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Banking and Debt Management Group
Beyond Traditional World Bank Finance Presentati
on to the Finance ForumSeptember 24, 2004
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Outline

• Strategic Framework
• Overview IBRD Financial Products
• How are IBRD clients using them?
• How could FS clients use them?

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Strategic Framework Outline

• Shifting the nature of the partnership
• Shifting the way we deliver financing
• Implementation at country/CAS level

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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

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Evolution

• Evolution in range and way IBRD delivers
  financing and financial advisory services.
• Full range of financial products and services to
  support countrys 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.

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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 Governments policy goals in debt and
  risk management
• contributing to country dialogue by introducing
  the dimension of financial partnership and
• potentially, opportunities for new lending.

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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.

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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.

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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.

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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
• Timingfrom appraisal/negotiations ? upstream
  and as part of CAS preparation and implementation

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Outreach

• Intensify targeted training and outreach.
• Improve/innovate financial products and services
  for clients.
• Mainstream Financial Advisory Services.
• ?on-going in 10 MIC countries

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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.

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C. Implementation at Country/CAS Level

• Understand the countrys 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

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Outline

• Strategic Framework
• Overview IBRD Financial Products
• How are IBRD clients using them?
• How could FS clients use them?

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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.

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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.

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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

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IBRD can help manage risks
IBRD can help clients reduce the risk on their
debtportfolio

• 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.

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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.

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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.

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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

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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.

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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

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Sample IBRD Pricing

• Sample 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

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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.

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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)

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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

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Outline

• Strategic Framework
• Overview IBRD Financial Products
• How are IBRD clients using them?
• How could FS clients use them?

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How are IBRD clients using the products?
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How are IBRD clients using the products?

• 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

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How are IBRD clients using the products?

• 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

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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

Original Obligations
USD
USD
Bond Holders
Bulgaria
IBRD
IBRD
Currency Swaps
USD
USD
Swap
Bulgaria
IBRD
Euro
Euro
Intermediary
Net Cash flows
Euro
Euro
Bond Swap Markets
Bulgaria
IBRD
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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

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Outline

• Strategic Framework
• Overview IBRD Financial Products
• How are other clients using them?
• How could FS clients use them?

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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.

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How could FS clients use them?

• 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???

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How could FS clients use them?

• Reduce the cost of debt.
• IBRD loans can provide cost savings relative to
  other funding sources for some countries

Indicative Market Spreads Over Libor for
Selective Countries
Brazil Indonesia Jamaica Lebanon
545 bp 200 bp 543 bp 346 bp

• 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

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How could FS clients use them?

• 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

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How could FS clients use them?

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

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How could FS clients use them?

• 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

Example of Transformed Loan
To Financial Oil (USDeq of x) barrels of oil
17 years 5 years X ?24 barrels per year Y
barrels per year
From USD 17 years 5 years 24 level
principal installments LIBOR 50 b.p.
Terms Currency denomination Final
Maturity Grace Period Principal
Amortization Interest Payments
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How could FS clients use them?

• 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.

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For More Information
http//treasury.worldbank.org/index.html http//ww
w.worldbank.org/FPS

• Financial products
• IBRD lending rates
• Public debt management
• Training for clients and WB staff
• Analytical tools
• Other TRE products and services
• Information for investors

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Questions / comments?