Selection Of Financial Intermediaries

Introduction

1. Purpose of Selecting Financial Intermediaries for the Bank

1.1 Trade Finance

1.2 Program Lending

1.3 Equity Participation

2. Principles Guiding the Appraisal of Financial Intermediaries

2.1 Ownership Structure

2.2 Macroeconomic Environment

2.3 Legal Framework for Financial Sector

2.4 Financial Analysis

3. Process for the Appraisal and Selection of Financial Intermediaries

3.1 Rationale of the Process

3.2 Description of the Process

3.3 FI List

4. Administrative Specifications

4.1 Use of Bank Funds

4.2 On-Lending Terms

5. Supervision and Monitoring of Selected Financial Intermediaries

5.1. Reporting Procedures to be Followed by Financial Intermediaries

Introduction

This policy is adopted by the Board of Directors pursuant to the provisions of the Portfolio Risk Management and Investment Policies. The document is issued to facilitate the implementation of the Financial Sector Policy, and is in compliance with the provisions of the Operations Cycle Policy.

In addition to establishing general guidelines for the appraisal and selection of financial institutions, the present document sets general principles for the use of financial institutions in Bank financed operations.

1. Purpose of Selecting Financial Intermediaries

The Bank will work with selected financial intermediaries in its countries of operation where such delegation of responsibility assists the Bank in servicing a market segment more efficiently or effectively than the Bank might be able to do directly.

The Bank’s involvement with financial intermediaries may take the form of lending, equity participation, or provision of guarantees. In all cases, the selected financial institution must meet the Bank’s criteria outlined in this document.

The present guidelines cover the selection and use of financial institutions by the Bank in any of the capacities of partners (co-financiers), vehicles (intermediaries), or clients (investees) for: (i) on-lending (SME credit lines, guarantees, trade finance facilities, other program finance operations); and (ii) capacity development and institutional building financing (debt, equity, guarantees), and shall constitute the basis for individual legal agreements governing such operations. The Bank shall deal with financially sound institutions that are locally incorporated, except in certain cases of co-financing, and, active in the member countries.

The document provides the mechanisms and procedures to ensure qualification of financial institutions for participation in Bank financed operations in conformity with the Portfolio Risk Management and Investment Policies document.

The appraisal and selection of financial intermediaries to participate in Bank financed operations is done with the observance of the procedural requirements set forth in the Operations Cycle Policy and following the detailed procedures in the Operations Manual.

The three main areas of activity, which most likely would be conducted more efficiently through financial intermediaries, are:

(a) trade finance;

(b) program lending;

(c) equity participation.

1.1 Trade Finance

The primary functions of Trade Finance are (i) to support exporting companies in member countries by providing pre-export finance, short-term guarantees, medium and long-term supplier credits, and buyer credits, and (ii) to assist regional financial institutions to provide an array of instruments demanded by the local market and to establish a track record of working internationally. Most Trade Finance business will be conducted through financial intermediaries for the following reasons:

• Most Trade Finance products, such as pre-export financing, will normally require a financial intermediary to perform due diligence on the exporter (local company) and assume that risk.

• In the interest of facilitating economic development in member countries, the Bank will want to support, wherever possible, local financial institutions and help this important sector of the economy grow, rather than remove local intermediaries from a transaction by operating directly with the exporting/importing company.

• The Bank will not compete with local financial intermediaries but will work with them to fulfill its mandate of regional development and cooperation.

1.2 Program Lending

Program lending operations will concentrate on private sector development and sustainable development operations, with a focus on medium size companies incorporated in the member countries. This approach is intended to foster economic growth in our member countries, to promote entrepreneurship and generate employment.

Debt financing mainly, but also guarantees, will be extended through the eligible financial intermediaries and used primarily for modernization, restructuring and promotion of SMEs in sectors related, but not limited to: (i) manufacturing of goods with export potential; (ii) manufacturing of import substitution products; (iii) regional development and sector restructuring in member countries; (iv) telecommunications, transportation, information technology, oil and energy construction and other infrastructure related activities; and (iv) development of market and social service operations.

Depending on the experience and credit standing of the intermediary, the Bank may require that it approves each commitment individually or certain commitments above a specified amount. Sovereign or additional guarantees may be sought for programmes oriented to regional development and promoted by the governments of the respective member countries.

Pricing of the above mentioned facilities would primarily reflect the opportunity cost of capital for the Bank, the country risk and the program (operation) risk – in most cases the credit risk of the relevant financial intermediary. Lending terms will be in line with the Bank‘s Pricing Policy, the pricing model developed in the Portfolio Risk Management and Investment Policy, and the general principles outlined in the present document, while at the same time targeting competitive rates which make Bank products attractive with a view to achieving the intended development impact under Bank supported programs.

1.3 Equity Participation

Bank equity investment may be effected as either stand alone or as a specific component of a structured project financing package, or on particular instances as specified in the SME Strategy through investment funds. Pricing will respect the provisions of the Portfolio Risk Management and Investment Policy.

In specific cases the Bank may wish to use the professional services of specialized fund managers and/or equity analysts. Although not all of these service providers qualify under the terminology of financial intermediaries, the Bank will regard with utmost attention the financial strength and track record of such financial companies.

Potential contribution by the Bank in country or regional investment funds which were not established at the Bank’s initiative in order to promote private sector development through provision of seed, incremental or mezzanine capital to SMEs in member countries, require detailed and careful screening not only of the fund and its administrator, but also of the other fund participants. Safeguarding the Bank’s reputation and standing as a regional development institution is in this particular case more important than the revenue generation potential under low risk conditions.

2. Principles Guiding the Appraisal of Financial Intermediaries

The selection process of acceptable participating financial intermediaries in Bank sponsored projects and programs require careful analysis in the following areas:

1. Operating environment, including:

(i) ownership structure;

(ii) macroeconomic environment;

(iii) legal framework governing financial sector institutions and operations;

2. Evaluation of financial intermediaries, including:

(i) eligibility criteria;

(ii) appraisal.

In addition, a very important element in the decision to select a financial institution as participating intermediary is the demonstrated capability, experience and willingness to do the particular business required for the successful implementation of the Bank financed operation.

The appraisal of financial intermediaries is a multi-staged process, with contributions from Banking & Non-banking Financial Institutions Department and Financial Analysis Department and Risk Management Department.

2.1 Ownership Structure

The ownership structure of a FI is a crucial factor in determining the acceptability of the institution for the Bank’s purposes. Experience has demonstrated that banks which belong to a group of companies owned, or in majority controlled by, a single entity can be used as sources of cheap financing by other companies in the group, with little or no attention paid to sound banking principles. Thus, banks whose assets include a significant number of inter-company loans should be examined with great care, especially when the group of companies to which the bank belongs is controlled by a single person/entity. The element of ownership will be fully explored when conducting the analysis of a potential FI.

In addition to the ownership structure, various other qualitative factors, such as quality of corporate governance, adequacy of staffing, and market knowledge of the institution shall be considered.

2.2 Macroeconomic Environment

Given the critical importance of the macroeconomic framework for the stability of the financial sector, the Bank will consider using financial intermediaries mainly within the context of a satisfactory macroeconomic framework. Thus, the following elements will be examined when assessing the adequacy of the macroeconomic environment:

- Existence of interest rate distortions, dual interest rates, or segmented markets;

- Multiple currencies in use;

- Multiple exchange rate practices, parallel foreign exchange markets;

- PSBR (public sector borrowing requirement), maturity/structure of debt, balance of payments, foreign debt;

- Fiscal and monetary policy, tax collection, public sector deficit

- Economic indicators (inflation, GDP, unemployment, etc.)

2.3 Legal Framework for Financial Sector

The Bank will seek to use intermediaries only in those countries of operation where the financial sector is adequately regulated and financial institution supervision is carried out in a manner satisfactory to the Bank. For this purpose, the Bank will take into consideration:

- Existence, adequacy, and enforceability of prudential regulations;

- Degree of independence from political interference of the regulatory and supervisory authorities;

- Quality of the decision-making process in financial institutions;

- Staffing and professional capacity of the supervisory authority to carry out off-site surveillance and on-site inspections;

- Accounting and auditing standards;

- Legal treatment of troubled financial institutions;

- Development of judicial system;

- Financial system liberalization and proper level playing field;

- Deposit insurance legislation and institutional arrangements.

2.4 Financial Analysis

Analysis of the institution’s financial health will include an evaluation of the accepted ratios and other numerical elements considered by reputable rating agencies and other organizations specializing in the surveillance of financial institutions. Attention will be given, in particular, to: (i) solvability and degree of impairment of capital; (ii) quality of assets and level of provisions; (iii) evaluating the sustainability and quality of earnings; and (iv) adequacy of liquidity. The financial analysis shall be performed in conformity with the provisions of the Operations Manual. The specific variables for the financial intermediaries include:

- Capital adequacy

- Earnings

- Liquidity

- Effectiveness of loan administration (appraisal, supervision, and collection)

- Adequacy and timeliness of audited financial statements

3. Process for the Appraisal and Selection of Financial Intermediaries

This section will outline the Bank’s internal procedures for screening, analyzing, and approving financial institutions.

3.1 Rationale for the Process

Given the importance of financial intermediaries for the Bank’s operations, the internal selection procedures must ensure that approved Financial Institutions (FIs) meet the required standards of transparency and sound banking principles, and represent promising regional financial institutions with which to cooperate.

On a priority basis, FIs should be selected in connection with a specific operation, either at the recommendation of an Operation Leader or as a result of an application by an interested financial institution. However, the selection and due diligence process needs to be conducted independently and impartially.

Furthermore, the Bank needs to pay closer attention to reaching out to potential FIs. While the Bank is primarily demand driven, it also fully intends to devote greater resources to meeting its operational target of having a minimum of two approved FIs in each member country through which the Bank undertakes its financial intermediary operations (trade finance, SME credit lines, etc.) and to developing appropriate strategies and financial mechanisms to achieve this. This represents a core operational commitment of the Bank for member countries with developing banking systems, where the Bank’s presence can particularly provide value added for institutional development purposes. A FI may participate, simultaneously or sequentially, in a number of similar or different operations; the only restrictions being that (i) aggregated authorized exposures remain within the maximum exposure limit for that particular FI, and (ii) each individual operation be within the maximum maturity, with both limits to be established.

The maintenance of the FI list is the responsibility of the Banking & Non-banking Financial Institutions Department. The follow-up and evaluation of the status of FIs shall be performed independently, separated from the Banking function, by the Financial Analysis Department (FAD) and the Risk Management Department (RMD). This ensures the following: (i) independent assessment of the quality of a financial institution is made without the pressure of having a project/program approved or continued; (ii) the list of selected FIs is maintained centrally, and is available whenever the need for an intermediated operation arises; and (iii) the Banking teams, Banking & Non-banking Financial Institutions Department (BNFID) in particular, have the opportunity to concentrate on operations identification, generation, implementation and supervision.

The next section further details the procedure step by step.

3.2 Description of the Process

1. The Operation Team will identify potentially eligible financial intermediaries and based on the information received, the Operation Leader will request a preliminary assessment of the institution to be performed by Financial Analysis and Risk Management Department, recommending a maximum exposure amount and tenor.

2. If the financial intermediary meets the criteria for financing, the operation moves on to the Appraisal and Due Diligence stage, Financial Analysis Department will perform full analysis, including creditworthiness analysis, while the Operation Leader will coordinate the preparation of the Final Review Document. Through its risk assessment, Financial Analysis and Risk Management Department will confirm the exposure and tenor limits and will make pricing recommendations for the operation.

3. Upon the completion of the analysis, a recommendation from the related VP accompanied by analysis performed and specific risk assessment prepared by RMD, and other documents (as required) from other departments will be submitted to the Credit Committee for its consideration.

4. The Operation Leader will inform the Client about the Credit Committee decision and the operation will be submitted to BoD for its approval.

5. The supervision and monitoring of financial intermediaries (as borrowers) evolution and performance, and submission on a regular basis (normally annually for performing FI, but on certain instances the frequency may be increased to semi-annually or even quarterly) of necessary information to the Credit Committee is the responsibility of Operation Leader and Project Implementation and Monitoring Department; for such purpose they will cooperate closely with FAD and RMD, where necessary.

3.3 FI List

Financial institutions selected to act as FIs shall be included on a list of approved FIs to be created and maintained by the Banking & Non-banking Financial Institutions Department. For each FI, the list will include the FI’s administrative information (name, incorporation details, location, etc.), as well as recommended financial products and exposure ceilings to be considered when dealing with the FI. The main purpose of the list is to provide a quick reference guide for banking operations, which are time-sensitive.

4. Administrative Specifications

This section will outline, in general terms, for what purpose, and under which conditions, Bank funds shall be used by selected financial intermediaries.

4.1 Use of Bank Funds

In line, with the Bank’s mandate, use of Bank funds should have a b development impact, encourage and strengthen regional cooperation, and foster trade among member countries. Transition to prosperity and sustainable economic growth should be targeted as the ultimate goal of Bank involvement. Specific goals of the particular operations, including sub-projects, will be detailed in the loan agreements, and must meet the Bank’s eligibility criteria. Bank funds may be disbursed only for the purpose specified in the legal documentation.

Loans or equity channelled through selected financial institutions are normally back-to-back, although other arrangements, including revolving facilities, may be used where they are more effective in meeting the operation’s objectives. Repayments of on-lent funds by the final beneficiaries, or sale of equity investments, in favour of the financial intermediaries may be on a back-to-back basis with repayments by the financial intermediaries to the Bank, or on the basis of another amortization schedule acceptable to the Bank. When loan/equity repayments to the Bank by the financial intermediaries are not on a back-to-back basis, available funds may be used by the financial intermediaries, within their overall amortization schedule for: (1) constituting a special roll-over fund to finance operations approved by the Bank at the time the roll-over fund is constituted, (2) reinvestment of the funds on terms and conditions agreed with the Bank within the original maturity of the facility at the time of each new financing, or (3) prepayments to the Bank.

4.2 On-Lending Terms

Use of Bank funds by intermediaries for on-lending to final beneficiaries should normally be done in the context of the borrowing country’s interest rate structure and any program for financial sector liberalization and reform. In all cases, terms and conditions for Bank lending to the financial intermediaries, follow the guidelines covering loans exposure, currency, repayment, and principles of loan pricing set forth in the Bank’s Portfolio Risk Management and Investment Policies, and have priority over any local arrangements and practices. The on-lending terms follow the policy prescriptions set forth in the Financial Sector Policy.

Bank funds are priced depending on whether the financial intermediary is a direct borrower or an apex institution, according to country and intermediary/operation perceived risks and other elements considered to cover the Bank’s cost of funds, agreed return to shareholders, and operating and administrative expenditures. The Bank will take all necessary precautions to ensure that Bank funds are not priced largely off-line with what the intermediary would pay in the market for obtaining funding for similar maturity and currency of denomination. In effect, Bank involvement should substantially reduce the ‘country risk premium’ portion of the pricing, and permit the intermediary to on-lend considering primarily the commercial risks.

The funds on-lent to final beneficiaries are priced so that the financial intermediaries cover risks and costs, and receive an adequate profit margin. Where interest rates are market determined and the interest rate levels and structure are not affected by distortions, on-lending will be made at prevailing market rates. In cases where distortions are pervasive or market segmentation is such that access to funding by targeted final beneficiaries is constrained, the Bank will agree with the financial intermediary – usually during negotiations – and include in the loan agreement the applicable interest rates or the pricing model to be used, as appropriate.

5. Supervision and Monitoring of Selected Financial Intermediaries

During operation appraisal and negotiation, provision is made for effective and continuous monitoring and evaluation of the financial intermediary’s progress towards its objective, as well as its continued eligibility status. The performance indicators agreed on during negotiations might include economic, sectoral, financial, and institutional variables. These variables closely parallel to those used for the analysis of financial institutions.

During implementation of operations involving FIs, the Bank will conduct the supervision and monitoring activity in conformity with the provisions of the Operations Manual.

5.1 Reporting Procedures to be Followed by Financial Intermediaries

The Bank requires all borrowers to provide regular reports of an agreed form and content during the operation implementation period. Usually, at loan negotiation, the Bank agrees with the financial intermediary on the form and content of the reports, which must be in line with the following general guidelines:

• Annual audited financial statements (where appropriate, the audited financial statements will restate financial statements prepared locally, but in accordance with International Accounting Standards: In cases where cumulative inflation for the last three years exceeds 100 per cent, inflationary accounting procedures according to IAS 29 will be applied);

• Interim audit reports and quarterly financial statements, or provisional financial statements in cases when quarterly financial statements are not available;

• A statement of major changes in the financial intermediary’s financial policies and practices introduced over the period covered by the report, indicating whether these changes resulted from decisions of the board of directors, management, or economic/regulatory authorities;

• A summary of magnitudes and trends of major operations (e.g. lending, investment, discounting, off-balance sheet activities);

• Such details as the Bank may reasonably request on the use of Bank funds (commitments, disbursements, nature of beneficiaries, pertinent financial information on the sub-borrowers, terms & conditions of the sub-loans, details on goods and services financed and methods of procurement, risk classification of loans under Bank funds, security type or other arrangements, level of provisions, repayment profile, destination of exports/ origin of imports);

• Such other information as the Bank considers necessary for its review purposes.