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

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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

Page | 19

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