FINANCIAL INTERMEDIARY OPERATIONS Issues S. Brajovic Bratanovic, ECSPF

Financial Intermediary Operations – A Diverse Set with Different Objectives SME Development or FSD ( credit lines through commercial banks) Rural Finance Operations (also using credit cooperatives) Community Development (typically micro-finance) Poverty Alleviation Programs (including social investments, housing and education) Operations in Infrastructure/Energy Supporting Sector Reforms or Environment

Financial Intermediary Operations – Use Different Financial Intermediaries Credit Lines through commercial banks (e.g., for SME development - with FSD objectives, housing finance, etc.) Rural Credit Cooperatives (e.g., in rural finance) Micro Finance Institutions and NGO (e.g., community development) Social Investment Funds Non-bank Financial Institutions ( investment funds, guarantees, etc.)

The Same Key Issue – Implementation Performance IP is less then satisfactory FI Operations are complex and, therefore, subject to a complex set of risks, including: – Risk on Downturns in Policy and Market Environment – Operational and Financial (Business) Risks – (Standard) Project Implementation Risks

Risk of Downturns in Policy and Market Environment Applies to FIs, Beneficiaries and Subprojects. Due to: –Generally Cyclical Nature of Businesses and Markets, and/or –Macroeconomic Instabilities and Policy Reversals in Individual Countries, and/or –(Un)expected External Shocks or Spill-Overs (e.g., 9/11, Asian Currency Crises)

Operational and Financial (Business) Risks For Financial Intermediaries, the most critical are: – Credit Risk –Interest Rate and Currency Risk Associated with Bank Funding ( magnify the credit risk ) Specific Business Risks that Apply to Individual Beneficiaries and Subprojects.

(Standard) Implementation Risk for Bank Projects General Supply/Demand Characteristics Price of Bank Funding Other Cost Related to Bank Funding (e.g., high administration requirements and paperwork, time consuming for senior management of FIs and senior policy makers) Effectiveness of Project Implementation Arrangements

Is There Any Help ???  OP8.30 Provides Recommendations and General Instructions on: –Macro Framework related to risks in policy and market environment “ should be satisfactory, should not be distorted ” –Sector Policy Framework (related to risk in market and business environment of intermediaries) –Eligibility Criteria for FIs –On-lending Terms and Use of Bank Funds (related to credit risk)

Any Issues with OP8.30??? Is not specific enough regarding minimum conditions in macro/business and market environment. (Leaves too many important details to interpretation) Has not been consistently applied to all financial intermediary operations (e.g., to micro-finance and in rural finance) Can not be effectively applied to non-bank intermediaries (e.g., investment funds, NGOs in micro-finance business) Lacks effective lessons of experience

Any Other Issues??? Inadequate basis for effective quality review at entry: – No consensus on what constitutes “ minimum requirements ” for various types of FI operations – No consensus on what constitutes “ good practices ” for various types of FI operations There could be significant regional variations (e.g., ECA practice must reflect EU directives. EAP “ best practice ” may require different standards.)

Possible Solution: Expand application of standard Bank Policies (OP8.30?) to all FI Operations Reach (regional? Bank?) consensus on “ minimum standards ” Learn (regional? Bank?) “ lessons of experience ” Establish effective “ quality at entry ” reviews and help desk Establish effective FI portfolio management assistance and “ clinics ” Provide semi-automatic feed-back for continuous improvement of standards and lessons of experience