World Bank Document€¦ · 2009-12-31 · Fully operational and ready for implementation...

Document of The World Bank

Report No: ICR00001157

IMPLEMENTATION COMPLETION AND RESULTS REPORT (IBRD-71290)

ON A

LOAN

IN THE AMOUNT OF US$5.0 MILLION

TO THE

REPUBLIC OF GUATEMALA

FOR A

FINANCIAL SECTOR TECHNICAL ASSISTANCE LOAN

December 16, 2009

Finance and Private Sector Central America Country Management Unit Latin America and the Caribbean Region

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CURRENCY EQUIVALENTS (Exchange Rate Effective December 11, 2009)

Currency Unit = Guatemalan Quetzales (GTQ)

GTQ 1.00 = US$ 0.1204 US$ 1.00 = GTQ 8.3015

FISCAL YEAR January 1 – December 31

ABBREVIATIONS AND ACRONYMS

AML/CTF Anti-money Laundering and combating Financing of Terrorism BANGUAT Banco de Guatemala, Central Bank of Guatemala CAMEL Capital, Assets Management, Earnings, Liquidity CAS Country Assistance Strategy CEMLA Centro de Estudios Monetarios Latinoamericanos CFATF Caribbean Financial Action Task Force CHN Crédito Hipotecário Nacional CICTE Inter-American Committee Against Terrorism CIS Credit Information System DPL Development Policy Loan FCB Bank Capitalization Fund FIRST Financial Sector Reform and Strengthening FOPA Deposit Insurance Fund FSAL Financial Sector Adjustment Loan FSAP Financial Sector Assessment Program FSTAL Financial Sector Technical Assistance Loan GDP Gross Domestic Product GT Guatemala IADB Inter American Development Bank IAS International Accounting Standards IBRD International Bank for Reconstruction and Development ICR Implementation Completion Report FOMIN IADB’s Multilateral Investment Funs IFI International Financial Institutions IFRS International Financial Reporting Standards IMF International Monetary Fund IVE Intendencia de Verificacion Especial, Special Audit Office M&E Monitoring and Evaluation MOUs Memorandum of Understanding MSME Micro, Small, Medium Scale Enterprise Development NBFI Non-Bank Financial Institution

NICs International Accounting Norms NPLs Non-Performing Loans OAS Organization of American States P&A Purchase and Assumption PAD Project Appraisal Document PCU Project Coordination Unit PDO Project Development Objective PPF Project Preparation Facility RBS Risk Based Supervision ROA Return on Assets ROE Return on Equity RTGS Real Time Gross Settlement System SB Superintendency of Banks TA Technical Assistance TF Trust Fund TTL Task Team Leader UNDP United Nations Development Program WHCRI Western Hemisphere Credit Reporting Initiative

Vice President:Pamela Cox

Country Director: Laura Frigenti

Sector Manager:Lily L. Chu

Project Team Leader:Ilias Skamnelos

GUATEMALA FINANCIAL SECTOR TECHNICAL ASSISTANCE LOAN

CONTENTS

1. Project Context, Development Objectives and Design...............................................12. Key Factors Affecting Implementation and Outcomes ..............................................63. Assessment of Outcomes ..........................................................................................114. Assessment of Risk to Development Outcome.........................................................165. Assessment of Bank and Borrower Performance .....................................................176. Lessons Learned........................................................................................................197. Comments on Issues Raised by Borrower/Implementing Agencies/Partners...........20Annex 1. Project Costs and Financing..........................................................................22Annex 2. Outputs by Component..................................................................................24Annex 3. Economic and Financial Analysis .................................................................30Annex 4. Bank Lending and Implementation Support/Supervision Processes.............34Annex 5. Beneficiary Survey Results ...........................................................................36Annex 6. Stakeholder Workshop Report and Results...................................................37Annex 7. Summary of Borrower’s ICR and/or Comments on Draft ICR.....................38Annex 8. Comments of Cofinanciers and Other Partners/Stakeholders .......................41Annex 9. List of Supporting Documents ......................................................................42

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A. Basic Information

Country: Guatemala Project Name: Financial Sector Technical Assistance Loan

Project ID: P076853 L/C/TF Number(s): IBRD-71290

ICR Date: 12/16/2009 ICR Type: Core ICR

Lending Instrument: TAL Borrower: REPUBLIC OF GUATEMALA

Original Total Commitment:

USD 5.0M Disbursed Amount: USD 3.5M

Revised Amount: USD 5.0M

Environmental Category: C

Implementing Agencies: Superintendencia de Bancos Banco de Guatemala

Cofinanciers and Other External Partners: B. Key Dates

Process Date Process Original Date Revised / Actual

Date(s)

Concept Review: 02/05/2002 Effectiveness: 03/13/2003

Appraisal: 06/03/2002 Restructuring(s):

Approval: 06/25/2002 Mid-term Review: 02/01/2005 02/01/2005

Closing: 06/30/2005 06/30/2009 C. Ratings Summary C.1 Performance Rating by ICR

Outcomes: Satisfactory

Risk to Development Outcome: Moderate

Bank Performance: Satisfactory

Borrower Performance: Satisfactory

C.2 Detailed Ratings of Bank and Borrower Performance (by ICR) Bank Ratings Borrower Ratings

Quality at Entry: Satisfactory Government: Satisfactory

Quality of Supervision: Highly Satisfactory Implementing Agency/Agencies:

Satisfactory

Overall Bank Performance:

Satisfactory Overall Borrower Performance:

Satisfactory

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C.3 Quality at Entry and Implementation Performance IndicatorsImplementation

Performance Indicators

QAG Assessments (if any)

Rating

Potential Problem Project at any time (Yes/No):

No Quality at Entry (QEA):

None

Problem Project at any time (Yes/No):

Yes Quality of Supervision (QSA):

None

DO rating before Closing/Inactive status:

Satisfactory

D. Sector and Theme Codes

Original Actual

Sector Code (as % of total Bank financing)

Banking 50 50

General finance sector 50 50

Theme Code (as % of total Bank financing)

Standards and financial reporting 33 33

State enterprise/bank restructuring and privatization 67 67 E. Bank Staff

Positions At ICR At Approval

Vice President: Pamela Cox David de Ferranti

Country Director: Laura Frigenti D-M Dowsett-Coirolo

Sector Manager: Lily L. Chu Danny M. Leipziger

Project Team Leader: Ilias Skamnelos Jose De Luna-Martinez

ICR Team Leader: Ilias Skamnelos

ICR Primary Author: Ilias Skamnelos F. Results Framework Analysis

Project Development Objectives (from Project Appraisal Document) To provide technical assistance to support the implementation of the Government's financial sector reform program aimed at restoring the soundness of the financial system. The FSTAL will provide assistance for: (i) closing and liquidating insolvent banks; (ii) recapitalizing weak but viable banks; (iii) strengthening overall financial regulation and supervision; and (iv) fostering market discipline and competition among financial intermediaries.

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Revised Project Development Objectives (as approved by original approving authority) (a) PDO Indicator(s)

Indicator Baseline Value

Original Target Values (from

approval documents)

Formally Revised Target Values

Actual Value Achieved at

Completion or Target Years

Indicator 1 : Closure of insolvent banks and/or transfer of assets and liabilities of insolvent banks to other financial institutions.

Value quantitative or Qualitative)

To create the mechanism to assist in the closure of insolvent banks and implement as needed.

Fully operational and ready for implementation (including operating manual formally approved).

None Achieved

Date achieved 06/07/2002 06/30/2007 06/30/2009 03/20/2007 Comments (incl. % achievement)

The operational and legal frameworks were established, with: (i) licenses for three intervened banks revoked, and (ii) two banks successfully resolved using the new scheme of purchase and assumption.

Indicator 2 : Establishment of Fiduciary Fund for Bank Capitalization


Creation of Fiduciary Fund for Bank Capitalization (FFCB). Approved by Decree 74-2002.

Full implementation of FFCB.

None Achieved

Date achieved 06/07/2002 06/30/2007 06/30/2009 03/20/2007

Comments (incl. % achievement)

Fund is fully operational, approved by Ministerial Resolution in 2004. Staff were trained on its operation; manual was amended in Dec 2006 to incorporate improvements. FFCB funds were provided to FOPA and 3 banks participated in a large bank resolution.

Indicator 3 : Recapitalization of weak but viable banks


Recapitalization of weak but viable banks, as they become apparent through supervisory reports or related analysis.

For banks already identified, process of recapitalization or satisfactory reduction in provisioning requirements (as per reports, by provision of further doc./ add collateral) completed.

None Achieved

Date achieved 06/07/2002 06/30/2009 06/30/2009 05/05/2009 Comments Provisioning needs that emerged in a few banks were resolved.

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(incl. % achievement) Indicator 4 : Establishment of a Credit Information System (credit bureau)


Credit Information System established.

Bureau fully operational and updated to increase its support to banking system; active cooperation/use of private banks.

None Achieved


The Credit Information System has been operational since 2004. There is an active cooperation and use by private banks.

Indicator 5 : Draft of new laws on secured transactions, non-bank financial institutions, insurance companies, and collective investment vehicles


Drafts of new laws completed

Draft laws presented to relevant authorities.

None Achieved


The movable collateral bill was approved. The insurance bill is pending third andfinal review in Congress. The draft bill of microfinance is being reviewed by the Monetary Board and other government parties.

Indicator 6 : Draft and implementation of new accounting rules Value quantitative or Qualitative)

Draft and implementation of new accounting rules

Implementation of new accounting rules

None Achieved


The Monetary Board approved the New Accounting Manual for entities subject to inspection by the Superintendency of Banks in December 2006. Revisions were incorporated in January 2008.

Indicator 7 : Adoption of a better legal framework for rapid debt collection


The draft on movable collateral including a section on collateral execution under preparation.

Legal framework in place.

None Achieved


The draft on Movable Collateral was approved on October 24, 2007, and has been effective since January 1, 2008. The registry has been operational since January 2009.

Indicator 8 : Establishment of the Special Unit Against Money Laundering within the SB


Establishment of the Special Unit Against Money Laundering within the SB

Continued strengthening of Unit and improved practices in

None Achieved

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AML/CFT. Date achieved 06/07/2002 06/30/2009 06/30/2009 05/05/2009

Comments (incl. % achievement)

The unit was established in the Superintendency of Banks in 2002 and has been proactively strengthening its AML/CFT activities. It participates in a number of international organizations and, in July 2004, FATF listed Guatemala in its list of cooperative

Indicator 9 : Modernization of the payment system for large transactions Value quantitative or Qualitative)

Modernization of the payment system for large transactions

System fully operational.

Achieved

Date achieved 06/07/2002 06/30/2009 06/30/2009 Comments (incl. % achievement)

The Real Time Gross Settlement system was implemented and linkages with internal and external systems were established.

(b) Intermediate Outcome Indicator(s)

Indicator Baseline Value

Original Target Values (from

approval documents)

Formally Revised

Target Values

Actual Value Achieved at

Completion or Target Years

Indicator 1 : Establishment of Bank Resolution Framework, including the Bank Capitalization Fund (SB and Banguat jointly).

Value (quantitative or Qualitative)

Bank Resolution Framework, including the Bank Capitalization Fund contemplated in new legal framework..

Implementation of Bank Resolution Framework, including the Bank Capitalization Fund.

None Achieved


The bank resolution framework is fully operational and has been successfully used to resolve two banks in October 2006 (with FFCB support to purchasing banks) and in January 2007

G. Ratings of Project Performance in ISRs

No. Date ISR Archived

DO IP Actual

Disbursements (USD millions)

1 11/21/2002 Satisfactory Satisfactory 0.00 2 05/29/2003 Satisfactory Satisfactory 0.05 3 12/05/2003 Satisfactory Satisfactory 0.05 4 05/28/2004 Satisfactory Satisfactory 0.25 5 12/01/2004 Satisfactory Satisfactory 0.83 6 04/22/2005 Satisfactory Satisfactory 0.83

7 11/21/2005 Moderately SatisfactoryModerately

Unsatisfactory 0.93

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8 05/17/2006 Satisfactory Satisfactory 1.21 9 08/04/2006 Satisfactory Satisfactory 1.47

10 10/26/2006 Satisfactory Satisfactory 1.59 11 04/13/2007 Satisfactory Satisfactory 2.01 12 11/06/2007 Satisfactory Satisfactory 2.46 13 05/16/2008 Satisfactory Satisfactory 2.62 14 05/20/2008 Satisfactory Satisfactory 2.62 15 11/05/2008 Satisfactory Satisfactory 3.30 16 05/11/2009 Satisfactory Satisfactory 3.53

H. Restructuring (if any) Not Applicable

I. Disbursement Profile

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1. Project Context, Development Objectives and Design

1.1 Context at Appraisal Country and Macroeconomic Background. Guatemala’s advances on the macroeconomic front in the early 1990s had begun to face pressures in the run up of the 2000 presidential elections, both from external shocks as well us from macroeconomic policy choices. Guatemala averaged real GDP growth of 4 percent in the 1990s, compared to an average population growth of 2.7 percent, with the inflation rate declining to less than 9 percent in 2001 from a high of 42 percent in 1990. The country enjoyed a low level of external indebtedness at 13.7 percent of GDP, with central government budget deficits averaging about 1.5 percent of GDP. However, in the run up to the 2000 presidential elections, the Government pursued expansionary monetary and fiscal policies which resulted in a widening of the current account deficit, a depreciation of the currency, the loss of foreign exchange reserves, and a credit boom due to increased liquidity in the banking system. This deterioration was aggravated by adverse terms of trade movements, particularly due to depressed coffee prices and weather related conditions, including the 1998 Hurricane Mitch. The new Administration assumed office in January 2000 aiming at stabilizing the economy, but economic growth suffered from a restrictive policy and further external shocks. Restrictive fiscal and monetary policies succeeded in reducing the budget deficit to 2.2 percent of GDP in 2000; interest rates on bank loans declined sharply from an average of 27 percent in late 1999 to less than 20 percent a year later; capital began to flow back to the country, and international reserves increased sharply to US$1.8 billion at the end of 2001 (close to 5 months of imports). But these policies also kept economic growth only slightly above population growth, with the economy suffering from a sharp decline in coffee prices (the main export) in 2001 and the global economic slowdown that further reduced economic growth to just 2.1 percent. The Government’s program to reestablish a stable macroeconomic environment was agreed with the IMF and supported by a 21 month Stand-by credit of US$100 million approved in April 2002. Financial Sector Background. The fragility of the financial sector, documented by the 2000/2001 Financial Sector Assessment Program (FSAP), was a threat to the Government’s program towards reestablishing a stable macroeconomic environment. The FSAP identified a number of shortcomings of the financial sector’s institutional, legal and regulatory framework, warning of the possibility of a systemic crisis unless the vulnerabilities were addressed. Banks off-shore and off-balance sheet operations were neither reported nor regulated, and anecdotal information suggested that they amounted to the same volume as regulated operations. Guatemala’s regulated banking sector comprised of 31 banks with assets equivalent to 34.8 percent of GDP, plus 3 additional private banks (Metropolitano, Promotor and Empresarial) which the banking authorities had to intervene in 2001. Most banks operated at the center of financial conglomerates that included a related,

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unregulated, off-shore bank as well as related financieras, insurance companies, securities brokers, and companies engaged in leasing, factoring, credit cards, and warehouse business, which could be regulated or unregulated. The unregulated entities catered exclusively to Guatemalan residents. The credit boom of the late 1990s had taken place in a context of poor banking supervision and prudential regulation, and, when the economy slowed down, a number of banks experienced a sharp increase in Non-Performing Loans (NPLs). The regulated portion of the financial sector had shown signs of stress since 1998, with six banks suffering liquidity and solvency problems and remaining in operation largely due to emergency loans from Banco de Guatemala (Banguat) and deposits from the public sector (in addition to the three banks which the authorities had to intervene). In addition, as the FSAP noted, lack of information and inadequate accounting practices obscured the real situation in the sector. Reported figures for March 2002 indicated a well capitalized sector with capital equivalent to 14 percent of risk-weighted assets, compared to the required 10 percent; but taking into account the substantial under-provisioning of NPLs, several more banks presented significant capital shortages. Rationale for Bank Assistance. The high cost of the interventions in 2001 convinced the Government of the need to strengthen financial sector regulations and supervision, resulting in a request for support from the IFIs with the Bank in a strong position to provide assistance. Paying off depositors in full in three small weak banks and two finance companies had an initial cost to Banguat of close to US$200 million. Concerned with the possibility of further bank failures, the Government requested support from the IFIs to elaborate a new legal and regulatory framework that would address the major shortcomings diagnosed by the FSAP. A FSAL was approved to assist the Guatemalan authorities implement the Government’s financial sector reform program.1 In tandem with the adjustment operation, the technical assistance loan FSTAL was approved to assist the Guatemalan authorities to implement the financial sector reform program agreed under the framework of the FSAL. Support for financial sector reform was an important component of the CAS Progress Report. The fragile state of the banking system had not been anticipated at the preparation of the 1998 CAS, and the CAS itself did not provide explicit lending program for financial sector reforms. The financial sector reform program of the Bank was thus addressed in the CAS Progress Report (No.24235-GU), which considered the reform implementation as crucial component to ensure macroeconomic stability and establish the pre-conditions for growth. The Bank was to play an important role in assisting the strengthening of Guatemala’s financial sector and providing targeted support through technical advisory services as a follow up to the FSAP, including assistance for the preparation of the new financial laws. In order to avoid redundancies, the Bank

1 The ICR for the FSAL (Report No ICR0000475) presents in detail the systemic approach undertaken by the Bank in assisting the authorities and the integral role of the FSTAL. The outcome performance of the FSAL was rated Satisfactory.

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collaborated closely with the IMF and the Inter-American Development Bank (IADB) that also provided technical assistance and budget support.

1.2 Original Project Development Objectives (PDO) and Key Indicators The FSTAL was to provide technical assistance to support the implementation of the Government’s financial sector reform program aimed at creating a modern, stronger and better functioning banking sector, able to improve and expand its intermediating functions and to withstand shocks. It would provide assistance for: (i) closing and liquidating insolvent banks; (ii) recapitalizing weak but viable banks; (iii) strengthening overall financial regulation and supervision; and (iv) fostering market discipline and competition among financial intermediaries. The key performance indicators were: (i) closure of insolvent banks; (ii) transfer of assets and liabilities of insolvent banks to other financial institutions; (iii) establishment of the Fiduciary Fund for Bank Capitalization (FCB); (iv) recapitalization of weak but viable banks; (v) establishment of a Credit Information System (credit bureau); (vi) draft of new laws on secured transactions, non-bank financial institutions, insurance companies, and collective investment vehicles; (vii) draft and implementation of new accounting rules; (viii) adoption of a better legal framework for ’rapid debt collection; (ix) establishment of the Special Unit Against Money Laundering within the Superintendency of Banks (SB); and (x) modernization of the payment system for large transactions.

1.3 Revised PDO (as approved by original approving authority) and Key Indicators, and reasons/justification The Program Development Objectives and Key Indicators were not revised.

1.4 Main Beneficiaries The government agencies beneficiaries of the FSTAL were Banguat and SB, but, ultimately, the project aimed at benefiting all users of financial services in Guatemala, including depositors, creditors, investors, firms and households.

Box 1. The Government’s financial sector reform program

The Government’s financial sector reform program involved:

(a) the modernization of the financial sector legal and regulatory framework with

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Banguat and SB were to benefit from legal, regulatory and institutional reforms aimed at strengthening the financial system and avoiding a banking crisis. The financial services users were to benefit from a sound financial system that would offer better savings, investment, and credit instruments to a larger segment of the population under competitive conditions; and, in the longer run, contribute to maintain macroeconomic stability and foster economic development.

1.5 Original Components The project had six components:

1) Rapid exit and resolution of insolvent banks. This component would finance TA to the SB to: (i) establish qualitative and quantitative benchmarks to assess the solvency and viability of banks; (ii) design templates to prepare and evaluate bank’s rehabilitation plans; (iii) design legal and financial instruments to carry out the transfer of liabilities from insolvent banks to solvent banks; (iv) transfer assets from insolvent banks to a special trust; (v) establish mechanisms to compensate institutions acquiring assets and liabilities from insolvent banks; (vi) manage and sell remaining assets of insolvent banks rapidly; and (vii) establish mechanisms for payment of depositors of insolvent banks.

2) Establishment and operation of the Fiduciary Fund for Bank Capitalization (FCB). This component would finance TA to assist Banguat to establish and put in operation the FCB2, including: (i) assess the banks’ capitalization requirements; (ii) design fnancial instruments to capitalize weak but viable banks; (iii) draft legal and operating documents for the operation of the FCB; (iv) formulate policies and strategies to sell FCB’s participations in financial institutions; (v) monitor evolution of capitalized banks; (vi) audit the FCB; and (vii) establish a plan to close the FCB once its goals have been achieved.

3) Strengthening of the SB. This component would finance TA to establish a Credit Information System (credit bureau) to centralize, organize and maintain information of debtors of financial institutions operating in Guatemala. The loan would also finance the acquisition of software and hardware for the operation of the credit bureau. This should encourage the establishment of better lending practices in Guatemala, reducing the amount of future NPLs loans and improving the efficiency of the overall financial system.

Other activities that would be financed under this component included3: (i) review and update of the draft law on secured transactions; (ii) draft a new law on non-bank financial institutions, improving the legal framework of this sector in accordance with best international standards; (iii) draft a new law for collective investment vehicles

2 The FSAL’s proceeds were to be used to help implement the new bank resolution mechanism, including the funding of the FCB, which together with the deposit insurance fund (FOPA) would form the two main tools that the Government needed for banking resolution.

3 This component would complement the TA to be provided by IADB which aims at financing the drafting of new prudential regulations as well as strengthening off-site and consolidated supervision.

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(mutual funds and investment firms); (iv) update accounting principles and disclosure practices for all type of financial intermediaries; (v) review and propose amendments to existing legislation to improve the legal framework for debt recovery; (vi) a new legal framework for off-shore entities; (vii) draft a new law for insurance companies; and (viii) assist the SB to determine Banguat’s capital requirement to cover its accumulated losses.

4) Anti-money laundering. This component would finance TA to strengthen the Special Unit Against Money Laundering to prevent and sanction money laundering activities. The loan would also finance the acquisition of hardware and software required for the unit's operation, as well as the training of the unit's staff, and the development of new supervisory tools to detect money laundering activities.

5) Strengthening of Banguat. The loan would finance the acquisition of hardware and software to modernize the payment system for large financial transactions. The loan would also finance technical assistance to assist Banguat to adopt international accounting standards and the formulation of a strategy for the long term development of Guatemala's financial system.

6) Project Management Unit. This component would finance TA for the adequate and efficient utilization and monitoring of the different components of this loan that retained a degree of flexibility to allow adjustments to respond to changing priorities within the overall framework of the operation.

1.6 Revised Components The project components were not revised.

1.7 Other significant changes The project underwent the following loan amendments: (i) on November 2005, US$2 million was cancelled by the Ministry of Finance for budgetary reasons under areas that the authorities would develop under their own or other funding4; and5 (ii) on May 2007, under a new government, new strategic priorities among the benefiting institutions, as well as the insolvency of two banks in late 2006 and early 2007, the canceled US$2 million was re-established by a new government under new activities in line with project objectives and existing components6. More specifically, the reinstated amounts supported efforts to advance in the transition to a risk-based supervision model and enhanced consolidated supervision of financial conglomerates, strengthen supervision of AML/CTF activities, enhance the financial safety net, and continue the modernization of the payments system.

4 The impact was small, since eliminated activities were already in progress, or would still take place but funded by other means (i.e., IADB-FOMIN, SIB, US Treasury).

5 On December 2005 the direct contracting threshold ceiling was also increased in relation to the acquisition of software under the Payments Systems component.

6 Re-categorization and new procurement guidelines were adopted, changing the procurement sections on the Legal Agreement. Notably, the authorities also requested a larger financial sector focus of that year’s DPL III.

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The loan’s original closing date was June 30, 2005. It was extended three times, initially in June 2005 until June 30, 2006; in June 2006 until June 30, 2007, and; in May 2007 with the re-establishment of the cancelled funds until June 30, 2009. The project faced a slow start, with a nine month delay in its execution, while further delays were the result of the early lack of coordination among the beneficiary agencies, as well as delays due to elections, change in Government, change of Superintendent, a major change in Guatemala’s disbursement procedures and the role of UNDP (causing the Bank to temporarily suspend disbursement requests), and complex procurement work (for example related to payment system activities). The rationale behind these extensions and loan amendments is further explored in context under Section 2 and related lessons learned are derived in Section 6.

2. Key Factors Affecting Implementation and Outcomes

2.1 Project Preparation, Design and Quality at Entry The project’s preparation, design, and quality at entry were:

(i) Consistent with government and Bank priorities, and counting on the strong support and commitment of the authorities. The project was prepared in response to an emerging crisis and at the Government's request to support the implementation of its financial sector reform program. The authorities had moved decisively to intervene three insolvent banks and all five new financial sector laws that the FSTAL helped implement had been approved by Congress before Appraisal. The CAS Progress Report, which was approved simultaneously with the FSTAL by the Board, clearly presented the importance of the financial sector reforms and the Bank’s catalytic role.

(ii) Incorporated lessons learned in the project design. The project clearly identified and incorporated in its design lessons learned from earlier projects. These included building on a sound background analysis, with the TA based on the recommendations of the 2000/2001 FSAP that was accurate in assessing the weaknesses of the financial sector and identifying the shortcomings of the financial sector legal and regulatory framework. Furthermore, the project aimed at building on the experiences and lessons learned from banking crises (internationally and in other Latin American countries), as well as on best practices on crisis resolution and prudential regulations. In addition, the project focused on the need for strong commitment and ownership of the relevant stakeholders, and the desirability of retaining flexibility during project implementation. Finally, it aimed to built on Bank experience with TA loans involving more than one beneficiary agency to ensure the effective coordination of these agencies.

(iii) Coordinated closely with other multilateral agencies. The Bank, IMF and IADB had provided assistance since early 2001 to the design of the financial sector legal and regulatory framework in line with the FSAP recommendations. In response to the Government’s request, the Bank and the IADB coordinated on identifying the TA work each would finance, with the latter preparing a US$900,000 grant facility to assist the authorities in drafting prudential regulations required to enforce the new Bank Supervision Law and to strengthen off-site supervision.

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(iv) Established realistic objectives and flexible components to achieve them. The project’s incorporation of lessons learned from other experiences in banking crises and the Bank’s close involvement in the design of the new financial sector framework helped in establishing realistic objectives. Yet the project aimed for flexibility within and across its components for achieving the longer term objective of financial stability through the institutional strengthening of the two implementing agencies.

(v) Identified effectively risks and associated mitigation measures. The risks associated with this operation were clearly identified at the PAD and were relevant to the operation. One risk mentioned was the possible lack of coordination among the financial agencies that materialized to a certain degree at the early stages of the project. Despite incorporating lessons learned in the design of the PCU, operating under the oversight of a high level executive committee to overcome issues related to involving more than one beneficiary agency, effective coordination only materialized as experience was build during implementation. To the extent that other risks materialized, the mitigation measures were effective in minimizing their effect on the development objectives.

2.2 Implementation The project faced a slow start, with a nine month delay in its execution. The project was approved by the Board end June 2002, but the executive delayed presentation to Congress. Congressional approval was obtained mid-November. The loan agreement was signed in December 2002 and the project was declared effective mid-March 2003. Decree 74-2002 defined as executing agencies the SB and Banguat, with contracts signed jointly by the legal representatives of both entities. The SB was responsible for managing the resources of the Loan through the Project Coordination Unit (PCU), using UNDP as the procurement agency and in close coordination with Banguat. The PCU was created in March 2003, while it was formally established in the SB with the July 2004 Agreement No. 26-2004, enhancing clarity in its role and responsibilities.7

The post effectiveness delays were the result of inexperience with Bank loans within the PCU, Banguat and SB (addressed by vigorous training in Procurement and Financial Management), but largely due to lack of coordination among the beneficiary agencies. More specifically, there was lack of agreement between the two implementing agencies on (i) who would sign the Agreement with UNDP -after some delay, it was agreed that both agencies would; and on (ii) the use of a special account for disbursement of the loan. After delays, the authorities agreed to use a special account that was established in Banguat. While the decision was being made on the choice of disbursement (from project effectiveness until January 2004), early work (for priority components 1 and 2) was funded with loan advances provided by UNDP, reimbursed at a later stage by the project.

7 The PCU consisted of the Director and Administrative Assistant, is also integrated by the Director of Legal Department, the Director of the Research Department, the Director of Financial Services Department and the Internal Auditor of the Superintendency of Banks, as well as the Director of the Department of Monetary Stabilization Operations from the Banco de Guatemala.

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Another administrative structural drawback limiting the project’s implementation was the necessity of approvals by both Banguat and SB, independent of who was the beneficiary. The Bank team suggested that signing take place only on the part of the institution that was directly affected by the relevant project component. The authorities agreed in order to avoid further delays and the UNDP contract was amended to reflect this. From October 2007, the SB signed the contracts resulting from components 1, 3, 4 and 6 and Banguat from components 2 and 5. Due to the delay in the signing of the loan and declaration of effectiveness, the authorities advanced their own funds to initiate work in the project (thus demonstrating their strong commitment to the project’s outcomes), resulting in the reallocation of funds across components to better reflect TA needs. These changes posed a further coordination issue for the PCU that aimed to ensure that the goals of both institutions were achieved. The Bank team also worked closely with the authorities to ensure that the reallocation of funds across components better reflected the shifting TA needs. Disbursement improved significantly following the resolution of these hurdles. Yet, some expected and other unforeseen events posed further delays at later stages. These included delays due to elections, change in Government, change of Superintendent, a major change in Guatemala’s disbursement procedures and the role of UNDP (causing the Bank to temporarily suspend disbursement requests), as well as complex and delicate procurement work (for example related to payment system activities). However, the PCU was very proactive to anticipate issues and take prompt actions, leading to the relatively large disbursement and major progress towards achievement of objectives in spite of these delays. Intensive supervision was also complemented by procurement and technical missions by Bank experts, as well as further training on procurement, financial management and disbursements. One important event during implementation was the cancelation of US$2 million on November 2005 and its re-establishment on May 2007. The cancelation took place by the Ministry of Finance for budgetary reasons under areas that the authorities would develop under their own funding. However, under a new government and new strategic priorities among the institutions, as well as the insolvency of two banks in late 2006 and early 2007 (see Box 4 in Annex 2), the amount was re-established under new activities in line with project objectives and existing components.8 More specifically, in line with the interpretation of the two bank failure events, the reinstated amounts supported efforts to advance in the transition to a risk-based supervision model and enhanced consolidated supervision of financial conglomerates, strengthen supervision of AML/CTF activities, enhance the financial safety net, and continue the modernization of the payments system.9

8 Notably, the authorities also requested a larger financial sector focus of that year’s DPL III.

9 It should be noted that the Bank had given its no-objection, on an exceptional basis, to the direct hiring of a law firm to carry out a forensic audit added in the context of the bank failures of 2006 and 2007 (about US$550k). This was eventually cancelled due to delays related to safeguarding integrity through key procurement considerations and because two related legal processes took place in the meantime helping

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Overall, these delays resulted in the loan’s original closing date of June 30, 2005, to be extended three times until June 30, 2009, (with two of the extensions for one year only) in order to enable the full implementation of the loan. However, it should be noted that these extensions were also an opportunity under a flexible TA structure (that allowed reallocations based on priorities) and a strong Bank supervision team, to closely assist the authorities in meeting the financial sector development challenges. The continuous and strong effort to revisit activities as needed has been central in enhancing the achievement of objectives. The authorities requested a further extension at the end of 2008. However, as the project had already achieved its PDO following previous extensions which totaled four years, further extensions could not be justified under the Bank's closing date policy and the project was allowed to close. The final undisbursed amount was US$1.47 million. Table 1 in Annex 1 reports on the procurement processes completed or canceled.

2.3 Monitoring and Evaluation (M&E) Design, Implementation and Utilization M&E was carried out as part of normal project supervision, with the ISRs reporting in detail on progress and flagging issues that required attention going forward.10 Staff and management effectively used this to make decisions about technical assistance focus and the ratings of the operation. Performance indicators were not quantified (as the focus on result measurement was not yet established at the time of appraisal, but also due to the nature of some specific components), but progress against them was regularly tracked and reported by the PCU and was closely monitored during project supervision missions that collected qualitative information as well as quantitative data on banking sector performance (in particular under the components of the payments system and the credit bureau).11

2.4 Safeguard and Fiduciary Compliance

No safeguard issues were identified for this project. There were no compliance issues on financial management, procurement or disbursement requirements under the project. Fiduciary compliance was good throughout the project and no issues were raised during implementation. No issues were also raised in project audit reports and financial management reports that were produced regularly. No major procurement issues arose during implementation. The only procurement issue raised (at the end of the project) was on the difference of internal procedures on the method of shopping of goods among the

achieve these objectives (Chapter 11 in NY for Refco and liquidation process in Barbados for Bancafe International).

10 Please note that the target value of Indicator 5 (’Approval of draft laws’) under the Implementation Status Reports’ (ISR) Project Development Objectives is not in line with the PAD/ Loan Agreement target ('draft a proposed new law') and has been revised accordingly under the ICR.

11 Cooperation and the exchange of information was very fluid, evidence of the frequent exchange of highly confidential material.

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Bank’s new guidelines and UNDP’s. There were also regular and vigorous trainings for the PCU in Procurement and Financial Management

2.5 Post-completion Operation/Next Phase The sustainability of the reforms, the improved institutional capacity and better financial sector infrastructure were at the center of the FSTAL. As Section 3 explores in more detail, the government’s financial sector reform program helped restore the soundness of the financial system by closing insolvent and recapitalizing viable banks, while significant progress was made strengthening overall financial regulation and supervision. Nevertheless, the 2006 FSAP Update concluded that, while the 2006/07 successful resolution of two banks highlighted the significant progress made, the need for further strengthening remains. The resolution of Bancafé and Banco de Comercio showed the adequacy of the new legal and institutional framework, but also exposed the need for further strengthening consolidated supervision, and for better risk-management practices by financial institutions. Given the nature of safeguarding financial stability that involves the continuous identification of problems and reforms to the national financial architecture, the Bank has aimed to assist the Guatemalan authorities beyond the lifespan of this project. The FSTAL supported work in the areas identified by both FSAPs and since the completion of the project the Bank has remained engaged through FIRST Initiative support, namely through a Crisis Simulation Exercise (TF094008/ P116500) and follow up TA in the fields of consolidated risk based supervision, and intra and interagency contingency planning, coordination and related protocols. In addition, a Western Hemisphere Credit Reporting Initiative (WHCRI)12 assessment of the country’s credit reporting systems has been requested.

12 A partnership between Centro de Estudios Monetarios Latinoamericanos (CEMLA) and the World Bank.

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3. Assessment of Outcomes

3.1 Relevance of Objectives, Design and Implementation The objective of strengthening Guatemala’s financial system to reduce the risk of a financial crisis and stimulate prudent lending remains highly relevant to Guatemala and to the Bank assistance strategy in that country. Despite the substantial progress in strengthening the financial sector achieved under the FSAL and FSTAL, more remains to be done. The 2006/07 bank failures, although successfully resolved, point to the need to further strengthen supervision of financial conglomerates to detect and prevent the type of illegal activities that led to these bank failures. Several objectives of the FSTAL remain relevant for the near future, especially in the 2008/09 global financial crisis environment, including the objective of moving towards a risk based supervisory approach and fully adopting international accounting norms. Also, the objective of improving access to credit though new legislation to strengthen creditors’ rights and transparency of financial information, and establishing the institutional framework for non-bank financial intermediaries remains a very relevant objective to stimulate growth and employment creation in Guatemala. The Country Partnership Strategy of August 2008 (Report No. 44772-GT) in particular makes the strategic recommendation that “firming up gains in banking regulation should be complemented by improving SME access to finance and developing the non-banking financial sector”. It points out that continued financial sector assistance during this CAS was highly relevant and that the remaining challenges center on: (a) strengthening the regulation of the banking sector by removing risks of unregistered offshore operations and related lending; (b) deepening the financial sector; and (c) facilitating access among small and medium enterprises. The FSAP Update (March 2007) in addition commented positively on the progress on stabilizing the financial sector and noted the challenges remaining concerning the supervsion of financial groups.

3.2 Achievement of Project Development Objectives The primary objective was to provide TA to support the implementation of the Government's financial sector reform program aimed at restoring the soundness of the financial system. A clear evidence of the increased strength of Guatemala’s financial system is that it has been able to withstand the failure of two banks (in October 2006 and January 2007) with minimum risk of contagion to other banks in the system, as well as the impact of the global financial crisis. Annex 3 presents a brief but detailed macroeconomic and financial sector review, with Table 2 exploring selected financial indicators. Annex 2 provides a detailed discussion of outputs and two boxes on two of the most important outcomes, the transition to risk based consolidated supervision and the safety net and bank exit framework in Guatemala. In brief, the project achieved the following sub-objectives:

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1) Rapid exit and resolution of insolvent banks. The component financed TA to the SB to establish mechanisms for the rapid exit and resolution of insolvent banks. Box 4 of Annex 2 describes the current integrated mechanism in place that includes a good bank - bad bank mechanism. In October 2006 and in January 2007, the operations of Banco del Café S.A. (Bancafé) and Banco de Comercio S.A. were suspended, and FOPA was authorized to provide funds to the trusts constituted to exclude the assets of these banks, up to the amount of the deposits covered by FOPA’s guarantee (Q1,600.0 million for Bancafé and Q360.0 million for Banco de Comercio, 23.6 percent and 37.8 percent of the total deposit obligation of the two banks). These two bank resolutions are very significant. They are the first rapid resolution cases ever implemented with the new framework without going through liquidation. They put into practice the new resolution mechanism, and verified the resilience of the new bank resolution framework. The resources provided by FOPA plus the total amount of the excluded assets of the suspended banks allowed for 100 percent coverage of the deposits in both institutions. This mechanism allowed FOPA to utilize fewer resources (Q564.6 million less) than it would have had to utilize to cover the promised guarantee, favoring its financial situation. The processes were carried out in a rapid and orderly way, preserving the stability of the system.

2) Establishment and operation of the Fiduciary Fund for Bank Capitalization

(FCB). The component financed TA to assist Banguat to establish and put in operation the FCB. In January 2007, the FCB provided financial assistance to FOPA for Q360.0 million (see Box 4 in Annex 2), and to the three banks that participated in the process of exclusion of assets and liabilities of Bancafé with Q138.4 million (subordinated debt to cover the increase in their respective minimum capital requirement due to the acquisition of the business units that were incorporated in their balances). Since then, the FCB has also provided financial assistance in the order of Q108.6 million to three banks to cover the minimum capital requirement, either related to the acquisition of new business units or mergers with other banks. On October 2008, FOPA made a partial repayment of Q100.0 million to FCB.

3) Strengthening of the SB. The component financed TA to establish a Credit

Information System (CIS, credit bureau). In April 2004, the SB issued norms to guide the CIS operations, and the CIS has been open for consultation by the banks in the system since May 2004, relying on inputs from 43 supervised entities. From May 2004 to February 2009, there were a total of 4,027,417 queries from its users. Credit registry data has contributed to enhance credit concentration and risk assessment. The data in the CIS data base has improved quantitatively and qualitatively with the required reporting by the banks of their evaluation of their corporate portfolios of large debtors based on capacity to pay. This improved information is being used by the SB to strengthen its supervisory function.

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The component also financed the preparation of new laws on secured transactions, non-bank financial institutions, insurance companies and collective investment vehicles.13 Although all drafts were completed, only the Law on Secured Transactions (the Movable Property Guaranties Law) has entered into force as of January 2008 (the Congress approved Decree 51-2007 on October 2007, amended in 2008 by Decree No. 46-2008). The Law aims towards greater acceptance of movable collateral by financial institutions to help unlock access to credit for enterprises, especially MSMEs.14 Substantial progress was also made with the remaining laws with the NBFIs Laws submitted in 2006 and under review by the Monetary Board15, and the Insurance Activity Law (initiative no 3500) pending at the third and final reading before approval in the Congress.16

Finally, the component financed TA to support the implementation of the transition to risk based and consolidated supervision (see Box 4 in Annex 2). As part of the process of institutionalizing risk based supervision (RBS), the SB begun applying it in 2008 (as a first stage) to the five largest financial groups that represent about 80% of financial assets of the system. The five largest banks were completed in 2009 and work is now turning to others. Once RBS is fully completed at the individual level of all companies comprising the financial groups, the full implementation of consolidated

13 Please note that the related target value of Indicator 5 (’approval of draft laws’) under the Implementation Status Reports’ (ISR) Project Development Objectives is not in line with the PAD/ Loan Agreement target ('draft a proposed new law') and has been revised accordingly under the ICR.

14 Guarantees on bank loans are mostly fiduciary, counting for 47 percent of the total in March 2009, with another 24 percent being real estate and 5 percent a mixture of fiduciary/real estate. Greater acceptance of movable collateral by financial institutions will help unlock access to credit for enterprises, especially MSMEs. Smaller enterprises, particularly micro-enterprises, have less acceptable collateral than larger companies. While the latter can generally offer real estate as collateral, smaller companies not only have less collateral (as a percentage of loan value) but it consists more commonly of movable collateral. The law effectively gives small business owners more access to credit by making the guarantees required by banks more flexible. Intangible assets such as commercial patents and other intellectual property are accepted to request a non-fiduciary loan. Also, business owners are able to use future yields, shipment guarantees, and livestock, among other things, to leverage loans. One of the benefits of the law is that it standardizes assets, which, until the legislation was passed, had been treated in different ways by diverse institutions and legislations. The new legal framework has also enabled the creation of the Registry of Non-Real-Estate Assets (Registro de Garantías Mobiliarias) in the Ministry of Economy, which has been active since January 2009, but still counts with low inscriptions as it is establishing its role in the sector. To further foster credit growth and increase the efficiency of collateral, work could include the strengthening of creditor rights, insolvency proceedings and extra judicial restructurings.

15 The Ley de Sociedades de Microfinanzas draft is under discussion by the Monetary Board since the issuance of a favorable opinion on 2006 (the next step is its presentation to the executive branch for submission to Congress). However, following a meeting on September 2006 between banks, Banguat and the Ministry of Economy it was not possible to reach an agreement on four points and no significant advances have been made since then. The Ley de Entidades Civiles de Microcrédito No Lucrativas is also under review by the Monetary Board, as of mid 2008.

16 The project was presented to the Congress on November 2006 and passed the first reading, followed up by a second reading on 28 November 2006. The third reading is pending before final approval.

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supervision will be completed, a feat expected by 2011. It should be noted that, since 2003, all banks are required to establish risk management committees and SB verifies that policies and procedures for risk management are part of the banks’ risk manuals. However, more has to be done to homologize procedures and performance varies among banks.

4) Anti-money laundering. The component financed TA to strengthen the Special

Unit Against Money Laundering. The Intendencia de Verificacion Especial (IVE) has been active since December 2001, as part of the SB, in strengthening the AML activities in Guatemala. Savings and credit cooperatives were obliged to report since November 2002, while lotteries, raffles etc have been included since December 2007. Since 2005 the Law includes the prevention of terrorism financing. IVE has implemented new forms of reporting under the “Know Your Customer” rules, while it has also introduced customs declarations forms. Over its years in operation, IVE has received and investigated suspicious transactions (for example 391 in 2007 and 330 in 2008), and submitted money laundering related complaints to the prosecutor (32 from 101 reports in 2007, and 21 of 48 in 2008). In addition, IVE provided information to the Public Ministry and foreign financial analysis units (205 and 37 requests respectively in 2007, and 216 and 31 respectively in 2008). Finally, IVE has provided talks, seminars and training on methodologies, procedures and practices for the prevention, detection and control of money laundering and terrorist financing prevention.

In July 2004, FATF removed Guatemala from its list of non-cooperative

countries, following an in-situ visit to the SB. IVE participates in the Caribbean Financial Action Task Force (CFATF), of which it held the vice-presidency in the period 2005-2006 and the presidency in 2006-2007; the Inter-American Committee Against Terrorism (CICTE); the Organization of American States (OAS); and the Egmont Group of Financial Intelligence Units. As of end 2008, Guatemala has signed 37 MOUs with other Financial Intelligence Units in Americas, Europe and Asia, with the aim of exchanging information relating to the laundering of money or other assets. Furthermore, to date, 19 MOUs have been expanded and now include matters relating to the exchange of information concerning the prevention of terrorist financing.

5) Strengthening of Banguat. The component financed the modernization of the

payment system for large financial transactions. In 2002, Banguat created the Payments System Committee to coordinate the implementation of the project for the Modernization of the National Payments System The regulatory framework for the payments system has been substantially strengthened and the RTGS has been fully operational since January 2006. The World Bank’s Global Payment Systems Survey of 2008 places Guatemala at the high level of development with regard to Large-Value Payment Systems, the only country in that list in the Central America region.17 The component also financed TA to assist Banguat to adopt international accounting standards and the restructuring of its

17 See Massimo Cirasino and Jose Antonio Garcia, 2008, Measuring Payment System development, the World Bank. Neverteless, the study also recognizes that significant work remains to be done in other aspects of the payments system.

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financial statements in accordance. The change was implemented beginning January 2009, with Banguat adopting international accounting standards to the extent that its organic law allows.

3.3 Efficiency Although a cost-benefit analysis cannot be done for a project of this nature, the benefits attributable to the project are described in Section 3.2 and Annex 2. Most importantly, the supported reforms have helped reduce the risk of a systemic banking crisis avoiding the high associated social and fiscal costs. The successful implementation of two bank resolutions, including the fourth largest bank in October 2006, alongside the resilience of the system during the 2008-09 international turbulence are evidence of the progress made since the high costs incurred during the interventions in 2001.

3.4 Justification of Overall Outcome Rating Rating: Satisfactory This rating takes into account the consistent relevancy of the project objectives, the achievement of the PDO and the benefits that have been realized in large part due to project outputs. An overall rating of “highly satisfactory” has not been given, taking into account that the component that financed the preparation of new laws on secured transactions, non-bank financial institutions, insurance companies and collective investment vehicles was successful in completing the drafts, but only the Movable Property Guaranties Law entered into force, thus limiting the developmental impact.

3.5 Overarching Themes, Other Outcomes and Impacts (a) Poverty Impacts, Gender Aspects, and Social Development

Not applicable. However, although the FSTAL was not intended to have a direct impact on poverty or social development, it has had an indirect one by addressing financial sector weaknesses through the strengthening of the regulatory and supervisory framework and practices and by adopting an efficient and orderly bank resolution mechanism. These reforms have reduced the risk of a systemic banking crisis avoiding the high social costs associated with such crises. The international experience is that financial crises entail huge fiscal costs that crowd out social spending with dramatic effects on poverty increase.18 The strengthening of banks and increasing profitability has enabled banks to increase lending, which is an important factor to promote economic growth. (b) Institutional Change/Strengthening

18 The fiscal cost of the 1999 banking crisis in Indonesia amounted to 50 percent of GDP. The Brazil crisis of 1994 had a fiscal cost of about 13 percent of GDP and the Mexican crisis of 1994/1995 had a cost to the Government of about 20 percent of GDP. A study of the cost of banking crises in 56 countries during 1973-1997 found that they had generated an accumulative loss of 8.3 percent of GDP.

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The FSTAL has had a major impact in strengthening the institutional capacity of Banguat and SB. Banguat has reduced the institutional vulnerabilities it faced due to flaws in the payments system, and has also strengthened its capability to manage the FCB, a pillar of Guatemala’s financial sector safety net. SB has also strengthened its capability to supervise the financial system by implementing a new regulatory and supervisory framework that involves risk-based consolidated supervision of financial groups. SB has also created and is successfully managing the IVE (addressing money laundering and terrorism financing issues) and the CIS (credit bureau). Both institutions have also received intensive training in bank resolution procedures which enabled them to successfully implement two bank resolutions through P&A schemes, respectively for the fourth largest bank in October 2006 and a smaller bank in January 2007. (c) Other Unintended Outcomes and Impacts (positive or negative) N/A

3.6 Summary of Findings of Beneficiary Survey and/or Stakeholder Workshops N/A

4. Assessment of Risk to Development Outcome Rating: Moderate The development outcome sustainability is favorable in a number of ways. The authorities’ commitment to strengthen their capability of supervising and supporting financial sector development has been demonstrated in the past by their commitment to develop components using their own funds, and is firmly embedded in the institutional culture of both institutions as exemplified by continued efforts to improve existing Laws and norms based on ongoing international improvements in best practice, as well as their request for an extension of this FSTAL in 2009, a Crisis Simulation Exercise with FIRST Initiative funding and follow up support on contingency planning. The reforms supported by the FSTAL have also been maintained through a change in administration and changes in the positions of Minister of Finance, governor of Central Bank and Superintendent of Banks. The new bank resolution mechanism has been successfully tested and proven effective in containing a possible sector wide crisis. Most notably, the recent events in global financial markets have highlighted the strength of the sector and the stronger institutional capacity of the authorities to deal with such pressures. Since the 2006/07 bank resolutions, the financial system has remained stable, with Annex 3 providing a brief review of the financial sector. There is the risk however that Guatemala’s economic conditions could deteriorate due to external or internal shocks, to such an extent that would affect the financial sector as a whole. However, the prudential regulation and bank resolution mechanism supported by the FSTAL would minimize the risk of a systemic crisis.

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5. Assessment of Bank and Borrower Performance

5.1 Bank Performance (a) Bank Performance in Ensuring Quality at Entry Rating: Satisfactory The project was based on solid sector work. The policy reforms under the FSAL and the TA work agreed with the Government were based on the recommendations of the 2000/01 FSAP and post FSAP TA work by the Bank, the IMF and IADB. As such, they offered a systemic, coherent and well integrated response, addressing short-term needs and longer term development issues. The PAD was well-written and issues well described. The output indicators were generally appropriate and were all achieved, even though some draft laws have not yet been approved. Quality at entry would have been rated highly satisfactory except for: (i) the PCU, despite incorporating lessons learned from other projects with dual implementing agencies, faced problems at the early stages of implementation. Nevertheless, it should be pointed out that the Bank team and the PCU were highly pro-active in identifying and resolving issues, and that such structures are complex by nature with hard to identify one-off or generally applicable solutions. To that end, the project offers lessons learned under Section 6; (ii) it would have been useful to have quantified targets for some of the components, but at the time of preparation, quantified targets were not required (the project was prepared using the earlier logistical framework without baseline and annual targets). (b) Quality of Supervision Rating: Highly satisfactory The Bank monitored project implementation and the procurement process through close and regular supervision missions. The Bank discussed with the beneficiaries implementation plans and delays, and was proactive in identifying and resolving issues. Importantly, the Bank team was closely engaged with the authorities in the implementation of the financial sector reforms supported by this operation and the FSAL, and provided close technical assistance to the authorities in addressing problems that emerged in rapidly changing circumstances. The authorities also requested the Bank team’s help with the supervision of broader activities related with the project development objectives. The Bank was flexible and receptive to introducing changes within the project objective to meet changing circumstances and requirements. Procurement and financial management was monitored closely, with staff frequently joining supervision missions and providing practical and concrete advice, as well as training, to the PCU.

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(c) Justification of Rating for Overall Bank Performance Rating: Satisfactory This rating takes into account the Bank’s performance during all phases of the project. The team developed excellent relationships with the authorities that praised the Bank for its provision of intensive technical assistance to both Banguat and SB through supervision missions and the organization of workshops. In particular, the authorities recognized the Bank’s receptiveness to changing conditions and the actions taken to promptly address these.

5.2 Borrower Performance (a) Government Performance Rating: Satisfactory The Government’s performance during preparation and implementation was satisfactory. The Portillo administration reacted positively to the FSAP recommendations and requested support from the IFIs to design and implement a comprehensive financial sector reform program. The Berger and Colom administrations maintained the same commitment to the reform program as the previous administration. The only problem in regard to government performance was the initial delay in effectiveness, which was however tied to building support among Congress for the FSAL. The project team had good communication with and access to authorities’ officials as needed.

(b) Implementing Agency or Agencies Performance Rating: Satisfactory Banguat and SB performance during preparation and implementation was satisfactory. Both agencies worked closely with the Bank in the design of the operation. They remained highly committed to the project’s development objectives throughout implementation, particularly demonstrated by their strong commitment and coordination with the Bank in overcoming the early implementation delays. They remained extremely engaged, requesting Bank technical support and advice as conditions and priorities in the financial sector reform efforts changed. Importantly, the work undertaken is continuing

Box 2. Bank team technical assistance to the authorities Areas of intensive Bank assistance during supervision worth mentioning include:

(i) Bank assistance to establish and utilize the bank resolution mechanism. Bank staff supervised closely the work of the international consultants that elaborated the FCB operating principles and procedures and participated in the training provided to BANGUAT and SB staff. The Bank team was pro-active in suggesting and later approving modifications tothe FCB operating principles to respond to the type of assistance requested by the banks. Bank staff was intensively involved in assisting the authorities with the first two bank resolutions using the P&A procedures. Drawing from early lessons from these resolutions, Bank staff helped to identify areas for

h i b k i i d l i i d i d h h i i d fining the use

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beyond the lifespan of the FSTAL, further highlighting the strong commitment of the authorities. One example is the transition to risk-based supervision, which is a difficult process that takes several years to accomplish. (c) Justification of Rating for Overall Borrower Performance Rating: Satisfactory The overall Borrower performance is rated satisfactory, reflecting the performance of the Government, Banguat and SB, as well as their commitment to the project objectives, the quality of project management and implementation capacity.

6. Lessons Learned It is desirable to retain a degree of flexibility in the project to allow adjustments to respond to changing priorities within the overall framework of the operation. Broad definition of the disbursement categories can contribute to such flexibility and facilitate the movement of funds without difficult formal reallocations. This is particularly relevant if the implementation period is lengthy, there is a risk that individual priorities become less relevant. The project allowed the Bank team to be responsive to the changing needs and priorities of the benefiting agencies, and a crucial aspect of achieving this is the build in flexibility, but also the strength of the TTL and the Bank team in staying engaged with the client and providing solid technical advice. Although the quality of the technical analysis underpinning a TA operation is crucial, timely TA and advice as part of the Bank supervision process is a key factor of success. The FSTAL was based on the findings of the FSAP and further technical analysis conducted during preparation. However, the timely technical assistance and advisory services to the implementing agencies that was carried out during supervisions was critical in: (i) maintaining a continued technical and policy dialogue that strengthened the authorities’ ownership and commitment to the development objectives; (ii) allow adjustments to respond to changing priorities within the overall framework of the operation. Nevertheless, needed resources are not always available to be used to fund Bank staff, which sometimes is the best qualified to provide the TA needed. Mechanisms are needed to fund this type of Bank provided technical assistance in ways that do not impinge on the usually limited preparation and supervision budgets. The commitment and ownership of the authorities is central to success at both the design and implementation stage, and should be encouraged with institutional strengthening and capacity building. The preparation of the project counted with the strong commitment of both the highest levels of Government and the implementing agencies. The successful development of regulations for the resolution of insolvent banks, the new handbook of RBS and the chapter on consolidated supervision were all due not only to the high quality of international consultants recruited but also the commitment made by the authorities in providing technical resources and personnel exclusively dedicated to these tasks. Importantly, as technical capacity was build and the new supervisory vision was

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institutionalized, the SB claimed clear ownership, reflected in their commitment to continue such work beyond the lifespan of the FSTAL. A “hit the ground running” implementation structure under two executing agencies can be elusive. The PCU’s staff limited experience with Bank-financed operations can result in implementation delays, however resources can be provided to enhance management, procurement and financial management capacity as needed. The lack of coordination among the beneficiary agencies, particularly with regard to the redistribution of available resources among competing priorities, is a recognized yet elusive intrinsic issue in projects with two implementing agencies. It is important to recognize such concerns early on and allow sufficient time for their resolution. A proactive PCU and Bank team is crucial in handling such issues, allowing for funds to be mobilized in a timely manner to priority areas. In addition, projects using two agencies, may in some cases consider managing funds separately and build in a process for reviewing the transfer of money from one to the other that would operate in a more independent systematic way. A number of technical lessons learned can be drawn as well: (i) the change from a compliance based supervision approach to a risk-based consolidated supervision approach may take longer than usually envisaged. The Plans of Action of the SB to implement the financial sector legal and regulatory reforms had benchmarks that proved excessively optimistic and did not take into account that the implementation of some of the reforms is a complex process that may include the training of the staff of the supervisory agency and of the banks; (ii) a well funded Bank Capitalization Fund can be an effective stabilizing factor. The fund can anchor expectations in the financial system, independently of its actual utilization. Importantly, the fund should be able to lend to the deposit insurance fund as both funds have complementary roles in bank resolution processes (further safety net lessons learned can be found in Box 3 in Annex 2).

7. Comments on Issues Raised by Borrower/Implementing Agencies/Partners (a) Borrower/implementing agencies

SB highlighted the fact that this project represented a milestone in the development of the Guatemalan financial system. From the SB perspective, the most important change has by far been the shift towards a risk-based supervisory approach. The institution believes that this change will have long-lasting and positive repercussions not only within the SB itself but also on the supervised entities. In this same vein, the SB points out that the development of procedures for bank resolution, coupled with the adoption of an explicit mechanism of deposit insurance have helped create a better environment for the development of the financial system overall. Banguat highlighted that the enactment of up to date laws that cover the activities of new players in financial markets will prove to be beneficial in the long run. The most visible impact in the short run was the acquisition of the RTGS system, helping to develop the internal financial market and avoid operational failures in events of shortened liquidity. (b) Cofinanciers

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N/A (c) Other partners and stakeholders

N/A

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Annex 1. Project Costs and Financing

(a) Project Cost by Component (in USD Million equivalent)

Components Last Amendment (USD millions)

Actual/Latest Estimate (USD millions) Percentage

1. RAPID EXIT AND RESOLUTION OF INSOLVENT BANKS

0.17 0.17 3.37%

2. ESTABLISHMENT AND OPERATION OF THE FCB 0.26 0.24 4.80%

3. STRENGTHENING OF THE SB 2.13 1.81 36.30%

4. STRENGTHENING OF ANTI-MONEY LAUNDERING 0.58 0.34 6.74%

5. STRENGTHENING OF BANGUAT 1.34 0.55 11.05%

6. PROJECT COORDINATION UNIT 0.47 0.36 7.28%

Total Project Costs 4.95 3.48 69.54% Front-end fee IBRD 0.05 0.05 1.00% Total Financing 5.00 3.53 70.54%

(b) Financing

Source of Funds Appraisal Estimate

(USD millions)

Actual/Latest Estimate

(USD millions)

Percentage of Appraisal

Borrower 0.90

International Bank for Reconstruction and Development 5.00 3.53 70.54%

Table 1. Additional report on procurement processes completed, but that failed or got canceled, 2009

Process Institution US$ Comments

Consulting firm to support a banking forensic investigation and to define follow up strategies

SB 524,276 The selected law firm demands were contrary to the laws of the country and the World Bank’s

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(US$524,276.43) standards. The Banking Commission conducted a forensic audit of the bank.

Implement second phase of work on the monitoring and analysis of financial risks (US$80,000.00)

SB 80,000 The Banking Commission decided not to carry out this activity for non technical considerations.

FCB specialized software development (estimated US$30,000.00).

Banguat 112,600 The process was performed twice. The tenders received were not consistent with the needs of FCB. Banguat decided to develop it in house.

Payments system interface interconnection between MoF and Banguat (estimated US$ 173,800.80).

Banguat 280,000 The amount requested for the service was three times more than anticipated (due to interface uniqueness) and the authorities decided to develop in-house solution.

Total 996,876

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Annex 2. Outputs by Component Rapid Exit and Resolution of Insolvent Banks - Completed In accordance with Guatemalan law, the project supported the Operating Procedures Manual for the Exclusion of Assets and Liabilities; draft standard contracts for such transfers; proposed amendments to the regulations of the Board of Exclusion of Assets and Liabilities and the FOPA; the Procedures Manual for Regularization Plans of troubled banks. In October 2006 and January 2007, the Monetary Board suspended the operations of two banks in the system, further described in Box 3.19 Derived from this experience the authorities also carried out the modification under JM resolution 22-2008, while future trust fund supported TA is expected to continue support based on lessons learned and best practice international experience. Establishment and Operation of FCB - Completed The Bank Capitalization Fund (FCB) was established on November 15, 2002 by Decree No. 74-2002. The Project supported in 2004 the Regulations and Manual of Operation of FCB, and in the following years provided training and the necessary tools for the institutions involved in the operation of the fund. FCB’s regulations were issued by the FCB Technical Committee and approved by the Ministry of Finance, by Government Agreement No. 51-2004, with amendments in 2006 to the rules of eligibility of banks to be financed through Ministerial Agreement No. 48-2006. The utilization of FCB is described in more detail in Box 3, but included support to FOPA by Q360 million in 2007 (with a repayment in 2008 of Q100 million), and financial assistance amounting to Q366.9 million to three banks that had participated in the process of orderly exit of Banco del Café, S. A., for the purpose of covering the required minimum amount of additional equity, arising from the participation of these entities in that process. It also provided funding to three banks in the system for Q181.0 million, to cover the required minimum amount of additional equity resulting from merger processes.

19 Two weak banks-Banejer and Banoro were resolved with the Government capitalizing CHN in 2002 with Q100 million to allow it to absorb Banejer; and with Q193.9 million in 2003, to allow it to merge with Banoro. These resolutions were made using the old system of Government capitalization, instead of the bank resolution mechanism of the new Banking Law, partly due to lack of experience of the authorities with the new resolution procedures. The Bank had also received a petition to fund a financial study of Crédito Hipotecário Nacional (CHN) under Component 1, as per request from the Minister of Finance in line with urgent priorities in the context of IMF discussions. The project team had urged the authorities to define a course of action based on the analytical work already undertaken by the SB. A high level commission was created regarding the strategy with respect to CHN, however no progress was made along this front.

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Box 3. Guatemala’s safety net in practice and lessons learned

Guatemala’s financial safety net, supported in its creation by the WB FSAL and accompanying FSTA, consists of: (i) a bank regularization/resolution mechanism, establishing a procedure of dealing with problem banks that consists of agreeing on a regularization plan, ordering the suspension of the bank’s operation in the case that the regularization plan is unsuccessful, and transferring the bank’s deposits and an equivalent amount of its assets to willing banks in the system. The residual assets and liabilities are transferred to a trust fund for their liquidation; (ii) the Deposit Insurance Fund (FOPA), which insures deposits for up to Qs20,000 (US$2,600) per individual or entity in a local bank or subsidiary of a foreign bank. It is a fund administered by BANGUAT (the Central Bank) constituted by quotas paid by participating banks, returns on investments of the fund, proceeds from liquidation of banks and Government contributions. FOPA also received the equivalent in Quetzals of US$73.5 million from the FSAL; (iii) the Bank Capitalization Fund (FCB), which has the objective to support financially the process of regularization and strengthening of the national banking system, within the context of processes of bank mergers, acquisition of assets, and processes of exclusion of assets and liabilities. Also, when strictly necessary it can support financially the FOPA. In October 2006 and in January 2007, the operations of Banco del Café S.A. (Bancafé) and Banco de Comercio S.A. were suspended, and FOPA was authorized to provide funds to the trusts constituted to exclude the assets of these banks, up to the amount of the deposits covered by FOPA’s guarantee (Q1,600.0 million for Bancafé and Q360.0 million for Banco de Comercio, 23.6 percent and 37.8 percent of the total deposit obligation of the two banks). These two bank resolutions are very significant. They are the first rapid resolution cases ever implemented with the new framework without going through liquidation. They put into practice the new resolution mechanism, and verified the resilience of the new bank resolution framework. The resources provided by FOPA plus the total amount of the excluded assets of the suspended banks allowed for 100 percent coverage of the deposits in both institutions. This mechanism allowed FOPA to utilize fewer resources (Q564.6 million less) than it would have had to utilize to cover the promised guarantee, favoring its financial situation. The processes were carried out in a rapid and orderly way, preserving the stability of the system. This experience has highlighted the need to enhance the effectiveness and funding of both FOPA and the FCB. Despite FOPA’s subsequently recapitalization (through additional fiscal funds, an increase in premiums charged to banks, and additional secured funding form banks in the system), there is a need to secure additional funding sources to support possible future bank resolutions. In January 2007, the FCB also provided financial assistance to FOPA for Q360.0 million (with a repayment on October 2008 of Q100.0 million), and to the three banks that participated in the process of exclusion of assets and liabilities of Bancafé with Q138.4 million (subordinated debt to cover the increase in their respective minimum capital requirement due to the acquisition of the business units that were incorporated in their balances). Since then, the FCB has also provided financial assistance in the order of Q108.6 million to three banks to cover the minimum capital requirement, either related to the acquisition of new business units or mergers with other banks. The failure of these banks also highlighted some important vulnerabilities in the sector, and convinced the authorities of the need to further strengthen risk-based consolidated supervision of financial conglomerates, and to create a financial crimes investigation unit. Since the failure of these two banks, domestic financial markets have remained stable. Some lessons for the establishment of a financial safety net: (i) the transition from an old to a new legal system, particularly the risk that new prudential rules could expose weak financial conditions, can accelerate the need to capitalize some banks and close others, when deposit insurance schemes are still under-funded andunable to cover insured depositors. (ii) in addition, when new legislation limits the Central Bank’s LOLR capabilities, it is important to strengthen or create financial safety funds to facilitate bank resolutions. (iii) well capitalized Deposit Insuranceand Bank Capitalization Funds can be an important signal to the market that the system is in a position to face any possible banking crisis, helping to strengthen confidence in the banking system; (iv) a strong financial safety net should follow a holistic approach to each design, not overlooking any of its components; (v) when the decision to create a guarantee fund to reimburse depositors is left to the discretion of the banks, authorities must be prepared that such a fund may never be created. Some lessons also apply to the design of Bank support for the financial safety net: (i) liquidity support for the establishment of funds should be tranched to support not only the enactment of a new financial legal and regulatory framework, but also its implementation that should be accompanied by technical assistance; (ii) earmarking proceeds for the establishment of funds can provide confidence and successful resolution of weak banks.

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Strengthening of the Superintendency of Banks (SB) - Completed

(i) Establishment of a Credit Bureau: The bureau has been operational since May 2004 and the rules governing its operations are contained in the Agreement 12-2004 of the Superintendent of Banks. There are currently 454 active passwords, distributed among a total of 41 supervised entities. From May 2004 to February 2009, there were a total of 4,027,417 queries from its users. With support from the Project, the bureau received the necessary equipment, servers and software, as well as training courses.

(ii) Preparation of new laws on secured transactions, non-bank financial institutions, insurance companies and collective investment vehicles: In the preparation of the draft laws mentioned, inter-agency committees were formed with the Banguat, the SB and the Ministry of Economy, with the help of international consultants, experts in each of the subjects. Although all drafts were completed, only the Law on Secured Transactions (the Movable Property Guaranties Law) has entered into force as of January 2008 (the Congress approved Decree 51-2007 on October 2007, amended in 2008 by Decree No. 46-200820). Substantial progress was also made with the remaining laws with the NBFIs Laws submitted in 2006 and under review by the Monetary Board21, and the Insurance Activity Law (initiative no 3500) pending at the third and final reading before approval in the Congress.22

(iii) Strengthening off-site and consolidated supervision23: The project supported implementing the transition to risk based and consolidated supervision, under an IADB financed new Manual24, and the incorporation of the section of the

20 On July 4, 2008, the Ministry of Economy issued the Acuerdo Gubernativo, No. 181-2008, incorporating in its structure the registry of Movable Property Guaranties. A fully functioning registry has been operational since January 2009.

21 The Ley de Sociedades de Microfinanzas draft is under discussion by the Monetary Board since the issuance of a favorable opinion on 2006 (the next step is its presentation to the executive branch for submission to Congress). However, following a meeting on September 2006 between banks, Banguat and the Ministry of Economy it was not possible to reach an agreement on four points and no significant advances have been made since then. The Ley de Entidades Civiles de Microcrédito No Lucrativas is also under review by the Monetary Board, as of mid 2008.

22 The project was presented to the Congress on November 2006 and passed the first reading, followed up by a second reading on 28 November 2006. The third reading is pending before final approval.

23 In line with its Strategic Plan, the SB made adjustments to its organizational structure in order to allow the creation of multidisciplinary groups for strengthening the supervision of financial groups through the distribution of analysis functions (off-site ) and monitoring (in situ) in three departments to ensure the health of these groups as well as the creation of a research department to investigate and guide on the adequacy and implementation of the different supervisory practices.

24 IADB TA support contributed in the development of the Procedures Manual for Risk Based Supervision (banks and off-shores)- the chapter on consolidated supervision is part of the manual.

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insurance and finance companies, towards the effective supervision of financial conglomerates. In addition, it supported the development of a number of Manuals, related to monitoring and managing risk, establishment and merging financial institutions, business continuity etc.25 The project finally supported the acquisition of software and hardware, studies and several courses and internships on regulation, risk based and consolidated supervision, risk management, off-shores monitoring, on-site NBFIs supervision, IFRS, insurance etc.

(iv) Update of accounting principles and disclosure practices for financial institutions: With respect to accounting principles in 2006 the Monetary Board (under resolution JM-150-2006, amended by JM-9-2008) issued a new Accounting Manual that came into effect on early 2008.26 In addition, the Superintendent of Banks issued procedures for the consolidation of financial statements of firms under financial groups (Agreement No. 06-2008), and in January 2009, resolution JM-168-2008 entered into effect amending the Accounting Manual with regard to the registration of capital reserve accounts, aiming to strengthen the assets of the banks. Regarding disclosure, the Superintendent of Banks has issued Agreement 15-2007 on Provisions for financial disclosure and Agreement 16-2007 on Guidelines for Information Disclosure, while further regulation is under discussion to expand such practices. A registrar for external auditors is also operating within SB, with the institution continuing the strengthening its capacity to review working documents of external auditors, as a way of verifying reports and deter fraud.

25 The SIB carries out in-situ and extra-situ supervision of all the banks in the system since June 2002. The scope and periodicity of the in-situ inspections depend on the risk profile of the entities and, in general, there is one in-situ inspection per year of different aspects of the banks’ operations. Extra-situ inspections are carried out daily, weekly or monthly through the analysis of the data provided by the banks.

26 The Accounting Manual adopted international accounting norms (NICs). However, there are three remaining areas of difference with respect to the NICs, which according to the SIB reflect a more conservative approach appropriate to the Guatemalan circumstances, namely: (i) financial institutions will use accrual accounting (NICs) in all their accounts except for lending operations which will be recorded on a cash basis; (ii) some investments are registered at Cost Method vs. Participation Method of NICs that would adjust by retained income; and (iii) potential liability for terminating employments will be provisioned for as opposed to being kept implicit as per NICs. Overall, there have been significant improvements in converging towards NICs conventions, while these differences cannot be considered material.

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Anti-Money Laundering - Completed The Special Audit Office (IVE) was established by Decree No. 67-2001, and was incorporated in SB’s organizational structure under Resolution No. 38-2002. The Decree Law No. 58-2005 to Prevent and Suppress Terrorism Financing was published in 2005 and the relevant regulations in 2006, assigning to IVE the prevention of terrorism financing, in addition to money laundering. The project supported the acquisition of software and hardware, consultancies to strengthen IVE’s operation, as well as external training and internships on the detection and prevention on money laundering and terrorism financing. In addition, the project financed the methodology for the analysis of suspicious transactions related to terrorist financing, and the verification of the degree of compliance with FATF recommendations. Over it years in operation, IVE has received and investigated suspicious transaction (for example 391 in 2007 and 330 in 2008), submitted money laundering related complaints to the prosecutor (32 from 101 reports in 2007, and 21 of 48 in 2008). In addition, IVE provided information to the Public Ministry and foreign financial analysis units (205 and 37 requests respectively in 2007, and 216 and 31 respectively in 2008). Finally, IVE has provided talks, seminars and training on methodologies, procedures and practices for the prevention, detection and control of money laundering and terrorist financing prevention. As of end 2008, Guatemala has signed 37 MOUs with other Financial Intelligence Units in Americas, Europe and Asia, with the aim of exchanging information relating to the laundering of money or other assets. Furthermore, to date, 19 MOUs have been expanded and now include matters relating to the exchange of information concerning the prevention of terrorist financing. Strengthening of the Central Bank (Banguat) - Completed

(i) Modernization of the Payments System for Large Transactions - Real Time Gross Settlement System (RTGS): In August 2002, Banguat created the Payments System Committee to coordinate the implementation of the project for the Modernization of the National Payments System. Regulations were approved

Box 4. Risk Based Supervision in Guatemala

One of the most significant advancements for the SB has been the paradigm shift towards Risk Based Supervision (RBS). The SB is in the midst of a transition from the “traditional" approach to RBS. The former concentrated on mainly on verifying compliance with laws and regulations (traditionally those related to liquidity, solvency and soundness of assets). This was the case in Guatemala until 2007 (using as the core supervisory model a version of CAMEL, a rather static and ex post model), when the SB, with assistance from the project, started shifting focus towards evaluating and monitoring risks, both financial and otherwise, depending on their size and complexity, and before their impact on the supervised entities’ financial and operational situation. This implies an ongoing assessment to identify,

itor and control risks. Oficio No. 6342008 of the Monetary Board has made RBS

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by resolution JM-166-2005 by the Monetary Board and the system began operations on January 2006. The system provides real time gross electronic settlement of transactions in national and foreign currency. A number of other Resolutions were passed in 2007 and 2008 further strengthening the RTGS system. The Project supported work on the provision of strategic advice (legal and technical) on modernizing the Payment System, the acquisition of hardware and software for operating, monitoring and linking the RTGS system.At 31 December 2008, 19 banks in the system, 3 finance companies and the National Stock Exchange were participating in the RTGS system.27

Table: Operations liquidated in the RTGS

Type of Operations2007 2008 2007 2008 2007 2008 2007

I. By participants 34,546 36,913 194,862 239,037 3,496 3,708 2,307II. By Banguat 2,117 2,619 5,490 1,685 570 805 34

III. By Cámara de Compensación Bancaria de cheques 11,694 10,385 47,533 50,567 9,378 8,330 1,468IV. By Cámara de Compensación Automatizada 0 497 0 23 0 271 0V. By Negotiation Systems 1,513 1,743 88,804 62,812

Totals 49,870 52,157 336,689 354,122 13,444 13,114 3,809

No of Operations Millions Quetzales No of Operations Millions Dollars

(ii) Adoption of new accounting standards by Banguat: Banguat received training on the implementation of International Accounting Standards (IAS) and the restructuring of its financial statements in accordance. A number of Banguat commissions studied the regulatory and legal context for IAS adoption and exchanged opinions with SB, concluding that the accounting rules should correspond to the provisions contained in its own Organic Law, with the accounting principles based on IAS. The change was implemented beginning January 2009, with Banguat adopting international accounting standards to the extent that its organic law allows.

27 The net multilateral result of the Clearing House is settled in the RTGS system, while the system also includes the internal systems of Banguat - the Accounting and Financial Information System (Sistema de Información Contable y Financiera, SICOF), the Integrated Securities System (Sistema Integrado de Títulos Valores, SITV) and other systems. In terms of communicating the system is connected to two communication networks, a local (BANCARED) and an international (SWIFT), and has interfaces to interact with key systems like the Electronic Money Banking Chamber (Mesa Electrónica Bancaria de Dinero, MEBD), the Banking Clearing House of Checks (Cámara de Compensación Bancaria de Cheques) and the Automated Clearing House (ACH, Cámara de Compensación Automatizada) developed and managed by the Banking Association of Guatemala, the Electronic Trading System of Foreign Exchange (Sistema Electrónico de Negociación de Divisas, SINEDI) and the Electronic Clearance System (Sistema Electrónico de Liquidación, SEL) developed and administered by the National Stock Exchange.

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Annex 3. Economic and Financial Analysis

Not applicable, however, a general macro and financial sector review and some statistics are provided below.

The macroeconomic situation

Guatemala experienced a boom in the years just before 2008, caused by rapidly growing exports, remittances and capital inflows attracted by the growing economy. In those years reserve money, deposits and credit expanded rapidly, mostly as a result of the large inflows of dollars, and the quetzal appreciated against the dollar in nominal terms and more so in real terms. In early 2008, with the economy overheating, the central bank intervened to reduce the rate of growth of the monetary variables. While the global crisis has resulted in a sharp decline in the main sources of dollars—exports and remittances—the uses of dollars have declined even more, in such a way that Guatemala is still experiencing net inflows of foreign exchange. For this reason, reserve money and deposits are still growing at relatively high rates (26% and 15%, respectively). Different from other countries in Central America, credit has kept on growing, although at a much lower rate (about 5% per year).

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The still expansionary monetary policy is complemented by a moderately expansionary fiscal stance. The fiscal deficit is expected to increase from 1.7% in 2008 to 2.8% in 2009, mainly as a result of a decline in the fiscal revenues and of a modest anti-crisis expenditure program. Given that the public sector’s debt is just 20% of GDP, the country is in a strong macroeconomic position to face the global crisis as long as it can maintain the large net inflows of dollars that have prevailed in the recent past.

The financial sector Guatemala’s financial system is small compared with other countries in the region and dominated by banks. Guatemala compares unfavorably with other countries in the region in terms of domestic financing to the private sector (above 40% as percentage of GDP, below the region’s average of almost 60%). The supervised system comprises of banks (onshore and offshore); finance, insurance and bonding companies; foreign exchange houses; warehouses; and leasing, factoring and credit card companies. As of January 2009, the banking sector accounted for about 84 percent of the assets of the financial system. Supervised non-banking sectors are small. Finance and insurance companies account only for 14 percent of the system’s assets and the participation of bonding companies, warehouses and exchange houses does not reach 1 percent. The insurance and pension sectors are small and underdeveloped, the former heavily oriented toward non-life insurance and the latter largely public. There is no equity market and the private debt market consists mainly of short-term promissory notes, mostly issued by credit card

28 Credit was growing at 5% in April 2009, at the end of a long process of slowing down from rates over 25% in late 2006 and early 2007. It is important to note that the onset of the global crisis reversed the relative growth of credit and deposits—before September 2008, credits were growing at higher rates than deposits; since then, the opposite has been true.

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companies and a few enterprises. The government and Banguat are the primary bond issuers. In the unregulated sector, microfinance institutions have grown in recent years reaching an estimated total of about 4 percent of the banking system’s credit portfolio. Close to 300 registered Savings and Credit Cooperatives are the most relevant microfinance institutions in terms of lending and provide a wide range of financial services like micro-savings, remittances payments, micro-insurance, and housing loans to mostly un-banked, moderate-income Guatemalans. The banking sector is mainly domestic and privately owned. The number of onshore banks has dropped from 31 in 2002 (primarily through mergers and acquisitions29) to 19 banks as of January 2009. The four largest onshore banks hold about 73 percent of the system’s assets30, with a moderate but rapidly increasing since 2006 Herfindahl-Hirschman concentration index for assets, credit portfolio and deposits. In addition, 7 banks operate as offshores and belong to financial conglomerates associated with onshore banks. The majority of the 16 finance companies also belong to the local financial groups. In total there are 10 financial conglomerates with Q134.4bn (US$17bn) of assets. In terms of ownership, although 7 onshore banks count with foreign participation, the main foreign bank is Citibank with a market share of about 7%, while Banco Azteca, a Mexican bank that initiated its operations in Guatemala in 2007, specializes in micro consumer loan operations.31 There are no majority state-owned banks in the system, with the government only holding a minority position in Banco de Desarrollo Rural (Banrural), an institution with about 18 percent of the banking sector’s assets that is dedicated to providing small short-term loans to farmers. Crédito Hipotecário Nacional (CHN), an autonomous government entity that specializes in mortgage loans, has faced continuous difficulties since 2001, with losses reported for 2008 and a high NPL level despite several restructuring attempts. Reported ratios of performance and solvency of banks have improved after the banking sector crises of 2001, but weaknesses remain. Financial sector legal and regulatory reforms implemented since 2000 have improved banks’ solvency and resilience to market volatility. Official figures indicate that all banks in the system present capital to asset ratio over the statutory minimum of 10 percent, with an average of 10.3 percent as of December 2008 (in line with the other Central American countries ratio). The quality of the banks’ lending portfolios has improved with non performing loans (NPLs) as a percentage of total loans dropping from a system’s average of 13.8 at end 2002 to 2.4 percent in December 2008. NPLs have started to increase in the last three months although they still stand at a comfortable level at 3% as of April 2009. Bank profitability has also improved with an increase in the system’s Return on Assets (ROA) from 0.6 at

29 The banking crisis of 2006-07, including the intervention of Banco de Café (the fourth largest bank at the time) and Banco de Comercio, further reinforced the trend.

30 The four largest onshore banks are Banco Industrial, Banco G&T Continental, Banco de Desarrollo Rural and Banco Agromercantil de Guatemala.

31 HSBC has been reported planning to begin operations in 2009.

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end-2002 to 2.1%. percent in April 2009, and for Return on Equity (ROE) from 10.7 to 21.9% percent in April 2009. However, weaknesses remain primarily through the low level of provisioning for NPLs. The Superintendence recognizes that provisions are low and ruled in January 2009 that banks should increase them to either 1.5% of the total portfolio or 100% of NPLs, whatever is higher. It gave banks 10 quarters to achieve this, a period that made the measure feasible. At the same time, even though the regulation and supervision of offshores has intensified, they could still present a weakness to the sector. Table 2: Selected Banking Sector Indicators

Dec-05 Dec-06 Dec-07 Dec-08 Jan-09No of Banks 26 24 21 19 19Balance Sheet (Q millions)Assets 88,679 106,698 118,393 130,778 133,331

Investments (net) 25,624 31,154 25,064 28,126 29,263Liquid assets 13,534 16,741 18,078 19,197 20,403 Loans 43,560 51,515 68,984 74,826 74,886NPLs 1,082 1,202 1,111 1,789 1,960 Provisions 951 1,135 1,172 1,309 1,361

Liabilities 81,251 97,011 107,504 117,350 120,071Deposits 67,199 78,804 86,904 97,654 99,474

Capital 7,428 8,688 10,888 13,428 13,260Primary capital 5,573 6,013 7,218 8,380 8,776

Note:Assets (US$ millions) 11,666 14,046 15,515 16,806 16,769Assets of 5 largest banks (% Total) 61.4 71.0 77.8 79.1 79.0Loans in US$ (% Total) 27.6 30.2 33.1 33.6 34.2Income Statement (annualized)Interest income 5,594 6,043 10,245 11,075 12,713 Interest expense 2,090 2,329 4,111 4,453 5,043Operating expenses 3,770 3,811 5,030 4,994 5,280 Pre-tax profit 1,387 1,613 2,229 2,684 3,593Net Income 1,128 1,293 1,834 2,188 3,300Financial Indicators (%)Statutory Capital to RiskWeightedAssets 12.8 14.2 15.0 14.7 15.0NPL/Total Loans 2.5 2.3 1.6 2.4 2.6Provisions/NPLs 87.8 94.4 105.5 73.2 69.4NPL-Provisions/Primary Capital 2.4 1.1 -0.8 5.7 6.8ROE 15.2 15.1 16.9 16.3 24.9ROA 1.3 1.2 1.6 1.7 2.5Liquid assets/Total Assets 15.3 15.7 15.3 14.7 15.3Source: SB

Just like the Central American region overall, Guatemala’s banking sector initial liquidity concerns related with the international financial crisis have abated. The largely domestic banking system of Guatemala has been shielded from direct external event repercussions,

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and subprime exposure was not an element of the banking sector. While second round effects may include the impact of the economic slowdown, lower remittances and the recent depreciation of the quetzal, the primary concern in the last quarter of 2008 was a squeeze in credit lines from international banks (initially reported drop of 25 percent). However, the Guatemalan authorities responded with a number of preventive measures (see Box 5), with supervisory focus now shifting to the system’s high liquidity and its profitability outlook.

An important event has also been the Rosenberg events of May 2009, with allegations involving Banrural’s management and activities. Although statistics are still unavailable, anecdotal evidence points to minor deposit migration that was largely met by drawing temporarily on market liquidity, while a recovery has allegedly already taken place. Importantly, the system experienced no contagion or any disruptions in its operation, pointing to a strong public perception on its ability to withstand such pressures.

Box 5. The authorities’ response to the global financial crisis

The main response by Banguat has been to: (i) ease the requirements on banks’ accounting of reserves, in force since November 2008; (ii) established a temporary US-dollar fund facility for banks. This facility was initiated on November 2008 and was extended until March 2009, but so far less than 35 percent of the US$290m funds have been utilized by banks; (iii) cut its intervention rate to 6.25 percent. This was the result of three distinct interventions, as Banguat cut its intervention rate by 25bp on January, 50bp on February and 25bp in March, following a slowdown in inflation. These decisions followed two consecutive years of overshooting of Banguat’s target and negative real interest rates in 2008, but the fall of oil and commodity prices in late 2008, combined with falling domestic demand, resulted in a change in Banguat’s policy stance. So far the intervention rate cut has not translated to an

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Annex 4. Bank Lending and Implementation Support/Supervision Processes

(a) Task Team members Names Title

Alejandro Alcala Gerez Sr Counsel Alvaro Larrea Procurement Specialist Amelia Veronica C. Yuson Program Assistant Antonio Leonardo Blasco Financial Management Specialist Bujana Perolli E T Consultant Cara Zappala Special Assistant Denika L. Torres Guajardo Temporary Efraim Jimenez Consultant Enrique Antonio Roman Financial Management Specialist Fabienne Mroczka Financial Management Analyst Gisela Durand Consultant Gregorio Impavido Sr Financial Economist Gustavo Castro F. Raposo Finance Analyst Hela Cheikhrouhou Financial Economist Ilias Skamnelos Financial Sector Specialist, TTL Joaquin G. Gutierrez Lead Financial Sector Specialist Jorge Kamine Counsel Juan Carlos Mendoza Senior Financial Economist Keisgner De Jesus Alfaro Senior Procurement Specialist Luis R. Prada Villalobos Senior Procurement Specialist Manuel Vargas Sr Financial Management Specialist Mariluz Cortes-Gorman Consultant Mario Guadamillas Program Manager Monica Lehnhoff Procurement Analyst Paola J. Granata Consultant Yira J. Mascaro Sr Financial Economist

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(b) Staff Time and Cost Staff Time and Cost (Bank Budget Only)

Stage of Project Cycle No. of staff weeks USD Thousands (including

travel and consultant costs)Lending

FY02 16 63.77 FY03 2 8.24

Total: 18 72.01 Supervision/ICR

FY03 6 17.17 FY04 25 96.64 FY05 29 86.25 FY06 21 97.15 FY07 28 176.55 FY08 16 101.55 FY09 16 0.00

Total: 141 575.31

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Annex 5. Beneficiary Survey Results N/A

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Annex 6. Stakeholder Workshop Report and Results N/A

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Annex 7. Summary of Borrower’s ICR and/or Comments on Draft ICR (Summary of Borrower’s ICR - General Conclusions Section translated from Spanish) It is important to note that the World Bank played an important role in developing the project, making available groups of experts who supported the actions and strategies undertaken within it, contributing decisively to provide greater safety and soundness to the Guatemalan banking system through the modernization of the Superintendency of Banks and the Bank of Guatemala. The Superintendency of Banks, having significantly developed the regulation arising from the modernization of the financial legislation of 2002 and having managed the development of the methodology for risk-based supervision, and according to the commitments set forth in the Loan Agreement, achieved a very important qualitative leap at the institutional front placing it at the forefront of financial supervisory systems worldwide. The Superintendency of Banks developed the standards for a prompt and orderly exit of insolvent banks. The Bank of Guatemala developed regulations for access and use of the Bank Capitalization Fund-FCB. The Superintendency of Banks has fully achieved the specific purpose of this project in modernizing the regulatory framework of the Guatemalan financial system according to international standards in supervision, as well as in having achieved its own internal reinforcement in methodologies, systems and tools developed to perform risk-based supervision. Of the objectives established for the purpose of this project, those not fully achieved were related to the passing of new laws: a. Secured Transactions Law, was the only one approved on 24 October 2007 by the Congress of Guatemala in Decree 51-2007 and entered into force on 1 January 2008; b. The draft Law on Insurance Activity is pending third reading in the Congress; c. The draft Microfinance Law is being reviewed by the Monetary Board. The Superintendency of Banks developed 38 norms derived from the new financial laws (11 priority ones to be approved by the Monetary Board, 4 priority ones to be approved by the Superintendency of Banks and 23 non-priority to be approved by the appropriate authority). As regards support to the Superintendency of Banks and the Bank of Guatemala to upgrade their tools, ie information systems and inspection manuals used in the supervision of institutions, these have been fully achieved through consultancies that were part of the project implementation.

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The information tools that the Superintendency of Banks has developed and implemented to date, through a system called "SIS", have become an electronic platform of high value for purposes of the monitoring systems in the service of the Superintendency of Banks. The Bank of Guatemala has developed the System of Real Time Gross Settlement-RTGS-with the project participation in the licensing of the tools it utilizes. During project implementation, the Superintendency of Banks processed acquisitions under the World Bank procedures Licenses and equipment procured under the Project resources fulfilled a necessary and substantive function to support the implementation of new tools developed by the Superintendency of Banks and the Bank of Guatemala. Developments in the banking and financial system of Guatemala in the last three years have done nothing but demonstrate the high level of importance that the project played for the Superintendency of Banks. The project design had a fully adequate basis for the needs and requirements of this decade that could be viewed as the immediate challenges for the Superintendency of Banks. The events in the past three years, marked not only by the departure of two failing banks in the system but also by the many processes of acquisitions, mergers and entries of foreign banks, have highlighted the need for a strengthened Superintendency of Banks, renewed in its methodologies and conceptual tools and fully capable to cope with the complexities demanded by the current economic conditions. From the perspective of the overall project design, it can be argued that the central objective of strengthening the Superintendency of Banks and the Bank of Guatemala, to modernizing the regulatory framework in accordance with international standards in banking supervision, was highly relevant in terms of the events described. It should be noted that the two suspended banks were appointed to the respective Board of Exclusion of Assets and Liabilities and were set deadlines for the exclusion of assets and liabilities, returning to depositors 100% of the balances in their accounts, and proceeding to the establishment of trusts to transfer assets excluded from the balance sheets of these banks. It is noteworthy that the processes set out were undertaken quickly and orderly, and complying with the Law on Banks and Financial Groups, the Regulations of the Fund for Savings Protection and the Board for the Exclusion of Assets and Liabilities, and the Manual of Exclusion of Assets and Liabilities, allowing to mitigate the inherent systemic risk. The Superintendency of Banks is in the midst of a transition from the approach called "traditional supervision" in terms of functions within the banking and financial system to a focus on "Risk Based Supervision." Importantly, within this new approach, the Superintendency of Banks of Guatemala made significant progress in implementing new methodologies and analysis tools with support provided through this project. The new approach to supervision in Guatemala has been developed and is fully conceived in the new Handbook of Risk Based Supervision, which is driving the Superintendency of Banks to implement a specialized supervision, comprehensive and discretionary.

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Reviewing in depth the dimensions of the methodological change in the approach to supervision, it can be seen that the actions of the components implemented as part of this project were highly effective in promoting the paradigm shift towards risk-based supervision and thus placing the Superintendency of Banks of Guatemala in a leading position with respect to modern supervision systems worldwide. After completing the initial implementation of the new approach in the five largest financial groups in the system, it is clear that the supervised institutions have shown their willingness to cooperate adequately with the Superintendency of Banks, having begun to be in constant feedback with the authorities with respect to their risk management systems. This has also had a positive impact to strengthen the importance of risk management units integrated within the financial institutions themselves. Finally, it has been possible to see a positive impact on the overall banking system towards a culture of comprehensive risk management as a result of the implementation processes of the new methodological approach by the Superintendency of Banks. The Superintendency of Banks has experienced a number of substantive changes within its organization, its procedures and work systems, which are fully in line with the methodological implementation required by the new supervisory approach. Among the most significant changes we include the implementation of the supervision of vertical groups and the creation of a comprehensive risk unit as part of the Supervision Intendency, the development of new monitoring manuals for other entities that make up the financial groups, and implementation of the rating processes of the various elements that make up for the comprehensive profiles of the supervised entities. With respect to the performance of the Project Coordination Unit -PCU- with regard to the agreed responsibilities for the implementation of this project, we can say that it has shown a highly satisfactory performance having met the actions and activities programmed in the project.

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Annex 8. Comments of Cofinanciers and Other Partners/Stakeholders N/A

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Annex 9. List of Supporting Documents • Project Appraisal Document on a Proposed Loan in the amount of US$5.0 million to the Republic of Guatemala for a Financial Sector Technical Assistance Loan. World Bank Report No. 24222-GU, June 7, 2002.

• Report and Recommendations of the President of the IBRD to the Executive Directors on a Proposed Financial Sector Adjustment Loan in the amount of US$150.0 million for the Republic of Guatemala. World Bank Report No.P7544-GU, May 31, 2002.

• Memorandum of the President of the IBRD to the Executive Directors on a Country Assistance Strategy Progress Report for the Republic of Guatemala. World Bank Report No.24235-GU, May 31, 2002.

• Financial Sector Assessment Program. Aide Memoire. World Bank/(MF Confidential Document. June 2001.

• Financial Sector Assessment Program - Update. Aide Memoire. World Bank/(MF Confidential Document. February 2006.

• Implementation Completion and Results Report on a Loan in the amount of US$150.0 million to the Republic of Guatemala for a Financial Sector Adjustment Loan. World Bank Report No.ICR0000475, September 25, 2007.

• Country Partnership Strategy for the Republic of Guatemala. World Bank Report No. 44772-GT, August 1, 2008.

• Informe de estabilidad financiera a Diciembre 2008. Superintendencia de Bancos, Guatemala, December 2008.

• Informe Trimestral del Sistema Financiero para Junta Monetaria a Junio de 2009. Superintendencia de Bancos, Guatemala, June 2009.

• Informe de Politica Monetaria a Junio de 2009. Banco de Guatemala, August 2009.

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Transcript of World Bank Document€¦ · 2009-12-31 · Fully operational and ready for implementation...