 |
Table of Contents |
 |
|
|
Financial Management and Analysis of Projects :
6. Financial Institutions
6.2. Reviewing FI Financial Management
6.2.1. General Operational Issues
6.2.1.1. State-owned FIs resemble
their commercial cousins in that frequently they have been formed
to address the needs of a particular community, or category of commerce
or industry, or branch of human activities, such as lending very
small sums to urban and rural poor through microfinance. Some state-owned
FIs are very large, such as the Industrial Development Bank of India
(IDBI) or the Agricultural Bank of China (ABC). Other state-owned
FIs can be very small and are sometimes operated by volunteers under
a manager seconded from a commercial bank. So, as there is no generic
model, each FI must be identified and prepared for a project, and
appraised as to its capabilities and capacities to deliver a proposed
project.
6.2.1.2. The objective of reviewing
FI operational performance is to assess its ability to: (i) deliver
subloans to achieve defined country/sector economic objectives,
(ii) efficiently recover subloans, and (iii) cover all operating
costs and make a reasonable profit on the invested capital. FIs
have numerous forms of performance indicators that can provide analysts
with an understanding of past and ongoing performance.
6.2.1.3. Where an existing FI is the
subject of a proposed project, or of a continuing ADB lending operation,
the financial analyst (or investment officer) should begin by closely
studying the FI's most recent annual financial statements
and associated auditors' reports and opinions.
6.2.1.4. For an ongoing project, this
review should be conducted against the objectives and recommended
operational performance set out in the most recent RRP. After drawing
conclusions as to past and current performance, the financial analyst
(or investment officer) should discuss their findings in detail
with the project officer and the FI management and, if appropriate,
with the proposed or actual borrower, and an apex institution (where
participating). Every effort should be made to reach agreement on
these initial findings; particularly on management deficiencies,
system defects, and performance shortcomings or failures.
6.2.1.5. This first step is essential
to ensure that the FI management understands and is likely to fully
support the likely objectives of a proposed project, or revision
of objectives (where necessary) for an ongoing project, as the ADB
mission continues its work of preparing or supervising a project.
6.2.1.6. Full collaboration by FI
management and their complete endorsement of a mission's proposals
is critical for the investment's success. Any reservations by FI
management or the borrower should be confirmed in the Aide Memoire
and reported to the MRM.
6.2.1.7. It is particularly important
to monitor the implementation and fulfillment of the stakeholders
responsibilities, and the impact of their obligations on: (i) their
respective national economies; (ii) performance of the institution
as a borrower; (iii) national influences on regional operations
(where present), and (iv) selected enterprises in representative
regions of countries as subborrowers.
6.2.2. Policy Framework for FIs and FI Loans
6.2.2.1.
The design and timing of FILs should take account of the prevailing
and expected macroeconomic environment, including the exchange rate
regime and international capital mobility, as well as conditions
in real sectors. Given the critical importance of the macroeconomic
and sectoral framework for financial sector sustainability and efficiency,
ADB considers FILs only in the context of a satisfactory macroeconomic
framework. Within this framework, ADB uses its lending and nonlending
services to focus on improving the incentive environment for FIs.
6.2.2.2. ADB involvement in the financial
sector of countries through FILs: (i) supports improvements in the
incentives structure for market participants, including elimination
of impediments to efficient resource mobilization and allocation;
(ii) supports development of infrastructure, including creation
and strengthening of sound and competitive financial institutions
and markets, and improvements in financial and prudential regulations,
banking supervision, and accounting and auditing standards; and
(iii) aims to remove or substantially reduce subsidies, whether
provided through interest rates, directed credit, institution-building
grants, or otherwise. (Institution-building TA grants and other
non-interest rate subsidies may be provided in a variety of ways,
for example, as preferential income-corporate tax treatment, free
use of facilities, consultancies, guarantees, training, and subsidized
staff costs and overheads).
6.2.3. Treatment of Interest Rate Distortions
6.2.3.1.
The level and structure of interest
rates are critical determinants of: (i) the economic efficiency
with which resources are allocated in an economy, and (ii) financial
sector viability.
6.2.3.2. By definition, interest rates
reflect the opportunity cost of capital in undistorted markets.
Interest rate distortions may lead to a misallocation of resources,
resulting in forgone national income. Therefore, the removal of
interest rate distortions in a country is an important objective
of financial sector reform programs supported by ADB-funded FILs.
6.2.3.3. When there are major interest
rate distortions in a country (e.g., large interest rate subsidies,
pervasive interest rate controls, or policies that cause extremely
high interest rates), ADB does not support a program until the country
establishes agreed programs to remove or substantially reduce the
distortions during implementation of the FIL.
6.2.3.4. Interest rate reforms should
be appropriately phased to minimize adverse impacts on the solvency
and liquidity of FIs and enterprises.
6.2.3.5. In determining whether there
are major interest rate distortions, the following factors should
be considered: (i) whether domestic interest rates are administered,
are determined noncompetitively, or are affected by the government's
fiscal tax/subsidy and regulatory policies; and (ii) when capital
markets are open, whether there are significant differences between
domestic interest rates and interest rates payable on borrowings
of foreign capital (that cannot be explained by prevailing economic
conditions).
6.2.3.6. However, under certain circumstances,
ADB may support programs that include directed credit or subsidies.
6.2.4. Treatment of Directed-Credit Programs
6.2.4.1.
ADB-supported FILs also aim to remove
or substantially reduce the use of directed credits, that are similar
to interest rate subsidies, as these lead to resource allocation
outside market mechanisms.
6.2.4.2. Directed credit programs
supported by ADB may be channeled through specialized FIs, particularly
those that concentrate their lending in certain subsector market
niches for business strategy reasons.
6.2.4.3. In many countries, increasing
access to credit by specific sectors (e.g., micro-finance institutions
or the rural sector) is a major government policy objective, and
some use directed credit to pursue this objective.
6.2.4.4. An ADB FIL may support directed-credit
programs to promote sustainable financing for such sectors, provided
that the programs are accompanied by reforms to address the underlying
institutional infrastructure problems and any market imperfections
that inhibit the market-based flow of funds to those sectors.
6.2.4.5. Such reforms include measures
to: (i) address obstacles that impede the flow of funds to the credit
recipients, or (ii) enhance the creditworthiness of the intended
beneficiaries through appropriate approaches such as mutual group
guarantees. When such targeted lending is commercially oriented,
it is not considered to be directed credit.
6.2.4.6. It is good practice to routinely
monitor the contribution of directed credits and their associated
concessional terms to the growth of the targeted sector(s) and poverty
reduction, taking into account any adverse impact on other parts
of the economy.
6.2.5. ADB Policy on Subsidies
6.2.5.1.
In some cases, subsidies may be an appropriate use of public funds
(e.g., poverty-reduction programs). ADB supports programs involving
subsidies only if they:
- are
transparent, targeted, and capped;
- are
funded explicitly through the government budget or other sources
subject to effective control and regular review;
- are
fiscally sustainable;
- do
not give an unfair advantage to some FIs over other qualified
and directly competing institutions; and
- are
economically justified, or can be shown to be the least-cost way
of achieving poverty reduction objectives.
6.2.5.2.
Subsidies that do not meet these tests should be phased out, or
are substantially reduced, during the course of a FIL.
6.2.6. Eligibility Criteria for FIs
6.2.6.1.
ADB requires assurances that FIs,
acting as onlenders using FILs and other investment operations,
are financially efficient and viable institutions. In particular,
they must:
- be
financially sustainable-as represented by adequate profitability,
capital, and portfolio quality, as confirmed by financial statements
prepared and audited in accordance with accounting and auditing
principles acceptable to ADB;
- have
acceptable levels of loan collections;
- have
appropriate capacity, including staffing, for carrying out subproject
appraisal (including environmental assessment) and for supervising
subproject implementation;
- have
the capacity to mobilize domestic resources;
- have
adequate managerial autonomy and commercially oriented governance
(particularly relevant when state-owned or state-controlled FIs
are involved); and
- have
appropriate prudential policies, administrative structure, and
business procedures.
6.2.6.2.
Using these criteria, ADB determines
the eligibility of a proposed FI, or it may require an apex institution
or other appropriate entity to do so.
6.2.6.3. New and existing FIs that
do not meet all the eligibility criteria for being intermediaries
may participate in an ADB-funded FIL if they agree to an institutional
development plan that includes a set of time-bound monitorable performance
indicators and provides for a midterm review of progress.
6.2.6.4. When an FIL includes such
FIs, the size and complexity of the FIL should be commensurate with
the FIs' implementation capacity; and the FIL may include
an institution-building component that the borrower may pass on
in the form of grants. Such FIs' continued participation in
the FIL is subject to their satisfactory implementation of their
institutional development plans; when progress is not satisfactory,
ADB considers appropriate remedial action, including suspension.
6.2.6.5. FIs whose performance in
relation to eligibility criteria has been unsatisfactory for an
extended period of time are required to take substantial corrective
measures and to demonstrate improvement before they are permitted
to participate in a FIL under an institutional development plan
as described above.
 Back
6.1. Introduction and Overview | Next
6.3. FI Investments |
Publications 
Top of page