Philippines - Banking System Reform Loan

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 22824 IMPLEMENTATION COMPLETION REPORT THE REPUBLIC OF THE PHILIPPINES B.ANKING SYSTEM REFORM LOAN (Loan No. 4412-PHL) December 14, 2001 Poverty Reduction and Economic Management Unit East Asia and Pacific Region |This document has a restricted distribution and may be used by recipients only in the performnance of their official |duties. Its content may not otherwise be disclosed without World Bank authorization.l  - 1i - CURRENCY EQUIVALENTS (as of December 2001) Currency Unit = Peso 1 peso = US$0.01923 US$1.00 51.98 pesos WEIGHTS AND MEASURES: Metric System FISCAL YEAR: January 1- December 31 ABBREVIATIONS AND ACRONYMS APT - Asset Privatization Trust BAP - Bankers Association of the Philippines BSP - Bangko Sentral Ng Pilipinas CAMEL - Capital, Asset Quality, Management, Earnings and Liquidity CAS - Country Assistance Strategy CPSD - Consolidated Public Sector Deficit DBP - Development Bank of the Philippines DOF - Department of Finance DST - Documentary Stamp Tax EFF - Extended Financing Facility FCDU - Foreign Currency Deposit Units GFI - Government-Owned Financial Institution GDP - Gross Domestic Product GNP - Gross National Product GRT - Gross Receipts Tax IFAC - Effects of Non-Application NPL - Nonperforming Loan PDIC - Philippines Deposit Insurance Corporation PNB - Philippine National Bank SCL - Single Currency Loan SEC - Securities and Exchange Commission SLIM - Solvency, Liquidity, Income and Management SME - Small and Medium Enterprise TA - Technical Assistance VAT - Value-Added Tax Vice President : Jemal-ud-din Kassum, EAPVP Country Director : Robert V. Pulley, EACPF Sector Director and Chief Economist : Homi Kharas, EASPR ICR Task Manager : Thang-Long Ton, EASPR  FOR OFFICIAL USE ONLY IMPLEMENTATION COMPLETION REPORT THE REPUBLIC OF THE PHILIPPINES BANKING SYSTEM REFORM LOAN (Loan No. 4412-PHL) CONTENTS I. Project Data ........................................1 2. Principal Performance Ratings ........... .............................2 3. Assessment of Development Objectives and Design, and of Quality at Entry ........................................2 4. Achievement of Objectives and Outputs ........................................6 5. Major Factors Affecting Implementation and Outcome ......................... 13 6. Sustainability ....................................... 14 7. Bank and Borrower Performance ....................................... 15 8. Lessons Learned ....................................... 17 9. Partner Comments ....................................... 19 Annex 1. Key Performance Indicators .23 Annex 2. Project Costs and Financing .23 Annex 3. Economic Costs and Benefits .24 Annex 4. Bank Inputs .24 Annex 5. Ratings for Achievement of Objectives/Outputs of Components 25 Annex 6. Ratings of Bank and Borrower Performance .26 Annex 7. List of Supporting Document -- Policy Matrix .27 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.   IMPLEMENTATION COMPLETION REPORT THE REPUBLIC OF THE PHILIPPINES BANKING REFORM SYSTEM LOAN (LOAN No. 4412-PHL) Project ID: PH-56524 Project Name: Banking System Reform Loan Team Leaders: Sanjay Dhar/Hemant Shah TL Unit: EASPR ICR Type: Core ICR Report Date: December 14, 2001 1. Project Data Name: Bankin S stem Reform Loan L/C/TFNumber: 4412-PH Country! Republic of the Philippines Region: East Asia and Department: /EASPR Pacific Region Sector/subsector. Finance/Banking Key Dates Original Revised/Actual Project Concept Document 01/28/1998 Effectiveness 12/29/1998 12/29/1998 Appraisal 08/03/1998 Approval 12/03/1998 Closing 06/30/2000 05/24/01 Borrower/lImplementing GOP/BSP Agency. Other Partners: JEXIM/JBIC Staff At ICR preparation At Appraisal Vice President: Jemal-ud-din Kassum, EAPVP Jean-Michel Severino, EAPVP Country Director: Robert V. Pulley, EACPF Vinay Bhargava, EACPF Sector Director: Homi Kharas, EASPR Jacques Loubert, EASFS Team Leader at ICR: Sanjay Dhar, EASPR Sanjay Dhar, EASPR ICR Primary Writer: Thang-Long Ton, EASPR Country Team Reviewer Sanjay Dhar, EASPR for the ICR:  -2 - 2. Principal Performance Ratings (HS = Highly Satisfactory, S = Satisfactory; U = Unsatisfactory; HL = Highly Likely; UN = Unlikely, HUN = Highly Unlikely, HU = Highly Unsatisfactory, H = High, SU = Substantial, M = Modest, N = Negligible) 2.1. The principal performance ratings are as follows: Outcome: U Sustainability: UN Institutional Development Impact: M Bank Performance: S Borrower Performance: U ICR QAG (if available) Quality at entry S not available Project at Risk at any time yes not available 3. Assessment of Development Objectives, Design and Quality at Entry 3.1 Original Objective: 3.1.1. Background The Philippine banking system withstood the impact of the regional crisis better than most neighboring market economies. Stronger capitalization in the top tier banks, lower corporate sector leverage and greater experience with financial crises allowed the country to better withstand the impact of the financial market shocks witnessed in the crisis aftermath, and a systemic banking crisis was avoided. Nevertheless, the banking and corporate sectors have both encountered prolonged periods of stress as the regional crisis was followed by a political crisis that afflicted the previous administration (through January 2001) and the subsequent global economic slowdown-each of which had adverse impacts on the economy, corporate profitability and the banking system. The quality of bank assets has consequently deteriorated, non-performing loans have risen to 18 percent, capital adequacy has weakened, and previously strong earnings have fallen. During loan preparation in 1998, the country's banking system was expected to go through a period of consolidation and retrenching, but the slow pace of recovery since the 1998 recession has intensified the degree of stress experienced relative to initial expectations. 3.1.2. The authorities recognized the importance of strengthening the banking system in the aftermath of the 1997 crisis. A comprehensive reform agenda for the banking sector was formulated with advice from the Bank and IMF. The agenda included: stronger prudential standards and supervisory vigilance; enhanced market discipline through stricter disclosure requirements and transparency; adoption of an intervention and resolution strategy for troubled banks; and measures to strengthen Philippines National Bank (PNB), which, at the time, was the second largest bank in the country, 46 percent government-owned, and in poor financial condition.  - 3 - 3.1.3. Objectives. The Banking System Reform Loan (BSRL) was the Bank's response to the government request to support its medium-term reform strategy to strengthen the banking system. It aimed at assisting the government realize its vision of a more resilient banking system where bank owners were expected to be buttressed by higher capital and stricter provisioning requirements and subjected to more stringent scrutiny from supervisors (backed up by greater legislative authority for supervisors) and market participants; and where banks would subsequently be more discriminating in intermediating financial flows as they involved foreign currency, major term transformation, or lending to volatile sectors. Specifically, the BSRL addressed the following objectives: * Improve on an ongoing basis the incentives for supervisors, bank owners, and the market to strengthen the framework for prudent banking; * Enhance the framework and the authorities' preparedness for early intervention and resolution of troubled banks; * Strengthen PNB towards the standards maintained by the top tier banks in the country; and * Reduce the incentives for regulatory and tax arbitrage across financial institutions and between the peso and foreign currencies. 3.1.4. Strengthening the prudential framework. The loan sought to improve the incentives for supervisors, bank owners, and the market to strengthen the framework for prudent banking on a continuing basis. 3.1.5. Refining the intervention and resolution strategy. The BSRL supported the authorities in enhancing the framework and preparedness for early intervention and resolution of troubled banks. 3.1.6. Strengthening government-owned or controlled banks. The overall soundness of the banking system would be enhanced with the strengthening of the financial performance of PNB, the second largest bank in the country at the time. PNB had suffered disproportionately during the 1997 crisis as a result of ineffective governance and a continuation of politically-pressured lending despite the reduction of government ownership to 46 percent. The effort to place PNB on a firmer footing would aid in the overall strategy of the government in strengthening the country's banking system. 3.1.7 Reducing regulatory arbitrage and intermediation costs. The objective here was to reduce the incentives for regulatory and tax arbitrage across financial institutions and between the peso and foreign currencies. 3.1.8. Legislative reform. The BSRL recognized that the effectiveness of many of the regulatory changes envisaged would require stronger legal authority for bank regulators. Hence, legislative changes were considered integral to the program and included objectives to: protect officials of the Monetary Board, BSP, and PDIC against suits arising out of their official conduct;  - 4 - enhance supervisory and enforcement powers of BSP and PDIC; and augment the legal authority of BSP to close insolvent banks and PDIC to promptly resolve closed banks. 3.1.9. The funding from the BSRL was to be used for balance of payments support to the Philippines as its access to private capital was reduced due to the regional financial crisis. The proceeds would help to alleviate the pressure on domestic resources to finance budget deficits, build reserves, and enhance market confidence in the banking reform program being undertaken by the government. 3.2 Revised Objective: 3.2.1. No revisions were made to the above-mentioned objectives. 3.3 Original Components: 3.3.1. The components of the BSRL were built on the objectives listed above with a series of specific conditions in the loan designed to strengthen the resiliency of the banking sector. 3.3.2. Sound macroeconomic framework. The BSRL necessitated the maintenance of a satisfactory macroeconomic framework, which is standard practice for adjustment lending. 3.3.3. Prudential framework strengthening. A series of measures designed to enhance the prudential standards for banking operations and supervisory effectiveness for the banking sector was to be undertaken. 3.3.4. Strategy for intervention and resolution. As the true level of capitalization of the Philippine banking system was weakened by the economic and financial market shocks through 1998 and with further possible stress, the government would take timely measures to develop and implement a strategy for identifying and dealing with insolvent or undercapitalized banks. These initiatives included: (i) a crash program of intensified monitoring of selected banks, (ii) explicit procedures and rules establishing a graduated response to capital shortfalls; and (iii) strategy for problem bank resolution. 3.3.5. Strengthening government-owned or controlled banks. The loan supported a process aimed to reforrn and strengthen PNB-commission an external diagnostic audit; strengthen PNB's financial performance consistent with the findings of the audit; transfer management and control to respected private ownership which could strengthen PNB on a sustained basis. Privatization was seen as a means to attain this objective. External audits of the two government-owned banks were also promoted by the BSRL (and financed by a trust fund). 3.3.6. Reduction of regulatory arbitrage and intermediation costs. The BSRL sought to reduce the burden of borrowing and the prudential risks associated with regulatory arbitrage, intermediation costs and underlying distortions that would add to the cost of borrowing. Measures to be undertaken by the authorities would ameliorate the differential in intermediation costs between peso and foreign currencies and tax and reserve treatments between peso and foreign exchange business.  - 5 - 3.3.7. Legislative and regulatory agenda. The BSRL finally supported changes in legislative and regulatory measures in order to provide legal protection to banking officials in performing their official duties, enhance the supervisory and enforcement powers of BSP and PDIC, augment BSP's and PDIC's legal authority to close insolvent banks and to resolve closed banks promptly. 3.4 Revised Components: 3.4.1. There was no revision in the original components, but in May 2001, the Bank did discuss with the authorities possible restructuring of some conditions. By May 2001, it was apparent that the government would not be able to comply with the original objectives relating to PNB under a reasonable timeframe (as it was considering re-acquiring majority ownership of PNB and rehabilitating it over an extended time period before privatizing it). In the context of deciding how to respond to a possible government request for a second extension to the BSRL (which was due to close on June 30, 2001), the Bank proposed to the authorities that it would be willing to adjust the conditions associated with PNB (assuming that irreversible steps were taken toward strengthening the bank and an appropriate restructuring plan was devised), together with a strengthening of the envisaged legislative agenda to permit more rapid resolution of distressed banks.' In the event, however, the government decided not to request a second extension of the loan and instead requested (on May 23, 2001) that the loan be cancelled. 3.5 Quality at Entry 3.5.1 The BSRL is rated satisfactory for quality at entry by the ICR. The loan was consistent with the objectives of the CAS Progress Report presented to the Board in March 1998 to provide technical assistance and quick disbursing loans to support structural reforms in the financial and public sectors at government request in January 1998. The BSRL was a response to this request to strengthen the financial sector and improve confidence in the uncertain external financing environment following the Asian crisis in mid-1997 in the form of balance of payments financing. 3.5.2. The banking sector was identified as particularly vulnerable to the repercussions of the regional crisis, and hence in need of strong ongoing supervision. The measures in the BSRL were designed to bolster this sector and ensure the government's preparedness for any potential difficulties in this sector in the crisis aftermath. The Bank's team worked closely with the government and the IMF's Monetary and Exchange Affairs Department staff in providing technical assistance on strengthening the banking system. The BSRL built upon the Bank's experience in the reform of the Philippine financial sector since the early 1980s. The Bank has played a significant role in several key reforms in this sector. 3.5.3. There was an active dialogue on banking issues with the government with ongoing technical assistance in banking and a PHRD grant approved by Japan to strengthen supervision capabilities within the BSP and PDIC and to strengthen the SEC's capacity. The Philippines was This was discussed during BSRL negotiations but the authorities could not commit to it as it had little chance of being enacted in theiT judgment. 1loweNey, in light of expeTience oveT the past three years, BSP and DOF officials considered such legislation to be more urgent.  - 6 - also under a stand-by program with the IMF, approved on March 27, 1998 and activated on October 30, 1998. 4. Achievement of Obiectives 4.1 Outcome/Achievement of Objectives 4.1.1. The BSRL objectives can be categorized into three broad categories: (i) measures directly under BSP control including regulatory and supervisory measures and efforts to enhance transparency; (ii) actions to strengthen PNB which required political will; and (iii) enactment by Congress of supportive legislation. All measures envisaged under the first category were enacted. However, PNB remains a distressed bank and has not been strengthened adequately-in late 2000, it was subjected to a damaging run necessitating a P25 billion emergency loan from the BSP and PDIC (which has yet to be repaid). While the authorities submitted considerable legislation on banking to Congress consistent with (and in some cases) beyond agreements reached under the BSRL, much of this legislation was not enacted by Congress. As a result, supervisory effectiveness and the ability to resolve distressed banks remain constrained even as banking stress has increased from the extended period of slow growth. 4.1.2. The overall outcome of the BSRL was hence judged to be unsatisfactory as the Philippine authorities could not met the objectives in two categories listed above. Even though all the measures (in category 1) under direct BSP control were implemented, the continued weakness of PNB and the lack of a credible plan to restore PNB to sustained soundness, and the non- enactment of legislative measures by Congress were both considered important enough to constrain the overall objectives and prevent the disbursement of the second and third tranches. 4.1.3. The government fulfilled all the conditions for Board presentation and loan effectiveness and several required for release of the second and third tranches. These included measures directly under the control of the BSP as mentioned above, e.g., measures that strengthened bank supervision, consolidated supervision, and on-site examination, implemented prompt corrective action guidelines, enhanced transparency through more stringent disclosure requirements, developed contingency plans to address systemic risks, and accepted the need to buttress protection of PDIC and BSP staff from legal challenges. A number of legislative items envisaged under the third tranche were also enacted, though others were not. 4.1.4. However, as discussed above, there were considerable delays in fulfilling the conditions for strategic private investment in PNB and necessary legislative changes to strengthen the banking authority and the legal protection of its officials, both of which were crucial to the successful implementation of the program. There were considerable delays and difficulties in meeting the objective of transforming PNB into a top-rated bank with a strategic private equity partner, first with the unsuccessful auction of government shares in PNB and subsequent maneuvering among the shareholders. The government that assumed power in January 2001 intended to fulfill the commitments made by its predecessor. However, the new authorities realized that the conditions called for in the second tranche could not be met even within the revised timeframe of the loan and requested the cancellation of the loan on May 23, 2001 with the Bank's concurrence.  - 7 - 4.1.5. The matrix below summarizes the outcomes of the BSRL. Objectives, Actions, Outcomes, and Measures undertaken for Tranche Releases Objective Action Measures Taken Second Tranche Third Tranche before Board Date not released not released First Tranche: disbursed Loan cancelled Loan cancelled Prudential - Increase capital - Timetable to raise minimum capital Framework requirements through 2000 announced in March 1998 and effective in December 1998 - Ensure conservative - Accelerated schedule for meeting general assessments of bank capital loan loss provisions in March 1998 and announcement of new schedule for specific loan loss provision effective in December 1998 - Tighter restrictions on bank - Circular issued for stricter qualification licensing and competency criteria for new licenses in July 1998 - Disclosure and mark-to- - Circulars issued by BSP to enhance market transparency and market discipline and mark-to-market trading and equity portfolios and mark-to-market accounting procedures: effective in September 1998. - Extend responsibility of - Auditors are to inform BSP of factors Circular issued in September auditors materially affecting soundness of a financial 1998 institution under and affirmative obligation. - New supervision - Objectives and action plan agreed and On-going methodologies implemented: Broader qualitative On-going assessment of banks with a forward-looking approach and priorities of issues and criticisms - Consolidated supervision - Implementation of supervision in accord Seven banks supervised on Ten additional banks with the core principles of the Basle consolidated basis supervised on Committee on Banking Supervision; Consolidated supervision consolidated basis Implementing guidelines issued institutionalized in October 1998. Early - Intensified monitoring - Action plan agreed Interventio - Priority list of problem banks prepared Supplementary on-site n and - Special, critical, and forward-looking on- inspections completed for 51 Resolution site inspections for realistic valuations of banks banks. Speeding up inspection reports competition - Early intervention and - Circular issued on matrix of sanctions Circulars issued in 1998 resolution according to capital-deficiency degree Guidelines provided for corrective actions by banks corresponding to their degree of capital deficiency. Guidelines provided for intervening and resolving insolvent and near-insolvent banks Contingency plan produced to deal with systemic crisis - Monetary Board Resolution issued in January 2000  -8- Strategic - Actions complementary to - BSP inspection done; PNB inspection - In-depth diagnostic audit of Unsatisfactory progress Private strategic investment updated to monitor its financial position PNB completed by PWC; but on action plan Investment measures to strengthen PNB in PNB consistent with the audit PNB's financial performance remains a cause of concern. - Due diligence review by the PWC office undertaken to update valuation and to advise on rehabilitation plan - Inability to strengthen the financial position of PNB - No substantive action to strengthen PNB on a sustained basis - Transfer of management and - Announcement of govemment intention to - Auction organized but failed - PNB financial control to strategic private sell its shares in PNB to a strategic private to attract potential investors, performance continued investor investor. Appointment of the financial especially from top-tier to deteriorate advisory firm, domestic or global banking - no selection of names strategic investor to - No divestment of transfer management government shares in PNB and control of PNB - No concrete plan to - Rehabilitation plan by strengthen financial PNB management performance of PNB and its management - PNB financial performance deteriorated and the bank is close to insolvent Regulatory - Reduce intermediation costs - Reserve requirements lowered in March - On-going measures Arbitrage and May 1998 to 8%; Liquidity requirement and raised in March 1998 Intermediat - Reduce incentives for - Liquid asset requirement on foreign Circular Letter issued ion Costs dollarization currency intermediation raised to 30% in June 1998 while the cost of peso reserve requirement lowered. Enactment of withholding tax on foreign currency interest for residents Legislative - Enhance protection for - Objective agreed with further review - Action plan agreed (based on Action plan carried out Changes supervisors the report of a leading private but legislation changes law firm) and legislation not yet enacted. In the required was submitted but interim, there were not included in the General Monetary Board Banking Law(GBL) of May Resolution in Oct 1999; 2000 PDIC Board Resolution in Apr 2000 adopting legal protection for BSP and PDIC staff - Limit appeals by bank - Objectives agreed Regulatory changes not owners yet enacted - Increase supervisory - Objective agreed Regulatory changes not authority of BSP/PDIC yet enacted - Failure resolution - Objective agreed Regulatory changes not yet enacted - Additional receivership - Objective agreed Regulatory changes criterion enacted in GBL - Liberalize foreign bank entry - Objective agreed Regulatory changes enacted in GBL Source: World Bank staff  -9 - 4.2 Outputs by Components: 4.2.1. Maintaining a sound economic framework. The loan agreement called for a satisfactory macroeconomic framework to be maintained. For practical purposes, the Bank made use of the satisfactory compliance rating established by the concurrent IMF Stand-By Arrangement (SBA) as the criterion to monitor the compliance with the maintenance of a sound macroeconomic framework. From 1998 up to April 2000, the government made adequate progress on the macroeconomic front, as certified by IMF missions. However, by October 2000, the situation deteriorated to a point where the IMF did not recommend the completion of the sixth and final review of the SBA because of sizable slippages in fiscal and reserve targets. The subsequent slide of the peso and loss of confidence following the allegation of corruption involving President Estrada adversely affected the country's macroeconomic performance, adding further political and economic uncertainties. The Bank's PSRs reiterated the need for the government to make its best effort to contain its fiscal deficit, focus on strengthening revenue collection, and formulate a realistic fiscal target for 2001. With the political and economic turmoil, a new government took office in January 2001. By March 2001, the Bank mission that was visiting the country noted that market confidence in the new government had improved, despite the difficult external conditions, but realized that the fiscal targets set for 2001 were going to be a challenge for the government. Without the IMF assessment under the SBA, the Bank needed to make its own macroeconomic evaluation. This was yet to be pursued, however, as the authorities requested that the loan be cancelled in May 2001. 4.2.2. Prudential framework strengthening. The activities under this area, as supported by the BSRL, proceeded well during the period prior to its presentation to the Bank's Executive Board. All the actions and agreements in this category were met. The measures included the announcement and implementation of a three-step process to increase minimum capital requirements and to enforce capital adequacy standards; general loan loss provisions introduced in October 1997 and additional specific loan loss provisions announced in March 1998; circular on tighter bank licensing issued in July 1998; two circulars requiring disclosures of selected banking information on a quarterly basis and providing regulations specifying mark-to-market rules for trading and equity portfolios. BSP formally issued auditors accreditation guidelines, putting into effect rules requiring external auditors to be placed under affirmative obligations to inform BSP of factors that affected the soundness of a financial institution and the accreditation of external auditors engaged by banks. 4.2.3. Strategy for intervention and resolution. To intensify bank monitoring and supervision, the government produced a priority list of troubled banks on the basis of early warning indicators. At the same time, inspection reports were conducted and completed. For early intervention and resolution, a September 1998 circular provided a matrix of sanctions according to the degree of capital deficiency. An additional circular was also issued to clarify the mandatory and discretionary corrective actions facing banks, depending on the degree of capital deficiency. The authorities established a high-level committee to develop a contingency plan for systemic banking difficulties, and drafts of this plan were discussed with the Bank and IMF. 4.2.4. Strengthening government owned or controlled banks. A key element of the overall soundness of the banking system in the Philippines-and also a test to assess the effectiveness of  - 1() - the enhanced supervisory regime-was the improved governance and financial performance of PNB. The government-agreed strategy was to transform PNB into a top-rated bank with a private equity partner that would have the incentive and ability to raise and maintain PNB's competitiveness, loan portfolio and capital adequacy up to the top tier of industry standards. To carry out this strategy, the BSRL supported the steps toward strategic investment in the PNB through a series of concrete measures. The pre-Board conditions were implemented, including BSP inspection in order to update information on PNB's financial situation, and two financial advisory firms were appointed to work together to advise the government on all aspects of PNB strengthening and full privatization (which was a condition of effectiveness). The government also announced its intention to divest from PNB to a strategic private investor through a bidding process. 4.2.5. Following the Bank's Board approval and effectiveness of the project, however, the implementation of the agreed conditions for the second and third tranche releases-as they related to PNB-did not proceed with satisfactory progress. Initially, there were delays in agreeing to the scope of the external audit. The external audit, valuation reports and privatization report were prepared but finalizing the audits was delayed by a number of factors until 2000, and the end-1998 data used rendered the audit out of date and less relevant for disclosure and valuation purposes by the time it was completed. Subsequently, the main issues centered on the unsuccessful search for a strategic private investor who could restore confidence in the governance and management of the bank, the manner in which divestment of the government's shareholding of PNB occurred, and the bank's deteriorating financial performance. 4.2.6. With PNB's financial position remaining under pressure, the government decided to sell part of its shares to infuse cash into the bank. However, the resulting dilution of its 46 percent stake in PNB undermnined the objective of selling the whole government stake to a respected strategic investor. Moreover, the manner in which the sale occurred was not fully transparent. And the new ownership of PNB was unable to generate confidence in the governance of the bank or adequately improve its financial position. The government's share in PNB was diluted first to 30 percent by a rights issue and then to 16 percent in June 2000 following a 5:6 stock right offer to shareholders of record as of June 26, 2000 with the government not participating. Earlier, the May 2000 auction of government shares was not successful due to a lack of qualified bidders (three expressions of interest were received, but two did not qualify, while under standard privatization procedures, two bids are required in public property auctions). The Tan group became a principal PNB shareholder (with about 65 percent ownership in 2000) and effective manager of the bank. The government did not expect that further auctions would improve the value of its shares and decided to postpone any further divestment effort. 4.2.7. During this period, the issue of PNB corporate governance came to the forefront as its financial performance continued to deteriorate. PNB shares were traded well below par, its NPLs rose to far above the industry average (to 50 percent of the net loan portfolio according to its President); capital adequacy remained below regulatory guidelines, despite capital infusion from the Tan group in 2000. Significant losses continued in 2001. Thus, its rehabilitation was given priority by the authorities who sought the IMF and the Bank's support for this view. The political situation in the Philippines however impeded the implementation of the rehabilitation program approved in principle by the Monetary Board in January 2001. The change in  - 11 - government in late January 2001 necessitated a reexamination of the PNB situation. The new government, faced with a difficult situation, undertook a number of actions. It initiated a new due diligence review by the local PriceWaterhouse Coopers office to update valuation and to advise on a rehabilitation plan. The government also was considering three alternatives: (1) a joint sale of majority and government shares to respected third party with banking expertise, with the possible appointment of an investment firm to advise on feasibility and modalities of such sale; (2) leaving majority ownership with the Tan group and giving the opportunity to this group to strengthen PNB prior to a possible future sale; and (3) re-assuming majority public ownership of PNB. 4.2.8. Following the Bank mission in March/April 2001, it became apparent that the government would not be able to comply with the condition requiring the strengthening of PNB's financial position before June 30, 2001 (the extended closure date of the loan). The possibility of a second extension of the loan was raised by the government with the prospects of a possible restructuring of the BSRL. After extensive discussions with the Bank's senior regional staff, the Philippine authorities concluded that they would not be able to meet the proposed conditions even with a further extension and decided to request cancellation of the loan. 4.2.9. Reduction of regulatory arbitrage and intermediation costs. The Philippine authorities proceeded with measures to reduce regulatory arbitrage and intermediation costs. Reserve requirements were lowered in 1998 by a total of five percentage point to 8 percent. While reserve requirements were raised to 10 percent in October 1998, interest was paid on reserves held by banks was increased. A 15 percent liquidity requirement on foreign currency assets was introduced in December 1997 and was raised to 30 percent in June 1998. A withholding tax of 7.5 percent on foreign currency deposits was imposed in January 1998 (the withholding tax on peso deposits was 20 percent). 4.2.10. Legislative and regulatory agenda. The first goal in the legislative and regulatory agenda was to protect banking officials from litigation arising from the enactment of their responsibilities. A leading private law firm was commissioned to advise on the issue. Following its assessment that stronger legislation was indeed needed, the authorities submitted to Congress appropriate language in the proposed legislation to strengthen the protection of banking officials. However, the General Banking Law that was approved in May 2000 did not include such provisions. The BSP and PDIC intended to re-submit appropriate provisions for protecting their respective staff into the proposed new legislative charters for BSP and PDIC for consideration by the new Congress in July 2001-but these have not yet been enacted. Bank staff were informed that if it became clear that the Congress would not accept these provisions, BSP was considering alternative ways of protecting its staff. The authorities indicated that they agreed with the need for enhanced protection and pursued this objective rationally. 4.2.11. The General Banking Law of 2000 included, among others, some of the measures called for by the conditions of the third tranche release: authorization of foreign bank ownership up to 100 percent during a seven-year window of opportunity; declaration of a bank holiday as grounds for placing a bank under receivership (although the GBL did not include the suspension of payments of deposit liabilities as grounds for placing a bank under receivership as specified by the third tranche condition); and putting a bank under receivership if its capital to risk assets ratio  - 12 - falls below 2 percent. However, this law omitted other criteria specified in the legislative agenda covered by the BSRL: legislation to limit legal challenges to bank closings ordered by the Monetary Board and to provide that only money damages be available in such cases; enhancement of the supervisory authority of BSP and PDIC, including the power to suspend and remove bank directors, officers and employees who violated banking laws from any further involvement in any bank; increase in penalties for banking law violations; granting bank exams at the discretion of the BSP Governor, Deputy Governor, or Managing Director; and enhancement of the PDIC power to dispose of assets of a bank once it is placed in receivership by the Monetary Board. 4.3 Net Present Value/Economic Rate of Return: 4.3.1. Not applicable. 4.4 Financial Rate of Return: 4.4.1. Not applicable. 4.5 Institutional Development Impact: 4.5.1. The BSRL supported the strengthening of the banking sector in the Philippines, especially in its prudential framework through prudential standards and supervisory effectiveness. Prudential standards were tightened with stricter qualification and competency criteria for new licenses. Transparency and market discipline in the banking sector were enhanced with a requirement for banks to disclose and discuss publicly more detailed information on a quarterly basis. 4.5.2. New supervision methodologies were implemented in the broader qualitative assessment of banks, using a forward looking approach and prioritizing the issues and criticism made and emphasizing issues other than portfolio quality, such as risk management capacity, funding vulnerabilities, as well as a review of the processes and systems that contributed to asset quality. Training was carried out for BSP and PDIC staff. The BSRL also assisted in the implementation of consolidated supervision of banking organizations in accordance with the Basle Committee on Banking Supervision. 4.5.3. The BSRL helped to intensify the monitoring of problem banks on the priority list on the basis of early warning indicators while emphasizing early intervention and resolution of problem banks with circulars on sanction matrix according to capital deficiency degree. 4.5.4. Other institutional impacts included the reduction on regulatory arbitrage and intermediation cost; this helped prudential risks associated with such arbitrage and the underlying distortions. 4.5.5. However, the non-enactment of legislation-on protection of banking regulator staff and to limit legal challenges to bank closure or for the imposition of other sanctions on banks for the violation of regulations-undermined the effectiveness of the enhanced regulatory framework. The progress with PNB reform did not proceed satisfactorily during the implementation of the  - 13 - BSRL. While the government agreed on the strategic reform and potential institutional impact in the banking sector for PNB to be transformed into a top-rated bank, the actions taken following Board approval were often not consistent with this objective, and the financial performance and corporate governance of PNB remain important issues for the authorities to resolve. These outstanding issues concerning PNB cast a shadow over the overall institutional impact of the lending operation. 5. Major Factors Affecting Implementation and Outcome 5.1 Factors Outside the Control of Government or Implementing Agency: 5.1.1. The implementing agencies for the BSRL were BSP on all aspects of banking regulation and supervision, the Department of Finance (DOF) on PNB-related issues (though BSP remained responsible for supervising PNB and was involved in discussions on how to handle PNB-related issues). BSP, DOF and PDIC cooperated in preparing legislation for submission to Congress. BSP drafted the contingency plan to address a banking crisis, taking into account comments from DOF and PDIC. 5.1.2. The environment for undertaking banking reforms was difficult, reflecting the slow recovery from the regional crisis and the financial instability (including a damaging run on a major bank private bank) associated with allegations of corruption against former President Estrada. These allegations and the alleged close links between the Estrada administration and the new controlling owner of PNB undermined confidence in the transparency through which the principal owner acquired his controlling shares, and also undermined confidence in the ability of PNB to enhance its own governance and financial performance. The fact that closure of PNB was thought to pose systemic risk and hence not considered a viable option also undermined the authority's ability to impose regulatory sanctions on PNB management. The inability to strengthen PNB in turn constrained the authorities from attracting respected foreign investors to bid for a strategic stake in the bank. The weak economy and the large number of "fire sales" of distressed banks in the region may also have reduced the attractiveness of a PNB sale. 5.1.3. While regulatory officials espoused the legislative objectives supported by the BSRL, Congress was less sympathetic-in particular, to giving banking regulators greater protection against lawsuits by the banking community or greater authority to impose sanctions or close banks that were unable/unwilling to comply with banking regulations. Thus the banking legislation that was passed in May 2000 excluded key objectives relating to these items and agreed to in the BSRL context. 5.2 Factors Generally Subject to Government Control: 5.2.1. All aspects of the BSRL were subject to government control if government is taken to include the legislature. If the executive only is included, enacted of legislation was beyond the control of government.  - 14- 5.3 Factors Generally Subject to Implementing Agency Control: 5.3.1. As discussed, a large number of regulatory and supervisory adjustments were enacted consistent with the objectives of the BSRL, as BSP had full authority to enact such changes (and most of the changes were in any case initiated by the BSP itself). 5.4 Costs and Financing: 5.4.1. The loan was US$300 million, $100 million of which was disbursed as the first tranche upon effectiveness on December 30, 1998. A second tranche and a third tranche were to be disbursed upon the fulfillment of distinct sets of conditions but the loan was cancelled before their release. The interest rate on the loan was the floating rate US dollar single-currency loan. The loan had a repayment period of 20 years with a five-year grace period. There was co- financing loan from Japan Bank for International Cooperation (JBIC-formerly JEXIM Bank) in the amount of US$300 million equivalent. The second and third tranches of the loan were not disbursed. The original closing date was June 30, 2000; at the government's request, this was extended to June 30, 2001. The government later requested, and the Bank agreed to, the cancellation of the loan on May 24, 2001. 6. Sustainability 6.1 Rationale for Sustainability Rating: 6.1.1. The "unlikely" sustainability rating stems from the inability to enact legislation to adequately protect banking regulators against litigation by those that they regulate, and to impose meaningful sanctions or close banks that do not comply with regulations, and the inability to find a means to strengthen PNB on a sustainable basis. The difficulties still encountered by the authorities in imposing its regulatory will on large banks undermined to some extent the considerable improvements in regulatory and supervisory criteria that were enacted during the BSRL preparation and implementation period. Nonetheless, it is recognized that when taking account of the constraints that banking regulators have to work under, Philippine regulators have performed well in containing the many risks they have had to face since the regional crisis first broke in mid-1997. 6.2 Transition Arrangement to Regular Operations: 6.2.1. This was a one time operation that was not expected to have any follow-up project. However, given the cancellation of the BSRL and the need to continue assisting the Philippines in its efforts to improve the financial sector, certain activities not contemplated or not completed under the BSRL may be included in a proposed public sector reform loan that is currently under preparation.  - 15 - 7. Bank and Borrower Performance Bank 7.1 Lending. 7.1.1. The Bank has a long and continuing relationship with its counterparts in the Philippines since the early 1980s. It has played an important supporting role in the implementation of the reform program of the country and in several key reforms in the banking sector. Prior to the crisis in 1997, technical assistance on strengthening the banking system was provided by the Bank. A major report in 1996 on strengthening economic and financial resiliency dealt, inter alia, with most of the issues that were later taken up in the context of the BSRL. (This report was not made public at the request of the authorities.) In 1998, a Bank team was working in parallel with a mission from the IMF to provide technical assistance to the authorities in the areas of contractual savings, housing finance, and capital market development. There has been an active dialogue on banking issues with the authorities. 7.1.2. While the Bank appreciated the overall risks for the banking system as it operated within a fragile macroeconomic environment, it did not anticipate the evolution of events relating to PNB-where before the government had a chance to sell its 46 percent share as a block to a strategic private investor its stake was substantially diluted. This complicated adherence to the PNB-related objectives envisaged in the BSRL. 7.1.3. The Bank realized that it would be very difficult to enact the requisite legislation by Congress, but nonetheless made the judgment that without such legislation regulatory and supervisory effectiveness would be significantly compromised, and hence passing the legislation was worth striving for despite the risks to satisfactorily completing the operation through disbursement of the third tranche. 7.2 Supervision: 7.2.1. The project was extensively supervised through several missions led by Bank staff from headquarters and in close coordination with the Country Director and other staff from the Bank's country office. Supervision missions frequently were buttressed by IMF's MAE staff and overlapped with IMF's area department missions with expertise in banking. Discussion and consultation were conducted both at the technical level and at the senior level between the Bank and the government, especially in the implementation of the conditions on the PNB. Bank staff responded to the changing circumstances and to government requests and stood ready to assist in carrying out the conditions called for in the loan. 7.3 Overall Bank Performance. 7.3.1. Bank performance is rated satisfactory, reflecting the fact that the scope of the operation was commensurate with the risks and weaknesses facing the banking system and the remedies proposed also appeared appropriate. It may be argued that the Bank could have insisted upon stronger legislation that would permit banking regulators even more authority to force rapid resolution of distressed banks. This was not done because the authorities in 1998 were adamant  - 16- that this would have no chance of enactment in Congress; as a result weaker, compromise legislation was agreed upon-the fact that even this has not been fully enacted suggests that the compromise reached in 1998 was warranted. Similarly, the Bank tried but was unable to gain agreement on the relaxation of bank secrecy laws in the Philippines (the objective of relaxing the law was included in the Letter of Development Policy but not as a specific loan condition.) While interpretation of the conditionality vis-a-vis PNB elicited considerable internal debate within the Bank, the decision to retain a strict interpretation of the second tranche conditions appeared to have been warranted, in light of the fact that PNB remains in a difficult position- indicating that the broad objectives relating to a sustained strengthening of the bank are not yet in prospect almost three years after Board presentation of the BSRL. Supervision of this operation was consistently led by senior task managers and collaboration with the IMF remained close throughout the implementation period. The presence of the Country Director in the field facilitated the dialogue and the coordination of the loan, and the Vice President and Sector Director were also involved in key decision-making phases of the operation. Relationships with the concerned government agencies remain strong notwithstanding the difficult negotiations conducted before and after the BSRL was approved by the Board. Borrower 7.4 Preparation: 7.4.1. The government of the Philippines played an active role in the preparation of the loan and negotiation of its conditions through the direct involvement and supervision of senior officials from the BSP, DOF and PDIC. 7.5 Government Implementation Performance: 7.5.1. As noted, all the regulatory/supervisory actions within the direct control of the BSP were satisfactorily enacted. Nevertheless, the assessment of government implementation of the program was rated unsatisfactory because of the non-enactment by Congress of the requisite legislation and the inability of the executive to force a resolution of PNB's financial difficulties along the lines envisaged under the BSRL-or indeed, to develop an alternative strategy to strengthen PNB's financial performance in a sustainable manner. While the number of positive actions on the regulatory/supervisory front were numerous, the un-enacted legislation and unresolved situation in PNB render overall performance unsatisfactory. Toward the end of the Estrada administration, there were considerable obstacles in fulfilling the conditions of the BSRL, aggravated by the political turmoil which became a serious distraction. The government that assumed power in January 2001 was proactive in seeking a viable solution to the PNB issue but decided that this was not possible within a reasonable BSRL timeframe. 7.6 Implementing Agency: 7.6.1. The BSP and the DOF maintained a continuing dialogue with Bank staff both at the Bank's Country Office and at headquarters. Both institutions coordinated and monitored the  - 17- program under the direction of the Governor and the Secretary. These senior officials were also proactive in trying to insure the implementation of the program as called for by the BSRL. 7.7 Overall Borrower Performance: 7.7.1. Overall performance of the government was not satisfactory with the non-fulfillment of two essential conditions-strengthening PNB and enactment of legislation-leading to the cancellation of the project without the disbursement of the second and third tranches. Resolution of PNB took on a political tone following the circumstances through which the controlling owner took control of PNB. Further, the attention of the authorities under the Estrada government was diverted due to the political turmoil through January 2001. The new government that assumed power in January 2001 was proactive in seeking ways to fulfill the outstanding conditions. However, given the time pressure, the authorities came to the decision to close the loan as the best approach. The Philippine authorities, however, stressed that they remained committed to the strengthening of the financial sector in general and would continue to work with the Bank in pursuing this objective. 8. Lessons Learned 8.1. Lessons learned from the BSRL include the following: ( Clear identification of political risk and interests must be adequately factored into the design of an operation. In this case, the risk that Congress would not enact all the envisaged legislation was recognized-indeed, this was a central feature of discussion during the prolonged negotiations between the authorities and Bank staff. But more could perhaps have been accomplished through a well-defined strategy of interaction with Congress. And the President's Report should have explicitly noted the risks associated with including enactment of contentious legislation into the conditionality of the operation. * Monitoring and enforcement of implementation is especially hard in a complex, multi- tranche adjustment operation. While much progress was made on the regulatory aspects of the loan under the control of BSP, the effectiveness of some regulatory changes as they related to large banks could be questioned, given the uncertainty associated with supportive legislative reforms-that were linked to a subsequent tranche. This complicated the task of supervision missions and perhaps also the credibility of the regulatory changes. * Cutting losses and canceling should always be on the table and may be preferable if second best solutions are unlikely to achieve the development objective. The government made the right choice in requesting cancellation in May 2001, but the Bank and government could perhaps have reached this conclusion earlier on. * There is a risk that multi-tranche operations can divert the focus of dialogue and attention away from important emerging issues in a rapidly changing environment. In these circumstances, rapid resolution through restructuring, disbursement or cancellation may be preferable to allowing difficult-to-resolve issues to drag on.  - 18- * Single-tranche operations may be preferable to multi-tranche operations where the objectives involve actions beyond the control of the executive, such as the enactment of legislation. One or more single-tranche operations that are based on the fulfillment of agreed conditions before the loan is presented to the Bank's Board may be a preferable way of proceeding in these cases. Single-tranche operations can serve to heighten the need to implement reforms within a specific time frame. They can also reduce the complexity of the operation by allowing for the flexibility to adjust the nature and timing of reforms envisaged in subsequent operations. However, in the BSRL case, it should be noted that a series of single-tranche operations would not necessarily have achieved a different reform outcome from the status quo-though they might have saved the government the commitment fees from agreeing to a larger three-tranche operation. Moreover, a multi-tranche operation does have the advantage of forcing a thorough discussion of the full reform program in terms of one coherent package.  - 19 - 9. Partner Comments 9.1 Borrower/implementing agency: ,n/, rn ~Tawoms . MANILA 0 G R 1 LII OFFICr OF T"I6 PCPUTY GOVCPNOR LJ 64 Dcccmle 10, 2001 Mr. Robert Vse P?e Coutmy Directw. ?lppne East MAig and Pacific TEE WORLD BANK wowi Ba Office Min 23/F Taipn Plc Ewomald Avenue, Oigps Cwner Pesig City Dea Mr. ?llCy; Re: AaM Secv Reform Loan As requtd, anuab se ours_w onma on X dmt Ilaq*mntiou Cmplti Rert (IC R) for the Pilipp4i BEg Ssor Refom Lon Heat reads. very tWuY yours, ALDURTO Dqipy G"oernor Aucb~: W's  - 20 - Annex A COMMENTS ON DRAT ThIUMENTATX COMPETION WPORT Althoug strengting of PNB an the cascen_t of crtain lgislation was tmot attaine, tc objeioves to stgn the frnmok for pn bnking nmd to pwo the abthorities prepaodns ff eidy in tion d _eutin trofbled banb were met. BSP'B contnuing effrts to enbmcc tw effectivees of baning speision, implenwtaio of prompt comnotiv o m, developkent of contingecy plans to add-ss systemic risks and ac tusparecy ac by thnscvis significant steps in enbaning the reutsy amework for the baking cor. Admitkdy fthgh tbr. effect of sucb meures would hve foud gr support via the enactment of legislafion such as legl ptction for ba1k official, en_ana2t of suprvisoy authorit of BSP and PDIC. and increased pcnlties for baking few violations. Als, the fbUowilg poins ould be includod in the htix of Outcomes of the BSRL (item 4.1.5, pp. 7-8 of Draft Report) O70.eto . tuZ .e . ; dudedb SbIlklAoiC NA4ftA hsunt in Pt[B _-wmpva Stratgic rivae Inestmet inNB Ireveie pIvtzation [lan for PN1R Lgslative changes - Liberalize fiA6 regulatory chapges ected in GBL bak entry fSectwn 73 of(GBL) *1 p mutt 14i was owed bq* isguWoy Asages a yet umers  - 21 - 9.2 Cofinanciers: Japan Bank for International Cooperation (JBIC) 9.3 Other partners (NG0/private sector): There were no other partners.  - 22 - IMPLEMENTATION COMPLETION REPORT THE REPUBLIC OF THE PHILIPPINES BANKING SYSTEM REFORM LOAN (LOAN No. 4412-PHL) Annex Tables Annex 1: Key Performance Indicators ........................... ...................... 23 Annex 2: Project Costs and Financing ................................................. 23 Annex 3: Economic Costs and Benefits ................................................. 24 Annex 4: Bank Inputs ................................................. 24 Annex 5: Ratings for Achievement of Objectives/Outputs of Components ................................................. 25 Annex 6: Ratings of Bank and Borrower Performance ....................... ............ 26 Annex 7: Policy Matrix ................................................. 27  - 23 - ANNEX 1: KEY PERFORMANCE INDICATORS PLEASE SEE THE ANNEX 7 -- POLICY MATRIX ANNEX 2: PROJECT COSTS AND FINANCING (US$ million) Project Cost by Component (in US$ million equivalent) Appraisal Actual/Latest Percentage of Estimate Estimate Appraisal Project Cost by Component IBRD 300 300 100 JBIC 300 300 100 Total Project Costs 600 600 100 Total Financing Required 600 600 100 Project Financing by Component (in US$ million equivalent) Component Appraisal Estimate Actual/Latest Estimate Percentage of Appraisal Bank Govt. CoF. Bank Govt. CoF. Bank Govt. CoF. BOP 300 300 300 300 100 100  - 24 - ANNEX 3: ECONOMIC COSTS AND BENEFITS Costs Benefits NPV ERR (%) Not Applicable N/A ANNEX 4: BANK INPUTS a) Missions Stage of Project Cycle No. of Persons and Specialty Performance Rating (e.g., 2 Economists, 1 FMS, Implementation Development etc.) Progress Objective Month/Year Count Specialty Identification/Preparation 5 2 economists, 3 FMS S S January 1998 Appraisal/Negotiation 7 3 economists, 3 S S August 1998 FMS, 1 Lawyer Supervision: February 1999 5 2 economists, 3 FMS S S August 1999 3 2 economist, I FMS S S December 1999 2 1 economist, I FMS S S April 2000 2 1 economist, 1 FMS U U October 2000 3 2 economists, IFMS U U December 2000 2 1 economist, I FMS U U April 2001 3 1 economist, 2 FMS U U ICR I 1 economist U U b) Staff Actual Stage of Project Cycle No. Staff Weeks $ ('000) Identification/Preparation 124.9 437.1 Appraisal/Negotiation Supervision 89.1 311.8 Sub Total . 214.0 748,9 ICR (est.) 8.6 30.0 TOTAL 222.6 778.9 Note: 1. Figures do not include Trust Funds.  -25 - ANNEX 5: RATINGS FOR ACHIEVEMENT OF OBJECTIVES/OUTPUTS OF COMPONENTS (H - High; SU = Substantial, M = Modest, N = Negligible, NA = Not Applicable) Policy High Substantial Modest Negligible Not Applicable Macro policies X Sector Policies X Physical X Financial X Institutional Development X Environment X Social X - Poverty Reduction X - Gender X - Other (Please specify) X Private sector development X Public sector management X Other (Please specify)  -26- ANNEX 6. RATINGS OF BANK AND BORROWER PERFORMANCE (HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HU=Highly Unsatisfactory 6.1 Bank Highly satisfactory Satisfactory Unsatisfactorv Highiv performance Unsatisfactory Lending C XI1 Supervision Bl ii Overall [ ] Xl X gIi 6.2 Borrower Highly satisfactory Satisfactory Unsatisfactory Hi2hli performance Unsatisfactor Preparation B B [C Government implementation performance Implementation agency performance Overall B B B  -27 - Implementation Completion Report Banking System Reform Loan Annex 7 Supporting Document Policy Matrix Action Before Board Date Second Tranche Third Tranche Prudential Increase Capital Timetable announced. Framework Increase minimum capital implemented with Circulars Nos. 117 and 156. Ensure General and specific loan loss conservative provisioning schedule assessments of announced. bank capital Implemented with Circulars Nos. 143, 159, 164. Tighter Adopted. restrictions on Implemented with Circular- bank licensing Letter in July 1998. Disclosure and Circulars issued. mark-to-market Implemented with Circulars Nos. 147 and 161. Extend Objectives agreed Regulation issued. responsibility of Implemented with Circular auditors No. 179. New supervisory Objectives and action plan On-going On-going methodologies agreed and implemented: Section Order No. 10 and Supervision Guidelines No. 98-7 and Regulation No. 171 Consolidated Adopted Seven banks supervised on Ten additional banks supervisions Implementing guidelines for consolidated basis. supervised on consolidated supervision Consolidation supervision consolidated basis. provided under Sector Orders institutionalized in Oct 98 Nos. 10 and 11. Early Intensified Action plan agreed Supplementary on-site Intervention monitoring inspections completed for and 51 banks Resolution Speed up completion reports of examination.  - 28 - Action Before Board Date Second Tranche Third Tranche Early intervention Circulars issued Circulars issued. and resolution Implemented under Circulars Guidelines provided for Nos. 172 and 176. corrective actions by banks corresponding to their degree of capital deficiency. Guidelines provided for intervening and resolving insolvent and near-insolvent banks. Contingency plan produced to deal with systemic crisis - Monetary Board Resolution issued in Jan 2000. Strategic Actions BSP inspection done; PNB - In-depth diagnostic audit Private complementary to inspection updated to monitor of PNB completed by PWC, Investment strategic its financial positions but measures to strengthen in PNB investment PNB, consistent with the audit and PNB's financial performance remain a cause for concern. - Due diligent review by the PWV office undertaken to update valuation and advise on rehabilitation plan - Inability to strengthen the financial position of PNB. - No substantive action to strengthen PNB on a sustainable basis. Transfer of Objective announced: - Auction organized but - PNB financial management and Government intention to sell failed to attract potential performance control to its shares in PNB to a strategic investors, especially from continued to strategic private private investor. top-tier domestic or global deteriorate investor A financial advisor firm banking names - no selection of appointed - No divestment of strategic investor to government shares in PNB transfer management - No concrete plan to and control of PNB strengthen financial - Rehabilitation plan performance of PNB and its by PNB management management - PNB financial performance deteriorated and the bank is close to insolvent  - 29 - Action Before Board Date Second Tranche Third Tranche Reduce Reduce - Reserve requirements On-going measures regulatory intermediation lowered in March and May arbitrage costs 1998: Circulars Nos. 166 and and 180 intermediati - Liquidity requirement on costs raised in March 1999: Circular No. 188. Reduce incentives Objectives agreed: Circular-Letter issued for dollarization - Liquid asset requirement on foreign currency intermnediation raised to 30% in June 1998 while the cost of peso reserve requirement lowered. - Enactment of withholding tax on foreign currency interest for residents Legislative Enhance Objectives agreed with further - Action plan agreed (based Action plan carried changes protection for review on the report of a leading out but legislation supervisors private law firn) and changes not yet legislation required was enacted. In the submitted but not included interim, there were in the General Banking Monetary Board Law(GBL) of May 2000 Resolution in Oct 1999; PDIC Board Resolution in Apr 2000 adopting legal protection for BSP and PD1C staff Limit appeals by Objectives agreed Regulatory bank owners changes not yet enacted Increase Objectives agreed Regulatory changes supervisory not yet enacted authority of BSP and PDIC Failure resolution Objectives agreed Regulatory changes not yet enacted Additional Objectives agreed Regulatory changes receivership enacted in GBL criterion Liberalize foreign Objectives agreed Regulatory changes bank entry enacted in GBL