Beyond Traditional World Bank Finance Presentation to the Finance Forum September 24, 2004

Beyond Traditional World Bank Finance

Presentation to the Finance ForumSeptember 24, 2004

Banking and Debt

Management Group

Outline

1. Strategic Framework

2. Overview: IBRD Financial Products

3. How are IBRD clients using them?

4. How could FS clients use them?

Strategic Framework: Outline

A. Shifting the nature of the partnership

B. Shifting the way we deliver financing

C. Implementation at country/CAS level

A. Shifting the Nature of the Partnership

IBRD: A provider of development assistance that also has a role as financial partner of MIC

Lending instruments Financial products

Evolution

Evolution in range and way IBRD delivers financing and financial advisory services.

Full range of financial products and services to support country’s program and overall sovereign debt/risk management needs.

True flexibility at inception and over the life of the loan to manage financial risks related to liquidity, interest rate, currency and commodity.

Why financial choice matters

Until 1999 choice to clients quite limited.

“New” products introduced potential value added beyond the VOLUME of lending financial mode of delivery of lending could now provide value in itself:

supporting Government’s policy goals in debt and risk management;

contributing to country dialogue by introducing the dimension of financial partnership; and

potentially, opportunities for new lending.

B. Shifting the Way we Deliver Financing

Integrating financial products into Bank country programs upstream and at a portfolio level.

Ensuring awareness of the full menu of financial products and services available.

Linking choice to overall sovereign debt/risk management.

Integration

Key strategic goal fully utilize untapped potential by shifting to an upstream, country-portfolio level integration of the most appropriate mix of available WBG financial products and services.

Culture change decisions on the portfolio and on each individual project to be supported by IBRD involve both development decisions and financial decisions.

Awareness

There is CLEARLY a disconnect between available financial products and knowledge of and use of these by both staff and clients.

Strategic Forum + MIC Task Force: Outreach is renewed priority

Intensify targeted training and outreach.

Improve/innovate financial products and services for clients.

Mainstream Financial Advisory Services on-going in 10 MICs.

Upstream Approach

Need to shift:

– Scope: from loan-by-loan portfolio approach

– Level of dialogue (with Staff):task managers country directors/managers

– Level of dialogue (in Countries):from line ministries Finance Ministry and sovereign debt managers

– Timing:from appraisal/negotiations upstream and as part of CAS preparation and implementation

Outreach

Intensify targeted training and outreach.

Improve/innovate financial products and services for clients.

Mainstream Financial Advisory Services.on-going in 10 MIC countries

Debt Management: The context for decision-making

Potential value added of using IBRD Financial Products can only be fully evaluated by looking ex-ante at the overall IBRD portfolio (existing and projected) within the framework of the sovereign debt/risk management strategy.

C. Implementation at Country/CAS Level

Understand the country’s sovereign debt management structure and strategy.

Present to country team and authorities how the IBRD financial products can help manage financial risks (FX, interest rate, commodity prices, etc.) at: 2 levels (country and projects) and 2 dimensions (existing IBRD portfolio and new lending)

Implementation + Implications: add value NOT create more unfunded mandates. we work in parallel to task managers and our support is centrally funded

Outline





The use of financial products in debt management

The framework for applying financial products is to design and implement a debt management strategy.

a critical step is to identify financial risks and plan on how to manage them.

Bank working in 12 pilot countries under the Bank/Fund Debt Reform and Capacity Building Program to support governments in developing a reform plan for debt management and domestic debt market.

Building Capacity in Debt Management

Establishing key objectives and priorities.

Establishing a prudent risk management strategy an strengthening middle office analytical capability.

Establishing an organizational structure that ensures clear accountability and transparency.

Establishing a clear legal framework.

Recruiting trained staff, and selecting and implementing effective management information systems.

Our Members’ Main Financial Risks

Financial risks of the government balance sheet may arise from:

Foreign exchange rates (Currency risk) Interest rates Liquidity/Rollover risk Credit Commodity prices

IBRD can help manage risks

For new IBRD debt Offering a menu of flexible, competitive terms for clients to choose the most appropriate product.

For existing debt (= outstanding IBRD portfolio) Offering products that allow clients to transform the financial characteristics as their needs change.

IBRD can help clients reduce the risk on their debtportfolio

Using IBRD products to manage risks

At the sovereign portfolio level:

Changing the currency and interest rate characteristics of existing IBRD debt.

Smoothing out the portfolio repayment profile.

Reducing vulnerability to commodity prices.

Lowering currency risk on government on-lending by swapping IBRD debt to local currency.

Managing the liquidity/rollover risk.

Using IBRD products to manage risks

At the loan level:

Locking in fixed interest rates (e.g. on-lending…).

Tailoring FSL repayment terms to meet project needs.

Blending IBRD and donor funds to reduce the overall cost of a project.

Overview of IBRD Financial Products

Loans– Fixed Spread Loans (FSLs) – Variable Spread Loans (VSLs)

Specialized Financial Products – Deferred Drawdown Option (DDO) Loans– Special Structural Adjustment Loans (SSALs)

Hedging products– Embedded in FSLs– Free-standing for:

• VSLs• Existing IBRD portfolio

Guarantees– Partial credit guarantees– Partial risk guarantees

Products for Standard New Loans

Key Attributes

Competitive, market-based pricing.

Long maturities.

All major currencies + local currency possible.

Fixed or floating interest rate.

Flexibility to modify key financial characteristics over the life of their loan.

Same price for all borrowers.

Regular Financial Terms for new IBRD Loans

Borrower chooses the currency

Flexible repayment terms

Principal repayment schedules based on the disbursed loan balances

Loan agreement provides for conversion options for currency and interest rate risk management

Hedges can be perfect

Fixed-Spread Loan Variable Spread Loan

Borrower chooses the currency “Standard” country repayment

terms

Principal repayment schedules based on the committed loan amount

A separate legal agreement is necessary to access stand-alone currency and interest rate hedges

Currency and interest rate hedges cannot be perfect

Sample IBRD PricingSample IBRD pricing

Cost of borrowings = LIBOR – 0.30%

Lending spread = 0.75%

Waiver = -0.25%

Total lending rate = LIBOR + 0.20%

Some pricing comparisons

Mexico = LIBOR + 1.22 %

China = LIBOR + 0.26%

Turkey = LIBOR + 3.21%

Philippines = LIBOR + 3.70%

Deferred Drawdown Option (DDO) Loans

No immediate need/interest in disbursing from the Bank (Standby Facility).

Access to a liquidity risk management tool.

Front-End-Fee paid by borrower only when disbursed.

Slightly higher commitment charges than regular loan.

Stand-alone Hedging Products

Interest rate swaps

Interest rate caps and collars

Currency swaps– into local currency where local currency swap

markets exist

Commodity swaps (on a case-by-case basis)

Local Currency Financing

Available as:

Currency conversion of current disbursements or disbursed and outstanding FSL amounts.

Currency swaps on disbursed and outstanding IBRD loan amounts (MDA is required).

Availability Subject to:– Liquid swap market in the local currency– Limited to the local expenditure component

Outline





How are IBRD clients using the products?

FY02 - 04 First Semester

RegionTotal no. of Loans

Total Amount (b.)

% of no. on FSL terms

% of Amounts on FSL terms

% of Customized FSLs

% of FSL with Automatic Rate Fixing Schedule

AFR 3 $0.1 100% 100% 67% 67%EAP 33 $3.1 42% 32% 57% 57%ECA* 63 $9.4 32% 27% 80% 10%LCR** 109 $12.0 84% 91% 50% 37%MNA*** 24 $1.3 63% 66% 67% 33%SA**** 8 $2.0 13% 2% 100% 0%

- - -Total 240 $28 60% 55% 57% 33%

** In addition the 6 consolidated loans for the FYR ($1.8 b.) had 2/3 of the amounts fixed. ** Mexico fixed the rate on $800 million *** Tunisia fixed part of its disbursed amounts**** One FSL to Pakistan. India is still borrowing on VSL terms


Colombia – Uses FSL rate fixing, currency choices and repayment

term flexibility to achieve the desired currency, interest rate and refinancing characteristics of its sovereign debt

Tunisia – Customizes repayment schedules to smooth out

repayment flows to reduce rollover risk

Latvia and Chile – Used a DDO as “insurance” against a potential temporary

financing shortfall


Mexico– IBRD uses USD/MXN swap market to provide

synthetic local currency loan in MXN – Government can eliminate currency risks in on-

lending to states and other entities Philippines

– LGU Urban Water and Sanitation Project (APL2)• JPY-denominated FSL with ARF to lock in low JPY

interest rates• Longer grace period• Cash flow considerations – preferred level principal

repayments

How are IBRD clients using the IBRD financial products?

Bulgaria– Uses stand-alone

hedging products to transform USD loans into EUR in preparation for EU accession

– First IBRD currency swap with a client

Bond Holders

IBRD

Bulgaria

USD USD

Swap Intermediary

Bulgaria

+ Currency Swaps

= Net Cash flows

Bond +Swap Markets

Bulgaria

Original Obligations

IBRD

IBRD

IBRD

USD USD

Euro Euro

Euro Euro

How are IBRD clients using the IBRD financial products?

• China – TB Control Project & Basic Education V Project

• Used an FSL to blend IBRD and DFID funds to achieve concessionary funding and obtain longer grace period

– Third Xinjiang Highway Project• FSL with a customized repayment schedule to match IBRD debt

service with projected revenues

• Papua New Guinea• Has selected FSLs because of flexibility to subsequently change

currency and interest rates

Outline



3. How are other clients using them?


How could FS clients use them?

Possible uses for FS projects:

Reduce the cost of debt within the agreed risk management strategy.

Reduce/enhance exposure to variable rates by converting variable rate debt to fixed interest rate or vice-versa.

Eliminating foreign exchange risk by lending in local currency or converting FX-denominated debt to local currency.

Reduce liquidity risk by tailoring repayment terms based on institution/project cash flow.


Possible uses for FS projects:

DDO used as a standby facility in a reform program for the banking sector for example.

Reduce vulnerability to commodity price volatility.

Help develop or start a mortgage market???


Brazil Indonesia Jamaica Lebanon+ 545 bp + 200 bp + 543 bp + 346 bp

Indicative Market Spreads Over Libor for Selective Countries

Reduce the cost of debt.– IBRD loans can provide cost savings relative to other

funding sources for some countries

– The variable interest rate on existing IBRD Loans can be fixed to reduce interest rate risk in volatile markets, or to lock in historically low rates

– Balances on loans that will not be disbursed could be cancelled, to reduce commitment fee expenses


Reduce/enhance exposure to variable rates by converting variable rate debt to fixed interest rate or vice-versa.

– Tariffs tend to behave like fixed interest rate (regulated)

– Allow on-lending in fixed interest rate

How could FS clients use them? Eliminating foreign exchange risk by lending in local currency or converting FX-denominated debt to

local currency.

Fixed Interest Rate Indication3 Years 5years

CurrencyLatin AmericaBrazilian Real 17.36% 17.74%Mexican Peso 9.37% 9.70%Chilean Peso 4.35% 5.40%Colombian Peso 11.50% 13.30%Eastern EuropePolish Zloty 7.58% 7.46%Czech Kroner 3.99% 4.44%Hungarian Forint 10.47% 9.96%Slovak Koruna 4.37% 4.63%AfricaSouth Africa Rand 8.52% 9.03%East AsiaIndian Rupee 4.63% 5.60%Indonesian Rupiah 9.33% 10.55%Malaysian Ringgit 3.80% 4.60%Philippine Peso 10.28% 11.28%South Korean Won 3.42% 3.63%Thai Baht 3.20% 4.05%


To

Financial Oil (USDeq of x) barrels of oil 17 years5 years[X 24] barrels per year [Y] barrels per year

Reduce vulnerability to commodity prices.– Through IBRD commodity swaps, transform existing or

new USD loans into “financial oil” loans – IBRD debt service would be positively correlated to oil

prices, reducing fiscal budget volatility

From

USD

17 years5 years24 level principal installmentsLIBOR + 50 b.p.

Terms

Currency denomination

Final MaturityGrace PeriodPrincipal AmortizationInterest Payments

Example of Transformed Loan


Reduce liquidity risk by tailoring repayment termsor contracting a DDO.

– Disbursement-linked FSL• May be better suited for local currency loans where available

maturities are short• Loans where project revenues are tied to timing and volume of

disbursements

– Example: • China – lower initial repayments, higher later payments. The

idea would be to wrap the IBRD loan around the shorter-term local bank loan to effectively create a single loan (but still legally two loans) with a longer repayment period.

For More Informationhttp://treasury.worldbank.org/index.htmlhttp://www.worldbank.org/FPS

Financial productsIBRD lending ratesPublic debt managementTraining for clients and WB staffAnalytical toolsOther TRE products and servicesInformation for investors

http://treasury.worldbank.org/index.html

http://www.worldbank.org/FPS/



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Documents

Beyond Traditional World Bank Finance Presentation to the Finance Forum September 24, 2004