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African Development Bank
PROPOSAL FOR A FRAMEWORK FOR MANAGING GCI RESOURCES
AND LARGE LOANS
April 2011
TABLE OF CONTENTS
EXECUTIVE SUMMARY 1
I. BACKGROUND 3
II. THE CHALLENGES OF EFFICIENT MANAGEMENT OF GCI RESOURCES AND LARGE
LOANS 4
SOUND BALANCE SHEET MANAGEMENT AND EXPOSURE GROWTH ........................................ 4
SUSTAINING THE BANK’S LONG TERM FINANCIAL CAPACITY ................................................ 5
KEY DRIVERS OF LARGE LOANS AND THEIR IMPLICATIONS FOR THE BANK’S FINANCIAL
CAPACITY ....................................................................................................................... 8
THE CHALLENGES OF EFFICIENT MANAGEMENT OF GCI RESOURCES................................... 10
III. PRUDENT MANAGEMENT OF THE BANK’S COMMITMENT CAPACITY 13
LEVERAGING ON THE FINANCIAL CAPACITY PROVIDED BY GCI-VI ...................................... 13
MANAGING VOLATILITY IN LENDING AND COUNTRY DEMANDS .......................................... 13
STRUCTURING AND SYNDICATING LARGE PBL AND INVESTMENT LOANS............................. 15
IV. MONITORING THE IMPACT OF LARGE LOAN SIZE 16
TRADE-OFF CRITERIA FOR TRANSACTION ENTRY INTO THE PORTFOLIO .............................. 16
PORTFOLIO LEVEL MONITORING ..................................................................................... 19
INCENTIVE MECHANISMS ............................................................................................... 19
V. CONCLUSION 20
ANNEXES
Annex 1: Impact of programmatic approach on the prudential ratios
Annex 2: Benchmarking with peer MDBs.
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EXECUTIVE SUMMARY
The primary business of the Bank is to support the social and economic development efforts
of its Regional Member Countries (RMCs) through the provision of development financing,
advisory and other technical assistance services, to the extent permitted by its financial
capacity and established credit risk and exposure management policies.
Prior to the global financial and economic crises, the Bank’s financial capacity was deemed
adequate to deliver its projected short to medium term operations. However, like other
MDBs, the Bank was called upon by both borrowing and non-borrowing members and the
international community to support its RMCs in countering the effects of the financial and
economic crises. In response, the Bank quickly and substantially scaled up its operations and
committed a record level of resources to certain RMCs in 2009. This included counter-cyclical
large reform support and project loans as well as new trade finance and emergency liquidity
facilities. As a result, not only has the size of the loans increased significantly (from an
average size of UA 66 million between 2005 and 2008 to an average of UA 166 million in
2009 while the largest loan size before was UA 336 million vs. UA 1.7 billion in 2009) but
also new instruments were added to the range of the Bank’s lending products. These
laudable responses resulted in a rapid depletion of the Bank’s financial resource capacity,
thereby accelerating the need for a General Capital Increase.
The Bank’s shareholders responded to this need by approving the Sixth General Capital
Increase (GCI-VI) of the Bank, which tripled the Bank’s authorized capital (200% increase)
with a 6% paid-in portion. This will bring the total usable capital after full subscription of
GCI, to around UA 35.3 billion compared to the pre-GCI level of UA 12.4 billion. Total risk
capital will also increase to UA 10.6 billion. In terms of lending, GCI-VI would permit an
annual sustainable commitment of around UA 3.6 billion over a planning horizon of 10 years.
In approving GCI-VI, shareholders highlighted the critical importance of prudently managing
the additional financial capacity, to ensure the long-term financial sustainability of the Bank,
while at the same time enhancing its effectiveness and relevance in all RMC borrowers. More
specifically, they opined that resource allocation should reach target niches and areas where
the Bank can achieve greater development impacts such as in Low Income Countries (LICs),
private sector development and regional infrastructure projects.
They further directed that in the long run, the GCI resources should be utilized in a manner
that would ensure optimal utilization, in order to avoid an early return to shareholders for
additional capital.
Several shareholders have voiced concerns about the size of certain individual (typically
budget support) loans extended to some countries during the financial crisis. While divergent
views have been expressed about the need for a specific large loan policy, there appears to
be a general agreement over the need for a careful management of unusually large loans
that rapidly use up scarce resources and potentially crowd out other borrowers with equally
legitimate needs.
In this regard, it is suggested that the management of large loans should be an integral part
of the overall sustainable framework for managing the Bank’s risk capital in general and GCI
resources in particular. Management does not recommend a specific financial policy for large
loans. Rather, the most important consideration is to better structure and manage
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transactions in a manner that minimizes their impact on the Bank’s prudential ratios in
general and its financial capacity in particular.
Accordingly, noting that GCI resources are not infinite and that recapitalization exercises
take time and have budgetary and financial implications on member countries and their tax
payers, Management, makes the following proposals for the Board’s consideration:
Areas Decision Points Key Proposals
Managing GCI
Resources
Lending Beyond SLL
Lending beyond the Bank’s Sustainable Lending
Level should be supported by additional internal
resource capacity through the building up of
reserves.
Countercyclical Buffer
Gradually build a capital buffer for
countercyclical lending, through stress testing of
the portfolio to systemic risks.
The Actual amount of the buffer shall be
determined each year during the Medium Term
Financial Outlook Presentation.
Managing Large
Loans
Large Loan Policy
No specific financial policy on large loans, but
an operational policy on PBLs as lending instrument
is proposed. The need for a financial policy shall be
reassessed during the implementation of the
revised MTS.
Criteria for Large
Loans
Guidelines on trade-off criteria for large loan
entry in the portfolio such as (i) country
concentration limit; (ii) impact on prudential limits;
(iii) development impact and additionality; and (iv)
crowding-out effect.
The criteria have to be reviewed periodically
to factor in the Bank’s evolving business strategy.
Caps on Budget
Support Loans
No hard cap on the share of budget support
and program loans in the annual lending
program, but a flexible management of country
demand for large program support through: (i) a
programmatic approach; and (ii) burden sharing
with other lenders.
The financial implications of the rolling lending
program of large loan shall be disclosed in the PBD
document.
These measures shall be complemented by other actions to be taken within the context of
the revision of the Bank’s strategy to: (i) better leverage on the capital resources provided
by GCI-VI; and (ii) strengthen its interventions in all RMCs particularly in niches where it can
have greater development impact for both LICs and MICs.
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I. BACKGROUND
1.1 On April 29, 2010, the Board of Directors informally discussed Management’s
proposals relating to “Managing Headroom constraints and large loans”. The proposals were
made in the context of the Bnak’s countercyclical lending in response to the financial crisis.
Such lending resulted, among other things, in a marked increase in the size of loan
commitments. This increase has put some pressure on the Bank’s prudential ratios. These
large loans were geared towards budget support operations and large infrastructure projects.
The large loans have also contributed to a faster than previously projected rate of rapid
consumption of the Bank’s capital which resulted in headroom constraints.
1.2 In May 2010, the shareholders of the Bank approved the Sixth General Capital
Increase of the Bank (GCI-VI) that will help ease the constraints on the prudential ratios and
the lending headroom. However, during the discussions and exchanges of views on
Management’s proposal on managing large loans, Board Members have reiterated the need
for an optimal management of additional GCI-VI capital resources and requested
clarifications on certain issues relating to large loans.
1.3 The issues raised focused primarily on the following: (i) the Banks’ commitment
capacity over a 10 year period; (ii) the rationale behind large loans and relevance of the
Bank’s intervention in large budget support programs; (iii) approach to managing large loans
given the UA 3.61 billion maximum annual sustainable lending limit; (iv) flexibility in
responding to country demands and supporting policy and economic wide reforms while
protecting the Bank’s capital base; (v) options and innovative instruments to provide support
to LICs and ensure that the Bank continues to remain relevant to all RMCs; and (vi)
approach to the development of the Indicative Operational Program and managing volatility
in country demand.
1.4 Acknowledging the critical importance of the concerns expressed, Management
engaged in bilateral consultations with Board members. Informed by these consultations,
Management submitted for Board consideration a revised document that provided further
clarifications on the issues raised. Management also undertook a benchmarking with peers.
The exercise revealed that none of the other MDBs has a large loan policy per se but they
manage large loan demands through their exposure management policy frameworks which
clearly define country limits, single obligor limits and sector limits (see Annex 2).
1.5 The document was referred to a joint AUFI/CODE for a technical review. In the
meantime, there have been several new developments that necessitated amendments and
updates to the Management’s original proposals. These are related essentially to the
requests made by some Board members to: (i) ensure that the Bank remains self-
sustainable beyond 2020 and that a new capital increase should be kept as remote as
possible and as a last resort option for strengthening the Bank’s capital base; (ii) diversify
the Bank’s portfolio while ensuring fair and equitable access to the Bank’s resources with a
call for a review of the Bank’s credit policy; and (iii) respond proactively but prudently to
1 The original GCI-VI projections indicate UA 3.6 million as SLL. With the 2010 financial results update, the new SLL
stood at around UA 3.8 million.
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recent socio-political developments in some regions of the continent. The proposals
presented in this report reflect the results of these developments.
1.6 The report is organized into five sections addressing the issues highlighted above and
makes some proposals for the Board’s consideration. Following this introductory background,
section 2 highlights the Bank’s financial capacity and the challenges of managing large loans.
Section 3 presents the approach for managing large loans and the available flexibility to
respond to country demands while protecting the Bank’s financial integrity. Section 4 deals
with monitoring the impact of large loans. Management’s conclusions and recommendations
are summarized in Section 5.
II. THE CHALLENGES OF EFFICIENT MANAGEMENT OF GCI RESOURCES AND LARGE
LOANS
SOUND BALANCE SHEET MANAGEMENT AND EXPOSURE GROWTH
2.1 One of the key expectations of shareholders that continue to be strongly voiced after
the recapitalization of the Bank is to maintain an adequate risk bearing capacity beyond
2020, the planning horizon used in the GCI-VI discussions. This requirement creates both
financial and operational challenges for the Bank in its intervention strategies in RMCs and
has some implications on the way it allocates resources to countries and approves loans.
2.2 To recall, the concern raised by certain shareholders is that despite the strong capital
position of the Bank, if it continues to extend large budget support loans, its financial
capacity will be quickly exhausted. Therefore, to address the issue it is important to provide
an assessment of: (i) the Bank’s financial capacity both in terms of risk bearing capacity and
lending headroom, (ii) the key drivers of large loans and their implications on the Bank’s
financial capacity, and (iii) the challenges of managing large loans in this context.
2.3 To better comprehend the dynamics of large loans, Figure 1 shows their linkages of
with the Bank’s financial and operational policy frameworks. Because of these
interrelationships, for the Bank to be able to fund large loans, it should have a strong risk
bearing capacity and sound balance sheet profile2. This intrinsic dynamic calls for not only a
prudent management of concentration risk profile of the portfolio but also the allocation of
lending across country programs and instruments (e.g. equity versus loans).
22 This shall be achieved through good portfolio management, pipeline development and higher pace of
disbursement to boost the earning base.
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SUSTAINING THE BANK’S LONG TERM FINANCIAL CAPACITY
The Bank’s Risk Bearing Capacity
2.4 The Bank’s strategic capital adequacy limits determine the financial capacity
headroom. These limits have been defined in the capital adequacy and exposure
management framework, which has established the limits on risk capital utilization (RCUR)
and leverage ratio at 100%. The leverage ratio is generally less constraining as it uses a
broader basis for the risk bearing capacity (risk capital plus the callable capital of A- or
better rated non-borrowing member countries).
2.5 The difference between the 100% limit and the actual RCUR level
corresponds to the available risk capital headroom for development related exposure,
treasury operations and operational risk of the Bank. The risk bearing capacity is measured
through stress testing of RCUR to several risk scenarios including expected risk profile of the
loan portfolio.
2.6 There are generally two major sources of increase in the risk bearing
capacity: (i) GCI cash flows (i.e. incremental paid-in capital); and (ii) annual transfers to
reserves. To ensure that at any given time, the Bank has adequate capital to support its
business and always remain on the path of self-sustainability, the increase in these two
sources should offset the increase in risk related to both the existing and new portfolio.
Table 01 provides the forecast of the Bank’s risk bearing capacity over the 10 year planning
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horizon. It shows that the Bank is currently adequately capitalized and has sufficient risk
bearing capacity consistent with the additional resources provided by the GCI-VI and its
triple-A rating. The total usable capital in 2020 will be around UA 34.3 billion and UA 35.3
billion after full subscription of GCI in 2022, compared to UA 12.4 billion before GCI-VI. Total
risk capital will be around UA 9.6 billion in 2020 and is expected to reach UA 10.6 billion by
2022.
Table 01: The Bank’s Risk Bearing Capacity over 10 year planning horizon (Amount in UA Billion)
The Bank’s Commitment Capacity
2.7 The strong financial capacity provided by GCI-VI (presented above) should be used
effectively for the Bank’s business growth in such a way that its financial soundness is
assured over a long period and its interventions strengthened going forward, particularly in
niches where it can have a greater development impact for both LICs and MICs.
2.8 However, the annual commitment capacity that could be achieved depends on the
risk profile of the assets, which in turn depends on the improvement/or deterioration of the
credit quality of the current portfolio and the risk appetite of the Bank (that drives future
operations). It is also worth recalling that during the GCI-VI negotiations the Bank estimated
its sustainable lending level (SLL) at around UA 3.63 billion, corresponding to the annual
volume of commitments that would maintain the prudential ratios within their limits at least
over a period of 10 years (i.e. from 2011 to 2020), assuming a WARR between 3 and 4.
Figure (01b) presents the annual commitment capacity of the Bank depending on the level of
internal resource generation capacity (transfer to reserves), while figure (01a) recalls the
commitment capacity simulated during GCI-VI discussions for reference.
Figure 01.a – GCI-VI Capital Increase Scenarios Figure 01.b – SLL and Annual Transfer to Reserves
3 This level was subsequently adjusted to reflect year-end 2010 actual financials.
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Net Paid-In capital 2.19 2.49 2.79 3.10 3.40 3.70 4.01 4.31 4.61 4.66 4.71
Net Reserves 2.63 2.68 2.75 2.86 3.01 3.20 3.46 3.76 4.09 4.47 4.87
Total Risk Capital 4.82 5.17 5.55 5.95 6.41 6.91 7.47 8.07 8.71 9.13 9.58
Usable Callable Capital 9.48 24.70 24.70 24.70 24.70 24.70 24.70 24.70 24.70 24.70 24.70
Total Usable Capital 14.3 29.92 30.28 30.69 31.15 31.65 32.21 32.81 33.45 33.87 34.32
Page | 7
2.9 The figures show internal resource generation capacity and the quality of the portfolio
have an impact on the Bank’s commitment capacity. The higher the internal resource
generation capacity the higher the volume of additional lending for equal risk. Similarly, for a
given level of risk bearing capacity, the higher the riskiness of the loan (in terms of excepted
losses), the lower the commitment capacity.
This level of commitment capacity should be prudently used through effective pipeline
development, lending allocation to countries, instruments and single obligor/borrower,
bearing in mind consideration of risk and equitable access to the Bank’s resources.
Future Exposure Profile
2.10 Although the Bank’s business as a development finance institution is to take credit
risks, it must nevertheless carefully manage the growth of credit exposures. This must be
done to ensure not only that it is consistent with its risk bearing capacity but also that the
unexpected significant deterioration through credit downgrade of a part of its portfolio do not
cause significant losses to the institution as a whole. Table 02(a) summarizes the projected
lending growth and balance sheet exposure assuming a weighted average risk rating of 2.2
for sovereign and 3.8 for non-sovereign. It shows that risk capital utilization is expected to
increase steadily with the growth of lending, if the projected disbursements materialize, but
will remain within limit. This is an indication that the Bank’s projected future commitments
are sustainable on overall portfolio basis.
Table 02(a) – Evolution of the Bank’s Exposure Profile
2.11 When increasing the risk appetite in favor of high and very high risk transactions,
RCUR will increase further as illustrated by Table 02(b). Therefore, to ensure that GCI-VI
resources cover the Bank’s exposure over a longer period it is important to re-balance the
portfolio over sliced lending cycles over the next ten years in terms of composition of risky
assets (public versus private sector lending, high risk rated versus low risk rated
transactions, instruments, etc.).
4 Average lending over the planning horizon is at SLL level although there are year-to-year fluctuations.
5 RCUR is below the 100% target of 2020 due to 2010 financial results, lower approval and disbursements than anticipated under the GCI-VI projections and positive migration in the portfolio.
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Anticipated Annual lending
Sovereign 1.22 2.49 2.32 2.26 2.22 2.33 2.45 2.57 2.70 2.84 2.98
Non-Sovereign 1.21 1.11 1.28 1.34 1.41 1.48 1.55 1.63 1.71 1.80 1.89
Total Annual lending4 2.43 3.60 3.60 3.60 3.63 3.81 4.00 4.20 4.41 4.63 4.86
Outstanding Portfolio
Sovereign 6.7 7.84 9.19 10.67
12.26
13.49
14.72
15.99
17.22
18.54
19.90 Non Sovereign 1.8 2.29 2.93 3.49 4.03 4.62 5.23 5.81 6.29 6.72 7.15
Total Portfolio 8.5 10.13
12.12
14.16
16.29
18.11
19.95
21.80
23.51
25.26
27.05 Financial Capacity Indicators
RCUR5 58% 64% 72% 74% 79% 83% 86% 88% 89% 92% 94%
Debt Ratio 84% 42% 46% 52% 55% 59% 63% 67% 70% 74% 79%
Gearing 53% 23% 27% 31% 35% 39% 42% 46% 49% 53% 57%
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Table 02(b) –Bank’s Exposure Profile and Risk Appetite
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Anticipated Annual Lending of which
3.60 3.60 3.60 3.63 3.81 4.00 4.20 4.41 4.63 4.86
Non-Sovereign
Baseline 1.11 1.28 1.34 1.41 1.48 1.55 1.63 1.71 1.80 1.89
Risk Appetite 1.40 1.44 1.48 1.56 1.68 1.80 1.93 2.12 2.27 2.43
RCUR Baseline
62% 69% 73% 79% 83% 86% 88% 89% 91% 94%
RCUR Risk Appetite 62% 72% 78% 84% 89% 92% 95% 96% 100% 102%
2.12 The assessment of larger loans in relation to financial capacity of the Bank should not
be limited to the impact on exposure growth profile but also in terms of the degree of
portfolio concentration they might yield6; given that concentration risk is a greater
determinant of the overall portfolio credit risk.
Thus, an increase in volume should not compromise portfolio quality. In addition, innovative
instruments for risk transfer ought to be considered to release future pressure on RCUR and
extend self-sustainability far beyond 2020.
KEY DRIVERS OF LARGE LOANS AND THEIR IMPLICATIONS FOR THE BANK’S
FINANCIAL CAPACITY
Drivers and Emerging Trends
2.13 In order to adequately address the large loan issues within the framework of an
optimal management of GCI resources, and within the boundary of the risk bearing capacity
presented above, it is important to provide the strategic and policy context of these loans. It
must be noted that they are related to the massive development challenges faced by RMCs
and the spillover effects of the recent crises (food, energy and oil price shocks, financial and
global economic downturn). The increased demand for larger loans reflects efforts by RMCs
to implement more comprehensive solutions to the development challenges and problems
that they face.
2.14 Thus, over the past two years the scope and volume of the Bank’s lending broadened
from ordinary project lending to program lending7 associated with sector reforms. Large
loans include both policy based loans and large investment loans. They have been used: (i)
to support and sustain economy-wide, specific sector policy and institutional reforms aimed
at improving the investment climate, economic diversification, (ii) growth stimulus program
through financial sector strengthening, and (iii) mitigate the adverse impact of the financial
crisis and global economic downturn, short term macro-economic instability, other
exogenous and endogenous shocks such as energy crisis, growth recovery from socio-
6 This is particularly the case when large loans are made to countries with greater absorptive capacity and high
portfolio expansion potential.
7 Lending instrument that support funding based on policy and institutional reforms in a specific sector, a number of
sectors/ subsectors and economy-wide.
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political disturbances. Table 03 provides a summary of the evolution of the size of loans
contracted over the period 2005 -2010.The three recent largest programs were approved in
2009 and they include: (i) the energy security resilience project of Medupi for South Africa,
(ii) the economic diversification support loan to Botswana, and (iii) competitiveness and
public sector efficiency loan to Mauritius. The cumulative disbursements on the net signed
amount of these loans range from 40% to 100% as at end March 2011.
2.15 Based on the assessment of OSGE and recent performance evaluation performed by
OPEV in February 2011, there are indications that these loans have achieved their intended
objectives although for some of them a longer time frame has to be considered to evaluate
the full scope of their impacts. It emerged from the assessment that, they have been
instrumental in strengthening country dialogue, ensuring that the Bank stands to respond to
country needs in crisis situation while keeping the momentum on the key reforms. The
assessment highlighted the importance of flexibility and country ownership. It however
identified some fiduciary, financial and macro-economic risks associated with fast disbursing
policy based loans.
Table 03: Size of loan
approvals from 2005 to 2010
(in UA million)
2005 2006 2007 2008 2009 2010
Total Approvals* 785 926 1,483 1,534 5,312 2,236
Average size 56 71 87 49 166 97
Maximum size 151 338 333 302 1,733 360
Public Approvals 615 654 666 778 4,302 1,220
Average size 76 109 111 78 269 174
Maximum size 151 338 229 302 1,733 360
Private Approvals 171 272 817 756 1,010 1,016
Average size 34 39 74 36 63 63
Maximum size 56 69 333 140 322 271
* Excluding Equity participation, Guarantees, Debt and Debt service Reduction and Grants; Source SEGL
2.16 Although the requests for large budget support loans may decline during the post-
crisis period, it is likely that the Bank will face some swings in the demand for these types of
loans or may be called upon to provide significant financial support for institutional and
economic wide reform programs needed by RMCs. Given its mandate, the Bank (like any
other MDB) can hardly opt not to respond in one way or the other to RMCs request for well
justified large loans with high developmental impact, additionality and strategic fit. This does
not mean that the size of the loan should be infinite given the financial implications
summarized below.
Financial Implications
2.17 There are several implications of large loans for the Bank both in positive and
negative terms depending on how effectively they are packaged and managed. In positive
and financial terms, if large loans are properly structured and priced they can generate
significant amount of income with relatively modest administrative costs.
2.18 However, large loans can also have negative effects. They can reduce and tie up
capital for a long period of time while putting pressure on prudential ratios (leverage and risk
capital utilization). They are often fast disbursing and therefore have treasury implications
(i.e. pressure on the leverage ratio). Thus, to meet the disbursement requirements the Bank
has to borrow significant amounts of resources on the financial markets. While the loan size
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increases borrowing needs, the liquidity policy requires holding the borrowed funds in short
term assets to meet the disbursement requests. This could yield to negative cost of carry if
such disbursement requests do not materialize. Moreover their treasury implications can be
significant if not well packaged and long standing undisbursed amounts persist.
2.19 Finally, large loans could force the Bank to postpone or even reject other projects
because of limited financial resources. To avoid this crowding out effect, they should be
managed through an appropriate trade-off process.
2.20 As indicated in Figure 03(a) and 03(b), if a significant share of the Bank’s sovereign
lending (e.g. 60%) is used to finance fast disbursing large loans, it could negatively impact
the Bank’s prudential ratios. The first direct impact would be on the leverage ratio as more
borrowing requirements will be needed each year to meet larger disbursements. In the case
of the RCUR, Table 04(a) shows the combined impact of large loans and a negative credit
migration. Indeed although the RCUR would marginally change under normal circumstances,
any rating downgrades on countries’ granted large loans would increase the usage of the
Bank’s risk capital hence reducing lending headroom for other borrowers.
Table 04(a) - Impact of Large loans on RCUR
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Baseline GCI VI Scenario 58% 61% 69% 73% 78% 83% 86% 88% 89% 91% 94%
Large Loans and credit migrations 58% 62% 71% 76% 82% 87% 91% 94% 95% 98% 100%
Variance 0% 1% 2% 3% 4% 4% 5% 6% 6% 7% 6%
Table 04(b) – Impact of Large Loans on Leverage Ratio
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Baseline GCI VI Scenario 84% 42% 45% 52% 55% 59% 63% 66% 70% 74% 79%
Large Loans and credit migrations 84% 42% 46% 53% 57% 61% 66% 70% 74% 77% 81%
Variance 0% 0% 0% 1% 2% 3% 3% 3% 4% 3% 3%
THE CHALLENGES OF EFFICIENT MANAGEMENT OF GCI RESOURCES
2.21 As shown in the assessment of the Bank’s financial capacity above, maintaining the
Bank’s prudential ratios far beyond 2020 implies that development intervention programs in
RMCs should be maintained at an average risk rating level. It also entails that if risk bearing
capacity is not sufficient for one reason or the other to sustain lending growth pace (e.g. at
SLL), annual lending volume would have to be curtailed.
2.22 In this paradigm, Lending to RMCs requires a careful balancing of
transactions size and risk. As transactions of high risk consume more risk capital, lending
volume to high and very high risk countries (which constitute a significant portion of LICs)
would be thin and may be well below the country development needs. On the other hand,
large volume of resources could be requested by relatively high creditworthy countries with
high absorptive capacity, and are likely to put pressure on the concentration risk profile of
the portfolio.
2.23 Given that lending around SLL is central in ensuring that the Bank remains
on the path of financial self-sustainability for a longer period, controlling large loan
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size is important as they could put pressure on the Bank’s financial capacity. They can
reduce and tie up capital for a long period of time while putting pressure on prudential ratios
(leverage and risk capital utilization).
2.24 In this context, managing large loans is not simply containing the growth in
loan size but managing expectations and challenges. It is an integral part of both
headroom and portfolio management processes.
Financial Challenges
2.25 Minimizing negative migrations in the portfolio - A large number of RMCs have
demonstrated resilience in the short term to the spillover effects of the financial crisis,
however long term needs remain high as the economies are still fragile. Some high credit
worthy investment grade countries that continue to contribute to maintaining a good
portfolio WARR of 3 have recently experienced socio-political turmoil that may trigger some
rating downgrades8. The post-crisis requirements could be large and the expected responses
from the Bank may not necessarily fully meet these demands by small project loans
particularly to MIC countries that have large absorptive capacity. Thus significant levels of
resources are needed to help avoid losing momentum in tackling fragility and maintaining
good ratings.
2.26 Maintaining portfolio growth momentum – Sound portfolio growth is critical for
increasing the earning basis and enhancing income generation capacity required to build-up
reserves. Large infrastructure programs and loans to support broad-based economy wide
reforms have been the major contributors to the reversal of portfolio contraction experienced
before 2008. Although these large operations were primarily compelled by the financial crisis
and the global economic downturn, they remain critical pillars for economic growth. The
Bank cannot opt not to respond to country demands in this area given the specific
circumstances of those borrowers requesting such support.
Operational Challenges
2.27 Equitable access to Bank resources - With the widening of borrowing spreads on
the international financial markets and volatility in domestic funding cost levels, there are
significant swings in the demands of the Bank clients. In such a context, operational
challenges emerge when there are concomitant surge in demands as experienced recently.
Several profiles have to be managed while maintaining lending at sustainable lending level
(SLL):
• MIC borrowers, which given their Medium Term national development programs,
have been seeking for more predictability in the volume of lending allocations to
facilitate the implementation of multi-year reforms aimed at sustaining macro-
economic growth
8 Some projects could be downgraded as result of recent socio-political crisis
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Active MIC borrowers that have always demonstrated their preference for the
Bank’s lending products but may exhaust their credit limits sooner than
anticipated as a result of active borrowing over the past ten years
• High credit worthy MIC countries that on a less frequent basis, seek for Bank’s
intervention to mitigate some specific sector risks or protect them from
endogenous and exogenous shocks and ensure security (such as energy security
projects, support to parastatals)
• MICs countries that do not use their lending allocations and for which resources
have to be frozen in case lending demand materializes
• LIC countries that in recent years have been pursuing strong reform programs
which have lost momentum due to the crisis and have requested for strong
Bank’s support in terms of sizeable volumes of operations.
LICs that have limited alternative non-concessional funding sources other than
ADB private sector resources and limited concessional resources. Their spreads
even in normal periods are relatively higher than those of MICs.
2.28 Providing sizeable loan amounts for interventions in niches supporting
sustainable growth - Surging demand for such large infrastructure, regional integration
and private sector projects, together with the drying up of financing alternatives has made it
imperative for increased interventions of the Bank in these strategic development niches,
which usually require large loan volumes.
2.29 Infrastructure remains a central pillar of the Bank’s strategy in the long term. The
recognition that a vibrant private sector and sustained economic growth are highly
dependent on well-developed infrastructure further reinforces the criticality of the sector.
Investment in infrastructure including information technology is meant to create a favorable
environment for sustainable growth but often requires loans of relatively large size.
2.30 Private Sector Operations (PSO) especially in LICs are expected to be scaled-up with
a significant component of large infrastructure projects. In this area as well as in regional
integration, the Bank can hardly play a catalytic role with small sized loans. Also to drive
private sector investment in Africa in order to sustain momentum in all these fronts, the
Bank has to show strong commitment in terms of amount invested.
2.31 However, these operations often involve LICs with relatively high risk rating, and the
size of loans required is far above their country allocation or lending headroom. This is also
the case for enclave projects.
In the light of these operational challenges, the overall business strategy that guides the
Bank’s large operations in the RMCs should factor not only the country risk rating, but also
the perceived business opportunities in the country, and the mandate of the Bank to support
niches of development activities in the country in order to enhance its development impact
and additionality.
Page | 13
III. PRUDENT MANAGEMENT OF THE BANK’S COMMITMENT CAPACITY
LEVERAGING ON THE FINANCIAL CAPACITY PROVIDED BY GCI-VI
3.1 Assume more risk to increase catalytic role - Given the challenges highlighted
above, as a premier development financing institution on the continent, the Bank is called
upon to not only increase lending volume, but also take riskier exposures with greater
development impact and additionality. The need to assume more risk is consistent with the
Bank’s catalytic role to provide seed funding to secure the participation of investors and
development partners in areas currently considered being too risky. As sovereign lending
remains limited by the credit policy to 16 eligible countries, this implies an increased share
of private sector operations in the Bank’s portfolio and strong presence in LICs and Fragile
States to leverage the capital provided by the GCI-VI while maintaining a sound portfolio
quality. Annex 1 provides options to meet these expectations.
3.2 Diversify client base - Further, with the additional financial capacity provided by
GCI-VI, the Bank has to increase its client basis to diversify its portfolio and use innovative
instruments to increase the volume of resources provided to the borrowers commensurate
with their diverse needs indicated above.
3.3 Achieving these objectives requires changes in the Bank’s approach to lending in
terms of: (i) managing lending programs constrained by significant volatility in country
demand; (ii) large transactions’ size in particular those of budget support loans; and (iii)
trade-off between equitable access to Bank resources, risk and impact on the Bank’s
financial capacity in extending loans to RMCs.
MANAGING VOLATILITY IN LENDING AND COUNTRY DEMANDS
Cyclicality in Bank’s lending demand to be factored in the Bank’s Future
Operational Strategy
3.4 The evolution of the global operating environment since the crisis offers significant
opportunities to the Bank and also poses at the same time substantial risks to portfolio
growth in terms of volatility in demands. Lending level was high in 2009 reaching UA 5.4
billion but decreased to a level of around UA 2.4 billion in 2010 with a number of projects
dropping out of the pipeline. Further swings in lending demand could be expected and this is
exacerbated by the pro-cyclical9 nature of private capital flows in Africa. The Bank has
experienced this situation in 2010 with the postponement of some commitments made at the
peak of the crisis by some borrowers through significant undrawn approved resources and
extension of disbursement deadlines.
In this context capping loans to creditworthy borrowers will be counter-effective.
9 In times of crisis when financing gaps are high, private sector lenders become more risk averse and reduce the
amount of available financing. When market conditions revert to normal, private lenders offer more resources at
attractive terms in the short maturity bands, reducing thereby the demands for multilateral financing.
Page | 14
Flexibility and responsiveness to country specific circumstances
3.5 The strategy to deal with lending in a highly volatile demand environment involves
better managing obligor credit risks and at the same time accessing potential opportunities
such as:
(i) Keeping MIC active borrowers engaged by ensuring greater
responsiveness to their specific requirements through trade-off between regions
and within region across countries. This allows lending significant amounts to a given
country when its demand is high and slow down lending when no firm demand exists;
and
(ii) Providing adequate headroom to LICs by developing innovative
instruments to grant a larger amount of loan while retaining only a portion of the
risks. Further details on these instruments are given in section 6 and in the annexes.
Trade-off across regions, countries and programs
As indicated above, prudent management of the Bank’s commitment capacity requires a
good headroom management and flexibility in the management of the lending program
through trade-offs. Idle capital should not be held in anticipation of lending that have less
likelihood of being firmed up and should be redeployed within some prudent limits to areas
with good business opportunities in order to build a stronger earning basis. Potential
project- drop outs in the indicative operational program should be proactively managed
through the building of a solid reserve pipeline with a good realism index (i.e. pipeline
development and project readiness in the processing cycle). In the same vein, surge in
critical projects should be accommodated through portfolio restructuring and flexible use of
country limits.
3.6 Flexible Use of Country Limits -Country limits are keys to addressing the equitable
access to ADB resources while reducing concentration risks. Compliance with these limits is
paramount in protecting the portfolio, but these limits could be applied with much more
flexibility. However, as country credit limits are not “entitlements”, blocking resources for
countries in anticipation of a demand that may or may not materialize could be detrimental
to an efficient utilization of the Bank’s capital resources. In this regard the Bank could make
use of:
(i) Front loading of future years resources to meet multi-year investment program needs
while ensuring a prudent and sustainable growth of outstanding portfolio; and
(ii) Reallocation of unused commitment capacity - Transfer to the pool of allocable
resources of the annual lending program, those projects earmarked which are
dropped without clear justifiable reasons. This would reduce volatility in the annual
lending program and would allow financing multi-tranche large loans for which annual
commitment is not guaranteed.
(iii) Stress testing of portfolio to changes in risk profile of countries, default correlations
among these countries, exposure distribution and concentration to guide re-allocation
of resources from regions/countries of high demand and business opportunities to
region of transient low demands.
Page | 15
3.7 It is however important to underscore that the premises to achieve the above
objectives hinge on (i) the elimination of the culture of “entitlement”; and (ii) the
endorsement of fungibility as advocated in the revised capital adequacy and exposure
management framework.
STRUCTURING AND SYNDICATING LARGE PBL AND INVESTMENT LOANS
3.8 Given the rationale driving the demand for these large loans, capping their size is not
the best approach in responding to countries demands while protecting the Bank’s financial
capacity in view of their fast disbursing nature. Management is of the view that a better
structuring of these loans would allow an improved leveraging of the Bank’s scarce
resources, through:
3.9 Enhance Burden Sharing arrangements with other lenders- The Bank has
always strived to coordinate and share the burden of large budget support programs with
other development partners and has endeavored to focus on areas where it has comparative
advantages and can add value. Such approach needs to continue to be strengthened with
early engagement of partners in its large program operations in RMCs and sharing risks.
3.10 Multi-tranche approach to the Bank’s Budget and program support loans- It
is true that with or without constraints on headroom, the size of the Bank’s large budget
support programs should be monitored as they are quick disbursing and tend to deplete
commitment capacity and borrowing. To mitigate this risk, the appropriate approach is
multi-tranche disbursements linked to specific reform triggers and monitoring indicators
taking into account the overall needs of RMCs within a medium-term expenditure framework
presented in the Result Based Country Strategy Paper (RBCSP). Annex 2 shows the impact
of such multi-tranche approach against a fast disbursing loan.
OFF-LOADING LARGE LOAN RISKS
3.11 Large loans raise concerns only when their risk profile is such that they quickly
deplete the capital resources available for lending over a longer term horizon. Also, some of
the borrowers are facing the prospects of being constrained by the prudential country
lending allocations. Several measures could be envisaged to reduce that undesirable impact
on the Bank’s balance sheet and clients.
3.12 The use of credit substitute and guarantees could release the pressure of risky or
large size transactions on the Bank’s prudential ratios and could be effective in enhancing
the Bank’s capacity to lend. Depending on whether guarantees are issued by the Bank or a
third party, its positive impact on prudential ratios will be different. Review for enhancement
of the current guarantee program of the Bank is a recommended action in this respect
3.13 Structured Third Party Guarantees – Two plain vanilla guarantees could be
considered under the current guarantee framework of the Bank: (i) direct ADB guarantee;
and (ii) a third party guarantee. Indeed when a guarantee is provided by the Bank and it
does not call for any disbursement (unless there is a default event) there is less borrowing
requirements hence marginal increase in the debt ratio. It reduces moderately the RCUR as
it applies to the net present value of future cash flows as opposed to the notional. In the
case of a third-party guarantee from a highly rated institution or country (MIGA, Investment
grade country or highly rated state owned entity) the credit strength of the transaction is
Page | 16
enhanced by the higher rating of the guarantor reducing thereby the risk capital
requirements and the pressure on RCUR. Consequently the amount of risk capital that would
otherwise have to be allocated to cover the incremental exposure to the borrower will be
available for use in the ordinary lending activities. In this regard, the Bank’s Private Sector
can deepen its partnership with MIGA to guarantee program for ADF countries for large
infrastructure projects that could not be funded by the limited country allocation under ADB
windows.
3.14 Expand Bond guarantee programme - The Bank can also guarantee sovereign and
other bond issues as it has recently done, with a partial guarantee, to bring these
instruments up to investment grade. The credit enhancement provided by the Bank’s
guarantee could draw a larger pool of institutional investors to finance projects in RMCs.
Again, this will release the pressure on the prudential ratios compared to the situation where
the same project was financed through direct loans.
3.15 Transferring risks to third parties- The Bank is engaged in an independent review
of its risk transfer opportunities for its lending operations. The limitations experienced so far
are of legal nature related to the preferred creditor status of the Bank as well as the loan
agreements that could prevent the Bank from transferring any country exposure to a third
party. The options being considered is to hedge the risk of portfolio impairment due to some
large borrowers or a cluster of medium size borrowers defaulting on their debt service
payment. Legal framework supporting such cash flow hedge has to be further assessed and
agreed upon with borrowing member countries. Given that some of these mechanisms entail
buying protection a trade-off should be made between setting aside a risk capital buffer
versus the cost of the protection.
IV. MONITORING THE IMPACT OF LARGE LOAN SIZE
4.1 The approach of flexible lending to countries advocated above does not imply that
program and loan size can be infinite, as the Bank has its own sustainable lending limit and
has to minimize portfolio concentration risk. It simply means that the Bank has to leverage
on the available commitment capacity to alleviate the headroom constraint on its clients. In
doing so, it ought to have adequate operational management processes for large loans in
order to maintain adequate portfolio diversification and ensure at any point in time
consistency between lending volume and risk bearing capacity.
TRADE-OFF CRITERIA FOR TRANSACTION ENTRY INTO THE PORTFOLIO
4.2 Some Board members have requested for a clear process for approving large loans
and criteria for determining the transaction size and structure. They also requested that
large project proposals to the Board should be accompanied by a note indicating the impact
of the transactions on the Bank’s portfolio risk and prudential ratios to guide the decision-
making process.
4.3 Assessment of best market practices and the lending strategy of other MDBs indicate
that there are no predefined criteria or formulaic approaches for determining loan size.
Management is of the view that a well articulated credit approval process could respond to
the Board members’ concerns.
Page | 17
4.4 It is therefore proposed that instead of limiting large loan size upfront, the approach
should be to strengthen and streamline the review process of large loans through adequate
trade-offs. The multi-criteria assessment framework guiding such trade-offs is illustrated by
Figure 04. It is based on two major considerations: (a) the risk case, particularly the impact
of large loans on prudential ratios; and (b) the development case which calls for equitable
and fair distribution of available resources. The most prominent criteria consistent with these
two cases are: (i) country concentration limit; (ii) impact on prudential limits; (iii)
development impact and additionality; and (iv)crowding out effect. Their rationale is
provided in the sections below.
Multi-criteria assessment framework
4.5 The spider chart (Figure 04) below illustrates the trade-off criteria that could be
applied to determine the
appropriate size of a
transaction. Each of the
indicative criteria is rated on
the score of 1 to 5. The dark
area delineates the frontier
zone of possible loan size.
Under this multi-criteria
trade-off framework, stress
testing the portfolio using
these criteria will determine
the loan size. Such
assessment should
accompany each loan
proposal which represents
more than 10% of the Bank’s
annual sustainable lending limit.
4.6 It is important to note that despite the above multi-criteria assessment framework,
each transaction has to be evaluated on a case by case basis.
Compliance with Concentration Limit
4.7 Among the four proposed criteria, the country’s limit is the first determinant when
considering large loans as it is linked to the capital adequacy framework of the Bank.
Henceforth, a project that will result in a breach of the Global Country Exposure Limit by
bringing the Bank’s total exposure to the country above its credit limit should be
restructured or reduced to a size that ensures compliance. In other words the available
headroom for a country is the upper bound of the loan size.
Impact on Prudential Ratios and the Bank’s SLL
4.8 As indicated in section 1 above, the additional GCI resources are meant to sustain the
Bank’s business growth while maintaining the prudential ratios (RCUR, leverage and gearing)
within their 100% limit. Therefore, any large loan that would push the prudential ratios
Figure 04 – Large Loan Trade-off Criteria
Page | 18
towards their trigger earlier than expected would have to be phased-out. Applying this
criterion means that in the context of the annual discussion of the PBD by the Board, the
projected 3-year Indicative Operational Program shall be presented by risk rating classes as
well as their impact on the prudential ratios. Such practice will guide subsequent decisions
on strengthening allocation to reserves/versus scaling down lending to some risk classes and
instruments.
4.9 Overall the general principle is that in the case of transactions with a negative impact
on the Bank’s prudential ratios, mitigating measures should be considered such as a
reduction or postponement of future projects, portfolio restructuring and project repackaging
in order to release headroom.
Crowding out effect
4.10 The need for and importance of equitable allocation of resources is particularly
pronounced during periods of high demand pressure or counter-cyclical lending. Under these
circumstances limiting loan size is particularly relevant for Policy Based Lending and quick
disbursing large infrastructure projects. The rationale underpinning this risk criterion is that
large loans would limit the Bank’s ability to respond to known or firm demands from other
clients in addition to putting pressure on prudential limits. For example, if two of these big
loans equivalent to 50% of the Bank’s annual SLL (UA 1.75 billion) are granted to 2
countries, it not only deprives the 36 ADF borrowers from getting sizeable loans but also
other ADB borrowers that still have large available unused country lending allocations.
Management’s view is that on the basis of portfolio diversification requirements, it is
considered prudent not to allocate more that a percentage of annual lending program to a
single borrower.
4.11 In considering this indicative operational target, it is important to take into account
several factors, and among them are the following four important ones: (i) the demand;
(ii) the risk profile of the transaction; (iii) the disbursement schedule (i.e. number tranches
over a given period); and (iv) the impact on portfolio concentration. When demand is low
and there is no crowding out effect, the Bank can hardly deny lending to a creditworthy
borrower that has significant unused lending headroom. Also, as illustrated by Table 05
below, a large size transaction with a good credit rating, consumes less risk capital than a
small size transaction with high risk. For equal size and equal risk, a transaction that is
disbursed in several tranches puts less stress on prudential ratios than a single tranche deal
as illustrated by Annex 1 of the document.
Table 05: Indicative Comparison of two Transactions of Different Risk Profile
(In UA Million and %)
Risk Profile of the
Country/Transaction Transaction Size
Average
Risk Charges
Impact on RCUR (Amount of
Risk Capital Consumption
High/Very High Risk 100 71% 71
Very Low Risk 750 8% 60
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4.12 However, given the concerns raised by several Board members on equitable access to
the Bank’s resources, the size of transaction would be within a band of 10% to 20% of the
Bank’s SLL with a possibility of waivers by the Board10 in periods of exceptional low demand
and significant available headroom for the overall projected portfolio. This corresponds to
around UA 550 million.
Risk/Versus Development Impact
4.13 For equal risks, development impact and additionality could be the differentiating
criteria. Therefore ADOA rating could be considered as a key trade-off factor. However, it
should be noted that a very high risk transaction has a greater likelihood of default and
therefore may not achieve its expected development impact at all. Expected losses on these
loans could put pressure on the Bank’s ability to generate sufficient net income, thus
increasing the risk of a reduction in possible transfers to development initiatives.
Consequently incremental increase in the riskiness of the portfolio (impact on the WARR)
should be a trade-off factor with ADOA rating.
PORTFOLIO LEVEL MONITORING
4.14 A portfolio level management is an important element in minimizing the opportunity
cost of holding idle capital, and the cost of carrying liquidity related to any abnormal
undisbursed balance of large loans. This could be achieved through (i) effective pipeline
development and monitoring; and (ii) incentive mechanism to meet the disbursement
triggers/or conditions precedent to disbursement.
Management of the Indicative Operational Program
4.15 To contain the pressure of large loans on the Bank’s commitment capacity, a set of
measures aimed at strengthening the lending and pipeline development strategy as well as
the periodic revision of the lending program shall be considered. These include the
introduction of a pipeline development index to ensure that only firmed projects are
anchored in the CSPs are considered in the IOP. In addition, this has to be accompanied by
secured preliminary arrangements agreed upon by the national authorities and at an
advanced stage in the processing schedule. The annual lending program shall be
supplemented by a two-year reserve pipeline within which projects could be easily appraised
and fast tracked in case of significant drop rate in the annual program.
4.16 Further, in presenting the PBD to the Board, in addition to providing its impact on net
income prospects, its financial impact should be highlighted in terms of the share of fast
disbursing transactions, expected level of RCUR and leverage on portfolio basis.
INCENTIVE MECHANISMS
4.17 In 2010, the Board approved the loan pricing framework articulated around four
measures, of which the introduction of a Graduated Commitment fee for fast disbursing
Policy Based Loans in view of the challenge of managing the Bank’s risk bearing capacity was
included. The purpose of the graduated fee is to discourage borrowers, without imposing an
10 During the discussion the IOP or the Transaction
Page | 20
undue penalty from delaying disbursements on loans possibly contracted for precautionary
purposes only, thereby using up risk capital that could be available for other lending.
4.18 Other mechanisms could be considered with the revised capital adequacy and
exposure management framework such as the additional capital charge or concentration risk
premium.
V. CONCLUSION
5.1 The Bank’s Triple A rating is vital, therefore the key prudential ratios that underpin
such rating must not be compromised through the Banks borrowing and lending programs.
The achievement of this goal has come under some challenges with the necessity to increase
private sector lending to below investment grade countries. The Bank is also engaged in
providing large amounts of loans to investment grade countries to assist them in their efforts
to build resilience and meet the challenges of fragility emerging from the global economic
downturn. Despite these new developments in its business model, the Bank has to
maximize the development impact of additional resources provided by the GCI without
jeopardizing its financial integrity.
5.2 Given the magnitude of the challenges and expectations from stakeholders, it is
important to carefully manage the overall envelope of the operational program to
accommodate excess demand through trade-offs, portfolio restructuring and detailed
operational procedures for use of trade-off criteria that would enable the Bank to manage
new demands adequately and as fairly as possible.
5.3 With respect to large loans, increasing lending amount and transaction size to single
borrower/obligor is sustainable provided that the additional risk that it entails is mitigated on
portfolio wide basis. A large loan policy per se, until the Bank’s business portfolio matures
and demand gains momentum and stability, is not recommended. Management proposes
rather a strengthening of the lending and pipeline development strategy, new approaches to
structuring and packaging transactions and the transfer of risks.
5.4 The decision to approve a large loan for entry in the portfolio could be made on the
basis of a number of factors depending upon the institutional risk appetite and the level of
credit risk that the Bank is prepared to bear. In this regard, there is no formulaic approach
but a set of trade-offs.
5.5 Management’s proposals for Board consideration are summarized in the Tables
below:
Areas Decision Points Key Proposals
Managing GCI
Resources
Lending Beyond SLL
Lending beyond the Bank’s Sustainable Lending
Level should be supported by additional internal
resource capacity through the building up of
reserves
Page | 21
Countercyclical Buffer
Gradually build a capital buffer for
countercyclical lending through stress testing of
the portfolio to systemic risks.
The Actual amount of the buffer shall be
determined each year during the Medium Term
Financial Outlook Presentation.
Areas Decision Points Key Proposals
Managing Large
Loans
Large Loan Policy
No specific financial policy on large loans, but
operational policy on PBLs as lending instrument is
proposed. The need for a financial policy shall be
reassessed during the implementation of the
revised MTS.
Criteria for Large
Loans
Guidelines on trade-off criteria for large loan
entry in the portfolio such as (i) country
concentration limit; (ii) impact on prudential limits;
(iii) development impact and additionality; and (iv)
crowding out effect.
The criteria have to be reviewed periodically
to factor the Bank’s evolving business strategy.
Caps on Budget
Support Loans
No hard cap on the share of budget support
and program loans in the annual lending
program but a flexible management of country
demand for large program support through: (i) a
programmatic approach and (ii) burden sharing
with other lenders.
The financial implications of the rolling lending
program of large loan shall be disclosed in the PBD
document.
ANNEX 1 –
Impact of Programmatic Approach on the Bank’s Prudential Ratios
2011 2012 2013 2014 2015
OPTION 1: 1 Single Large Loan
Approval 600 - - -
Disbursement 300 300 - - -
Total Exposure 525 600 600 600 600
Disbursed and Outstanding 300 600 600 600 600
Undisbursed Balance 300 -
- - -
Impact on Prudential Ratio
Cumulative Risk Capital Utilization Rate 1.52% 1.62% 1.51% 1.47% 1.30%
Cumulative Increase on leverage ratio 1.00% 1.98% 1.96% 1.93% 1.90%
OPTION 2: Loan Packaged into 3 Tranches
Approval 200 200 200 - -
Disbursement 100 200 200 100 -
Total Exposure 175 375 575 600 600
Disbursed and Outstanding 100 300 500 600 600
Undisbursed Balance 100 100 100 - -
Impact on Prudential Ratio
Cumulative Risk Capital Utilization Rate 0.51% 1.01% 1.45% 1.47% 1.30%
Cumulative Increase on leverage ratio 0.33% 0.99% 1.63% 1.93% 1.90%
Total Risk capital 5.17 5.55 5.95 6.14 6.91
Total Usable Capital 29.92 30.28 30.69 31.15 31.65
*Assumes a rating of 3 and risk capital charges of 15%
ANNEX 2 – BENCHMARKING
Practices of Other MDBS
The benching marking exercise of several MDBs and other DFIs revealed that none of them has a large loan policy per se but almost all of
them operates within their exposure management framework to manage large size loan demands to meet extraordinary needs when they
arise. When such needs arise most of them have a set of management criteria to inform their decision making. However, the decision on the
amount is invariably made in such a way that the over-all country limit over the medium term period is respected. They also use a
programmatic approach including multi-year tranching to minimize the impacts on their prudential ratios and to limit any potential crowding
out effect. It is important to note that this benchmarking is limited by the scope of disclosure of some MDBs.
Table A.2.1: Exposure Management Policy
Institutions Exposure Management Policy
Single Obligor Country Limit Sector Limit
World Bank (IBRD) N/A Single Borrower Limit is USD 15
Billion N/A
IFC
Maximum economic capital exposure for institutions is $75 million. For institutions or groups with a public rating of A- or better, there is a higher limit of $200 million. There are also nominal limits in place (based on net outstanding exposure) of $200 million and $800 million respectively.
IFC has policies that set guidelines on exposure to countries, sectors, products, and groups as well as single obligors.
The country exposure limits are determined by taking into account the economic environment, risk and size of each country. Business sector guidelines reflect common risk factors.
The maximum exposure to any country is limited to 7% of Total Resources Available (TRA, defined as
Finance and Insurance sector in any country is subject to a guideline level set to the higher of 5% of IFC’s net worth plus general reserves and 50% of the country exposure review trigger level.
To other single-risk business sector, which is dependent on a single, measurable, worldwide risk factor (such as world price for an
internationally traded commodity), is limited to 12% of IFC’s net worth plus general reserves, and is subject to a review trigger of 6% of IFC’s net
Institutions Exposure Management Policy
Single Obligor Country Limit Sector Limit
the sum of paid-in capital, retained
earnings, general and specific reserves). Exceptions to country specific limits can be made to manage exposure in transition situations or in light of special country circumstances.
worth plus general reserves.
ASDB Single (group) project exposure limit for NSO is $75mln or 25% of the project cost, whichever is lower.
Loans not exceed 20% of total lending on a 3-year moving average basis. No cap on OCR. NSO limit is $2.1bln.
15% of the private sector operations portfolio.
IADB
Inter-American Development Bank
(IADB) has set the single exposure limit for private sector borrowers at $200 million, or exceptionally up to $400 million.
The lesser of 25 percent of project cost (or 40 percent for small countries) or $75 million (equivalent
to 0.6 percent of IADBs paid-in capital and reserves at end-2000) or $200 mln Single (group)NS0---
---
IDB
The Bank’s total commitments to a
single obligor is capped at 30% of the
country’s limit or 150 million SDR---
Maximum country limit is set at 15%
of Bank’s total capital and is adjusted
depending on the country’s rating
No sector limit.
IFAD N/A
No single country, regardless of its income level, nor any single project shall be entitled to a disproportionate share of the Fund’s resources. The allocation to any single recipient country shall not exceed ten per cent (10%) of IFAD’s total annual lending, or such other per cent as may be determined by the Executive Board, to be applied flexibly depending on resource availability.
Not-Applicable because all loans are to the Agriculture Sector
EBRD
Single non-sovereign obligor limit is set at 5% of total risk capital.
Single obligor limit for equity exposures is set at 3% of risk
EBRD limits exposure in any individual country to 90% of paid-in capital and unrestricted general reserves.
Single sector limit is set at 20% of risk capital. Maximum cumulative
exposure to state sectors is capped at 40% of total portfolio.
Institutions Exposure Management Policy
Single Obligor Country Limit Sector Limit
10% of PRS in case of Single (Group)
NSO exposure limit.
EADB TBR TBR TBR
Table A.2.2 : Lending Policy
Institutions Lending Policy
World Bank
The bank grants loan on basis of set of conditionality: (a) maintaining an adequate macroeconomic policy framework (b) implementing the overall program in a manner satisfactory to the Bank (c) implementing the policy and institutional actions that are deemed critical for the implementation and expected results of the supported program.
WB grants Structural Adjustment Loan and Sectoral Adjustment Loan. These are policy based lending instruments. It introduced Special Structural Adjustment Loan in 1998 to provide crisis support to countries eligible for IBRD
assistance.
The share of structural adjustment lending (SAL) in total lending is 53%. The bank adopts case by case approach for loan approvals particularly crisis affected country.
IFC N/A
ASDB
Total annual programme lending for standard program loans is not to exceed 20% of total lending on a 3-year moving average basis. The ADF ceiling remains at 22.5% of total ADF lending.
IADB
Total-Equity-to-Loans Ratio (TELR) of 38%. Flexible Lending Instruments:
Sector Facility: Institutional development International Trade Finance Reactivation Program Program of Guarantee Disbursement Loans with Sovereign Guarantee Sector Facility: Transactional Infrastructure Projects Emergency Reconstruction Facility Conditional Credit Line for Investment Projects Lending Program for Trade, Integration and Competitiveness.
IDB
Institutions Lending Policy
IFAD
Lending criteria is performance based
Project’s effectiveness is measured against the capacity to achieve IFAD goals of enhancing agricultural output, poverty alleviation and rural population nutritional status enhancement
Lending by Country Group based on priority status criteria as follows: o LIFDCs (77%) o LDCs (35%) o Highly concessional o HIPC DI eligible
Policy to be flexible and adaptable to changing circumstances.
EBRD
EBRD's statutory policies restrict its activities to specific and well-defined projects, and policy-based lending is not permitted. Aside from this prohibition, the range of EBRD's activities encompasses virtually every kind of enterprise and
financial institution, using several financial instruments. Of EBRD's total outstanding DRE at year-end 2008, 13% was sovereign loans, 53% was private sector loans (including 1% of securities issued by private sector entities), 32% was equity and quasi-equity investments, and 2% was guarantees
EADB
Lending Operations: ordinary and special operations
Capital Resources: ordinary operations funded from OCR (EADB Capital stock, proceeds from Bank’s borrowing, loans repayments) and special operations financed by SFR (funds accepted by the Bank, repayment of loans funded through SFR)
Limitations to Lending activities:
o Total outstanding of OP may not exceed three times the total OCR o Total outstanding of SP may not exceed the total SPR
CDB
Capital Resources/Lending Operations: ordinary operations financed by CDB’ share capital and proceeds from borrowed funds, called Ordinary Capital Resources window (OCR) and special operations are funded from the Special Development Fund (SDF) and Other Special Funds (OSF) called Special Funds Resources window (SFR).
BMC’s are divided in Groups according to the source of financing (OCR and SFR). Lending Specifications Public Sector: ordinary operations, project lending limit of 80% of total cost; special operations project lending limit
of 90% of total cost.
Private Sector: CDB’s lending up to 40% of project cost (max. D/E of 1and DSCR of 2x). Policy also states financing maximum amount of US$750k or up to 2.5% of CDB’s
AFD Prudential limits are integrated in the Financial Risk Management Policy
Institutions Lending Policy
NIB
Exposure in relation to project cost: Nordic Investment Bank grants a loan for a single project which does not
exceed 50% of the total project cost. Exposure to sector: The exposure to a single sector shall not exceed the defined limit of the Bank’s total required
economic capital. Economic Capital is the amount of capital that the Bank needs in order to able to absorb severe unexpected losses, with a defined level of certainty.
Exposure by Country: There is no specific limit on the aggregate amount of lending exposure on a particular
member country. Exposure on non-member countries is subject to country limits. The Bank’s country risk limit policy sets the maximum country limits based on the risk classification.
NDF
Nordic Development Fund provides grant financing for climate investments in low-income countries. All grant
decisions are made by NDF’s Board of Directors. Grant amount ranges between EUR 500,000 and EUR 4 million.
Table A.2.3 : “Large Loan Definition
Institutions Large Loan Definition
World Bank
World Bank does not have a large loan policy of definition per se but do have Development Policy Lending (DPL) and the lending criteria and selectivity is determined in the context of the Country Assistance Strategy. The volume or share of DPL for a borrower is determined based on the (i) country’s financing requirements, (ii) the impact of DPL on the borrower’s overall debt sustainability (iii) the country’s absorptive capacity, and (iv) the country’s performance triggers
for CAS lending scenarios. DPLs are disbursed against satisfactory implementation of the development policy lending-compliance with tranche release and conditions, maintenance of a satisfactorily macroeconomic framework. The Bank on exceptional basis do provide special development policy lending beyond the level set up in CAS when the country has an extraordinary financing needs. This however subject to availability of adequate IBRD financial and risk bearing capacity.
IFC IFC do not have any large loan policy but work within their exposure management framework to determine large
lending limits.
ASDB
Special Programme Loan (SPL) is a modality for providing exceptional large-scale lending as part of an international
rescue effort to the member country affected by crisis. SPL is expected to provide crisis support on a large scale and it should be a part of an international effort that includes IMF and WB. The arrangements for burden sharing among the IFIs should be satisfactory to ADB.
IADB No Large Loan Policy-Operates within their Exposure Management policy that stipulates their country, single obligor,
and sector limits.
IFAD IFAD do not have any large loan policy but work within their exposure management framework to determine large lending limits.
EBRD
Loans for larger projects (€5 million - €250 million) EBRD investments in private sector projects can range from €5
million - €250 million. The average amount is €25 million. The EBRD's loans are structured with a high degree of
flexibility to provide loan profiles that match client and project needs. This approach determines each loan currency and
interest rate formula.
EADB EADB do not have any large loan policy but work within their exposure management framework to determine large lending limits.
Table A.2.4: Loan Products and Burden Sharing Approach
Institutions Loan Products MDB’s burden sharing approach
World Bank
PRGs (Partial Risk Guarantees), Loan, Local Currency Loans, Contingent financing
Uses burden sharing and syndication to finance large projects
IFC
Syndicated Loans Equity Finance Equity and Debt Funds Structured Finance Trade Finance
Uses burden sharing and syndication to finance
large projects
ASDB Policy based lending product line. Multiple –tranching. Release of tranche depends on compliance
with the policy conditionality.
Uses burden sharing and syndication to finance large projects
IADB
Single Currency Facility: Libor-based (SCF-LIBOR) Single Currency Facility: Fixed Rate (SCF-FIX) Local Currency Facility (LCF) Emergency Lending Facility (ELF) Blended Loans Conversion Offer
Uses burden sharing and syndication to finance large projects
IDB
Loans Trade Financing Equity Finance Project Finance
Use syndication for large loans
IFAD
Agricultural Loans IFAD attempts to multiply the impact of its own limited resources by undertaking projects jointly with other multilateral and bilateral agencies, while
ensuring the realization of the Fund’s own
objectives and establishing its own independent identity in the process. It looks look for co-financing investments in infrastructure projects.
EBRD Loans Equity Investments
Uses burden sharing and syndication
Institutions Loan Products MDB’s burden sharing approach
Guarantees
EADB
Direct loans Equity investment Guarantees
If their balance sheet can support they will do it alone but given their situation they will usually
syndicate for large projects
CDB
Loans Equity investment
Table A.2.5: Treatment of Special Cases
Institutions Specific Policy for Special Cases
World Bank
IBRD – eligible countries that are in a crisis and need extraordinary Financing needs, the bank may, on an excepcional basis provide Special Development Policy Lending (SDPL) beyongd the level set out in the Country Asistance Strategy (CAS). The magnitude of such financial support is subject to the availability of adequate IBRD financial and risk-bearing capacity.
The WB’s current policy on policy-based lending does not specify a ceiling, but follows an overall guideline that the share of development policy lending will remain at around 1/3rd of overall Bank commitments over the 3 fiscal years.
IFC N/A
ASDB
The Programme Cluster Approach: Chronological Sequencing/ multiple tranching.
Vertical Packaging of Policy Reforms involving multi-level policy reform program.
Horizontal (cross-sectoral) packaging of policy reforms (environmental management/poverty reduction are the few goals require an inter-sectoral approach).
Institutions Specific Policy for Special Cases
IADB
The board of Governors is authorized to approve emergency lending program which is over and above the existing
IADB’s existing pipeline. The large loan/emergency loan of $9 billion has been approved to mitigate the effect of sudden reversals in capital flows in 1998 threatening the growth in Latin American and Caribbean region.
IDB The proposal for large loan should get approved by the board and it is approved case by case approach.
IFAD
EBRD N/A
EADB
Exceptional Cases: Equity
o Total amount invested may not exceed 50% of the total OCR
o Total amount invested in any entity or enterprise may not exceed 50% of the total equity capital of that entity or enterprise. EADB may only seek to obtain a major equity position if action is deemed necessary to safeguard the Bank’s interests and as such determined by the Board of Directors.
Guarantees o Total amount guaranteed may not exceed 10% of the total OCR.
CDB
Case by case Analysis o Private sector lending of larger amounts may be conceded through private financial intermediaries and other
suitable financial institutions for on-lending for agricultural and industrial purposes.
o CDB may, from its OCR invest in equity capital of an entity or enterprise subject to such conditions
imposed by the Board of Governors.
LIST OF INSTITUTIONS
- World Bank
- International Finance Corporation (IFC)
- Asian Development Bank (ADB)
- Inter American Development Bank (IADB)
- Islamic Development Bank (IDB)
- East African Development Bank (EADB)
- Caribbean Development Bank (CDB)
- International Fund for Agricultural Development (IFAD)
- European Investment Bank (EIB)
- West Africa Development Bank (BOAD)
- Nordic Development Fund (NDF)
- Central American Bank for Economic Integration
- Nordic Investment Bank (NIB)
- Corporación Andina de Fomento
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