BF had taken care to ensure that it would be a market-developing tool, not a source of liquidity. Though it had missed the best moment to play a significant role as a market catalyst, in its design it remained, nonetheless, a capital market development instrument. In January 1995, however, market development had to be put aside. The situation called for quick liquidity to meet a financial emergency. Had the BF been in operation a year earlier, $500 million in potential backstop commitments would have been available to cushion the emergency. 26 Now, to provide emergency assistance the BF would need to be amended. In any case, its usefulness as a development tool was curtailed by the financial crisis: bond issuing came to a standstill while low liquidity and increased country risk made new issues appear unlikely for some time. By February 1995 the GOA and Bank had agreed to modifications that would permit rapid disbursement by the BF to participating commercial banks. 48. Though agreement in principle was rapid, the administrative follow-up negotiations were not. The necessary amendments and procedural steps were completed in August of that year. Time was consumed in deciding and negotiating the procedure for loan modification and the exact compromise between liquidity easing and the original developmental objectives. Renegotiation, administrative fiat, or Board amendment was each considered. A key operational requirement of the CMDP--the procurement of a financial manager--became entangled in a contractual tussle between the Bank's Legal Department and Salomon Brothers, already selected as the contractor. The final decision to accept the contractor's demand--clauses waiving indemnity and conflict of interest risks-- was considered precedent setting for all Bank procurement by the Legal Department. By the time the loan became effective in August, the peak of the crisis was well past: bank deposits, bond spreads and interest rates had for the most part recovered to their pre-tequila levels. 49. The BF that opened for operations in August 1995 had become a hybrid project, "temporarily" modified to provide liquidity, but still intended principally as a capital market development instrument. Though the Tequila emergency-and rationale for amending the BF--soon evaporated, the BF had been reprogrammed. During its brief operational life, from September 1995 to August 1996, all BF operations were carried out under the modified terms of reference; that is, banks were allowed to access BF resources for short run liquidity purposes, not only to "backstop" longer term lending and bond 26 One official exclaimed in February 1995, "The very type of market disruption we had in mind when the project was designed has come about... I am sure there is a lesson in this for us and the government!" Memorandum, David Ferreira to Mauricio Carrizosa. February 21, 1995.  15 issuing. Four auctions of backstop commitments and one, non-auction sale of a commitment were carried out during that period. 50. When the fourth auction, held in March 1996, resulted in no bids, the BF in effect closed its doors for reappraisal. This interruption of market presence lasted four months. Two supervision missions and a market survey were carried out and modifications to the BF were debated during that period. Operations were briefly renewed in August. Following a decision to switch from periodic auctions to a continuous offer of commitments, one more backstop was transacted. A few weeks later, however, the Facility was interrupted once again, this time because the accumulated sale of commitments had reached $200 million, the amount fixed by the loan contract as a tripwire for a Project Review. The extended "closing for inventory" whtich resulted made little sense for a project that was struggling to make itself known and to create a market. From October up to the date of cancellation in February 1997, the BF did not operate. The lack of operations became a self-fulfilling argument for cancellation, since the BF was incurring a monthly cost in commitment fees to the Bank, management fees to Salomon Brothers, and BF administrative expenses. D.2 The Design Factor 51. The wy in which the Backstop design was arrived at and its specific shape, both came to bear on project outcome. With respect to the design process, two features should be examined: the knowledge base and Borrower ownership. With regard to the particular shape taken by the Backstop product, several points bear examining-the management of the operation, and the narrow scope, complexity and inflexibility. Also, the innovative character of the project merits comment. D.2.1 The Knowledge Base 52. To a significant extent, the decision to launch a backstop product was a shot in the dark--the other side of the coin of the loan's innovative character. Bank officials acknowledged the high level of risk attached to the loan, but implementation proceeded with little apparent concern to minimize risk by improving the knowledge base. There were several approaches that could have been considered as ways to reduce risk: fuller consultation of Argentine bond market expertise, addition of capital market expertise to Bank's preparation and appraisal missions, at least a quick and highly focused capital markets study, and a review of Japanese experience--the principal precedent for backstopping experience. On the other hand, a small pilot project was not an alternative to the extent that any effective impact necessarily required a minimum size intervention, and, in the Argentine circumstances, a $5,00 million fund was itself a relatively small basis for achieving impact. The key technical assumptions-that in current Argentine circumstances a direct intervention could achieve a "significant impact" on maturities and that the backstop was an effective means for that purpose-were accepted with no apparent hesitation.  16 53. The project information base was thin in three areas: capital market conditions in Argentina; the little-tested backstop instrument itself, and, revealingly, the Bank's own procedures and practices as they would bear on the marketing challenge posed by the BF. 54. The first of these gaps-on Argentine capital market conditions--reflected a disregard for capital market ESW, in retrospect an error in view of the dynamic nature of the financial situation in Argentina, and the consequent need for close tracking of market conditions. A further reason for not developing ESW on capital markets was competition from other issues. During the project-design years 1992 and 1993, and even during the redesign period of 1994, the Bank's attention was taken up by matters of policy conditionality attached to the loan, above all BICE privatization and interest rate subsidies. A capital markets sector study was eventually carried out in 1994, but the draft report did not become available until after loan approval. 27 Two Staff Appraisal Reports were prepared, one in 1992 for the original version of the project and a second in 1994 for the reformulated project, but these followed SAR practice in taking the project concept as essentially given and focusing instead on project design and implementation. The loan files-memoranda, supervision reports, SARs--contain considerable discussion of technical features of the project. But there is a remarkable absence of basic statistical information or conceptual discussion on local interest rates, maturities, issuers and investors, instruments, and on the way in which hyperinflation had affected risk preferences and risk management practices. In particular, there is almost no discussion of or data on the yield curve-the fundamental objective of the project. 55. Paradoxically, high priority and urgency were reasons for going ahead without ESW. The loan was part of a larger effort to strengthen market confidence and policy commitment for a model reform program. As time went by, the original urgency diminished but slippage and frustration at procedural delays became reasons for pressing to close on the loan without prior ESW, even though the rapid evolution of market conditions were making ESW increasingly necessary. In the same way, the sense of urgency became a factor in the sidelining of the IFC-whose objections threatened to slow the lending process-and so deprived the project of one source of ongoing, updated information on Argentine capital market conditions. 56. The peer reviewer to the 1992 SAR pointed out the need for more study. In his opinion, the project justification needed to be strengthened through "a more complete review of the issues and gaps in the capital markets," and he listed specific unanswered questions regarding capital market conditions in Argentina, stressing the need for more analysis of potential market demand for the BF product.28 A regional financial sector economist who later would direct the 1994 Argentina capital markets study provided a similar opinion. In December 1992 he expressed "serious reservations about several 27 Argentina Capital Markets Study, Report No. 12963-AR, December 21, 1994 (gray cover). 28 Memorandum, Edilberto Segura to Paul Meo, August 19, 1992.  17 fundamental aspects of design," reservations that could only have been resolved on the basis of more knowledge of actual market conditions. 57. Surprisingly, fewer questions were raised concerning the lack of experience with backstop operations. On this score officials openly accepted the risk of the project concept. But loan documents spoke of two, mutually consistent tasks for the project: one, to carry out a specific, maturity-extending rnarket intervention through the backstop; a second, to innovate, teach and catalyze market improvements. And in terms of this second function, the lack of backstop experience appeared less threatening. If the primary goal was to set up a financial innovation beachhead in Argentina, confidence could be derived from the market expertise of FSD staff, from the involvement of an internationally prestigious financial institution-Salomon Brothers--and, more broadly, from the conviction that financial innovation was the order of the day. 58. The third deficiency, insufficient self-knowledge, was less obvious at the time but in retrospect was probably damaging to project success. It is implied when cancellation is blamed on Bank "inflexibility," the assumption being that a more agile Bank could have adapted the BF in ways to sustain its relevance. But why was the institution not aware of its own procedural limitations and capabilities? Why did an "inflexible" institution embark on a project that would turn on flexibility? 59. The answer seems to be organizational: the necessary information was there but not put together. Technical staff in FSD, who had a major role in project design and as de facto project task managers, was in a position to gauge the likely impact of delays and design changes on BF marketing possibilities. But they lacked experience with Bank operations and thus the capacity to judge the exceptionally difficult challenge for the institution that was posed by the CMDP. Changes were required in Bank rules and practices, especially in regard to the contingency nature of ithe loan, to disbursement against borrower purchase of bonds and existing real estate-not "productive" assets as traditionally defined by the Bank-and to the indemnity clause demanded by Salomon Brothers. 60. Some of these changes required major legal interpretations and procedural precedents. And, in the course of implementation, major modifications had to be approved in the project itself, especially when it was reformulated in 1993 and then amended in 1995. For technical staff it was also hard to foresee the extent to which the Bank would choose to allow policy considerations to override the market-related requirements of project implementation, as occurred when policy differences turned into lengthy interruptions. 61. During the project design stage an FSD official foresaw the need for considerable flexibility: "It is important that the BF be able to adapt to new bond structures ... in response to market demand." It was necessary, he said, to design the Fund in a way that would allow it "to leapfrog into the likely next stages of the fast-moving Argentine capital  18 markets." Otherwise, "we could well find that the BF is a party to which nobody comes."29 The analysis was in equal parts perceptive with regard to product design requirements and unaware of the improbable odds of bureaucratic success in meeting those requirements. D.2.2 Borrower Ownership 62. The BF-as a capital market development tool--never managed to spark enthusiastic Borrower ownership. The Bank, for its part, was slow to perceive and to admit this problem. To be sure, weak ownership was at times concealed by the fact that, during 1993, the GOA fully discussed and agreed to the BF concept and pressed the Bank for approval of the loan, and that, once the project became effective, the GOA proceeded with the organizational steps required to initiate BF operations. Moreover, GOA interest in the loan rose during the 1995 tequila emergency. Scant borrower ownership and even opposition could have been felt almost immediately when GOA loan processing dragged out during the second half of 1993. 63. Between 1991 and 1993, desperate circumstances led the GOA to seek the Bank's endorsement and financial support. This was part of a larger effort to establish the credibility of its economic program. The CMDP was viewed by the GOA in that context, that is, as part of an external support package for the short run liquidity and confidence- building needs of a radical reform program. At that moment, the "capital market development" objective was secondary. At the same time, a more specific purpose for the loan funds did emerge as a result of BICE's involvement. Because BICE had been conceived, along traditional development bank lines, as a tool for expanding employment and exports, it was a short step to the GOA's idea that the Bank loan could be seen as a source for funding industrial and export-related credits. More ambitiously, the GOA put together a funding package for BICE totaling $800 million, including $300 million from the Bank, $300 million from the Interamerican Development Bank, and $200 million from the Japanese Export-Import bank. There was a strong political motivation for this scheme: during 1992 and 1993 the GOA was pressed to show productive and employment- generating results from its economic program. The announcement of an $800 million export-related financing package took on considerable priority for the Minister of Finance. 64. During this same period--1992 and early 1993--however, the Bank largely unilaterally redesigned the loan on different lines. The GOA's proposal for an industrial and export promotion role was turned down. Adjustment support was dropped. The contingency concept was made the project centerpiece and given the specific form of a backstop-implying the possibility of limited or no disbursement. And the project was made to focus on a longer-term developmental and largely educational function. This reformulation surprised and disappointed the GOA, who continued to pursue the original credit line objective into mid-1993. However, in the face of continuing Bank refusal- communicated personally to the Minister of Finance by the Regional Vice President-and a Bank offer to raise the loan amount from $300 to $500 million, the GOA accepted the 29 Gary Perlin, Note on Facility and Product Design: A Financial Strategy, August 28, 1993.  19 new loan concept. As subsequently reported by participants in those meetings, acceptance was grudging and was decided largely for its announcement value.30 By contrast, GOA objectors to the loan, who moreover had had almost no participation in the design of the reformulated project, continued to hold senior positions. Indeed, one official who had little sympathy for the CMDP eventually replaced the Minister of Finance. During the loan's final months, when a subordinate expressed an interest in reformulating the project, the Minister stated that he had no interest in the project. 65. The sense of imposition may have been reinforced by the Bank's insistence to charge Argentina a "usage", fee of 0. 15% in addition to the standard comrnmitment fee of 0.25% on undisbursed funds. The Bank's position was that, though the Bank had never before charged on any one loan an amount different from what was being charged on all other loans, the added charge was justified by the equally unprecedented Bank commitment to disburse against Backstop obligations even in the event of Argentine debt arrears or default to the Bank. This additional fee was forrnally negotiated with and agreed to by the GOA, and staff had briefed. Board members on the additional fee prior to Board discussion of the loan. Nonetheless, acceptance of the Bank's position had come after the Goverrnent had "vehemently objected" to the prposal.31. However, when the loan was amended in July 1995 the extra fee vwas dropped. 66. A sense of imposition--at the level of BICE-- was also created by the procedure used to contract the firm that would act as financial manager for the project-Salomon Brothers. The financial manager function-essentially a service that was to be provided to and paid for by BICE--implied an intimate and fully trusting relationship with BICE and with the future BF. As it was, BICE officials later felt that they had not participated fully in the decision. Indeed, this particular decision reflected a more general barrier to ownership-Bank acceptance of BICE involvement was grudging and, through 1993, the Bank continued to hope that BICE would be privatized, opening the door to an entirely different managerial team. 67. Some key GOA representatives objected on grounds of economic principle, and these arguments gathered strength over the life of the project as the GOA's market-oriented economic reforms became consolidated. The criticisms focused especially on govenment involvement in BICE and on the fact that the BF, a goverment institution, when it fulfilled its contractual obligation to purchase uncollaterized medium term bonds, would in effect lend at softer terms than those of the Centrl Bank. The last point carried weight in a context in which very strict liitationis on Central Bank rediscounts had been set up as the 30 In May 1993, during an election cazmaign, Minister of Finance Domingo Cavallo had already announced a series of measures to strengthen proxuctive activity and raise employment, including subsidized loans for small and medium business borrowers- BICE was to be central in that effort, and to be financed through an $800 million package, including the prospective Capital Market Development loan- Another source of Bank pressure on the GOA to accept the contingency version was its recent approval of a $450 million Brady-Plan debt-refinancing loan. 31 Memorandum, ShahidHusaintoMemibersoftheLoanCommittee,November 12, 1993.  20 linchpin of the entire economic model. Beyond these specific objections, the project suffered from obscurity and lack of comprehension. Senior Finance and Central Bank officials were often uninterested or even unaware of the BF. Many commercial banks were equally uninformed. 68. The Central Bank's passive and minor role in loan meetings was another source of Borrower reluctancy. Its official attitude was agnostic, but private opinions were skeptical or opposed. Moreover, officials responsible for bank supervision within the Central Bank were not apprised of the project until after its approval. Yet, as a back-up lender against systemic risk to a part of commercial bank activity the BF would overlap the Central Bank's lender of last resort and rediscount functions. Indeed, in line with that logic, when the fuiture of the BF was being debated in 1996, the Central Bank proposed that it be merged into a larger fund, a $6 billion Repos, to provide liquidity to the financial system as a whole in the event of a systemic threat. The proposal raised questions that should have been discussed with the Central Bank more widely when the loan was being designed. Did it make sense to provide a separate backstop facility for a segment of the financial system and to do so on different terms from the Central Bank's system-wide backstop function? 32 D.2.3 Design Features 69. As noted above, the design of the BF became a major motivation in itself for the loan. Beyond its contribution to capital market development in Argentina, the loan was seen as a technical breakthrough, a piece of financial engineering that would open a productive and market-oriented form of government intervention while testing a new lending product. At the time, the President of the Bank was stating that the institution's "principal role" was "to catalyze private capital flows." It was at this juncture that the backstop made its appearance. Contingency lending appeared to re-open the door to financial sector lending in a way that would support, rather than replace market finance. The Director of FSD spoke of "new-style DFIs," that would be in the business of "developmentfinance -rather than the more narrow and time-bound field of development lending."33 The excitement generated by the project at that time lingers on in the Bank. The BF is still described as a "grand" concept, and even, as the "most innovative" project in the Bank's history. 70. In a project evaluation, however, it is not clear what weight should be assigned to innovative quality. The borrower's justification for incurring interest, fees, and at times onerous policy conditions does not extend beyond the benefits expected to flow directly from the project and accrue to the borrower. Yet a lending innovation may create externalities that benefit future borrowers and assist the Bank in carrying out its mission. It would seem that two, entirely separate judgments must be made, one regarding cost-benefit 32 In addition to the practical argument for involving the Central Bank more centrally, it happened that the Central Bank Governor of the negotiation period became the Minister of Finance in 1996. 33 Gary Perlin, The Role of Capital Markets in Development Financing," Address given at Seminar for Chief Executives of Development Banks, World federation of DFIs-UNIDO, Madrid, October 6, 1994.  21 to the borrower-the necessary justification for a loan contract-and another regarding externalities. 71. For the borrower the question of innovative value became moot. Indeed, whether or not the larger design was path breaking, mundane aspects of project design were more important in determining the unsuccessful project outcome. 72. First, the BF was designed in a way that limited its potential market impact and attractiveness. An accumulation of restrictions turned the backstop into a narrow, almost niche product. Detailed market specifications-tenures, eligibility, pricing method-were written into the loan agreement. Other market terms were incorporated into the Bank- approved "master facility" that provided standard conditions for individual contracts. Entrepreneurial response to changing market conditions thus required layers of bureaucratic approval in the Bank. 73. Though the BF had a broad "capital markets development" objective and was intended to have a "significant effect" on financial market maturities, it counted on only one instrument, the backstop. Securitization as an additional tool was considered but dropped, and concurrent market-developing projects in Argentina by the IFC and MIGA 34 were not linked to the BF effort. Further, the potential clientele for the backstop was narrowed to a thin segment of the capital market. Only commercial bank debentures were to be backstopped; corporate issues, it was felt, should be insured by the private sector.35 Moreover, only highly rated commercial banks-as it turned out, about one in five--would be eligible. 36 At the same time, the ]3F was made less interesting for the larger and stronger banks by a $50 million ceiling on outstanding transactions with any one bank, a limitation that was consistent with Bank staternents that target borrowers were to be small and medium enterprises.37 There was an even more powerful, though unintended constraint on participation by strong banks: insuring with the BF--a public institution--was feared to 38 provide a perverse market signal. A survey of potential clients carried out by Salomon found "a poor perception of banks that do participate." In fact, beyond its limiting effect on participation by the stronger banks, this perverse market effect pointed to an inherent flaw in the concept of a government-provided backstop. 34 In FY93 MIGA extended a US $50 million guarantee to the First National bank of Boston to create a long-term investment mortgage program in Argentina. That same year the IFC supported an underwriting facility at BGN. 35 Memorandum, Gary Perlin to Mauricio Carrizosa, Nov 18, 1993. Perlin argued that "providing liquidity to the financial sector is more clearly a role that governments naturally play." A few months earlier an IFC official had recommended including real sector bond issues in the BF terms of reference. Julio Lastres to Paul Meo, June 4, 1993. 36 As of April 1994, Argentina had 166 banks, of which 34 were state-owned, 31 were private and foreign-owned, and 101 private and owned by nationals. By April 1996, 36 banks had been pre-qualified by BICE as potential BF clients. 37 The ceiling was also to prevent excess exposure by the BF to any one bank. Actually, the ceiling was defined as no more than 25 percent of a participating Bank's paid-in capital and as no more than 10 percent of the Facility. 38 A GOA official referred to this as the Groucho Marx effect: "I wouldn't join a club that accepted me as a member."  22 74. Access to the backstop was circumscribed in other ways. A number of restrictions were aimed at ensuring the developmental objectives of the BF. Banks had to satisfy a compIex and often ambiguous list of tests aimed at ensuring the Bank's "developmental" and "productive" objectives for the loan. Poor drafting of the standard client-BF contract, the "master facility", aggravated this barrier. Argentine officials and bankers blame the contract obscurities on the choice of a law firm which turned out to be insufficiently familiar with Argentine practices. Though it was later revised, the contract contributed to the BF's marketing difficulties. 75. These limitations handicapped the BF's chances of making itself felt in the capital markets.39 The "significant impact" objective had been the justification given in 1993 for raising the loan amount from $300 million to $500 million. For Bank officials, marketing does not appear to have been a source of concern during implementation, a reflection of their considerable faith in the catalytic effect of a narrowly targeted intervention. 76. But the marketing problem became evident during backstop auctions. When no bids were presented at the fourth auction, a re-examination was set off, including a market survey carried out by Salomon. The survey found strong confirmation of those marketing problems. To begin with, only 7 out of 36 banks responded to the questionnaire. Salomon's report concluded: low participation in the survey was due mainly to banks notfully understanding the structure of the fund... banks definitely need more marketing material and information ... banks have unanimously expressed their need to better understand the pricing process . the legal structure and the legal requirements are complex and archaic ... legal requirements are numerous.40 Later interviews with banks that did purchase backstop commitments gave the same message. All purchasers felt that they had been assisted by the BF, but all recalled exceptional difficulties in the transaction. One bank stressed the problems created by the "poorly drafted" contract and saw the BF as an inexperienced market operator. Another described the contract as "creative but very complex and a source of errors of interpretation." A third noted the loss of time and high cost of legal rigidities. 77. It is notable that the issue of over-complexity was raised twice during project design, and that in both cases the Bank officials concerned had a special claim to authority. Both were Japanese and were aware of Japanese experience with debenture backstopping-the very precedent that had inspired FSD staff when they proposed its application to Argentina.4' 39 Memorandum, Paul Meo to XX, June 22, 1993. 40 Salomon Brothers, "The World Bank, Review of the Backstop Fund S.A., "Argentina, Feb 14, 1996. 41 Memorandum, Masakazu Watanabe to Mauricio Carrizosa, July 30, 1993. Watanabe thought the proposal workable in the context of a relatively developed capital market, but that in Argentina's circumstances  23 78. Pricing became a second design problem. Where a private firm faced only the need to maximize profits, the BF was saddled with a public good objective: it was expected to influence the market while minimizintg subsidization. The market could not be used as a guide because medium and long-termt markets scarcely existed. An FSD official said, "There is little or no science to the pricing of the backstop." It was decided that backstop commitments would be sold through periodic auctions, a method that would elicit information on market demand. But the auction mechanism was restrictive and inflexible when it came to adjusting interest rates and maturities and awkward as a way to market an unfamiliar and complex product. Auctions were eventually dropped, but not before adding to the backstop's implementation difficulties. 79. These various causes of rigidity and narrowness in the BF product are consequences of Bank guidelines to ensure close control over the specific uses made of its funds, above all, to ensure that their use was indeed "productive" and "developmental." Due to the enormous scope for fungi bility in bank balance sheets, these restrictions were largely a matter of keeping up appearances, but time and effort had to be expended in ensuring formal compliance and, as occurred, in obtaining Bank waivers.42 80. A third design feature was the choice of management procedure. The decision was to rely on a specially created project implementation unit-the Backstop Fund created within BICE. This approach facilitated Bank oversight but its ad-hoc character and institutional distance from key official actors in the financial markets contributed to weak Borrower ownership. The approach also meant building financial market expertise from scratch. An expert financial manager-in the event, Salomon Brothers-and the close attention of FSD in the Bank, were to help develop that capacity. 81. As a management strategy, the plan worked poorly. From beginning to end the BF was woefully under-equipped for its task. Salomon officials commuted from New York with little effect and declining interest.43 Their initial effort appears to have been considerable, in part, it seems, because the firm was caught up in the same wave of technical enthusiasm that was felt in the Bank.44 But much of that effort-as called for by their terms of reference--was dedicated to sophisticated issues of technical design, especially pricing, rather than to the elementary administrative, educational, and marketing efforts needed to make the project move. The main responsibility for those efforts lay in the BF. "the transaction structure must be much simpler." Koji Kashiwaya similarly warned that the BF proposal was inappropriate for the prevailing market conditions in Argentina. Memorandum to Ernest Stern, July 28, 1993. 42 Gary Perlin of FSD pointed to the "fungibility of assets" as a reason for reducing the Bank's "overly complex monitoring requirements" which would add "uncertainty and possible administrative hassle to the [bond] rollover process." The Bank should, instead, "provide reasonable flexibility to the participating banks." Memorandum to David Ferreira, February 7, 1994. 43 Several months went by before Salomon officials discovered that the project had been canceled. 44 Despite a substantial fee, Salomon officials ruefully refer to their BF work as an unprofitable overcommitment.  24 82. Within the Bank, project implementation involved a division of labor. The Region focused principally on administrative steps, bureaucratic clearances, and policy compliance. FSD assisted in those tasks in the course of providing intensive technical advice and oversight. FSD officials were heavily involved and in practice carried out much of the work of the project task manager, including the fielding of supervision missions. But, though there was much cooperation, the Region and FSD had different visions of project success, and therefore, of project problems. FSD was closer to the entrepreneurial problem whereas the Region was responsible for administrative good behavior. It thus became difficult for the Bank to arrive at an overall vision, especially since there was an inherent conflict between those two sets of priorities. 83. Whether the innovative nature of the backstop had positive externalities for other borrowers and for the Bank is difficult to determine. 84. What is certain is that the project has opened new lending doors. In 1993 the contingency loan was a gleam in the Bank's eye. Though still novel, it is increasingly accepted as a lending alternative. Moreover, its potential applicability seemed wide. Conceived as a "final product "for capital market lending, it quickly became an "intermediate product" for loans in other sectors, that is, a piece of the financing machinery for any loan. As such, it has been considered in the context of export development and infrastructure projects. 85. On the other hand, the contingency loan has not yet developed into an established, powerful lending solution in any class of applications. The first attempt was planned as part of an energy sector privatization project in Jamaica. This project was proposed during 1993, but dropped before reaching the Board. A second attempt, in a financial sector loan in India approved in 1995, failed almost immediately. Other experiments have proved more lasting, notably a pre-export facility in Moldova in which the Bank backstops the government's political risk guarantee. Backstopping is being considered for other pre- export guarantee facilities, in Bosnia, Ukraine and South Africa. 86. But the contingency loan is still at an experimental stage. Each new application involves learning, and experience with the concept remains limited. The very flexibility of the application means that it will take a variety of experiments and more time to arrive at an evaluation of its usefulness. But experimentation is likely to be a prolonged process for another reason: the contingency loan may have an Achilles heel in implementation. The concept seems to require a degree of responsive and finely-tuned execution that is not the rule in borrowing countries, nor for that matter, in the Bank. E. PROJECT SUSTAINABILITY 87. The project has had no lasting impact on Argentine capital markets. At the same time, most of its original objectives have been achieved through alternative market innovations. Medium term bond markets, both bank and corporate, have developed  25 considerably; rating agencies have become established; long term lending has expanded, though mostly on the basis of mortgages. Finally, there appears to be no interest among private bankers or government officials in Argentina in a replication of the backstop model. F. BANK PERFORMANCE 88. Bank performance was admirable in terms of the energy, creativity and timeliness with which it set out to meet a perceived need in Argentine economic recovery and development. It identified new prioiities in a fast-changing environment. It committed itself strongly to a Borrower following a model reform program, putting aside past disappointments and possible justification for a more cautious response. 89. Perhaps most notably, the Bank carried out several significant changes in its procedures and legal interpretations., as it adjusted to the requirements of the backstop mechanism. Those changes, particularly the precedent set in the form of contingency lending, have opened a lending door that is currently being explored in other Bank projects. Finally, it acted with decisiveness to prompt the Borrower to cancel the project when a lack of demand for the BF product threatened the Borrower with potential losses from continuing commitment and management fees and expenses. 90. Bank performance was deficient however in its failure to admit to the continuing shallowness of Borrower commitment to the backstop concept. The Bank appeared to rely too much on its own estimate of likely project success and on an assumption that success would create Borrower ownership, underestimating the damaging effect of a reluctant partner. 91. The Bank was also deficient in its assessment of the managerial and design requirements of a highly market-sensitive product. Though it was following desirable practice in insisting on policy compliance and in the caution with which it carried out procedural changes, it did not sufficiently perceive the conflict that such standard practices would imply a need for entrepreneurial flexibility and marketability. Its usual emphasis on product specificity and targeting took the Bank too far in the direction of product narrowness, rigidity and complexity. In a similar way, its concern for precedent and for Bank-wide rules and procedures meant that decisions related to the BF project were taken too slowly for market requirements. G. BORROWER PERFORMANCE 92. Borrower performance was deficient in two major and related respects. First, the Borrower signed Loan documents agreeing to the project concept--the backstop mechanism--though it did not only mildly endorse the idea. Indeed, even as it proceeded to request the loan, the GOA view leant. to skepticism and disappointment with regard to the project concept. Up to this day, the GOA never abandoned its strong preference for traditional FILs, especially for the snmall business sector. As a result, project  26 implementation was handicapped by a lack of borrower enthusiasm and a degree of self- contradiction. 93. Second, Borrower implementation and management became inadequate. Contrary to the unprecedented efficiency displayed in the processing of loans related to financial sector adjustment and privatization at about the same time, in this case the project implementation agency--BICE--proceeded with much less energy and initiative in achieving the processing steps required to make the loan and the subsequent loan amendment effective. Moreover, BICE managerial effectiveness fell short of the project requirements for a highly agile and ineffective marketing of the backstop, a failure that resulted in the persistent obscurity of the backstop instrument. Finally, BICE's failure to follow the agreed credit appraisal procedures prompted a suspension of operations in May 1996. 94. The performance of Salomon Brothers as project financial adviser appears to have fulfilled the terms of reference as agreed. H. ASSESSMENT OF OUTCOME 95. Weighing all the factors, project performance was unsatisfactory. Even though the operation contained a number of positive features, ultimately, the short life of the project, the scarcity of operations, and the persistent obscurity of the product--as perceived by the market-- justify a negative assessment. Macroeconomic and program-endorsing objectives were met, and the application and testing of a new lending product was made possible, but the fundamental capital market objectives of the project were not achieved. The Borrower never came to a positive, much less enthusiastic view of the backstop idea. Implementation was made more difficult by unforeseeable circumstances, but inadequate performance on the part of both the Bank and the Borrower were contributing factors. In both cases, design and implementation fell short of the unusually high demands placed on effective implementation by the product's innovative nature.  27 ANNEX 1: CHRONOLOGY OF CAPITAL MARKET DEVELOPMENT LOAN ARGENTINA 1991 First Bank TOR call it a "private sector development" project. Concept is a $300 Nov mission (pre- million financial intermediary loan (FIL) plus technical assistance for appraisal) financial sector reforms. 1992 First Staff Proposes: a, FIL using BICE (new second-tier institution); targeting of "outer Aug Appraisal Report maturities"; privatization of BICE; screening of solvent banks by BICE; Dutch auct.ions; securitization of BICE loans; co-financing with IDB; macro and capital market policy conditions. Bank-IFC coordination breaks down. 1992 BICE Bank and GOA disagree on privatization of BICE and on BICE subsidized Aug-Dec disagreement credit lines. Bank decides to reformulate project. 1993 Reformulation New Financial Sector Department (FSD) begins to assist search for Jan-Feb alternative approach. Backstop (stand-by, contingency) concept proposed. Privatization of BICE remains condition. Focus shifts to institutional (capital market) development, including technical assistance and policy conditions. Issues emerge: how much of project would be a standard loan to finance BICE onlending (GOA's priority); should state banks be allowed as BICE clients (GOA "yes", Bank "no"); do Bank Articles allow disbursement for procurement of bonds? Bank and IFC send separate, uncoordinated "capital market development" missions in February. 1993 Complementary Board approves $400 million Financial Sector Adjustment Loan--part of a Feb lending lending surge to Argentina that starts late 1992. 1993 Preparatory GOA accepts contingency idea BUT main interest remains BICE credit line. Feb Mission Technical and legal aspects studied. IFC sends a separate "capital market development" mission to Argentina in same month. 1993 Interest New policy issue arises when GOA introduces interest subsidy program for Apr subsidies small enterprises. Bank seeks dissuasive policy leverage through coordination with IDB. 1993 Initiating Memo Revised $300 million project contains TA, adjustment, credit line to BICE, May and backstop facility components. Also IDB cofinancing ($200 million). 1993 Agreement VP for LAC and Minister of Finance strike deal in Buenos Aires: GOA will June cut subsidies; loan raised to $500 million; backstop accepted. July 1993 Staff Appraisal Final draft narrows project to a contingency "Backstop Facility". Targets are to Feb Report longer matLrities and capital market expertise-and-institution-building. To be 1994 (successive complemented by large capital market TA project. IDB drops out; Bank loan drafts) raised to $500 million. Credit line, adjustment and securitization components are dropped. Insistence on BICE privatization dropped. Interest subsidy reduction condition kept. Market pricing is stressed. 1993 Loan Dec Negotiations 1994 Board approval Strong support. Questions on IFC role. Mar 1994 GOA interest GOA decree sets out annual interest rate subsidy program for PYMEs. Bank Mar subsidy sees breach of loan covenant, preventing signing. 1994 Capital Markets Analysis belatedly weakens rationale for Backstop. June Report 1994 GOA-Bank New wording for interest subsidies clause ends four-month disagreement and July negotiations delay in signing.  28 1994 Legal paperwork Additional five-month delay in signing due to slow legal processing by July-Nov GOA, and to technical complexities of backstop. 1994 Financial Procurement of Financial Manager for backstop begins with invitation to six Sep Manager firms. 1994 Loan signing Companion Capital Market Technical Assistance Loan signed previously. Nov 1994 Mexico sets off In Argentina liquidity tightens, interest rates spike, maturities drop: scope for Dec "tequila" crisis medium term bonds--and for Backstop Facility--curtailed. 1995 GOA requests Amendment process started: entails Legal and Board OKs, redesign of Feb loan Backstop rules and product, speedup of Financial Manager procurement. amendments 1995 GOA pre- GOA formal request arrives March 10, after GOA public announcement. Mar announces amendments 1995 Financial Salomon sends proposal March. Accepted by BICE May. Salomon and Mar-May Manager Legal Dept. disagree on indemnity and conflict-of-interest clauses. 1995 Legal impasse Salomon and Legal Dept. disagreement delays roject three months. May-Jul 1995 Bank-S.B. agree Bank accedes to Salomon clauses creating a procurement precedent. Jul 1995 Board approves Allows temporary (1995-96) use of Backstop funds for short term liquidity Jul amendments needs of banks. 1995 Financial Contract signed with Salomon: procurement took i I months. Aug manager 1995 Public launching Press Conference in Buenos Aires announces Facility. Context: liquidity and Aug of Backstop interest rates not yet recovered to pre-crisis levels. 1995 Loan is 17 months after Board approval, 9 months after signing. Aug effective. 1995 First auction Four banks pre-qualified; one bids and obtains a commitment (guarantee of Sep bond purchase under conditions of market trauma) from Facility for $45 million. Nov 1995 Second auction Postponed from Oct. Total $55 million to two banks. 1995 Third auction Three banks get total of $50 million in commitments. Outstanding Dec commitments by Backstop total $150 million. 1996 Fourth auction No bids. Mar 1996 Reappraisal Bank supervision missions (March and June) and Salomon client survey Mar-July (April) are basis for numerous and some radical proposals for managerial and product design changes. Potential clients are uninformed, express limited interest and have poor image of Backstop. Salomon visits banks to market Backstop. 1996 Final A bank buys a $50 million commitment under new, continuous offer system Aug commitment: bringing total sales to $200 million. Commitment operations interrupted for First Project Project Review--interruption becomes permanent. Review is triggered 1996 Repo plans Argentine Central Bank discusses plans for a Repo facility. Oct 1996 Project Review Radical alternatives are discussed in Bank and GOA, viz. transfer of Oct backstop funds into Repo facility; or cancellation. 1997 Cancellation Bank decides against restructuring. GOA cancels loan. Mar  29 ANNEX 2: SUMMARY OF ASSESSMENTS A. Achievement of objectives Substantial Partial Negligible Not applicable Macro policies x Sector policies x Financial objectives x Institutional development x Physical objectives x Poverty reduction x Gender issues x Other social objectives x Environmental objectives x Public sector management x Private sector development x Other (specify) x B. Project sustainability Likely Unlikely Uncertain x C. Bank performance Highly satisfactory Satisfactory Deficient Identification x Preparation assistance x Appraisal x Supervision x D. Borrower performance Highly satisfactory Satisfactory Deficient Preparation x Implementation x Covenant compliance x Operation (if applicable) x E. Assessment of outcome Highly Highly satisfactoy Satisfactory Unsatisfactory unsatisfactory x  30 PART II. STATISTICAL ANNEX TABLE 1: LOAN DISBURSEMENTS: CUMULATIVE ESTIMATED AND ACTUAL (US$ million) FY96 FY97 Actual 15.73 90.62 Date & amount of cancellation: March 17, 1997 - US$393.7 M TABLE 2: PROJECT TIMETABLE Steps in Project Cycle Date Planned /1 Actual Date/or Duration Identification (Initial Executive March 1991 Project Summary) Preparation 28 months Appraisal August 17, 1993 Negotiations December 13, 1993 Board Presentation March 1, 1994 Signing November 29, 1994 Effectiveness August 31, 1995 Loan closing March 17, 1997 /1 Project proceeded erratically. Therefore, no reliable plans can be cited.  31 TABLE 3: BANK RESOURCES: STAFF INPUTS /1 Stage of Actual Project Cycle Weeks US$ Through appraisal 143.4 374.9 Appraisal-Board 63.2 259.3 Board-effectiveness 4.0 10.9 Supervision 58.3 243.1 Completion 9.2 37.8 TOTAL 278.1 926.0 /1 Includes Bank-financed consultants. Dollars are direct costs only. TABLE 4: RELATED BANK LOANS/CREDITS Loan Purp Amount Year of Status (US$ M) Approval FY98 Preceding Operations 3558-AR FSAL (Structural Adjustment) 400.0 1993 Closed 3710-AR Capital Market TA (Technical 8.5 1994 Active Assistance) Subsequent Operations 3878-AR Provincial Bank Privatization 500.0 1995 Active 3926-AR Bank Reform 500.0 1995 Active  32 TABLE 5: MISSIONS Number Specialized Performance rating T Stage of Project Month/ of Days in staff skills Types of l cycle year persons field represented Implementation Development problems 1/ Status objectives Through appraisal March1991 1 11 A August 1993 14 10 A,B,C,D,E,I Appraisal through March 1994 1 5 1 Board approval Board approval through effectiveness Supervision June 1995 1 A U S Delay in effective-ness (Portfolio Status due to Gov't. request to Update) change covenant wording; slow Gov't. proces-sing of decrees for signature;andlengthy procurement process. (Portfolio Status April 1996 2 15 B S S Loan performance Update) improved since effectiveness. (Portfolio Status May1996 2 5 A,B S S Project management still Update) needs to be improved through strengthening of marketing efforts. June 1996 1 5 B S S Performance of the Backstop Fund re-mains unsatisfactory. Oct./Nov. 2 17 A, B U S Weak Gov't. com- 1996 mitment to the pro-ject. Four of the 14 conditions in the Articles of Agree- ment have not been met. Gov't should formalize its request for cancellation. (Portfolio Status July 1997 U U Development object-ives Update) were never met. Two restructuring efforts failed. Loan was cancelled effec-tive March 17, 1997. Completion 1998 1/ Key to specialization: A. Task Manager B. Capital Market Specialist C. Private Sector Specialist D. Consultant E. Legal Counsel F. Division Chief  33 TABLE 6: STATUS, OF LEGAL COVENANTS Agreement Section Type of Present Description of Covenant Comments Covenant Status Loan Section 05 C BICE to enter into Administratiuon Agreement and In compliance Agreement 3.02(a) Financial Management Agreement. Section 05 C Backstop Fund to cease issuing backstop commitments In compliance 3.03(a) prior to project reviews. Section 01 NA G;overnment to submit audit of special account. Not applicable ___________ 4.01 (ii) Section 10 C Execution and delivery of the Administration Agreement, In Compliance 6.01 (a) the Financial Management Agreement and the Subsidiary Loan Agreement. Section 10 C Delivery of a model Facility Agreement. In compliance 6.01 (b) Section 10 C(Government and Fund to take all action in order to permit In compliance 6.01 (C) the procurement of goods and consultants' services for Plart B of the Project to be financed out of the proceeds of the Loan be undertaken in accordance with the provisions set forth or referred to in this Agreement. Section 10 C Delivery of opinion that the Project Agreement has been In compliance 6.02 (a) f'ully authorized or ratified by the Fund and is legally binding upon the Fund in accordance with its terms. General Conditions. Section 10 C Delivery of opinion that the Administration Agreement, In compliance 6.02 (b) the Financial Management Agreement and the Subsidiary ILoan Agreement have been duly authorized or ratified by the respective parties thereto, and are legally binding upon the respective parties thereto in accordance with lheir respective terms. Section 10 C Delivery of opinion that the Facility Agreements, when In compliance 6.02 (C) executed and delivered by the respective parties thereto based on the model referred to in Section 6.01(b) of this Agreement, will be legally valid and binding upon the respective parties thereto in accordance with their _respective terms. Section 10 C Delivery of opinion that the action referred to in Section In compliance 6.02(d) 6.01(c) of Loan Agreement has been taken and no other action on behalf of the Borrower or the Fund is required for the procurement of goods and consultants' services for Part B of the Project in accordance with the provisions of this Agreement. Section 05 C Backstop Fund to enter into Administration Agreement In compliance 2.01(b)(i) with BICE. Section 05 C Backstop Fund to enter into Backstop Facility In compliance 2.01(b)(ii) Agreements with participating banks. Section 05 C Backstop Fund to enter into subsidiary Loan Agreement In compliance 2.01(b)(iii) Section 05 C Backstop Fund to comply with obligations under Admi- In compliance 2.01 (b)(iv) nistration Agreement, Facility Agreements and the I_________ Subsidy Loan Agreement. Section 05 NA Fund to furnish copies of Facility Agreements. Not applicable 2.01(c) Section 09 C Fund to exchange views with the Bank with regard to In compliance 2.02(a) progress of the project. Section 09 C Fund to report conditions that interfere with In compliance 2.02(b) implementation. Section 09 C Fund to submit quarterly report on FONs purchased. In compliance 2.04 Section 05 C Procurement to follow provisions of Schedule 3. In compliance 2.05 Section 05 C Fund to observe agreed commitment ceilings. In compliance 2.06  34 Section 05 CP Fund to carry on its operations in accordance with sound Parctices need to be 3.01 practices and agreed provisions. improved (see Form 590) Section 05 NA Fund to be appropriately insured. Not applicable 3.02 Section 01 NA Fund to submit its financial statements and audits. Not applicable 4.01(b)(ii) Covenant Types: I = Accounts/Audits 8 = Indigenous people 2 = Financial performance/generate revenue from 9 = Monitoring, review and reporting beneficiaries 10 = Project implementation not 3 = Flow and utilization of Project funds covered by categories 1-9 4 = Counterpart funding 11 = Sectoral or cross sectoral 5 = Management aspects of the project budgetary or other resource or executing agency allocation 6 = Environmental covenants 12 = Sectoral or cross-sectoral policy/ 7 = Involuntary resettlement regulatory/institutional action 13 = Other Present Status: C = covenant complied CD = complied with after delay CP = complied with partially NC = Not complied with NA = Not applicable because of Loan cancellation/liquidation of Backstop Fund