Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-6612-AR REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED BANK REFORM LOAN IN AN AMOUNT EQUIVALENT TO US$500 MILLION TO THE ARGENTINE REPUBLIC JUNE 29, 1995 Public Sector Modernization and Private Sector Development Division Country Department I Latin America and the Caribbean Region This document has a restricted distribution and may be used bv recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS Currency Unit - Peso (Arg$) EXCHANGE RATE Arg$1 = US$1 FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS BCRA = Central Bank (Banco Central de la Reptiblica Argentina) BCTF = Bank Capitalization Trust Fund BHN = National Mortgage Bank (Banco Hipotecario Nacional) BICE = Investment and Trade Bank (Banco de Inversi6n y Comercio Exterior) BNA = Banco de la Naci6n Argentina CAMEL = Capital, Asset Quality, Management, Earnings and Liquidity CAS = Country Assistance Facility CIF = Cost, Insurance and Freight CNV = National Securities Commission (Comisi6n Nacional de Valores) CPI = Consumer Price Index EFF = Extended Fund Facility FSAL = Financial Sector Adjustment Loan GAAP Generally Accepted Accounting Principles GDP = Gross Domestic Product IDB = Inter-American Development Bank IMF = International Monetary Fund LFE = Law of Financial Entities MERCOSUR Southern Cone Trade Bloc (Mercado del Cono Sur) NYFed = Federal Reserve Bank of New York OCC = Office of the Comptroller of the Currency OPP = Operating Principles and Procedures P/E = Price/Earnings Ratio PYMES = Small and Medium Enterprises (Pequenias y Medianas Empresas) RWA Risk-Weighted Assets SEDESA = Deposit Insurance Corporation (Seguro de Dep6sitos Sociedad An6nima) SEF Superintendency of Financial Entities (Superintendencia de Entidades Financieras) SOE = Statement of Expenditures VAT = Value-Added Tax WPI = Wholesale Price Index FOR OFFICIAL USE ONLY ARGENTINA BANK REFORM LOAN TABLE OF CONTENTS Page No. I. THE ECONOMIC SETTING ...... .............. 1 A. Economic Context .................... 1 B. Recent Perfornance .................... 2 C. The Mexico Crisis .................... 3 II. THE FINANCIAL SECTOR ...... .............. 5 A. Background .......... 5 1. Structure of the Banking System ....... ............ 5 2. Resource Mobilization and Interest Rates ..... ........ 6 3. Adjustment of Commercial Banks ...... ............ 6 4. Bank Regulation ............................. 7 5. Supervision ............................. 7 B. The Recent Financial Crisis ........ ........... 8 1. Deposits .................. 9 2. Stock and Bond Markets .................. 10 3. Deposit and Lending Rates ................... 11 4. Failed Institutions ........ . ................... 11 5. Government Response to the Crisis ................. 12 6. Deposit Insurance ............................ 13 7. Future Structure of Banking ................... 13 C. Capitalization and Consolidation of Private Banks ..... ........ 14 1. Capitalization of Banks ........................ 14 2. Consolidation of Private Banks .................... 14 3. Selective Restructuring of Banks ................... 16 4. Liquidation ................................ 17 D. The Governnent's Distress and Failure Resolution Policies ..... 17 1. Corrective Actions by the Superintendency ............ 17 2. Resolution of Illiquidity or Insolvency ..... .......... 18 3. Liquidity Assistance . ......................... 18 4. Suspension .............................. 18 5. Revocation of License and Liquidation ..... .......... 18 6. Loss Allocation ............................. 18 This Report is based on the findings of a mission that visiLed Argentina in April 1995. Mission members included Messrs. D. Leipziger and M. Carrizosa (Mission Leaders), H. Shah (Sr. Financial Sector Economist), D. Scott (Sr. Financial System Specialist); M. Slough (Sr. Financial Specialist), R. Toro (Lawyer), S. Silverberg (Consultant) and Messrs. A. de Juan and G. Caprio (Peer Reviewers). Ms. C. Bernard. Mr. 0. Grimes and Mr. G. T. Nankani are the responsible Division Chief. Projects Adviser, and Department Director respectively, and Mrs. C. Coss is responsible for its processing. This document has a restricted distribution and may be used by recipients only in the performance of their official dutics. Its contents may not otherwise be disclosed without World Bank authorization. E. Restructuring with BCTF Financing .................... . 21 III. THE PROPOSED LOAN ................................ 24 A. Background .................................... 24 1. Past Bank Involvement ......................... 24 2. The Bank's Response to the Current Crisis ............ 24 B. Loan Objectives ................................. 25 C. Loan Description ................................ 25 D. Loan Conditions ......... ........................ 28 E. Disbursement, Procurement, Accounting, and Auditing ... ...... 31 F. Loan Supervision ................................ 32 G. Risks, Benefits, and Social and Environmental Impacts .... ..... 32 1. Risks ................................... 32 2. Benefits ................................. . 33 3. Social Impact . . . . . . . . . . . . . . . . . . . . . . .34. . . . . . .34 4. Environmental Impact . . . . . . . . . .. . . . . . . . . . . .. . .34 IV. RECOMMENDATION ................ 34 ANNEXES A. Status of Bank Loans .............................. 35 B. Status of IFC Investments .......................... . 36 C. Policy Matrix . . . . . . . . . . . . . . . . .3.8.. . . . . . . . . . . ... . .38 D. Key Macroeconomic Indicators. . .. 39 E. Key Financial Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . .40 F. Operating Principles and Procedures Governing BCTF Assistan for Acquisition or Merger .......................... . 44 G. Argentine Banking System Statistics .................... . 46 H. Mergers and Acquisitions Among Argentine Private Banks ..... . . 53 I. BCRA Prudential Regulations ......... . . . .. . . . .. . . . . . . 54 J. Banking Supervision Procedures . ....... . . . . . . . . . . . . . . .59 K. Summary of Differences Between BCRA Accounting Rules for Banks, Argentina GAAP and United States GAAP ...... . . . . . . . . . . . 64 L. Central Bank Restructuring, Closure, and Transfer Provisions .... . 66 M. Financing Needs for Private Bank Restructuring ...... . . . . . . . . 71 N. The Bank Capitalization Trust Fund ....... . . . . . . . . . . . . . . 74 0. The Legal Provisions of the Deposit Insurance System ..... . . . . . 76 P. Liquidity, Capitalization, and Classification of Private Banks ..... . 80 Q. Illustrative Components for Institutional Development Plan ..... . . 88 R. Draft Letter of Development Policy .................... . 90 MAP: IBRD No. 26842 ARGENTINA BANK REFORM LOAN Loan and Program Summary Borrower: The Argentine Republic Beneficiaries: Private Commercial Banks Amount: US$500 million Terms: The loan is proposed to be a fixed rate single currency loan in US dollars, with a maturity of up to fifteen years. Each semester's disbursements would have a maturity of 12 years from the rate fixing date, including 3 years' grace. The interest payment dates are August 15 and February 15, with the first expected rate fixing rate on August 15, 1995. Objectives: The purpose of the loan is to provide balance of payments support to the Argentine Republic in the aftermath of the regional crisis that has abruptly curtailed the country's access to foreign capital. At the same time the loan will support the Government's ambitious bank reform program. That program has the following principal objectives: (i) to hasten the process of consolidation of a fragmented private banking sector; (ii) to improve the financial structure of a distressed banking sector in the context of acquisitions, mergers and restructurings, and (iii) to contribute to the restoration of confidence in the banking system. Description: A fast disbursing loan is proposed. The loan would disburse in three equal tranches in accordance with conditions noted in the Policy Matrix (Annex C). Counterpart funds would be made available to the Bank Capitalization Trust Fund. Release of the second and third tranches would also require the achievement of US$167 million of transactions by the Trust Fund in accordance with principles agreed between the Government of Argentina and the Bank (Annex F). Benefits and Risks: Project benefits include the restoration of confidence in the private banking sector, which has been badly battered by the events following the Mexico crisis which resulted in a massive outflow of deposits. While the situation has now stabilized, many banks are in financial difficulty. The new failure resolution approach being adopted by the Government, and the Bank Capitalization Trust Fund operation that the project helps finance offers the opportunity for an orderly consolidation process. The vehicles are recapitalization and refinancing for banks willing to accept the requirements of this Trust Fund. The borrower expects the US dollar single currency loan terms to facilitate improved debt management, and the fixed interest rate to protect against possible market interest rate increases after the loan is fully disbursed. The principal risk to the project remains macroeconomic, insofar as the economic situation in Mexico, and, more generally, Latin America remains unsettled and the Argentine economy continues to be vulnerable. This could result in a further loss of confidence, a deeper economic crisis, and a renewal of deposit flight. To the extent that the financial sector can be strengthened by recently announced government measures, including a stronger failure resolution mechanism, that risk can be and has been effectively lowered. Macroeconomic risks have been reduced by the adoption of a very strong fiscal program, aimed at producing a sizeable surplus this year, and by continued prudent and effective economic management. The other project risk is a deterioration in the integrity of the distressed bank resolution framework. This risk is being addressed by the authorities through significant changes in legislation, a clear commitment to improve the quality of banking supervision, and the creation of the Bank Capitalization Trust Fund to facilitate the restructuring of the banking system. Poverty Category: Not applicable Estimated Disbursement: The loan would be disbursed in three equal amounts against import documentation, and the counterpart proceeds will be used by the Bank Capitalization Trust Fund. Disbursements would be conditioned upon a satisfactory macroeconomic performance and financial sector policies to be described in the Letter of Development Policy, satisfactory operation of the Trust Fund, and, for the Second and Third Tranches, the achievement of at least US$167 million in eligible transactions. These transactions will be subject to ex-post review in accordance with agreed benchmark criteria. Schedule of Disbursements: US million US million Bank FY 96 97 Annual 167 333 Cumulative 167 500 Financing Plan: US million World Bank 500 Argentine Government 2J000 2,500 Rate of Return: Not applicable Project Number: AR-PA-40904 REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED BANK REFORM LOAN TO THE ARGENTINE REPUBLIC IN AN AMOUNT EQUAL TO US$500 MILLION 1. I submit for your approval the following report and recommendation on a proposed adjustment loan to the Argentine Republic to support private bank reform to the Argentine Republic for the amount equal to US$500 million, with the aim of consolidating and strengthening the financial sector. The loan would be a fixed rate single currency loan in US dollars, with a maturity of up to 15 years. I. THE ECONOMIC SETTING A. Economic Context 2. Four years have passed since Argentina, emerging from the severe economic crisis of 1989-90, adopted the Convertibility Plan in April 1991. This innovative plan restructured Argentina's economic landscape. From extreme hyperinflation, the country moved relatively quickly to an annual inflation rate of 3.9 percent in 1994. Output and productivity increases have been remarkable for the last four years, with Gross Domestic Product (GDP) growth averaging 7.7 percent. The initial consumption-led boom has matured into a healthy pattern of investment and export-led growth. Privatization of state assets has been far-reaching, and much more successful than expected. As a result of the economic recovery, poverty levels have declined significantly, although economic restructuring with a rigid labor market has resulted in increased unemployment, about 12 percent of the labor force by late 1994. To deal with problems caused by an initially overvalued exchange rate, the Government launched a number of microeconomic reforms, particularly in labor legislation, with the aim of reducing labor costs and increasing productivity. The result, plus exchange rate developments in Brazil, have allowed export expansion to be strong in recent years and to underpin growth. 3. The Convertibility Plan was part of a comprehensive reform program at the national levelP' including reforms of the state and financial institutions, privatization, and extensive market liberalization. While fiscal adjustment has occurred at the federal level, provincial fiscal deficits persist, mainly because of the continued inability of 1/ Past Bank support for this program has entailed various operations in support of financial sector adjustment, capital market development, privatization, and modernization of the public sector. provincial governments to contain current expenditures and sufficiently increase their own-source revenues. The combined fiscal deficit of the provinces was equal to 0.7 percent of GDP in 1994. In this context, public provincial banks were extremely vulnerable, as they could obtain no relief from provincial governments. This has allowed the Government to move forcefully, with World Bank assistance, to privatize and/or liquidate the great majority of the provincial banks. On May 4, 1995, the Bank approved a Provincial Bank Privatization Loan (Ln. 3878-AR) in the amount of US$500 million equivalent. B. Recent Performance 4. With the dynamic evolution of the economy, demonstrated by a shift in consumption to export-and investment-led growth, GDP in 1993 and 1994 grew by 6 and 7.1 percent, respectively. Gross fixed investment reached 20 percent in 1994, associated with increased national and foreign savings. Exports, which were affected by declining international prices in 1992-93, rose by 20 percent in 1994, with manufactured goods exports exhibiting particular buoyancy, growing at an average of 27 percent in 1993-94. Better international prices for grains and improved economic conditions in Brazil contributed to export growth. In 1994, imports grew at the fast pace of 27 percent. Imports of capital goods led the expansion, indicative of the acceleration in investment and the restructuring of the economy. Financing trade and current account deficits was not difficult, given Argentina's improved access to international financial markets during 1993 and 1994. During the first two months of 1995, exports rose by 35 percent, while imports remained approximately at the previous year's level. 5. With the increased accumulation of international reserves, and the reduction in bank reserve requirements earlier in 1993, monetary aggregates expanded at a fast pace. Bank credit also grew at a fast rate, reflecting the sub-par, but rapidly improving, monetization of the economy. Interest rates on peso deposits declined from 25 percent in December 1992 to 9 percent by early December 1994, just before the Mexico crisis began. Interest rate spreads, although also declining, remained high, indicative of the continued segmentation and shallowness of the financial system. Towards the end of 1994, approximately half of Argentina's financial assets were dollar-denominated, and interest rates and spreads on dollars were much lower than those for peso-denominated assets. Continued capital inflows sustained the growth in aggregate demand. Liquid international reserves at end-November 1994 stood at US$14.5 billion, a significant increase since the end of 1992. Nevertheless, the general rise in dollar interest rates, which started in early 1994, produced a deceleration in reserve accumulation and credit expansion in the first three quarters of 1994. The government's fiscal position remained prudent, however, with rough balance in its consolidated accounts achieved in 1994. The Government remains committed to maintaining a sound macroeconomic framework, as described in the Letter of Development Policy (Annex R). -3- C. The Mexico Crisis 6. Argentina was particularly vulnerable to the events in Mexico due to its relatively heavy reliance on foreign capital inflows (financing in 1994 an estimated current account deficit of 3.6 percent of GDP), the inflexibility of its exchange rate regime, and the need for a strong financial system under the Convertibility Plan. Compared to Mexico, however, Argentina enjoyed several advantages: (a) its current account deficit was less than half that of Mexico; (b) it had stable political and economic leadership; (c) its level of international reserves remained high; (d) public debt maturities were not concentrated in the short-term spectrum of the market; and (e) many of its structural reforms--privatization, governmental reform, domestic market liberalization, and foreign investment--were deeper. Nevertheless, Argentina could not escape the effects of Mexico. Its stock and bond markets suffered precipitous losses, and, given its exchange rate system, the Central Bank lost more than US$5 billion of its reserves between December 1994 and end March 1995. 7. Partly generated by memories of past confiscations of deposits, the disruption of The Mexican economy triggered a banking crisis. Loss of confidence led depositors to withdraw a total of about US$8 billion from the banking system, thereby causing a major liquidity crisis. As a result, interest rates increased to levels unprecedented since the onset of the Convertibility Plan, and in March 1995, the banking system was on the brink of a fatal run on deposits. The Central Bank, converted into a currency board in 1991, was rigorously constrained in its ability to provide liquidity. 8. The Government reacted forcefully to the crisis. During February and March 1995, it took courageous measures to reestablish a fiscal surplus by cutting expenditures on, inter alia, export subsidies, public sector wages, and social security expenditures, while raising Value-Added Tax (VAT) rates and other taxes and eliminating many tax exemptions. These measures are expected to yield some US$6.3 billion, about 2 percent of GDP, during the remainder of 1995. Swift action by Congress in approving unpalatable emergency measures added to their credibility. The Government intends to maintain strong macroeconomic management under an IMF-EFF program, which was extended to June 3, 1996, with an increased amount of US$2.4 billion. 9. As the Government announced these measures in mid-March 1995, it also assembled an international financial package of approximately US$11 billion in support of the Convertibility Plan. About US$5.4 billion would come from the IMF, the Inter- American Development Bank (IDB), and the World Bank; with an additional US$800 million from the Eximbank of Japan; over US$2 billion from two large bond issues; and US$2.4 billion is expected from projected asset sales. As a result, by early April 1995 financial markets showed signs of stabilization and recovery, and appear to have become firmer. Not only did the authorities react firmly to the crisis on the eve of - 4 - presidential elections by suspending insolvent banks, but they have also received strong political support in Congress, where financial reform legislation was approved swiftly and the mechanism for crisis resolution was rapidly put into place. 10. The Mexican crisis brought to light important lessons for Argentina. It highlighted the extent of the economy's reliance on volatile capital flows; revealed the need for a strong financial system, given the Central Bank's limited lender of last resort capabilities; reemphasized the need to sustain the credibility of the economic program; and clearly illustrated the difficulties of a fixed exchange system in times of generalized crisis. The Government's forceful and rapid reaction to the crisis has reduced concerns about future domestic policies, but the external environment remains uncertain. Although the initially strong negative reaction of financial markets to the Mexican crisis has been partially abated, a clear reluctance to renew significant flows of capital towards emerging markets remains, particularly flows to Latin America. Moreover, there continues to be a general lack of market discrimination between countries in the region. Even under an optimistic scenario, in which the principal countries affected by the crisis adopt appropriate economic policy measures to reestablish credibility in the eyes of international investors, access to international financial markets may only be slowly reestablished, and capital inflows are likely to remain well below those observed in previous years for quite some time. 11. If international capital market access remains narrowly constrained, which appears to be the case, net capital inflows, even with the enhanced assistance of multilateral organizations, may be barely positive in 1995. This compares to capital inflows of US$10.5 billion in 1994. The net result will be severe import compression in 1995 with import levels at least 10 percent lower in real terms (compared to 1994), and a severely reduced current account deficit of possibly 1.2 percent of GDP, approximately one third of the deficit in 1994. In this scenario, the bulk of capital inflows will come from official sources. Furthermore, to achieve this adjustment in the external accounts, economic activity would decelerate sharply, an unfortunate outcome in light of the already high rates of unemployment. 12. The recent Country Assistance Strategy (CAS) (Report No 14278-AR), discussed at the Board on May 4, 1995, highlighted the very low growth prospects for 1995 resulting from the strong fiscal program necessitated by the crisis. This heightened level of economic uncertainty has put further stress on financial markets and has retarded the return to normal asset values in the banking system. Although the inflow of IMF resources has aided in the restoration of reserve levels, Central Bank reserves are at least 20 percent below their pre-crisis level and the system is still vulnerable to ebbs in confidence. The need for balance of payments support is noted in the CAS (see paras. 46-47), and quick disbursing assistance to the Government's program of bank reform is fully consistent with those circumstances. II. THE FINANCIAL SECTOR A. Background 13. Structure of the Banking System. Argentina's financial sector consists chiefly of commercial banks. This is a result of Argentina's Law of Financial Entities (LFE) which allows banks to extend a full scope of financial services. Of a total of 203 financial institutions existing in December 1994, 168 were commercial banks which accounted for 98 percent of total financial sector assets. The remaining 35 banks were finance companies or savings institutions that do not offer checking account services. As of April 15, 1995 the number of commercial banks had shrunk to 140, owing to 15 mergers, principally among the cooperative and regional retail banks. The banking system as of that date included three federal public banks (Banco de la Naci6n Argentina (BNA), Banco Hipotecario Nacional (BHN), and Banco de Inversi6n y Comercio Exterior (BICE), 29 provincial/municipal banks (three of which have been privatized); 57 national private banks (including the formerly federal Caja Nacional de Ahorro y Seguros, privatized in 1992), 31 foreign private banks, and 20 cooperative banks. Table 1 below indicates the share in total assets, loans, and deposits of the banks. Overall, private banks (including cooperatives) accounted for about 55 percent of total assets, and 59 percent of total deposits as of February 1995. The 10 largest private banks21, each with assets over US$1 billion, accounted for between 28 and 30 percent, respectively, of total assets, loans and deposits (Annex G provides bank-level detail). Table 1: Breakdown of Total Assets, Loans and Deposits as of 2/28/95 (%) | Type of Bank Total Assets Loans Deposits . ;~~1. Federal 21.2 18.8 14.9 Provincial/Municipal 22.1 22.9 24.7| National Private 30.7 31.8 32.1 Foreign 16.9 17.0 17.9 Cooperatives 7.4 8.2 9.4 Sub-Total B:aks 98.3 98.7 99.0 FXinance Companies 1.5 1.1 0.8 Credit Unions 0.2 0.2 _ _ 0.2 Total System 1O0~~~~~~~G 100.0 .100.0 2/ These are: Galicia, Rio, Frances, Cr6dito Argentino, Roberts, Quilmes (domestic) and Citibank, Boston, Deutsche and BN Lavoro (foreign). - 6 - 14. Resource Mobilization and Interest Rates. Until 1990, financial deepening in Argentina decreased as a result of declining confidence in the domestic currency and other financial assets. Successive episodes of hyperinflation and outright asset confiscations in the early 1980s and later in 1990 discouraged investors and depositors from holding domestic financial assets. Since 1990, the Government has sought to increase mobilization of financial resources and thereby contain the cost of capital to meet the anticipated expansion of demand. Macroeconomic stabilization and growth policies were very successful in increasing resource mobilization, at least until the end of 1994. With greater interest rate stability and higher growth, currency and bank deposits increased from an average of 5 percent of GDP in 1990 to 19 percent in 1994 (see Figure 1 and Annex E). The policies were further successful in increasing corporate equity and bond issues. Corporations, including commercial banks, raised an impressive US$9.9 billion in equity issues and registered US$6.5 billion in bond issues during 1990-1993. Finally, increased resource mobilization reduced lending rates (Figure 2), from 52 percent at the onset of the Convertibility Plan in April 1991 to 23 percent in November 1994 (see Annex E). 15. Adjustment of Commercial Banks. Macroeconomic stabilization, financial sector policies, and improved regulation and supervision encouraged banks to become more efficient. First, the Convertibility Law established a firm constraint on the Central Bank's capacity to extend credit to commercial banks. The constraint on BCRA lending chiefly affected public banks, where financing declined from about 160 percent of deposits in 1990 to zero in 1994. Central Bank financing of private banks amounted to only 5 percent of deposits in 1990 and declined to zero in 1992. The constraint on the Central Bank lending was the chief condition persuading public banks to adjust and privatize"'. The provincial authorities could no longer afford to own loss-making banks when their own budgets were severely strained and bail-out financing from the Central Bank was no longer available. 16. Second, as a result, stabilization increased the capacity of commercial banks to mobilize deposits and bonds, and reduced reserve requirements (to 43 percent) increased their lending capacity. The increased intermediation capacity permitted banks to reap economies of scale. Furthermore, with lower inflation and increased availability of credit, intermediation spreads declined, from an average of 27 percent per year in April 1991, to 11 percent per year in November 1994; this decline in spreads put competitive pressure on banks to reduce costs. With increased resource mobilization and competitive pressure, financial sector productivity (the ratio of sector 3/ The Federal Government has privatized a major national bank, the Caja Nacional de Ahorro y Seguros, sold with support from the Bank's Financial Sector Adjustment Loan (FSAL, Ln. 3558-AR), and liquidated the Banco Nacional de Desarrollo, also supported by the Bank's FSAL. Provincial governments are slowly following suit; with one provincial bank (La Rioja) liquidated and three others (Chaco, Corrientes, and Entre Rios) privatized, and with more to be liquidated/privatized under support from the Bank's Provincial Bank Privatization Loan (Ln. 3878-AR) approved on May 4, 1995. GDP to employment) increased by 180 percent between 1990 and 1994 and operational costs declined from 13 percent of total assets in 1990 to 8 percent in 1994#'. 17. Consolidation in the banking system, which proceeded at a fast pace following the financial crisis of the early 1980s, slowed after 1990. Following a decline from a high of 214 banks (35 public and 179 private) in 1980 to 165 (33 public and 132 private) in March 1991, the number of banks stabilized. Nevertheless, the larger institutions gained in market share. As discussed below, as a result of lower deposit growth since 1994, the pace of commercial bank consolidation has resumed and is expected to continue during the foreseeable future, stimulated further by the flight to quality of deposits during the recent crisis. 18. Bank Regulation. Prudential regulations of the BCRA cover: (i) capital adequacy and minimum capital requirements; (b) reserve requirements; (c) loan classification and loan-loss provisioning; (d) operations with affiliated companies; (e) consolidation; (f) internal and external auditing; and (g) diversification of credit risk (see Annex I). Minimum capital requirements for commercial banks are subject to risk ratings based on normal CAMEL criteria. Minimum capital requirements were set at 11.5 percent of risk-weighted assets (adjusted by the CAMEL-based risk rating) as of January 1995. These include a minimum of about 8 percent of risk-weighted assets in tier one (equity) capital. Portfolio classification has been changed from a classification system based primarily on guarantees to one reflecting a borrower's financial situation and repayment capacity. Provisioning requirements are determiined both by portfolio quality and by the guarantee arrangements. Details on loan classification and provisioning are given in Annex I. As of December 1994 the sub-normal portfolios in public and private banks were 33 percent and 10.3 percent, respectively. 19. Supervision. Together with the improvement in prudential regulation, enforcement capacity is being strengthened steadily. The Superintendency of Financial Entities (SEF)'s capabilities have been improved during the 1990s under support from the Bank's Public Sector Reform Technical Assistance Loan (Ln. 3362-AR)) and Financial Sector Adjustment Loan (Ln. 3558-AR)), and through technical assistance and training from the Federal Reserve Bank of New York (NYFed) and the US Office of the Comptroller and the Currency (OCC). SEF now has a staff of around 500. The staffing of the Supervision Division was increased as of July 1994 from 160 to approximately 300, organized into six on-site inspection groups specializing in different types of financial institutions (see Annex J for a full description of the enhanced supervision program which is now in effect). The managers of these inspection groups were hired through an executive search from international accounting firms and are being paid competitive salaries. One hundred and ten newly trained bank examiners who were hired out of 2,000 applicants in 1994 replaced 100 retiring examiners. 4/ The Argentina: Capital Markets Report, dated December 1994, contains a fuller discussion of these issues. (Report No. 12963-AR) 20. About 84 financial institutions have undergone full inspections during the past nine months, and off-site surveillance of all banks is undertaken monthly. On-site inspections include a CAMEL rating of the institution, which is used for determining capital requirements and will be used for assessing deposit insurance fees. Despite the increased burden placed by the need to monitor troubled institutions as a result of the crisis, SEF expects to complete examination of all institutions by September 1995. The capacity of the Superintendency to react to crisis situations has improved significantly, although no regulatory agency could have coped with the large, systemic crisis of the first quarter of 19955'. As of March 1995 the financial situation of troubled financial institutions was being monitored daily by a new reporting and analysis division, with the help of upgraded information systems and following reporting requirements noted in Attachment 1 to Annex J. The crisis has uncovered the offshore activities of several banks and SEF is now requiring consolidated balance sheets on a line by line basis. B. The Recent Financial Crisis 21. Private banks in Argentina may be divided into five groups: (i) large domestic retail banks with a national network; (ii) foreign banks; (iii) wholesale banks; (iv) cooperative banks; and (v) regional retail banks. These are listed in Annex G, Table 6 and described in more detail in Annex P. The recent liquidity crisis has not only reduced the deposits of the entire banking system and caused interest rates to rise sharply, but has led to a significant change in the composition of deposits, liquidity and assets among the various groups of banks. In essence, the large domestic banks and foreign banks have gained market share at the expense of the wholesale banks, cooperative banks and regional retail banks. 22. The current financial crisis began in late November 1994 with the bankruptcy of a small but trusted non-bank trader (ArgenBonex). An increasingly weak bond market and the recognition of the high gearing of security traders led commercial banks to finally cut credit to broker-dealers. These actions further softened the bond market. The problem was greatly exacerbated after the December 20, 1994 devaluation in Mexico with the massive withdrawal of foreign investors from Argentina and elsewhere. The resulting losses sharply weakened the wholesale banks that had a significant inventory of government securities. Banco Extrader, a small wholesale bank, failed soon after the Mexican crisis. The wholesale banks typically had only one branch, no retail deposit network, and relied primarily on corporate, inter-bank and institutional deposits. Concerns about their solvency and liquidity led to rapid 5/ Although the regulation and inspection procedures have improved considerably in recent years, significant improvements in enforcement are still needed. Some of the more important problems are well-disguised insider lending, and continued accrual of interest of non-performing loans. To improve assessments of systemic portfolio quality, classifications of individual borrowers are being compiled and standardized across banks. Borrowers from banks having liquidity problems are being analyzed to detect insider lending. - 9 - withdrawal of corporate and institutional deposits, sharp cuts in their interbank lines, and withdrawal of their deposits from provincial banks. Table 2: Recent Developments in the Argentine Banking Sector 11/30/94 12/20/94 12/31/94 1/31/95 2/28/95 3/31/95 4/15/95 Deposits in Commercial Banks (million) Pesos 23,833 24,498 22,750 21,979 21,034 17,679 18,610 Non Pesos 24,039 24,625 24,427 24,802 24,501 23,575 22,836 Liquidity in the Banking System (million) Cash 2,941 2,950 3,061 2,932 2,750 2,300 2,300 Balances with other Banks 1,788 n/a 1,509 1,398 n/a n/a n/a Balances with BCRA 1,113 n/a 1,091 1,200 1,350 1,950 2,000 Marketable Government Securities 3,548 n/a 3,048 2,942 n/a n/a n/a Deposit Rates (% p.a.): Peso 3 month 8.4 10.0 11.1 12.0 13.0 21.0 22.5 6 month 8.4 9.3 9.6 9.9 14.0 20.5 20.0 Deposit Rates (% p.a.): US$ 3 month 6.0 6.0 6.3 6.5 7.0 11.0 11.4 6 month 6.0 7.4 7.3 6.8 7.7 10.0 10.9 Weighted Average Lending Rates (% p.a.) Peso 21.0 25.0 35.0 40.0 45.0 60.0 60.0 US$ 16.0 18.0 22.0 28.0 30.0 45.0 45.0 Prime Rates (% p.a.) Peso 10.2 11.8 19.0 18.0 24.0 28.0 26.0 US$ 8.5 9.3 12.0 12.0 15.0 21.0 20.0 Overdraft Rates (% p.a.) Peso 25.0 35.0 35.0 45.0 45.0 65.0 65.0 International Reserves of BCRA 14,318 n/a 15,663 13,792 13,077 10,197 11,685 (US$ million) Merval Index 526 516 460 435 323 382 426 23. The structural conditions of the banking sector--no deposit insurance, absence of a significant lender of last resort, the ready conversion of pesos into dollars at parity, and ease of capital movements--as well as the memories (para. 14) of many previous financial crises -- fueled a mini-run on deposits and a flight to quality among many depositors in the system. Simultaneously, interbank market access shrank down to 10 top private sector banks and the interbank rate increased sharply, pushing several solvent but illiquid institutions to the brink of failure. 24. Deposits. Deposits in the Argentine financial system stood at US$49.1 billion on December 20, 1994 and dropped 16 percent to US$41.3 billion by end March 1995. Not surprisingly, peso deposits fell faster, by 24 percent, accounting for some US$6.9 - 10 - billion out of the total deposit losses of US$7.9 billion since December 20. Dollar deposits fell about 7 percent over the same period, mainly in the month of March. Annex E shows recent trends in deposits, loans and the M4/GDP ratio, all of which indicate similar developments (also see Figure 1). Figure 1 RATIO OF LOANS AND BROAD MONEY TO GDP 1991- 1995 19. D% 19.12% eo~~~~~~ ow- TTIO%01 1 16. 20%14i'llll .1 0 % 14.0%II IIIII 6 0X 7mi i l f4T I l l i XI g I m I II m I 0 II I II * 12.0% 7.0% 1991 1993 1995 1992 1994 Year anc IAMnth 0 M4/GDP t Pank Loaan/GDP Source: Central Bank Data 25. Until February 1995, the biggest losers were the wholesale banks, with deposit losses of over 70 percent and an insurmountable crisis of confidence. Many other banks also suffered deposit withdrawals too large and too rapid to survive. Provincial banks lost about 40 percent of their deposits; cooperatives lost one-third. Foreign banks lost some overseas deposits but gained local deposits. Private retail banks lost about 21 percent of their deposits. However, the ten leading private banks gained market shares in deposits. Thus, the relative positions of different banks have been dramatically transformed, and the process of consolidation has been accelerated. 26. Stock and Bond Markets. Prices and trading volumes dropped sharply, while volatility increased dramatically. The Merval index (the stock price index at the Buenos Aires Stock Exchange) dropped from 516 on December 20, 1994 to 323 by end-February 1995, but recovered to 426 by April 15, 1995. The bottom, around 320, was reached in late February 1995. At that point, the index had fallen about 38 - 11 - percent since the Mexico crisis, and currently is still around 18 percent below the pre- crisis level. The market Price/Earnings (PE) ratio which was 18.3 in November 1994 fell to about 12 at the end of February 1995. The trading volume in Buenos Aires Stock Exchange ran around US$12 to 13 billion monthly prior to December 1994, and has steadily fallen to around US$1.5 billion monthly by late April 1995. No new equity or eurobond issue, and only one 90-day local commercial paper placement, has occurred since December 20, 1994. While several placements (up to US$1 billion worth) of negotiable obligations are in the process of Comisi6n Nacional de Valores (CNV) approval and preparation, it is unlikely that new issuance will occur any time soon. With the trading volumes unusually low and volatility extremely high, most issuance and even ordinary portfolio management decisions are in limbo. 27. The prices of Government securities fell sharply due to the crisis as well as generally rising interest rates. As a result, their secondary market yields have risen significantly. In addition, the fragmented structure and varying liquidity of different government securities have greatly amplified the differences between their secondary market yields, which now range from 15-30 percent per year. Both the prevalence of such yields in government paper and the absence of any discernible interest rate benchmark contribute to a significant rise in the interest rate on commercial loans. 28. Deposit and Lending Rates. Deposit and lending rates increased markedly in response to strong demand and low liquidity (see Figure 2). The loss of deposits, together with continuing liquidity and solvency problems, have made the banks very conservative in new lending. While the prime corporations have not faced the worst credit crunch, credit to Pequefias y Medianas Empresas (PYMES) has been sharply curtailed. The closure of or contraction in activities of cooperatives and provincial banks has also further constrained credit to PYMES. The sharp reduction in credit and the high rates are both bound to result in a deterioration in portfolio quality, which can be fully reflected only over a period of time. 29. Failed Institutions. By late April 1995, two banks were in liquidation, and five others and four financial companies were in a 30-day suspension period (cf. paras. 47- 48 on the suspension and liquidation process). Only Banco Finansur reopened following an acceptable restructuring plan. As many as 46 private banks are possible merger or acquisition candidates. Two new banks have been formed as mergers of eight and seven cooperatives, respectively (see Annex H for details). Other typical mergers include absorption of a cooperative bank by regional or other cooperative banks, mergers between small regional retail banks and the stronger wholesale banks, and acquisition of regional banks by the larger national banks seeking increased presence in a particular region. Finally, many wholesale banks are being liquidated and are continuing to sell their assets in order to repay their liabilities. - 12 - Figure 2 EFFECTIVE DEPOSIT AND LENDING RATES AnnuaIrzed F%tog 1991-1995 100 D% 90.0% ll. 0% 70.0% 50. 0% 50.D% 40.0% - ------ 30.0% 20.0% 1992 1994 1993 1995 Yoar and Month o PQ8O DLposlt Rate + Pe5n Lending Pate Source: Data from Central Bank and Carta Econ6mica 30. Government Response to the Crisis. Faced with this situation, the Government struggled to provide liquidity. This effort included: (i) an initial "club" of five private banks in early January 1995 each contributing about US$50 million to purchase illiquid wholesale bank portfolios; and (ii) a transfer of 2 percent or about US$870 million of the banks' reserves at the Central Bank into a special account with the Banco de la Naci6n Argentina (BNA). BNA, acting as agent for and on instructions from the Central Bank, lent the funds to wholesale and provincial banks at 16 percent p.a. against collateral of bank assets and in some cases personal guarantees of the owners. These funds were quickly exhausted. In February 1995, the Trust Fund for Privatization was established to handle the workout of provincial banks. 31. The Central Bank's capacity to act as a lender of last resort is constrained by the Convertibility Law which requires it to limit its monetary liabilities below its international reserves. As of April 1994, BCRA provided US$1.8 billion in extraordinary liquidity assistance to all banks.O' Banks met further liquidity needs through lower reserves requirements (about US$1.7 billion) and by exercising their right to borrow a part of their required reserves (about US$1.3 billion), currently set at 6/ Private banks received US$1,165 million of this amount. This is in addition to the BNA safety net lending of US$468 million, which was financed by the more liquid private banks themselves. - 13 - 32 percent. The Central Bank's charter was amended to allow it to extend the maturity of its liquidity rediscounts, thereby enabling it to lend for terms beyond 60 days and above the previous ceiling of the net worth of a bank. However, under the restriction of the Convertibility Law, BCRA has little capacity at present to provide further liquidity. With available liquidity in the system virtually exhausted, and the increasing likelihood that the extraordinary liquidity advances to many banks may not be repaid, the government established a Bank Capitalization Trust Fund (BCTF) to handle the recapitalization/restructuring of distressed banks (see Annex N). 32. Deposit Insurance. In April 1995, the Government created a limited deposit insurance scheme, effective April 17, to help restore confidence in a deposit system badly shattered by the events of early 1995 (see Annex 0 for details). Deposits with maturities of less than 90 days are insured up to US$10,000. A further US$10,000 insurance is provided for deposits exceeding 90 days maturity (total insurance on these deposits is US$20,000 minus any claims on deposits below a 90-day maturity). These insured amounts include the first right of claim that deposits of up to US$5,000 have on the reserves of a failing bank. For term deposits, the new insurance applied to new deposits after April 18, 1995. The insurer, a privately financed Deposit Insurance Fund, would cover nearly 100,000 holders of fixed-term accounts, plus a large majority of savings and current accounts, totalling about US$10 billion, or a quarter of deposits. The fund will be financed by contributions from the banks. The fund is likely to reverse the decline in small deposits, but less likely to encourage the return of institutional deposits. The role of deposit insurance in the loss allocation process is described in paras. 49-54. 33. Future Structure of Banking. The long overdue trend towards consolidation started before December 1994, and has accelerated considerably since then. The profile of the sector is likely to change. First, the ongoing strain on provincial finances and the poor financial situation of provincial banks will trigger further privatization or closures of these banks. Most wholesale banks with a single branch and limited retail depositor base are likely targets for take overs. The cooperative banks have several weaknesses: highly regional and poorly diversified portfolios, strong affiliation with specific clientele which weakens their portfolio, high costs, and inadequate capacity to raise capital. These cooperative banks are therefore merging/disappearing quicky and are already down to 20 by end April 1995 from 39 in August 1994. The smaller private banks also lack economies of scale and loyalty of depositors, and face higher cost of attracting deposits. They would be forced to either merge or be acquired. 34. If the authorities continue to implement the prudential norms forcefully, the number of Argentine banks in the coming five years may be halved from about 160 at the beginning of 1995. The surviving banks may comprise 30 foreign banks, 5 to 10 cooperative banks, 5 to 10 provincial/federal banks, 5 wholesale banks, a dozen or more first-tier private banks with national branch networks and about 20 second-tier banks with smaller national, or multi-provincial presence. Such consolidation will still - 14 - leave Argentina with proportionately many more banks than in Mexico, Chile or Brazil, and thus is not likely to reduce competition substantially. The two largest public banks would have control of one third of the market share, and two or more foreign banks would operate with a significant retail franchise. The retrenchment would force the banks to cut costs, rationalize their branch networks and introduce better technology. However, at present only about six of the banks are publicly listed, and progress in terms of greater public shareholding, reduction of family controls and professionalization of top management will take longer. C. Capitalization and Consolidation of Private Banks 35. Capitalization of Banks. To shed light on possible acquisition and merger prospects, private domestic banks in Argentina, including cooperative banks, were independently classified into five groups (A, BI, B2, B3 and C), using 14 rating parameters measuring, inter alia, liquidity, solvency, capital adequacy, portfolio quality and provisioning, profitability and operational efficiency. The detailed methodology used for this exercise is described in Annex P. Figures 3 and 4 indicate the distribution of private national banks and their assets by category. Banks in categories A and B1, are clearly the most capable of acquiring weak banks, although some banks in category B2 may also be suitable candidates for acquiring other banks or being major merger candidates. Categories B3 and C contain most of the banks that are under BCRA assistance and intensive surveillance. 36. The capital shortfall in the domestic private banking system has been estimated by comparing the figures for actual capital with those required by BCRA and making adjustments for shortfalls between actual loan-loss provisioning and the classification of the banks' loan portfolios according to the latest BCRA prudential regulations. The likely capital shortfall is discussed in para. 66 and in greater detail in Annex M in the context of anticipated acquisitions and mergers. 37. Consolidation of Private Banks. The recent crisis has accentuated the fragility of Argentina's smaller banks, and is likely to accelerate a process of consolidation which was already underway. The changes in the BCRA Charter and banking legislation will strengthen BCRA's role in orchestrating acquisitions and mergers. From a capital viewpoint, the ten largest private banks would be best placed to act as acquiring banks in merger transactions. The regional banks are widely perceived to be overstaffed and inefficient, so an acquiring bank would branches and reduce staff substantially to achieve economies of scale. Some large banks are undertaking acquisitions, including acquisitions of selected assets and branches of regional banks. The more likely acquirers are intermediate-size banks wishing to increase market share. Overall, it is estimated that there is a possible set of 40 banks (rated A, B1 or B2) - 15 - Figure 3 PRIVATE NATIONAL BANKS Distribution by RatIng - February 1995 30 28 _ _ _ _ _ 26 24 ___ 22 20 ___ 14 12 _ _ _ 10 8 6 4 2 0 A Ratlng Cntegory Nujrber of Bnkls Source: Mission estimates. Includes cooperative banks Figure 4 PRIVATE NATIONAL BANKS SharQ of Assets - FPbrudry 1995 45 O% 40.0% 35. 0% 30. 0% 25 0 15. 0% ___ ___ 1D.D0% 5.D% 83 Rntlng Category Share of A5sets Source: Mission estimates. Includes cooperative banks. - 16 - that could contribute to the consolidation process by either acquiring or merging with other banks. A small number of banks may also be capable of restructuring themselves with BCTF assistance. 38. One problem foreseen by potential acquiring banks is that immediately following the takeover many of the acquired bank's depositors could withdraw their deposits. This phenomenon is likely to occur because many of the smaller regional and cooperative banks in the interior have been limiting or scheduling withdrawals. Only after a period would deposits recover--and this would most likely occur if a larger bank with a good name acquires the smaller bank. In the interim, the merged bank could well suffer from liquidity difficulties. For this reason, the acquired bank would have to be free of existing short term debts to the BCRA and BNA for past liquidity assistance. The BCTF will therefore extend loans to refinance these obligations in the context of consolidation transactions that restitute the liquidity and capital adequacy of the acquired or consolidating banks. 39. Mergers between the medium and small cooperative banks and regional retail banks are more likely because they can strengthen themselves through economies of scale and increased market power. However, such transactions--over ten of which have occurred during the last six months--run the risk that merging several relatively weak banks without strong management or upgrading staff and systems could merely create larger weak banks. To prevent a failed merger SEF will require, that merging banks redress shortfalls in capital requirements, that management is suitable, and that the merged entity has a strong business base. 40. In order to facilitate merger and acquisition program, the BCTF will provide financial assistance. Acquiring banks will be offered access to subordinated convertible loans from the Trust Fund to help meet tier two capital shortfalls in the acquired bank(s) after deducting increased loan-loss provisions and other asset write-downs. Such assistance should be subject to the acquiring bank meeting or exceeding tier one (i.e., equity) capital requirements. The large, acquiring banks should be able to maintain the required ratio of 2 to 1 between equity capital and tier two capital (subordinated debt) without additional equity injections. The same will not necessarily be true of mergers between smaller and medium sized banks, which may have to seek new capital from their shareholders in addition to the debt provided by the Trust Fund. 41. Selective Restructuring of Banks. In some cases, SEF can recommend to BCTF that a bank be considered for restructuring, without undergoing a merger or an acquisition. These cases will tend to be few, but where they exist, the eligibility requirements will be strict with respect to the initial level of tier one capital. If BCTF provides assistance in the form of subordinated loans, which count as tier two capital, such assistance will only be given on a matching basis with additional ownership capital. Moreover, the treated bank will agree to undergo an institutional diagnosis and to prepare a business and institutional development plan which the SEF can monitor. - 17 - As with all banks receiving BCTF financing, the emerging bank will meet all prudential capital requirements and will be free of regulatory forbearance. 42. Liquidation. The Government is understandably concerned about the occurrence of a large number of bank liquidations which could negatively affect depositor and investor confidence in the Argentine financial system. Nevertheless it is likely that there will be a number of smaller retail banks and wholesale banks which will not find acquisition or merger partners. These banks probably belong to category C in Figures 3 and 4. For some of these banks the eventual solution will be orderly liquidation, with settlement of insured depositors' claims by the new deposit insurance scheme, purchases of selected assets by interested banks (either with or without matching liabilities) and the disposal of the residual balance sheet by a liquidator. It will be in the interest of creditors that the residual balance sheet be as small as possible, given the protracted delays and the legal fees involved in a court-administered settlement. Two banks have recently started liquidation procedures. D. The Government's Distress and Failure Resolution Procedures 43. The focus of Argentine distress resolution policies is: (i) early identification of problems, (ii) a set of remedies related closely to the severity of the problem and the degree of cooperation of existing managers/owners, and (iii) minimization of court- ordered liquidation which a time-consuming and costly process. Broadly the process can be divided in two stages. In the first stage, SEF holds the primary responsibility for identifying problems from its routine oversight procedures and resolving them through administrative remedies. In the second stage, in which the problems are more acute, BCRA would attempt to resolve them through liquidity support; suspension of the operations of a bank; recapitalization, merger, or acquisition; or liquidation of the institution. 44. Corrective Actions by the Superintendency. The Superintendency monitors compliance with prudential norms (see Annexes I and J for details of prudential norms and supervision) from daily and monthly reports, off-site examinations, and annual external auditors' reports.7' The largest 120 banks are subject to a full annual on-site inspection and the remaining smaller 80 banks and finance companies are subject to a similar inspection every 18 months. The banks which have received extraordinary borrowings from the BCRA are subject to considerable on-site inspection and even daily monitoring (see Annex J, Attachment 1 for the format of such daily reporting). In April, some 80 banks were subject to daily reporting. The steps that SEF can take to deal with problems identified in the course of monitoring are explained in Box A below. 7/ The audit must give an opinion on compliance with the Central Bank's prudential requirements. The Central Bank can disqualify and levy fines on auditors that fail to report a bank's non-compliance. - 18 - 45. Resolution of Illiquidity or Insolvency. More serious cases of insolvency or illiquidity are dealt with as follows. Entities requiring such consideration are identified either: (i) by one of the six specialized Inspection Groups when the corrective actions described above do not rectify the problems; (ii) based on information provided the Groups for Follow-up or Coordination or Financial System Analysis; or (iii) when an entity requests extraordinary or repeated liquidity assistance from the BCRA. At this point, BCRA may either provide liquidity assistance or suspend the bank's operations. 46. Liquidity Assistance. BCRA evaluates requests for liquidity assistance on the basis of deposits lost, amount of assistance requested, additional funding needs based on projected cashflows, and guarantees and collateral offered. Until February 28, 1995, such liquidity assistance was available for a maximum of 30 days extendable to 60 days, and up to the net worth of the institution. Since then, Law 24,485 (see Annex L) has amended the Charter of the Central Bank, to offer "extraordinary" assistance beyond these ceilings. Apart from other collateral BCRA may request, the law requires that liquidity advances be guaranteed by a controlling packet of shares. 47. Suspension. If a bank is found to be in need of significant recapitalization, merger or acquisition, or liquidation, it is placed in "suspension" for a period of 30 to 90 days to protect it from the creditors and to permit time for a workout. Suspension may be invoked by the Superintendent, with the approval of the Chairman of the Board of BCRA, or may be requested by the bank concerned (see Annex L). During suspension, if the bank can present a plan for rehabilitation (typically recapitalization with merger, acquisition or other changes in ownership) acceptable to BCRA, suspension is removed and normal operations are resumed. 48. Revocation of License and Liquidation. If an acceptable plan is not produced, the bank's license is revoked and the bank will be liquidated. Prior to license revocation, the Central Bank is now authorized (Article 35 bis of the Law of Financial Entities (LFE)) to perform any required segregation of assets and liabilities and sell the institution or sell a part of its assets and a corresponding amount of senior liabilities, with the remaining liabilities to be repaid under administrative liquidation or bankruptcy procedures. 49. Loss Allocaton. Where asset values of a suspended bank exceed its deposit liabilities, but not total liabilities, the Central Bank can now divide the bank's assets and liabilities so that an acquiring bank assumes all deposit liabilities and a comparable amount of unencumbered good assets. (Where liabilities are secured, creditors would have access to the value of the collateral up to the amount of their claim.) The remaining assets and unsecured, non-deposit liabilities (which have a lower creditor priority than deposits) would then be transferred to the courts for liquidation. 50. In those cases where the asset values of the suspended bank are less than deposit liabilities, the Central Bank may still be able to effect a transaction in which the assets - 19 - BOX A Problem Resolution by the Superintendency 1. The six Inspection Groups of the Superintendency apply the following four types of remedies: change of management, changes in banking practices, increased capitalization by existing shareholders, and administrative fines and restraints. Normally, these remedies would be exhausted before considering extraordinary financial assistance from BCRA, suspension, or revocation of operating license. 2. Memorandum of Intent and Understanding. The Memorandum is a formal agreement between the Directors of the non-complying bank and the SEF. It specifies the actions and time-tables to correct infractions of law, regulations, or to improve the financial strength of the entity. It is used when the problems do not pose an immediate threat to the entity or its stakeholder, and the management is cooperating in their resolution. The Memorandum is not a legally binding contract, but non-compliance with it results in more serious actions. 3. Plan for Regularization and Improvement. While similar in content to the Memorandum, the Plan is a legally enforceable instrument provided for under the Law of Financial Entities (Article 34) and the Charter of the Central Bank (Article 46). BCRA requires that the Plan be disclosed publicly. 4. Cease and Desist Order. Under Article 47 of the Central Bank Charter, the SEF can issue a cease and desist order against a bank or its staff which are in violations of the law, regulation, or a Plan for Regularization or which are engaged in improper banking practices. Cease and Desist orders are issued when the SEF judges the management unwilling or unable to implement corrective measures prescribed. All cease and desist orders must be made public. 5. Disqualification. The Law of Financial Entities permits SEF to disqualify a person from managing a financial entity for grave violations of the law, pursuit of rash banking practices or personal gain, and violations of cease and desist orders, if such conduct can harm the solvency of the entity, stability of the system or the interest of depositors. 6. Fines. BCRA can also impose fines on entities and persons for violations of law, regulations, administrative orders or conditions imposed, or for imprudent banking practices. - 20 - and a reduced depositor claim are transferred to an acquiring bank. This would require an agreement whereby depositors would accept less than the full present value of their claim. The Central Bank is now authorized to approve these agreements with depositors so that their claims would be covered by the estimated value of the bank's assets. This might involve a proportionate reduction in depositor claims, the substitution of a long-term instrument for a portion of depositor claims, or some other arrangement whereby a portion of depositor recovery is based on the successful collection of troubled assets by the acquiring bank. In such a transaction the deposit insurer would cover losses that would otherwise be borne by insured depositors, and the insurer would assume any additional recovery claims that might be available to insured depositors. 51. In most such cases, it will be advantageous for uninsured depositors and the deposit insurer to accept some potential loss in order to avoid liquidation, the delays in recovery that would accompany liquidation, and the likelihood of a lower present value recovery in liquidation. In those cases where a satisfactory compromise does not develop or where there is no interested acquirer, the asset collections and eventual distribution to creditors would be handled through the liquidation process. Insured depositors would be paid by the deposit insurer, to the extent the insurer has funds, and the deposit insurer and uninsured depositors would have an equivalent claim on recoveries that would come ahead of the claims of unsecured non-deposit creditors. 52. Where the liabilities of suspended banks exceed their assets, losses will be borne first by shareholders and next by unsecured general creditors. Where assets are insufficient to cover deposits, the deposit insurer will make insured depositors whole, to the extent it has available funds. Losses that would accrue to depositors would be shared on a pro rata basis between uninsured depositors and the deposit insurer. It should be noted that each depositor has a priority claim of up to US$5,000 on the reserve balances of the failing bank at the Central Bank. To the extent that such funds are present, they will reduce the required outlay and (to some degree) potential loss of the deposit insurer. Since the Deposit Insurance Fund has an interest in the outcome of negotiations with regard to the transfer of deposit liabilities to an acquiring bank, it needs to be included in those deliberations. 53. In sum, when the assets of a failing bank are inadequate to cover all liabilities, the shareholders are first to lose and the remaining creditors are paid according to the following order of priorities-: (i) up to US$5,000 to depositors from the bank's reserve with BCRA; 8/ A discussion and some workout examples of partitioning of assets and loss allocations under different scenarios are set out in Annex 0. - 21 - (ii) secured creditors up to the amount of their security (any shortfall to be claimed pari passu with unsecured creditors under (v) below); (iii) depositors pari passu with the deposit insurer (by right of subrogation) for any claims paid; (iv) BCRA; and (v) unsecured general creditors (including labor and tax claims). 54. This bank resolution mechanism was sorely tested in response to the recent liquidity crisis triggered by the disruption of Mexico's economy. The mechanism has worked, insofar as five banks have already been suspended and three more are in the process of liquidation. Nevertheless, it was not designed to deal with a systemic breakdown of confidence. For this reason and in light of the severity of the current crisis, an additional mechanism was added to aid the resolution process. E. Restructuring with BCTF Financing 55. Law 24,485 significantly increases the authority and capacity of BCRA to deal with distressed banks by permitting it to divide assets and liabilities for this purpose. Simultaneously, the creation of the Bank Capitalization Trust Fund (BCTF) has considerably augmented the capacity of the authorities to finance the merger or acquisitions necessary for distress resolution. This Fund will be financed by an amount equivalent to US$2.0 billion from the proceeds of the Argentina bonds recently issued by the Government and would also received the counterpart funds (US$500 million) from the proposed Bank loan. BCTF would extend medium-term loans to the qualified acquiring banks or investors, to qualified merging banks, or to qualifying banks sufficiently capitalized to be considered for restructuring and willing to undergo an institutional diagnostic and follow-up plan. Under the proposed loan, the Government has agreed with the Bank on the use of the BCTF's resources as governed by the Operating Principles and Procedures of BCTF, agreed with the Bank. These principles are summarized below. Operatine Principles and Procedures Governing BCTF Assistance for Acquisition or Merger * BCTF is established to facilitate and finance an orderly transfer of assets and liabilities from weak banks to financially and managerially strong banks. It will provide no financing without a strong prospect of the bank's recovery. - 22 - * BCTF will provide financing for acquisition of weak banks, or their segregated assets and liabilities as determined by Article 35 bis of the of Law Financial Entities on behalf of the Central Bank. BCTF will not purchase or hold the same on its own account, except in exercise of its collateral rights. * Typically, BCTF will finance acquisitions of banks that have received extraordinary liquidity assistance from BCRA or BNA and are rated 4 or 5. * If necessary, BCRA request the audit of the bank to be sold prior to BCTF financing, by an auditor acceptable to BCRA. Such an audit shall be requested for the sale of whole or part of a suspended bank, on the basis of Article 35 bis of the LFE. The auditor will offer an opinion concerning the fair market value of the assets and liabilities to be sold and will certify that insiders are not treated in a preferential manner. - To ensure financially sound and well-managed entities after acquisition or merger, the acquiring banks must have a current rating of 1 or 2 and comply with capital adequacy and liquidity requirements. In the case of mergers, a bank rated 3 can be considered provided BCRA submits evidence to verify the level of tier one capital, capital adequacy in light of current asset values, the strength of management, and the business viability of the merger entities. The Superintendency will assess and verify that (i) the acquiring bank has the financial and managerial capacity to undertake the transaction successfully, (ii) the financial risks to BCTF of the transaction are acceptable, and (iii) the managers and principal owners of the acquiring/merged entity meet the "fit and proper" qualifications. Any 3-rated bank will submit a business development plan within 60 days of receiving Trust Fund resources. * The BCTF may also undertake financing in the context of restructurings, provided that the bank is eligible by virtue of having (a) minimum tier 1 capital requirements, (b) adequate management and business base, and (c) agreeing to undertake an institutional diagnostic of its difficulties. In receiving BCTF financing, the bank will have verified that it meets all capital adequacy requirements without counting BCTF financing, that BCTF funding will be matched one for one by new ownership capital, and that it is willing to comply with an Institutional Development Plan to be monitored by the SEF. BCTF loans for restructuring will not exceed 10 percent of the volume of resources available to the Fund. * Recapitalization (subordinated) loans will not exceed 25 percent of the risk-weighted assets (RWA) for assets being acquired, 15 percent of - 23 - RWA for assets involved in the case of a merger, or 10 percent of RWA for assets of a restructured bank. BCTF's secured loans will not exceed the amount of outstanding loans from or on behalf of the BCRA. BCTF assistance will require banks to repay all such extraordinary loans in the terms agreed with BCRA. * BCTF financed transactions will use competitive and transparent procedures for qualified bidders. * BCTF will only finance an acquirer in a qualifying acquisition or merger transaction through either subordinated loans of 8 years maturity (meeting tier two capital definition) and/or secured loans of up to 3 years. BCTF will determine the type of each loan and their maturities, to ensure viability of the merged entity, and keep subordinated loans to the minimum possible. BCTF will not provide direct equity/preferred capital; however, both kind of loans may be convertible to equity at terms fixed by BCTF. All refinancing of BCRA or BNA extraordinary assistance will be done in conjunction with transactions described in these principles. * To prevent continued dependence of acquiring/merging bank(s) on official support, the restructuring plan will be adequately financed. BCTF will obtain an opinion from the Superintendency that the consolidated post-acquisition/merger bank can satisfy the normal prudential regulations for capital adequacy, provisioning, portfolio classification, liquidity, and interconnected lending. 3 Loans will be denominated in US dollars with an interest rate for merger and acquisition recapitalization loans equal to at least the World Bank rate plus a spread of 0.5-1.0 percent per year and for other recapitalization loans and all refinancing loans equal to the cost of Argentina bonds plus a spread of 0.5-1.0 percent per year. * The BCTF may on a case-by-case basis consider other transactions which meet BCTF objectives, but these will require prior review by the World Bank, and will in aggregate volume not exceed 5 percent of the resources of the BCTF. - 24 - III. THE PROPOSED LOAN A. Background 56. Past Bank Involvement. The Bank has been actively engaged in the reform of the Argentine financial sector since 1986. The dialogue intensified with the advent of the Menem administration in 1989, when the Bank assisted the Government in drafting the new Central Bank charter, developing organizational plans for the Superintendency of Banks, and designing action plans for the reform of public banks. In the context of this overall framework, the Government proceeded to institute major reforms during the subsequent five years, supported by a series of Bank operations. Under the Public Sector Reform Technical Assistance Loan (Ln. 3362-AR), major reforms were carried out in both the Central Bank and the Superintendency in areas of training of staff, accounting, information systems, and organizational improvements. With the Financial Sector Adjustment Loan (Ln. 3558-AR), approved in 1993, the Bank continued to support reforms of the public banks, principally the national development bank, the housing bank, and the national savings and insurance bank, and to strengthen the regulatory environment. 57. Over the past year the Bank has continued its dialogue with the Government in the context of its Capital Markets Study (No. 12963-AR), which identified, inter alia, two major problems in the banking sector: (a) the need to radically restructure, privatize or liquidate loss-making provincial banks; and (b) the need for a consolidation and strengthening of a relatively fragmented private banking sector. In the last six months, both outcomes have emerged. Due to weaknesses in provincial public finances, and precipitated by the Mexican aftershock, provincial public banks came under unsustainable pressure. Although the Bank had already planned to deal with some provinces in the context of the Provincial Reform Loan (Ln. 3836-AR), approved in early 1995, the urgency of the situation and the political opportunity afforded by the crisis to privatize provincial banks led to rapid preparation of the Provincial Bank Privatization Loan, approved by the Board on May 4, 1995. 58. The Bank's Response to the Current Crisis. In the aftermath of the Mexico crisis, the Government has struggled to maintain confidence in the financial system, despite major losses in deposits from the system and an exhaustion of its very limited lender-of-last-resort (LOLR) capacity. The Bank announced its intention to provide an additional US$1.3 billion of quick- disbursing assistance as part of a multilateral effort involving the IMF, IDB, and the World Bank. The Eximbank Bank of Japan was also quick to respond with a loan of US$800 million. This coordinated action aims to augment rapidly official sources of capital in light of the abrupt cutoff of private flows following the Mexican financial crisis and the resulting urgent need for balance of payments support. The IMF is providing new funds equivalent to US$2.4 billion and the IDB is matching the Bank's level of additional assistance. These funds are to be provided as part of a strong program of fiscal strengthening that the Government had - 25 - already announced in the aftermath of Mexico and has further reinforced in the context of the Fund program. 59. In the framework of these measures, the Government of Argentina has requested the assistance of the Bank in helping to support its program of banking reform. The Government quickly established a Bank Capitalization Trust Fund to enable it to deal with distressed banks and facilitate acquisitions and mergers in a manner that allows failed or irretrievably weakened banks to exit the system without triggering a systemic crisis of confidence. The Government is committed to financing the BCTF with an amount equal to some US$2.0 billion9'. As part of loan preparation, the Bank has provided advice in the areas of bank restructuring, failure resolution, and deposit insurance. The Government's commitment to designing an improved failure resolution system is also seen in its solicitation of advice from experts in the field and the high priority attached to the establishment of a limited deposit insurance system. The Government continues to value Bank involvement in assessing any future institutional needs of the Superintendency. B. Loan Objectives 60. The purpose of the loan is to provide balance of payments support to the Argentine Republic in the aftermath of the regional crisis that has abruptly curtailed the country's access to foreign capital. The foreign exchange is needed to help reduce the severity of inevitable import compression now underway in Argentina. The country's dependence on official flows has increased dramatically in 1995 and these sources will account for the bulk of capital inflows. 61. At the same time, the loan will support the Government's ambitious program of bank reform. That program has the following principal objectives: (a) to hasten the process of consolidation of a fragmented private banking sector; (b) to improve the financial structure of a distressed banking sector by encouraging acquisitions, mergers, and restructurings; and (c) to contribute to the restoration of confidence in the banking system. C. Loan Description 62. A fast-disbursing fixed rate US dollars single currency loan of US$500 million is proposed. The loan would have a repayment period of up to 15 years; and each 9/ The Government successfully sold US$1.0 billion of domestic and US$1.0 billion of foreign bonds to help finance BCTF. The bonds carry 3 year maturities and are priced over LIBOR. - 26 - semester's disbursements would have a maturity of 12 years from the rate fixing date, including 3 years' grace. The Government of Argentina is eligible for single currency loans as it has no unconverted VLR82 loans. The proposed US$500 million loan represents (35.7 percent) of the FY96 lending program for Argentina of (US$1.4 billion). The loan would disburse in three tranches in accordance with conditions noted in the Policy Matrix (Annex C) and in the subsequent section detailing Loan Conditions. The Borrower is the Argentine Republic and the implementing agencies are the Ministry of Economy and Public Works and Services and the Central Bank of Argentina. Counterpart funds would be made available to the Bank Capitalization Trust Fund and assurances to that effect are reflected in the Loan Agreement. All three tranches would be disbursed in accordance with policy conditions; however, the second and third tranches would also require the achievement of a specified level of US$167 million of eligible Trust Fund recapitalization transactions in accordance with principles agreed between the Government of Argentina and the Bank (Annex F). The Borrower has requested that the loan be a fixed-rate US dollar single currency loan. 63. Counterpart funds will be used by the BCTF for recapitalization and debt refinancing of liabilities in order to render a bank receiving BCTF assistance fully able to meet all prudential capital requirements. Financing will be provided in accordance with principles agreed with the Bank for three possible kinds of transactions: (a) acquisitions by qualified banks of weaker or distressed banks or acquisitions of parts of insolvent banks which have undergone BCRA suspension and procedures of article 35 bis of the LFE; (b) mergers among qualified banks where at least the dominant merger partner is rated "3" on the CAMEL rating or its functional equivalent and has the managerial capacity and capital adequacy to undertake the transaction; or (c) a restructuring of a bank, deemed by the SEF to have fully adequate tier one capital, willing to both match any BCTF subordinated loans dollar-for-dollar with new ownership capital, and follow an institutional development plan to improve its management and operations (Annex Q). 64. Trust Fund loans will be two types: (i) subordinated (convertible) loans of a maturity of at least 5 years in an amount up to 10 percent (in the case of restructurings), 15 percent (in the case of mergers), and 25 percent (in the case of acquisitions of the risk-weighted assets involved in the transaction, all or part of which will constitute tier two capital; and (b) secured loans of up to 3 years maturity of an amount not to exceed the outstanding rediscounts and advances to the distressed bank from or on behalf of the Central Bank. The recapitalization limits are set to provide greater incentives for consolidation transactions. In addition, an overall cap of 10 percent of total BCTF resources has been set on financing of restructurings. 65. The Operating Principles place ex-ante restrictions on the financial conditions of banks to be assisted by the Fund in the context of acquisitions, mergers, or restructurings (see para. 55). However, regardless of transaction, however all banks receiving BCTF assistance must fully meet prudential capital and other BCRA - 27 - requirements. The Government has agreed that any forbearance granted to a bank will be extremely limited and time-bound and will not relate to capital adequacy. Audits are required for all transactions (see Annex K on Argentina is generally accepted accounting principles); the BCRA has already instituted a system for selecting external auditors for all suspended banks. The Trust Fund is expected to denominate its loans in US dollars, charging a rate which corresponds to its borrowing costs plus a spread to cover the operational costs of the Trust Fund. 66. Potential demand for financing of acquisitions/mergers is difficult to predict. At the peak of the crisis, some 80 private financial institutions (banks, finance companies, and savings and loan associations) with assets valued at US$14 billion were recipients of extraordinary liquidity assistance and many of these are still candidates for recapitalization, acquisition or merger. On the basis of data received from the Central Bank, and using the assumptions described in more detail in Annex M, the banking sector's potential demand for funds is estimated to be in the range of US$2.0 to 2.5 billion. This includes about US$1.6 billion of refinancing of Central Bank advances as well as US$350 to 870 million to meet identified or potential capital or provisioning shortfalls. For only those banks currently being assisted by the BCRA, total potential demand for financing is more likely to be in the US$1.8 to 2.1 billion range, using conservative estimates. Some of this demand--the tier one equity requirements--could be met by the acquiring banks themselves. Trust Fund resources are authorized to total US$2.0 billion, reflecting the proceeds of domestic and foreign bond that will be in place by July 1995 (the "Argentina bonds" placed among domestic and foreign investors), and the proceeds of the proposed Bank loan of US$500 million. Thus, the Bank would provide a maximum 20 percent of Trust Fund resources. 67. Any transaction not meeting the agreed rules and procedures of the BCTF would be subject to the Bank's prior review, as to its consistency with the objectives of the program. At the time of second and third tranche release, the Bank would make an assessment of whether those transactions that have not met the agreed rules and procedures undermine achievement of the objectives of the program. Such transactions would not be included in the amounts required for release of the second and third tranches (para. 72(b)) and are subject to limitation. 68. A central tenet of the proposed operation is SEF's progress on bank supervision, as part of the Government's program of financial sector strengthening and reform (described in the Government's Letter of Development Policy in Annex R). Further progress in bank supervision will be monitored on the basis of a diagnostic review and development plan to be agreed with the Government before release of the second tranche. The development plan will focus on supervision policy, the supervision process, regulatory reports, off-site supervision, and human resources development. Satisfactory performance with respect to the agreed action plan will be a condition of third tranche release. In addition, a loan condition provides for Central Bank implementation of enhanced surveillance standards, including full on-site inspections of - 28 - banks on an annual basis for the larger institutions and every 18 months for foreign and small banks, monthly off-site surveillance of all banks, and at least continuous monitoring of banks receiving extraordinary liquidity assistance from the Central Bank. Finally, under the operating procedures governing BCTF assistance, assisted banks with a BCRA rating of 3 will be subject to enhanced surveillance, including full bi- annual inspections that include an assessment of progress with respect to their development and restructuring programs. 69. The Bank needs to closely monitor the impact of the bank crisis resolution mechanism on the overall health of the banking system. Under current policies, the Central Bank should limit forbearance of capital requirements and should refrain from renewals of extraordinary liquidity assistance. Under the proposed condition, the Bank would review the capital position of commercial banks and the extension of Central Bank liquidity loans and determine whether the Central Bank's failure resolution policies are being effectively implemented. A positive review would be required for release of the loan's second and third tranches (para. 72(e)) D. Loan Conditions 70. Signature of a Letter of Development Policy (see Annex R) would be a Board condition. As detailed in the Policy Matrix (Annex C), release of all three tranches would be subject to compliance with the following conditions: (a) maintenance of sound macroeconomic policies that are consistent with and comply with the policy objectives and programs as described in the Letter of Development Policy (Annex R); and (b) continued adherence to a program of financial sector strengthening and reform, as described in the Letter of Development Policy (Annex R). 71. The following actions will need to be taken for loan effectiveness: (a) the Operating Principles and Procedures of the Fund, agreed with the Bank, have become effective and have been used for at least one eligible transaction; (b) at least US$167 million has been provided to the Trust Fund; (c) the Central Bank is implementing its crisis resolution procedures in accordance with recent changes in its Charter, program objectives, and policies described in the Letter of Development Policy (Annex R); and (d) the enhanced surveillance and inspection schedule is in effect. - 29 - 72. For Second and Third Tranche releases, the following additional conditions will apply: (a) the Trust Fund is operating in accordance with the agreed Operating Principles and Procedures, and the Bank is satisfied on the basis of an evaluation of transactions that its objectives are being achieved; (b) The Trust Fund has received adequate funding to carry out its mission, and its resources amount to no less than US$501 million (second tranche) and US$834 million (third tranche); (c) the Trust Fund will have issued subordinated debt instruments, as defined in para. 64, in an amount of at least US$167 million in the context of eligible transactions, and these transactions will have been deemed satisfactory according to agreed performance benchmarks (Box B), subject to the agreed maxima per transaction for the purpose of tranche release calculation (Box C); (d) No more than 10 percent of BCTF resources received will have been used for eligible restructuring transactions and the exceptions limit will have been enforced; (e) the Bank has received an acceptable annual financial audit review of the Trust Fund; (f) the Deposit Insurance scheme is receiving contributions as required and is functioning as designed; (g) the BCRA continues to satisfactorily implement its crisis resolution procedures (in accordance with relevant provisions of its charter, the reforms of the Law of Financial Entities and relevant decrees, as described in Annex L) in the judgment of the Bank on the basis of information provided on outstanding liquidity lines, forbearance of any prudential regulations, and suspensions and banks subject to provisions 35 bis of the LFE; (h) enhanced surveillance and inspection procedures as defined in para. 68 are being maintained and a report acceptable to the Bank has been submitted indicating the profile of Bank classification and implementation of agreed inspection schedules; (i) for second tranche release, the BCRA will have agreed on an Action Plan for the SEF based on a joint assessment with the Bank, and for - 30 - third tranche, satisfactory progress will have been made in implementing that Plan. BOX B EX-POST REVIEW BENCHMARKS (Applicable to Transactions under Trust Fund Support) SATISFACTORY RESOLUTION UNSATISFACTORY RESOLUTION I. A. BCRA certifies that bank meets I. Bank does not meet capital adequacy normal capital and liquidity and liquidity requirements and continues requirements. to receive forbearance on these requirements six months after transaction. B. Last full inspection performed according to agreed schedule. II. Bank is receiving any extraordinary liquidity assistance from BCRA. C. Bank has not received extraordinary assistance from the III. Bank has not been subject to a full Central Bank. inspection according to schedule. II. Bank has been placed under procedures of Article 35b of Law of Financial Entities. BOX C TRANSACTION CALCULATION FOR PURPOSE OF SECOND AND THRD TRANCHE RELEASE MAXIMUM MAXIMUM CREDIT PER CREDIT PER TRANSACTION TYPE TRANSACTION TYPE PER TRANCHE Acquisition $60 million No limit Merger $40 million No limit Restructuring $20 million $60 million * In reaching a level of $167 million, all transaction must meet all benchmark performance criteria noted in Box B. * In lieu of transaction, the Government may request the substitution of up of $50 million (total) in loans to the Deposit Insurance Fund, if, in its judgment, that improves the crisis resolution capacity of the system (see Annex 0 on the details of the pay-in schedule). - 31 - E. Disbursement, Procurement, Accounting, and Auditing 73. The loan proceeds would be used to finance the CIF cost of general imports, except those on the Bank's standard negative list. The following procedures will be apply to procure these imports: (i) goods (and associated services) imported by public and private sector entities and valued at US$10 million equivalent or more per contract would be procured using simplified ICB procedures, employing Bank-issued standard bidding documents. Contracts above this threshold would be subject to the Bank's prior review; (ii) imports valued at less than US$10 million equivalent per contract would be procured (a) by public sector entities in accordance with the applicable public procurement procedures and (b) by private sector entities, in accordance with established commercial practices. These procedures and practices have been reviewed and found acceptable by the Bank. Retroactive financing would be allowed for goods (and associated services) imported up to four months prior to loan signing, up to a maximum of US$100 million. 74. Counterpart funds are to be used by the Trust Fund (as described in paras. 62 and 62) to finance eligible transactions in accordance with agreed procedures. Transactions will be considered eligible once the Government has accepted and put into effect the Operating Principles and Procedures (Annex F). 75. Calculations based on reasonable assumptions as to the speed and cost of the anticipated transactions are consistent with the disbursement of the second tranche by July 1996 and the third tranche a year later, although the volume of transactions could well be more rapid. The first tranche is expected to be disbursed upon effectiveness of the loan. Disbursement of the second and third tranches will require, inter alia, the execution of US$167 million in eligible transactions under the Trust Fund, as defined in the loan agreement and in Annex F. 76. The Central Bank will submit disbursement applications to the Bank and will maintain separate records and accounts. Disbursement requests will be based on customs certificates, a procedure which was reviewed by the Bank and found to be satisfactory. Withdrawal applications documented by customs certificates will be made against Statements of Expenditures (SOEs) for contracts above US$10,000 but below US$10 million. 77. An audit report on the import documentation submitted, to be carried out by independent auditors acceptable to the Bank, would be contracted within 30 days and submitted to the Bank within 60 days after disbursement of each tranche. Audit reports would give an opinion with respect to SOEs prepared by the Central Bank. Receipt of a satisfactory audit report of the prior tranche would be a condition of subsequent tranche release. The loan Closing Date would be D.ecember 31, 1997. - 32 - F. Loan Supervision 78. Loan supervision will follow the principles of the Bank's new supervision strategy, with appropriate use of resources in the field. Loan supervision will take the form of monitoring Argentina's new system of supervision and distress resolution for the private banking system. In addition to an ex- post review of Trust Fund transaction, for purposes of tranche release, annual audit reviews of the Trust Fund's operations are required. Close contact will be maintained with the Federal Reserve Bank of New York, which is providing technical assistance to the Superintendency of Banks in the areas of supervision and prudential regulation. The Bank and the government will retain the option to either redesign or augment the existing Technical Assistance Loan for Capital Markets Development (Loan 3710-AR), should the need for additional technical assistance become necessary (see para. 68). Loan supervision will include review of the policies and operations of the Central Bank as they affect the use of the proceeds of the loan. Detailed reporting requirements have been established to enable the Bank to effectively supervise this project. G. Risks, Benefits, and Social and Environmental Impacts Risks 79. The principal risk to the operation remains macroeconomic, insofar as the economic situation in Mexico, and Latin America more generally, remains unsettled and the Argentine economy continues to be vulnerable. This could result in a further loss of confidence, a deeper economic crisis, and a renewal of deposit flight. Insofar as this risk is embedded in regional risk, it cannot be mitigated by changes in the proposed program; however, to the extent that the financial sector can be strengthened by recently announced government measures, including a stronger failure resolution mechanism and the introduction of limited deposit insurance, that risk can and has been effectively lowered. Macroeconomic risks have been reduced by the adoption of a very strong fiscal program, aimed at producing a sizeable surplus this year, and by continued prudent and effective economic management. 80. Several risks nevertheless remain. The first is that recent improvements in the quality of supervision would not be sustained. The quality and timeliness of supervision are central to the early identification of distressed banks and to judgments that need to be made on the quality of bank management. Recent supervisory policy changes are encouraging, but implementation of these reforms must be effectively maintained. Second, closure/liquidation needs to remain a credible option and the BCRA must use its new powers of Article 35 bis of the LFE to deal with insolvency. Although there is the risk that political considerations will impede regulators, this has not proven to be the case with recent bank suspensions. A third risk is that the Trust Fund's loans will not be repaid, namely, that transactions eventually fail, and the Government is forced to bear an additional fiscal burden. Strict Trust Fund rules - 33 - mitigate but do not eliminate this risk. At a maximum, the potential fiscal burden of the Fund is less than 1 percent of GDP. Another risk is that the Trust Fund would either run out of funds or suffer a maturity mismatch on its subordinated debt if those loans total more than the Bank loan. In either event, Government must be prepared to either secure additional official financing or seek further international bond financing. A final risk of the operation is that the process of bank closures and acquisitions will result in a further loss of confidence, but this risk must be borne if the system is to be worked out. Benefits 81. The program supports an improved mechanism for resolving the condition of distressed banks. This mechanism has been designed by the Argentine Government, with material input from discussions with Bank staff in the course of project preparation. Specifically, the operating rules of the Trust Fund were determined and agreed through these discussions. In addition, tranche release conditions refer to the adequacy of liquidity policy (within the constraints imposed by the Convertibility Law), bank supervision, and funding of deposit insurance. These agreements will strengthen implementation of the Government's bank distress resolution policies. 82. It is expected that the banking system will be stronger as a result of the program. The key forces to achieve this result include the further consolidation of Argentina's fragmented banking system and stronger surveillance and enforcement of prudential regulations. Although the banking system will not be fully protected against future shocks--an inherent risk of the convertibility system--the policies introduced by the Government provide for quicker and more effective Central Bank intervention to handle failing banks and minimize their adverse impact on confidence. 83. In sum, the program benefits include the restoration of confidence in the private banking sector, which has been badly battered by the events following the Mexico crisis and massive outflow of deposits. While the situation has now stabilized, many banks are in financial difficulty and the Trust Fund operation that the project helps finance offers, along with the new powers granted the BCRA to dismantle and send banks for liquidation, a viable approach to insolvency. Moreover, as the Trust will effectively broker mergers and acquisitions to remove weak or insolvent banks from the system, a more orderly consolidation process can be managed. As part of the debt restructuring of acquired bank liabilities, the Central Bank will be repaid its overdue loans, which is important for the health of the BCRA and its normal operations. The new failure resolution approach being adopted by the Government, and continuation of recent significant improvements in supervision are important issues associated with this project. The ultimate aim is a stronger and more efficient banking sector. 84. Finally, the project will have a financial benefit to Argentina. Argentina expects the US dollar single currency loan terms to facilitate improved debt - 34 - management and the fixed interest rate to protect against possible market interest rate increases after the loan is fully disbursed. Social Impact 85. The most likely social cost of consolidation of the banking system is a short term loss in employment. Most employment losses during 1991 to 1994 took place in public banks, as these banks downsized, restructured or privatized. In contrast, employment in private banks increased during the same period, and increased resource mobilization expanded the banking business. With the slowdown in the growth of deposits and the resulting consolidation of private banks, some short term employment losses can be anticipated. These losses come at a time of a downturn in aggregate economic activity and sluggish overall employment growth, and highlight the importance of the Government's social safety net program being supported by a parallel Bank operation. Environmental Impact 86. There are no expected environmental impacts associated with this project. IV. RECOMMENDATION 87. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and would be consistent with the approved guidelines for Bank support. I recommend that the Executive Directors approve it. James D. Wolfensohn President Attachments Washington, D.C. June 29, 1995 - 35 - ANNEX A THE STATUS OF BANK GROUP OPERATIONS IN ARGENTINA STATEMENT OF BANK LOANS (as of March 31. 1995) (US$ million) Loan Ficsd AMOUNT (loss UNOISSURSED Number Year Borrowor Purpose cancellations) Fully disbursed loans (421 5,033.3 0.0 of which SALISECAUDebt Reduction loans: 2676 1 986 Argentine Agriulture Sector 350 0 2815 1987 Argentin Trade Policy 496.0 2996 1989 Argentinr Trad Police 11 300.0 3291 1991 Argentina Public Enterprics Reform 300.0 3394 1992 Argentina Public Sector Reform 325.0 3555 1993 Argntino 00SR Support 460.0 3558 1993 Argentina Finncial Sector Adjustment 400.0 2641 1986 Argentina Water Supply 44.8 8.5 2864 1987 Argenti Power Oiatribution 276.0 84.9 2920 1988 Argentina Municipal Development 120.0 10.1 2984 1989 Argentina Social Sector 28.0 0.1 3280 1991 Argentina Provincial Development 200.0 141.1 3281 1991 Argentina Wate Supply 100.0 92.8 3292 t991 Argentina PEREL 23.0 1.3 3297 1991 Argentina Agricultural Services 33.5 13.9 3342 1991 Argentina Pub Sectr Reform T.A. 23.0 7.9 3460 1992 Argentina Tax Administration II 20.0 4.6 3520 1993 Argentina Yacyruta II 300.0 28.1 3521 1993,, Argentina Flood Rehab 170.0 62.7 0369 1993 Argentind Pub EntapriAe Rof II 300.0 0.03 3611 1993 Argentina Road Maintenance & Rehab 340.0 245.68 3643 1994 Argentina Matel & Child Health 100.0 86.4 3709 11 1994 Argentina Capitl Markets 600.0 500.0 3710 1994 Argentina Capital Markets TA 8.5 7.8 3794 21 1995 Argentina Secondary Education I 190.0 190.0 *383d 1996 Airdea Provincial Reform 300.0 240.0 3860 2t 1996 Argentina Municipal Development I 210.0 210.0 TOTAL 8,320.0 ot which has boen repaid 2481 .8 TOTAL NOW OUTSTANDING 6,838.2 AMOUNT SOLD 12.8 of which has been repaid 12.8 TOTAL NOW HELD BY BANK AND IDA 6,825.4 TOTAL UNDISBURSED 1 936 0 *1bi SECAL. SAL or O et Reduedon Loan It Not yet effective 2t Not yet signed. IOApr-BS - 36 - STATEMENT OF IFC INVESTMENTSANEB as a March 31, 1995 (USS Millions) Oniginr l Gross Cormmitme-nts Hold Hold by Undisbursd FistI Year IFC If C Partiai- t7y Parttici- (Ineluding Committe Obligor Type at Business Loan Equity pants- Tobta IFC pasf Pwrticip-nts; 1 9o(lgs Acindar S.A. Steel Products 27S94 - 20.73 48.57 25.00 _ 5.sa t 960 ai Papolbra Rio Parana S.A. Pulp and Pacer 3.00 _ _ 3.00 _ _ 1961 a/ Fad sS.A. Motor Veh. & Accessories 1.23 - 0.28 1.50 1982 a/ Pasa SAIC Petrochemicals 3.C5 - _ 3.CS - - 1965n2 ai Colulosa Argentina Pulp anas Paper 8.25 - 4.25 t 2.50 I 989 a/ EditoralCodexS.A. Prinbng and Publishing 5.00 1.o0 0540 7.00 - -- I 9eWi7 al Daimirn Siderea SAIC (ran anoSteei 14.75 - 2.25 i7.00 1971/73 a/ Calera Avelan da S.A. Cement 5.50 - - 5.50 t197'7/8418ttl88 Alp rgatas SAIC Textiles anti Shoes 62.93 5 C0 38.50 1 C4.4.3 34.22 29.00 1977185 a/ Soy-xS.A. Food and Food Process 21.00 - _ 21.00 1978/81/lSV/87193/94 Juan Minotb S.A. Cement 54.00 _ 67.50 t115 50 9.51 9.29 1978/85/87188S19 ar MassuhSA. Pulp and Papwr 25o85 5.25 3-00 32.90 19791SVJS7192 a/lIpakoS.A. Petroehemicals 21.00 1.15 9.00 31.15 19791S31S4 al Alpssea S-A Food &Food Proceass 5.20 1.51 - e.81 1984/88 Petroquimica Cuyo SA. Chmricals &Petrochem. 21.00 4.00 21.09 48609 3;52 4.25 1986 a/ AtanorS.A. Chemicals 7.00 1.00 - 3.00 I 986 Pop..Sadie r CaprtalMarkets - 0.05 _ 0.05 0.05 19aoJS7 Sadicar Capita lMarkets - 2.00 - 2.00 0.43 19Soa ROB-Cattorini Genea r tanutacturing - - - a.00 0.1Sa - I 9Se ROB-Benvenuto Food &agribusiness - - _ 0.0 - - I 9ft R0OB-eBoldt Timber. pulp &Paper - - - 0.00 - - - 19gSt ROB-CIave Plast General manufacturing - - - 0.00 I19So ROB-Cuyo Genwa manufacturing - - - 0.0 - - 1988 ROIB-GaverSante Industrr41 services - - - 00 , gae ROB-Klaukol Cement - - - 0.0 zo- 1 988 ROB-Labalcor Food a agrnbusines - - _ 0.0 - - t986 R0O3-Longvie Genrwa manutacturmng - - - 0.00 0.90 1986 ROIB-Pilar General manufacturing - - - 0.00 0.19 I 986 RO8-SudaLm ricana Industrisli equipment - - - 0.00 0.21 I 988 ROB-St.Ursula Food &argribusiness - - _ 0.0 - - 198a ROB-Stani Food &agribusin*ss - - - eoo - - I 986 ROB-Tags Industral servires - - _ 0.00 1 980 R08-D4rio 7Tmber. pulp & paxper - - _ 0.00 0 09 - - 1988 ROIB-Piedra Mining - - - °-°° °.0 ° 1 98B/89ol/995 Banco RobwS.A. CapitlMatMgk ts 4a800 - - 48100 Z0Z0( 1987 al Garovaglio y Zorraquin Gnenral Manufacturing 13.00 - - 13.00 1 987/90 Hicra Oil Crude Patrol. & Nat Clas 80 00 - 27 10 107.80 0.38 t9S7g/90i9 T rminZ S.A. Port Facilities 12.50 0.00 0.00 'Z250 5.0 CO 1 9SS al Astra CAPSA Lindero Energy 12.38 - _ 12.38S I 9S8 a/ Bridas S.A.P.I.C Energy 20.63 - - 20.63 1988 Arcer SAIC Genwal Manufacturing 12.00 - - 12Z00 t 00 1988 BGN-Colortbx T xties - - - °0 0°° ° 33 1 9SS BGN-Estrelha General Manufacturing - - - O.0 so- 1928a BGN-Irterpack 7imb r. pulp8&paPer - - - 0.00 0.50 1 988 BGN-Noroesto Food &agribusiness - - - d0 co 0t17 t 988 BGN-Cilsa Textiles - - _ 0.CC 0.07 t 988 BGN-Moldeeda Timber -pulp & paper - - - °0 °° 3 ° 33 It98S BGN-Oftalmologic 7irmb r-puip &paper - - _ 0.0C 9tt8 BGN-San Sebastian Food &agribusiness - - - .0CC 033 19as BGN-Tevcom Industris *quiPrment - - - a 00 0.t0 1988s BGN-Vallby Food & agribusiness - - - 0.00 0 t 7 198S BGN-Vandentil T xtiles - - - 0.00 0.17 1988/80t BGN-Flichman General Mranufacturing - - - 0 00 0.43 t gaa1ag Banco General de Nagocios AL Dev. Financse 20.00 - - 20-00 1t988l°2 a/ ChiretsOil Chomicals &Petrochem. - 86a2 - a.82 1 988192 Banco Rio de is Plata Capib Markets 50.00 - _ 50.00 32C00 - 7.53 1 g88193194 Sunge y Born Food and Food Process 63.00 - 57.50 12Z0.50 719.00 57.50 t 98Si93 BGN-Longvto General manufacturing - - _ 0.00 0.13 -- I gag a/ Argentime nvestment Comoarny SecuritievFinancial nst - 2.00 - 2Z00 1 989 al Chihudos Pstraobum Energy - 4.98 - 4.9a - _ It989 Banco Frances 0 - r Financ* 15.00 - - 15 .00 10o 9t 1989 R0OB-Carboctor Chomicais & petroch-m - - _ 0.00 0.14 1989BaGN -Cencosud Industrisl services - - - e 00 0.33 1989g ROB-Ci rvs Food& agribusin*s - - _ 0.0 - I 989 ROB-Com*si Gnenral manutacturing - - - 0.00 0.75 I gag RO8-Mal-ic Chemicals & p*rrochem - _ _ 0.00 1989 ROB-Maitwia Food &agribusinn - - - 0.00 I1989 Com. General deIlnv rsiones Finaneid tS vices - 0.10 - 0.10 0.0t 1 989 ROB-Frwechis Industri-l s rvices - - - o 00 0.49 - - It989 ROB-Lauwii Ch micals & p*trochem - - - 0.0W 0. 2S I 989 ROB-[MIR T xbles - - - 0.0W 0.75 1989 PIOB-Mosopr no Tlmb r-pulp & paper - - - 00W 0.10 ^ - IU ga8GN-Paradins Chemicals &petrochem - - _ 0W0 t 25 1 989 8GN-P xtorii Food & agribusineS - - - 0.0W 0 38 _ _ It989 B3GN-G nwro Food &agnibtuine. - - - °°°0 ' 36 1989/92 AsitaraCAPSA Energy 50.00 - 43°°0 93S00 24.90 28e87_ - 37 - ARGENTINA ANNEX B STATEMENT OF IFC INVESTMENTS as March 31, 1 995 (USS Millions) Originrl Gross Commritments Held Held by Undisbursed FM5col Yew IFC IFC Partici- by Partic,- (including Committtd Obligor Type of Businss Loan Equity pants - Total IFC pants Participants) 1989103 BGN-Solland Tourism - - - 0.00 0.40 - - 1990 BGN-Algodonera Textiles - - 0.00 0.54 - 1990 Corporacion de Inversiones y Privatizacion SA Financial Services - 0.08 - 0.08 0.08 - - 1990 SGN-Frtogotoba Food &agriousiness - - 0.00 0.25 - 1990 SGN-Willmor Food &agriousiness - - 0.00 3e - 1990/95 Patroken Petroquimica Chemicais& Petrochem. 40.00 - 11.00 51.00 35.87 7 33 10.00 '991 Banco deCrsditoAtgentino FinancialServices 10.00 - - 10.00 7.14 - t991 ROB-Guilford Textiles - - - 0.00 0.47 - 1991 ROB-Jugos Fod & Agribusiness - - - 0.00 033 - - 1991 ROS-interpack Timber.puip & papfr - - - 0.00 1 00 - - 1991 ROB-Surftacn Chemicals & oetrochem - - - 0.00 0.21 - - 1991 BGN-T8R Industrnl eruipment - - - 0.00 0.38 - - 1902 Frigorfic oRioglatense Fod & Agribusirmss 12.00 1.00 6.00 19.00 1033 5.00 2.00 1902 MBA Sociecad de Bolas SA CapitslMwkers - 0.18 - 0.18 0.18 - - 1992 Oleagtnosa Oeast Sunflover Seed Agribus. 20.00 - 15.00 35.00 18 93 12.50 1992 Potiaw SM Chemicais & Peochem. - 7.00 - 7.00 700 - - 1992193 Petolera Argentirn San Jorge Energy 15.00 27.00 35.00 77.00 40.75 32.08 25.18 1993 Alto PasnatSA. Timber. pulpand paper - - - 0.00 19.47 - - 1993 BridasSAPIC Energy 35.00 15.00 60.00 110.00 S0.00 55.00 - 1993 CadipsA S A Energy 15.00 5.00 20.00 40.00 20.00 13.00 9.20 1993 BGN-Caori Food & agricusiness - - - 0.00 I c0 - - 1993 ROB-Emprigas Industal serves - - - 0.00 1.13 -. 1993 Ferroexoreso Pampeano SAC Industrl Ecuioment 13.00 - 20.00 33.00 13.00 8.53 4.60 1993 ROB-Alimenems Food &agriousinew - - - 0.00 0.83 - - 1993 Malteria Pampa SA. Food & Agribusiness 12.00 - 12.00 24.00 12.00 12.00 1993 ROB-Mendoza Generaimanutacturng - - - 0.00 1.13 - - 1993 Nuevo CentalArgentinoSA RailroadEquinment 10.00 3.00 15.00 28.00 13.00 - - 1993S94 Molinos Rio de Ia Plata Food & Agribusiness - 3.00 - 3.00 7.82 - 1994 Banco General de Nagocios Dev. Finance 15.00 - - 15.00 15.00 - - 1994 Cevecwna y MaltriaO ulmes Food & Agribusiness 15.00 - 15.00 30.00 1500 5 .00 - 1994 ClAGenCombustible Crude Petroleum 25.00 15.00 40.00 80.00 40.00 40.00 - 1994 Empr-sa Distibuidora Industri Seice. 45.00 - 128.00 173.00 45.00 128.00 1994 Quitral Chemicals & Petrochem. - - - 0.00 - 1994 BGN-Ferrum Cmmnt&construc mat - - - 0.00 1 50 - - 1904 Masisa-Arg-ntinaSA. ForestProducts 11.00 - 11.00 11 00 - - 1994 Arg.Equity Investment I Limited- Financial Services - 4.00 - 4.00 A00 - - 1994 Yacylec _ lndustri Serfces 20.00 - 45.00 65.00 20.00 45.00 - 1995 Aceitera Food &Agribusrmss 15.00 10.00 15.00 40.00 25.00 15.00 15.00 1995 Mastellone Hermanos S A. Food & Agribusiness 40.00 - 35.00 75.00 40.00 - - 1995 MaximaS.A. AFJP FinancialServces - 10.19 - 10.19 10.19 - - i995 La Buenos Aires Vida Financial Services - 2.89 - 2.89 2.89 - 0.71 1995 La BuenosAiresRetiro FinancialServices - 1 17 - 1.17 1.17 - 0.53 1995 Kleppe,Caldero Food & agribusiness 8 00 - - 6O00 600 - - 1995 Aguas Infrastrucrure 38.00 750 134.50 179.50 4500 134.50 52.95 1995 Compania E!aborsdora de Productos Alimenticios SA. Food & agribusiness 15.00 - 6 00 21.00 15.00 6.00 - 1995 Robet Argentfna Investmwnt Capital Fund (AICF) Financi Services - 20.C0 - 20.00 20.00 - 17.73 1995 Robrts Argentina Investment Fund Manager Financial Sers - 0.15 - 0.15 0.15 - 0.13 1998 Soema HoldingComoeny 24.99 15.00 60.01 100.00 39.99 - 24.99 1995 Cadesa Supermarkem 28.00 - - 28.00 28.00 - 20.00 Toti G,oa Commitmet b/ 1152.90 181.00 96.61 220.6 Less: Cancellations. Terminatons. Repayment & Sales 481.57 8.19 297.95 785.72 Total Commitments Now Held cl 71 .43 174.32 667.65 1,513.89 848.24 687.65 205.56 Pendina Commitments AECSA 20.00 - 61.00 81.00 Emprcsa Distrbuidora Indust-l Services - - 8.00 8.00 Gasinvet Inira ucture - 20.00 - 20.00 Nahuslsat Infrastruture 30.00 5.00 - 35.00 Sancor Food &agribusinem 20.00 20.00 30.00 70.00 Transconor Infrsatructure 25.00 - 80.00 105.00 Tucuman Infrsructure - 0.30 - 0.30 sub-total 95.00 45.30 179.00 319.30 TOrl Commrn en Held and Pendig Commitments 766.43 20.1 2 84eJ65 1,833.19 Tobd Undcmbsed Commbenm 92.02 44.28 69.25 205.56 a, Investmens wthich have been fully cancelled, terminated. writen-otf. sold, reaeemed or repaid. bi Gross Commitments consist of approved and signed projects. cl Held Commitments consist of disbursed and undisbursed investrnern. ARGENTINA BANK REFORM LOAN Policy Matrix Objective/Action Accomplished Effectiveness Second Tranche | Third Tranche Macroeconomic * Agreement with IMF on * Maintenance of a sound * Maintenance of a sound 0 Maintenance of a sound Stability extension of EFF program. macroeconomic framework macroeconomic framework macroeconomic framework consistent with policy objectives consistent with policy objectives consistent with policy objectives and program described in the and program described in the and program described in the Letter of Development Policy. Letter of Development Policy. Letter of Development Policy Banking Reform 0 Limited Deposit Insurance * Crisis resolution procedures * Deposit Insurance scheme is * Deposit Insurance scheme is scheme established (4/18/95). are being implemented in working properly. working properly. accordance with program * Adoption of revised portfolio objectives. * Crisis resolution procedures * Crisis resolution procedures classification system. are being implemented in are being implemented in * Agreement on enhanced accordance with program accordance with program * Tightened capital adequacy surveillance and inspection objectives. objectives. requirements to 11.5% as of schedules. 1/1195. * Maintenance of enhanced * Maintenai,ce of enhanced surveillance and inspection surveillance and inspection * Legislation passed augmenting schedules. schedules. powers of BCRA to intervene banks. * Adoption by the SEF of an * Satisfactory progress in agreed action program. implementing the SEF action | c * Introduction of enhanced program. surveillance and inspection system. Trust Fund Operations * Legal basis for the Bank 0 Operational Principles and a Trust Fund is operating in * Trust Fund is operating in Capitalization Trust Fund Procedures (OPP), agreed with accordance with agreed OPP, accordance with agreed OPP, established. the Bank, have become effective has received adequate funding, has received adequate funding, and been used in at least one and its objectives are being and its objectives are being * Funding for the Trust Fund eligible transaction. achieved. achieved. from patriotic and international bonds secured. a Adequate funding for the 0 An agreed level of eligible * An agreed level of eligible Trust Fund is assured. transactions has been achieved. transactions has been achieved. * Failure Resolution process begun with suspension of a total a Restructuring and exceptional * Restructuring and exceptional of 10 banks (4/24/95). transactions are within agreed transactions are within agreed caps. caps. * Positive ex-post review of * Positive ex-post review of transactions according to agreed transactions according to agreed X benchmarks. benchmarks. * Annual financial audit review * Annual financial audit review of Trust Fund operations. of Trust Fund operations. - 39 - ARGENTINA ANNEX D BANK REFORM LOAN KEY MACROECONOMIC INDICATORS Macroeconomic Account, - Prolonged regional crisis scenario (In percent unless otherwise epecifled) 1993 1994 1995 1998 1997 1996 1999 2000 2001 2002 2003 2004 National Accounts: GDP growth 6.0 71 0.0 2.0 3.0 3.5 4 0 4.5 4.7 5.0 5.2 5.3 Growtaol p/capita pav. consumpt 31 51 (25) 06 1.1 1.0 09 1.3 1.5 2.7 3.4 4.9 GDP (USS bilion) 2554 279.6 285.1 298.0 315.0 334.1 356.2 381.2 408.7 439.4 473.3 510.4 % Share of GDP: Totallnvestrnent 184 19.9 172 17.3 17.7 18.3 19.3 20.4 21.5 221 22.3 22.3 Private 160 17.6 15.1 15.2 15.4 15.9 16.7 17.7 18.6 19.2 19.3 19.3 Public (consoldated) 2.4 2.3 2.1 2.2 2.2 2.4 2.6 2.7 3.0 3.0 3.0 3.0 Nabonal Savings 156 16.2 15.9 16.1 16.5 17.3 18.3 19.3 20.4 20.9 21.1 21.0 Prvate 13 6 15.3 14.9 14 3 14.4 15.0 15.8 16.6 17 6 17.9 17.8 17.4 Public (consoddated) 2.0 1 ° 1.1 1.8 2.1 2.3 2.5 2.6 2.8 3.0 3.3 3.6 Foreign Savmngs 2.8 37 1.2 1.2 1.2 1.0 1.0 1.2 1.1 1.2 1.2 1.3 ICOR (lagged) 3.3 3.0 (23.1) 10.0 6.7 5.9 5.3 5.0 5.1 5.0 5.0 4.9 Federal Public Sector (cash basis as % of current GOP): TotalCurrentRevenues 12.3 12.9 12.3 12.5 12.7 12.6 12.5 12.4 12.3 12.3 12.3 12.3 TotaICurrentExpendittresa/ 12.1 11.8 11.9 11.6 11.8 11.6 11.5 11.3 11.2 11.1 11.0 10.9 Interest Expenduraes 12 1.2 1.4 1.3 1.5 1.5 1.4 1.3 1.3 1.2 0.9 0.8 Social Secunty Savings 1.0 (0.5) (0.5) (0.5) (0.4) (0.4) (0.4) (0.4) (0.4) (0.5) (0.5) (0.5) PE Noninterest Savings 0.3 0.0 0.0 0.0 0.1 0.1 0.1 0.1 0.1 0.0 0.0 0.0 Pubic Savngs 1.5 0.5 (0.1) 0.4 0.6 0.6 0.7 0.7 0.7 0.7 0.8 0.8 Capital Revenues 1.0 0.3 0.6 0.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Capital Expenditures 1.0 1.0 0.7 0.7 0.7 0.7 0.8 0.8 0.9 0.9 0.9 0.9 NonfinancialPubflcSector 1.5 (0.2) (0.1) (0.1) (0.1) (0.1) (0.1) (0.1) (0.1) (0.1) (0.1) (0.1) Quasi-Fiscal Surplus 0.1 01 0.1 0.1 0.1 0.2 0.2 0.1 0.2 0.2 0.2 0.2 Overal Balance 1.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Memo: PnmarySurplus 2.7 1.1 1.3 1.2 1.4 1.3 1.3 1.2 1.1 1.1 0.8 0.7 Pnmary Surplus (USS M) 6.954 2,962 3,571 3,517 4,402 4.431 4,474 4,563 4,616 4,666 3,687 3,696 OperatonalPrim.Surplus(US$ M) 4,486 2,229 1,971 2,917 4,402 4,431 4,474 4,563 4,616 4,666 3.687 3,696 Interest Expenditures (USS M) 3,076 3,403 3,958 3.797 4,753 4,888 4,975 5,047 5,138 5.233 4,246 4,309 Operebonal Prim. Surplus Coverage Rato b/ 1458 65.5 49.8 76.8 92.6 90.7 89.9 90.4 89.8 89.2 86.8 85.8 Balance of Payments: ExportsGGNFS(realgrowth rate) 6.8 11.2 18.2 70 7.1 71 72 7.2 7.3 74 7.4 7.4 ExportsofGNFS/Current GDP 6.4 6.8 8.1 8.3 8.6 9.0 9.3 9.6 9.8 10.0 10.1 10.3 ImportsGNFS(realgrowthrate) 11.4 19.5 (11.7) 5.0 4.1 4.1 4.9 5.7 6.0 61 5.9 5.8 Imports of GNFS/Current GDP 8.2 9.2 8.0 8.2 8.3 8.4 8.5 8.6 8.7 8.8 8.9 8.9 Trade Balance (USS M) (3.668) (5,805) 303 628 1,514 2.581 3,642 4,676 5,569 6,613 7,941 9,494 Current Account Balance (USS M) (7,154) (10,365) (3,496) (3,704) (3.673) (3,257) (3.703) (4,387) (4,609) (5.442) (5.669) (6,505) Capital Account Balance (USS M) 11,988 10,903 301 4,362 4,492 3.924 4,482 5.289 5,465 6.124 6,422 7,326 Public 2,997 1,924 3,557 864 573 1.345 1.755 1,652 1,570 1.725 2,877 3,458 Private 8,991 8,979 (3,256) 3,498 3,919 2,579 2.727 3.637 3,895 4,399 3,545 3,869 CurTentAccountBalance/CurrentGDP (2.8) (3.7) (1.2) (1.2) (1.2) (1.0) (1.0) (1.2) (1.1) (1.2) (1.2) (1.3) Debt Indicators: Total Debt(USS M) 87.499 97,055 99,925 103,286 107,011 108,531 110.125 112,593 115,478 119.092 122,057 125,649 ForeignDebt(USSM) 74.660 84,325 86.989 89.767 92,743 94.912 97.394 100.492 103,765 107,697 111,927 117,062 DoomesbcDebt(Fed. Pub. Sector-USSM) 12.839 12,730 12,936 13,519 14,269 13,619 12.731 12.101 11,713 11,395 10,130 8,588 Total Federal Pubbc Sector Debt 70,071 70.896 75.010 75,987 76,957 77,191 77,447 77,755 78,164 78.744 79,517 80,535 Foreign Debt 57,232 58,166 62,074 62.468 62.688 63,572 64.717 65.654 66.450 67.349 69,386 71,947 of whlch: LT Pub. & Pub. Gted. 57.231 58,165 62,073 62,468 62,688 63.571 64.716 65.653 66,450 67,348 69.386 71,947 Domestc Debt 12.839 12.730 12,936 13.519 14,269 13.619 12,731 12,101 11,713 11,395 10,130 8,588 Total DebtVCurrent GOP 34.3 34.7 35.1 34.7 34.0 32 S 30 9 29.5 28.3 27.1 25.8 24.6 Foreign Debt 29 2 30.2 30.5 30.1 29.4 28.4 27.3 26.4 25.4 24.5 23.6 22.9 Federal Public Seclor 22 4 20.8 21.8 21 0 19.9 19.0 18.2 17.2 16.3 15.3 14.7 14.1 Private Sector 68 9.4 8.7 9.2 9.5 9.4 9.2 9.1 9.1 9.2 9.0 8.8 Domestc Debt (Fed Pubic Sector) 5 0 4 6- 45 4.5 4.5 4.1 3.6 32 2.9 2.6 2.1 1.7 Foreign Debt Service/Exports GNFS 46.7 48.9 53.7 51.0 50.7 46.9 48.2 47.1 44.6 41.8 38.0 37.2 Memo: IBRD Exposure indcators IBRDDStXGNFSdi 3.5 37 2.5 2.8 2.5 2.5 2.3 2.1 1.9 1.7 1.6 1.4 IBRO DS/MLT Frgn. Pub. Guaranteed OS ea 84 97 6.5 7.6 6.8 75 6.5 6.0 5.7 5.4 5.6 5.2 Pref. Cred. OS/MLT Fgn. Pub. Guar. DS fl 24.5 27.1 23 7 25 6 24.6 26.0 24.6 23.4 21.9 20.3 19.5 17.7 Share of IBRD Portfolio(%) 36 3.6 4.5 5.0 49 4.9 4.8 4.6 4.4 4.0 3.8 3.6 Money and Prices: Domestc Infeafon Index (annual c-) g/ 6.3 22 3.0 2.5 2.6 2.5 2.5 2.4 2.4 2.4 2.4 2.4 CPI intaton lV 7.5 39 3.5 1.6 2.3 2.3 2.3 2.2 2.2 22 2.2 Z2 RealExchangeRateIndex(1987=100) 489 493 48.6 482 48.2 48.2 48.2 48.2 48.2 482 48.2 48.2 LIBOR i 3 4 4.9 6.3 6.1 6.3 6.3 6.3 6.3 6.3 6.3 6.3 6.3 MI/CurrentGOP 5.9 6.4 62 6.3 6.4 6.6 6.7 6.9 7.1 7.3 7.4 7.6 as Includes Public Enterprises interest payments. bl Operafonal Pnrmary SurpkluDomestc and Foreign Interest Paymentr of the Publc Setor. c/ Preferred Credtors are World Bank, IMF and IDB. 4t Bai* guidetines inducate ths rado shortd not exceed 4% for high risk, 5% for moderate nsk and 6Y1 for lower rlsk counties. Argerrdna is curmeny classitfed as s igh risk country. el This redo should not exceed 20%. Debt service must be foreign publicly guaranteed, matume and long term. f/ This rado should not exceed 35%. Preferred credtors are World Bank, IMF and IDB. gt GOP deadator (penod average). Iv End of year. i/ Penod average LIBOR. -40- ANNEX E ARGENTINA BANK REFORM LOAN KEY FINANCIAL NDICATORS BROAD MONEY (M4) AND COMMERCIAL BANK LOANS Year Month Currency+ Loans M4/GDP Loans/GDP Deposits ($ million) ($ million) 1991 January 9,221 20,370 7.6% 16.8% l__________ February 9,746 22,049 7.4% 16.8% March 10,657 23,266 7.5% 16.4% April 11,954 24,365 7.8% 15.8% May 13,131 25,213 7.9% 15.1% June 13,947 26,401 7.7% 14.6% July 14,609 27,165 7.9% 14.7% August 15,452 27,874 8.2% 14.8% September 16,287 28,641 8.5% 15.0% October 17,260 29,354 8.9% 15.1% November 18,139 30,140 9.1% 15.2% December 19,379 30,940 9.6% 15.3% 1992 January 20,518 31,708 9.9% 15.4% February 21,584 32,317 10.3% 15.4% March 22,263 33,149 10.4% 15.5% April 23,082 34,278 10.6% 15.7% May 24,733 35,363 11.1% 15.9% June 26,442 35,695 11.7% 15.7% July 27,773 36,505 12.1% 15.9% August 28,624 37,978 12.4% 16.4% September 29,450 39,465 12.6% 16.9% October 30,166 39,739 12.8% 16.9% November 30,664 41,578 12.9% 17.5% December 31,490 42,635 13.1% 17.7% 1993 January 33,172 43,749 13.7% 18.0% l__________ February 34,290 44,952 14.0% 18.3% - 41- ANNEX E Year | Month | Currency+ Loans M4/GDP | Loans/GDP [ Ye|r Month Deposit Loans March 35,444 47,393 14.3% 19.1% April 36,366 47,915 14.5% 19.1% May 37,847 46,146 15.0% 18.3% June 38,818 46,871 15.2% 18.4% July 40,615 48,272 15.8% 18.8% August 42,819 48,579 16.5% 18.8% September 44,248 49,732 17.0% 19.1% October 44,660 49,493 17.0% 18.8% November 45,937 49,770 17.4% 18.8% December 47,162 51,226 17.7% 19.2% 1994 January 49,429 52,074 18.4% 19.4% February 50,246 53,370 18.6% 19.7% March 50,591 53,770 18.6% 19.7% April 50,629 54,492 18.4% 19.9% May 51,161 55,531 18.5% 20.1% June 51,784 55,957 18.6% 20.1% July 53,003 56,802 18.9% 20.3% August 53,426 57,135 19.0% 20.3% September 53,954 58,109 19.1% 20.6% October 54,223 58,196 19.1% 20.5% November 54,616 59,702 19.1% 20.9% December 55,715 60,009 19.4% 20.9% 1995 January 54,507 59,709 18.9% 20.7% February 52,618 59,150 18.2% 20.4% March 48,995 57,300 16.8% 19.7% April 48,652 55,358 16.6% 18.9% Note: M4 includes currency and peso and dollar sight and fixed-term deposits. -42- ANNEX E DEPOSIT AND LENDING RATES Year Month DoDar Peso Interbank Prime Primne Average Average Annual Rate on Rate on Rate Dollar Peso Peso Dollar Inflation l ~~~~~~~Monthly Monthly Lending Lending Lending Lending Rate l_________ j Deposits Deposits Rate Rate Rate Rate 1991 January 8.3% 148.3% 251.5% 193.2% 8.0% 178.2% l_______ February 6.9% 196.1% 237.1% 252.0% 10.8% 2801.7% March 6.3% 193.3% 184.3% 205.2% 10.9% 94.5% April 6.5% 22.5% 15.1% 51.6% 11.0% 49.4% May 6.9% 23.1% 31.7% 56.4% 11.8% 25.3% June 6.2% 28.2% 20.8% 46.8% 12.1% 28.3% July 6.9% 29.2% 29.9% 49.1% 10.6% 19.6% August 6.3% 24.7% 15.1% 42.0% 10.6% 6.2% September 5.8% 18.9% 20.5% 43.2% 9.5% 14.0% October 6.2% 17.8% 15.6% 38.5% 10.7% 14.0% November 6.0% 18.1 % 14.0% 37.3% 10.0% -2.4% December 6.5% 19.8% 20.3% 46.8% 10.8% -2.4% 1992 January 6.7% 17.8% 17.4% 37.3% 12.2% 22.4% February 6.0% 15.9% 9.6% 34.9% 12.2% 16.8% March 6.5% 15.6% 11.0% 32.5% 12.5% 23.9% April 6.3% 15.7% 13.4% 32.5% 12.2% 8.7% May 6.2% 15.8% 11.1% 31.3% 12.0% 4.9% June 6.0% 14.6% 7.2% 28.9% 12.6% 10.0% July 6.0% 15.0% 14.8% 33.7% 12.1% 16.8% August 6.4% 15.3% 11.3% 31.3% 11.4% 14.0% September 6.3% 15.6% 12.6% 30.1% 11.6% 11.4% October 6.3% 16.4% 13.2% 28.9% 11.6% 8.7% November 5.8% 18.4% 24.1% 30.1% 8.4% -8.1% December 6.7% 25.3% 33.6% 33.7% 14.0% -1.2% 1993 January 6.5% 20.1% 12.0% 30.1% 12.8% 10.0% February 6.3% 15.9% 5.2% 28.9% 11.8% 10.0% March 6.4% 13.0% 4.3% 26.5% 12.8% 1.2% April 6.6% 11.6% 5.9% 8.2% 10.8% 25.4% 11.8% 11.4% l_______ May 6.5% 10.5% 4.7% 7.7% 10.2% 24.2% 12.6% 10.0% -43 - ANNEX E Year Month DoUar Peso Interbank Prime Prime Average Average Annual Rate on Rate on Rate DoUar Peso Peso Dolar Inflation Monthly Monthly Lending Lending Lending Lending Rate Deposits Deposits Rate Rate Rate Rate June 6.3% 9.9% 6.0% 7.8% 10.5% 24.0% 12.4% 3.7% July 6.4% 11.0% 8.5% 8.4% 11.9% 24.5% 11.8% 1.2% August 6.2% 10.0% 4.8% 7.5% 9.9% 22.0% 12.7% 2.4% September 6.0% 8.8% 6.3% 7.5% 9.9% 22.5% 12.4% 4.9% October 5.9% 8.4% 5.7% 7.5% 9.7% 22.0% 11.9% 6.2% November 5.8% 8.1% 5.6% 7.3% 9.2% 21.7% 12.0% -8.1% December 5.8% 8.7% 6.7% 8.1% 10.4% 24.0% 12.4% -7.0% 1994 January 5.7% 8.1% 4.9% 0.7% 9.1% 22.0% 12.1% 0.0% February 5.5% 6.4% 4.5% 7.1% 8.2% 21.0% 11.4% -1.2% March 5.5% 7.0% 5.7% 7.6% 8.6% 20.8% 12.5% -1.2% April 5.5% 7.7% 8.3% 8.3% 10.2% 22.5% 11.6% 4.9% May 5.6% 7.8% 8.7% 8.3% 10.3% 22.5% 11.8% 6.2% June 5.7% 8.1% 7.9% 8.4% 10.3% 22.5% 12.5% 12.7% ________ July 5.8% 8.4% 9.0% 8.4% 10.6% 23.5% 11.8% 10.0% August 5.8% 8.6% 7.6% 8.3% 10.3% 23.0% 12.7% 3.7% September 5.7% 8.3% 6.2% 8.1% 9.7% 22.7% 6.2% October 5.7% 8.3% 7.5% 8.2% 9.8% 23.0% 6.2% November 5.8% 8.7% 7.5% 8.3% 10.0% 23.5% 7.4% December 6.1% 9.8% 14.1% 9.8% 13.6% 30.0% 6.2% 1995 January 6.5% 10.8% 12.7% 11.3% 17.7% 35.0% 16.8% February 7.0% 11.8% 12.1% 12.1% 19.1% 45.0% -2.4% March 8.0% 19.5% 23.2% 22.8% 33.9% 65.0% 2.4% April 19.6% 12.3% 65.0% -1.2% - 44 - ANNEX F ARGENTINA BANK REFORM LOAN OPERATING PRINCIPLES AND PROCEDURES GOVERNING BCTF ASSISTANCE FOR ACQUISITION OR MERGER 1. BCTF is established to facilitate and finance an orderly transfer of assets and liabilities from weak banks to financially and managerially strong banks. It will provide no financing without a strong prospect of the bank's recovery. 2. BCTF will provide financing for acquisition of weak banks, or their segregated assets and liabilities as determined by Article 35 bis of the of Law Financial Entities on behalf of the Central Bank. BCTF will not purchase or hold the same on its own account, except in exercise of its collateral rights. 3. Typically, BCTF will finance acquisitions of banks that have received extraordinary liquidity assistance from BCRA or BNA and are rated 4 or 5. 4. If necessary, BCRA request the audit of the bank to be sold prior to BCTF financing, by an auditor acceptable to BCRA. Such an audit shall be requested for the sale of whole or part of a suspended bank, on the basis of Article 35 bis of the LFE. The auditor will offer an opinion concerning the fair market value of the assets and liabilities to be sold and will certify that insiders are not treated in a preferential manner. 5. To ensure financially sound and well-managed entities after acquisition or merger, the acquiring banks must have a current rating of 1 or 2 and comply with capital adequacy and liquidity requirements. In the case of mergers, a bank rated 3 can be considered provided BCRA submits evidence to verify the level of tier one capital, capital adequacy in light of current asset values, the strength of management, and the business viability of the merger entities. The Superintendency will assess and verify that (i) the acquiring bank has the financial and managerial capacity to undertake the transaction successfully, (ii) the financial risks to BCTF of the transaction are acceptable, and (iii) the managers and principal owners of the acquiring/merged entity meet the "fit and proper" qualifications. Any 3-rated bank will submit a business development plan within 60 days of receiving Trust Fund resources. 6. The BCTF may also undertake financing in the context of restructurings, provided that the bank is eligible by virtue of having (a) minimum tier 1 capital requirements, (b) adequate management and business base, and (c) agreeing to undertake an institutional diagnostic of its difficulties. In receiving BCTF financing, the bank will have verified that it meets all capital adequacy requirements without counting BCTF financing, that BCTF funding will be matched one for one by new ownership capital, and that it is willing to comply with an Institutional Development Plan to be monitored by the SEF. BCTF loans for restructuring will not exceed 10 percent of the volume of resources available to the Fund. 7. Recapitalization (subordinated) loans will not exceed 25 percent of the risk- weighted assets (RWA) for assets being acquired, 15 percent of RWA for assets involved - 45 - ANNEX F in the case of a merger, or 10 percent of RWA for assets of a restructured bank. BCTF's secured loans will not exceed the amount of outstanding loans from or on behalf of the BCRA. BCTF assistance will require banks to repay all such extraordinary loans in the terms agreed with BCRA. 8. BCTF financed transactions will use competitive and transparent procedures for qualified bidders. 9. BCTF will only finance an acquirer in a qualifying acquisition or merger transaction through either subordinated loans of 8 years maturity (meeting tier two capital definition) and/or secured loans of up to 3 years. BCTF will determine the type of each loan and their maturities, to ensure viability of the merged entity, and keep subordinated loans to the minimum possible. BCTF will not provide direct equity/preferred capital; however, both kind of loans may be convertible to equity at terms fixed by BCTF. All refinancing of BCRA or BNA extraordinary assistance will be done in conjunction with transactions described in these principles. 10. To prevent continued dependence of acquiring/merging bank(s) on official support, the restructuring plan will be adequately financed. BCTF will obtain an opinion from the Superintendency that the consolidated post-acquisition/merger bank can satisfy the normal prudential regulations for capital adequacy, provisioning, portfolio classification, liquidity, and interconnected lending. 11. Loans will be denominated in US dollars with an interest rate for merger and acquisition recapitalization loans equal to at least the World Bank rate plus a spread of 0.5-1.0 percent per year and for other recapitalization loans and all refinancing loans equal to the cost of Argentina bonds plus a spread of 0.5-1.0 percent per year. 12. The BCTF may on a case-by-case basis consider other transactions which meet BCTF objectives, but these will require prior review by the World Bank, and will in aggregate volume not exceed 5 percent of the resources of the BCTF. -46- ANNEX G ARGENTINA BANK REFORM LOAN ARGENTINE BANKING SYSTEM STATISTICS Table 1 - Banks 1991-95 Number of Banks 3/31/91 12/31/94 2/28/95 4/15/95 Federal 4 3 3 3 Provincial/Municipal 29 29 29 29 National/Private 56 67 66 57 Foreign 30 31 31 31 Cooperatives 46 38 36 20 Sub-Total 165 168 165 140 Finance Companies 29 22 20 n/a Credit Unions 20 15 15 n/a TOTAL 214 203 200 140 Table 2 - Branches 1991-95 Number of Branches 3/31/91 2/28/95 Federal 941 599 Provincial/Municipal 970 1,102 National/Private 1,104 1,273 Foreign 372 394 Cooperatives 807 894 Sub-Total 4,194 4,262 Finance Companies 32 38 Credit Unions 4 21 TOTAL 4,230 4,321 -47- ANNEX G Table 3 - Bank Employees 1991-95 Banks 3/31/91 2/28/95 Federal 42,112 17,904 Provincial/Municipal 33,598 39,544 National Private 27,666 33,049 Foreign 12,690 13,738 Cooperatives 17,520 18,006 Sub-Total 133,586 122,142 Finance Companies 1,366 1,148 Credit Unions 312 308 TOTAL 135,264 123,598 Table 4 - Total Deposits and Credits as of 2/28/95 (US$ million) Banks Total Loans Deposits Assets Federal 18,533 10,775 6,797 Provincial/Municipal 19,418 13,064 11,255 National Private 26,793 18,148 14,606 Foreign 14,800 9,746 8,138 Cooperatives 6,422 4,714 4,281 Sub-Total 85,968 56,447 45,077 Finance Companies 1,272 626 380 Credit Unions 153 119 78 TOTAL 87,393 57,192 45,535 -48- ANNEX G Table 5 - Consolidated Balance Sheet of the Argentine Financial System as of 02/28/95 (US$ million) ASSETS LIABILITIES Cash/Banks 9,360 Deposits 45,535 Public Bonds 2,747 Interbank Loans 25,177 and Borrowings Loans 57,192 Other Liabilities 2,837 Interbank Loans 8,017 Total Liabilities 73,549 Investments 1,480 Fixed Assets 3,764 Other Assets 4,833 Net Worth 13,844 TOTAL 87,393 TOTALS 87,393 _49 _ ANNEX C TABLE 6 RANKIING OF BALNKS BY TOTAL ASSETS AS OF 2/23/95 (USS 000's) Ba-: .:. . .: - - ..... ..... -I:. :..-:. ........::-:--: 001 001 00011 NACION 12.970,488 002 005 00044 HIPOTECARIO 3.833,076 003 016 00039 C.AJA DEAHORRO 1,102.080 004 029 00300 BCO. DE INVERSION Y COM. EXS'TERIOR (BICE) 627,429 * -- ...... .. ,...... .. .. , ..... ... s.... .... .. . . . ... .... .. 001 002 00014 BUENOS AIRES 6,855.247 002 010 00020 CORDOBA 1,891,741 003 012 00029 CIL-DAD DE BUENOS AIRES 1,698,845 004 017 00061 MENDOZA 1,091,573 005 019 00081 SOCIAL DE CORDOBA 819,399 006 023 00071 S.ANTA FE 757,614 007 028 00075 PREVISION SOCIAL MENDOZA 639,050 008 031 00093 LiA PAMIPA 553,436 009 035 00098 MIISIONES 504,355 010 037 00083 C-ELBIJT 453,805 011 039 00097 NEUQUEN 421334 012 044 00086 SANTA CRUZ 379,997 013 046 00059 ENRE RIOS 359.631 014 047 00024 RIO NEGRO 347,632 015 050 00060 TUCUM AN 332,269 016 051 00095 FOR-MOSA 326,112 017 053 00045 SAN JUAN 313,992 0IS 068 00094 CORRIENTES 203,500 019 on 00268 TIERRA DEL FUEGO 194,455 020 079 00148 MLNICIPAL DE LA PLATA 154,593 021 084 00092 CATAMARCA 146,053 022 085 00049 JUICY 144,467 023 087 00089 SALTA 141.678 024 105 00085 SA-N LUIS 117,495 025 123 00087 SANTIAGO DEL ESTERO 76,467 026 124 00100 MfUNICIPAL DE PARA.NA SEMICFA 71.257 027 128 00065 MUNICIPAL DE ROSARIO 65.370 02S 132 00066 NIUNI CIPALDETUCUMAN 61,702 029 168 00309 NUEVO BANCO DE LA R1OJA 20,248 030 169 00141 SXNTAFESINO 20.066 PUYTh 14hIOhL BaE - pOIDsE NOIA - iL) : - ... .:. 001 003 00007 GALICIA 4,454.409 002 004 00072 RIO DE LA PLATA 4,285,841 003 003 00017 FRANCES 2.328,250 004 009 00012 CREDITO ARGENTINO 1,957,911 005 011 00150 ROBERTS 1,812,936 006 015 00043 QUILMES 1.221,139 007 0IS 00067 DEL SUD 1,073,344 003 024 00255 SUQUIA 745,253 009 030 00275 REPUBLICA 568.516 010 033 00034 MERCANIL 547,882 011 036 00238 UN'IBANCO 460,501 012 042 00229 BEEN AYRE 399,243 013 043 00153 GENERAL DE NEGOCIOS 393,076 014 042 00251 FEIGIN 345,S34 - 50 - ANNEX G TABLE 6 RANKING OF BANKS BY TOTAL ASSETS AS OF 2/22/5 (USS 000's) ~~~~~ME O ...................... ...... , , ,, ., . v , ......... . ,. ;;, ; ;.. .*~~~~~~~~~~~~~~....... . . *.. ... 001 006 00016 CITrBANK 2.S76,334 002 007 00015 BOSTON 2,733,751 003 013 00001 DELTSCHE 1,428.5t8 004 014 00265 NAZIONALE DEL LAVORO 1.223,731 005 020 00050 CREDIT LYONNAIS 812.971 006 025 00010 LLOYDS 715.521 007 026 00002 SHAW 689.005 003 027 00165 MORGAN 640,920 009 032 00006 SDAIMERIS 549.774 010 034 00005 HOLANDES 509,095 011 040 00027 SUTPERVIELLE 417,917 012 056 00025 SANTANDER 294,522 013 053 00013 POPULAR ARGENTENO 260.567 014 064 00003 ELROPEO 222,937 015 075 00263 CHENMICAL 175.165 016 077 00266 NATIONALE DE PAfUS 161,469 017 023 00042 CHASE 148.903 013 099 00267 REPUBLIC NAT BANK OF NY 123.997 019 107 00046 DO BRASIL 112.980 020 110 00259 ITAU 99,488 021 111 00253 NEW YORK 99,029 022 116 00018 TOKYO 37.726 023 117 00262 CONTINENTAL BANK NATIONAL 87,439 024 137 00260 E.XTERIOR 54,031 025 133 00294 INTERNAT NEDERLAN BANK rNV 53.439 026 143 00303 TRANSANDINO 44,486 027 145 00236 SAO PAULO 39,540 023 157 00269 REPUBLICA ORIENTAL DEL URUGUAY 27.361 029 165 00019 THE ROYAL BANK OF CANADA 21.607 030 178 00256 CMCORP 14,554 ciX< ~~~~~~~. . .:.. :' .. . ....... ....... :: :-: . :.:..........: : .... :: f': .:'. fi: f.'.' 001 021 00206 INTEGRADO 309.020 002 . 022 00191 CREDICOOP 7S2.119 003 033 00135 LNION COM. E lND. (BUCI) 435387 004 045 00162 MIAYO 377,136 005 054 00040 CASEROS 312,34 006 055 00179 ALMAFUERTE 310.701 007 059 00249 EL HOGAR DE PARQLTE PATRICIOS 260,535 003 062 00156 BICA 231,117 009 065 00176 COINAG 221.679 010 070 00205 INDEPENDENCIA 198.075 011 071 00175 SLDECOR 197,010 012 073 00219 DE LOS ARROYOS 133,539 013 073 00108 DEL ESTE 161,131 014 032 00136 NOROESTE 149.065 015 093 00137 EMPRESARIO TUCLUMAN 133.054 016 094 00139 NOAR 13239 017 101 00200 INSTIUCIONAL 126.809 013 103 00220 CARLOS PELLEGRLNI 122511 019 103 00234 LOCAL 108.231 020 109 00126 RLRAL SUNCHALES 104,412 021 115 00055 COOP. DE LA PLATA 90,349 - 51 - ANNEX G TABLE 6 R"NKING OF BANKS BY TOTAL ASSETS AS OF 212W95 (USS OOOs)- 015 049 00271 VELOX 345313 016 052 00287 MEDEIN 318.434 017 057 00140 FEDERAL 265,607 OIS 060 00056 CREDITO PROVINCIAL 253.507 019 061 00054 CO.%iERCLkL ISRAELITA 240,217 020 063 00062 ISRAELITA DE CORDOBA 225.024 021 066 00285 MACRO 216.119 022 067 00299 COMAI 215,942 023 074 00231 LINIERS 176.293 024 076 00254 NIARIVA 163.005 025 010 00110 CORONEL DORREGO 152.204 026 031 00286 MILDESA 150.190 027 03t 00277 SAENZ 140.621 028 089 00105 COM. DE TANDIL 13S.660 029 091 00115 OLAVAPRUA 135,5S2 030 092 00198 VALOR.ES 133.775 031 095 00297 EXPRINTIR. 131.595 032 096 00293 AUSTRAL 131.017 033 097 00147 I.NTERFNA-NZAS 130.177 034 093 00301 Pl.kNO 129.564 035 100 00235 COOPESUR 126,237 036 102 00279 PROVENCOR 123.777 037 104 00113 EDIFICADORADEOLAVARRiA 121.235 038 106 00064 MONSER.RAT 116.153 039 112 00133 CREDITODECLYO 9S.014 040 113 00280 FLORENCIA 91,221 041 114 00130 POPULAR FNANCIERO 91.204 042 11S 00292 MULTICREDITO 86,566 043 120 00311 NUEVO BANCO DEL CHACO S4.591 044 121 00273 LOS TILOS S2.497 045 125 00 73 IBERA 71.129 046 127 00107 CON. DE TRES ARROYOS 65,892 047 129 00161 PLATENSE 65,327 048 130 00112 AENr 63.025 049 131 00079 REGIONAL DE CUYO 62.540 050- 134 00290 CAUDAL 59389 051 135 00167 REAL 57.122 052 136 00284 BAIRES 57.053 053 141 00053 CREDITO COMERCIAL 43,445 054 144 0012S NUEVO BANCO DE AZUL 42.360 055 146 00296 BASEL 37.936 056 149 00307 MAYORISTA DEL PLATA 33.656 057 152 00247 ROELA 31.5S6 053 154 00291 DEL FUERTE 30,653 059 158 0027N ASFIN 27.565 060 160 00149 COFIRENE 27.055 061 170 00305 JLLIO 19,962 062 172 00306 PRIVADO DE INVERSION 19,569 063 173 00293 INVERSORA 18.975 064 176 00312 MBA 15.756 065 179 00310 DEL SOL 13,258 - 52 - ANNEX G TABLE 6 RALNKING OF BANKS BY TOTAL ASSETS AS OF 2/23/95 (USS 000's)- 022 122 00195 N1EVA ERA 79,164 023 126 00224 NORDECOOP 70,021 024 139 00192 HORIZONTE 52,417 025 147 00201 VALLEMAR 36,861 026 150 00210 MNERIDIONAL 32.946 027 153 00207 CES 30,967 023 155 00193 AlIANCOOP 30,482 029 159 00196 VAF 27,558 030 166 00231 RIO TERCERO 21,329 031 167 64085 LA CAPITAL DEL PLATA COO?. 20,955 032 171 00178 BALCARCE 19,875 033 174 00184 DE LAS COMUNIDADES 17,535 034 177 00166 SAIN JOSE 15,753 035 183 00172 NICOLAS LEVALLE 10,061 036 190 00180 NLCLEO 5,955 FU'C424.CO&fA.NTESAND SAVR1GS AD LOAM CO*.WNM:S . ..... 001 041 44001 ARGEMOFIN 404,050 002 069 44059 INVERCRED 201,092 003 086 44086 COLUNIBIA 142,782 004 090 44073 CORPORACION METROP. FINs.-NZAS 138,208 005 133 45056 MIONTEMIAR 61,269 006 142 44068 TUIELAR 45,915 007 151 44034 FINVERCON 32,492 008 156 44087 PECUNIA 28.414 009 161 45078 CREDITOS LUlRO 26,557 010 162 44077 BUROFINANZ 25,091 011 163 45008 LUJAN WILLIAMS 23.546 012 164 44032 FINANZAS Y MANDATOS 22,642 013 175 45085 FIDECA 15,825 014 181 44085 AGENTRA 11.350 015 182 45065 I.NASVENTAS 10,136 016 189 45125 TARRAUBELLA 6,472 017 198 45118 COFIBAL 2.016 018 199 45072 DELTUYU 1,219 019 200 44003 BULLRICH 1,04S 020 201 94026 G rULIANI 980 .. ............. .. . .... ...... ... ........... ..... .......... . . .. ........................ ... ......... . ................ .......... .......j7;;:. 001 140 64032 LA INDUSTRIAL 49,462 002 148 44019 ATLANTICO 35.592 003 180 64029 LA CAPITAL SOC. COOP. LTD.' 12.344 004 184 64055 BUENOS AIRES 9.589 005 185 64027 VILLA LURO 8,183 006 186 64112 FLORESTA 7,576 007 187 64043 TRANSMIAR 7.185 003 188 65203 CUENCA 7,092 009 191 64082 IMPULSORA 5,530 010 192 65022 DARDO ROCHA 5,353 011 193 64123 UNIVERSO 5.174 012 194 64024 PAVON 4.727 013 195 64025 VARELA 4,228 014 196 64119 VILLAREAL 2.984 0L5 197 65201 BETAM 23976 - 53 - ANNEX H ARGENTINA BANK REFORM LOAN MERGERS AND ACQUISITIONS AMONG ARGENTINE PRIVATE BANKS ACQUIRING BANK/ J BANK(S) ACQUIRED/MERGED NAME OF MERGED BANK Argencoop (merger among Cooperatives) CES, VAF, Nordecoop, Horizonte Aliancoop and Localcoop BISEL (Cooperative) De los Arroyos, Independencia, Coinag, Comunidades, Nuicleo and San Jose Banco Cooperativo de Caseros Banco del Noroeste Cooperativo Limitado Banco Integrado Departamental (BID) Bando de la Ribera and Aciso Banco Israelita de C6rdoba Banco del Credito del Cuyo Banco de Entre Rios S/A (BERSA) Banco del Este and Banco Institucional Cooperativo (BIC) Medefin Banco UNB Banco Bica (Cooperative) Banco Rural Sunchales Banco Patricios (Cooperative) Banco Nueva Era and Caja de Credito Cooperativa Buenos Aires Banco Mayo (Cooperative) Caja de Credito Dardo Rocha, Banco Cooperativo de la Plata, Banco Noar and Provencor Banco Uni6n Industrial y Comercial Banco de Credito Comercial de Santa Fe (BUCI), Mendoza (Cooperative) Banco del Sud Banco Shaw Banco del Suquia Banco Montserrat Banco de Credito Provincial Banco de Junin Banco Comercial de Tandil* Banco del Fuerte Banco de Corrientes Banco del Ibera * Merger still under negotiation as of 4/15/95 - 54- ANNEX I ARGENTINA BANK REFORM LOAN BCRA PRUDENTIAL REGULATIONS 1. The prudential regulations of the Banco Central de la Republica Argentina ("BCRA") cover the following issues: * capital adequacy and minimum capital requirements * reserve requirements * loan classification and loan-loss provisioning * operations with affiliated companies * consolidation * internal and external auditing * diversification of credit risk. These prudential regulations are summarized below. Capital Adequacy and Minimum Capital Requirements 2. The BCRA minimum capital adequacy rules, which are contained in Comunicaci6n "A" 2136 dated August 19, 1993, are based on those recommended by the Basle Committee, but are stricter than such recommendations. As from January 1, 19951 the minimum required capital for a bank is the sum of: (i) 11.5 percent of risk-weighted assets, taking into account not only the class of assets, but also the collateral for, and the interest rates applicable to, such assets; (ii) 12.5 percent of permanent fixed assets. The formula also includes a weighting coefficient ranging from 0.97 to 1.125 depending on the rating of a bank granted by the Superintendencia de Entidades Financieras y Cambiarias ("SEF") based on "CAMEL" criteria capital, asset quality, management, earnings and liquidity2. In practice, the SEF has not made these ratings public, and has not applied the differential coefficients to the capital adequacy calculation. Therefore, currently the coefficient applied is 1.00, which corresponds to bank rating category 2. The mininum capital to risk-weighted assets ratio was phased in gradually, starting with 8.5 percent in the second half of 1993, and rising I percent every six months until reaching the level of 11.5 percent as from January 1, 1995. The additional capital required in respect of permanent fixed assets acquired before June 30, 1993 was initially 30 percent, but was reduced 5 percent every six months until reaching 12.5 percent by January 1, 1995 (the level required for permanent assets acquired after June 30, 1995). 2 The specific coefficients are: rating 1: 0.97, rating 2: 1.0, rating 3: 1.03, rating 4: 1.07 and rating 5: 1.125. - 55 - ANNEX I 3. For the purpose of the BCRA regulation, "minimum capital" is equal to the sum of: (i) the "Basic Net Worth", which includes capital stock, capital adjustments, reserves, irrevocable capital contributions and retained audited earnings, and (ii) the "Complementary Net Worth," which includes general loan loss provisions for borrowers classified as "Normal", plus certain unaudited net income, less unaudited losses and less certain items such as permanent investments in other financial institutions, shareholders' receivables for uncalled capital and certain intangible assets. 4. According to BCRA Comunicaci6n 2177 (as modified by Comunicaciones "A" 2223 and 2264), subordinated debt may be treated as "tier two" capital but only up to 50 percent of "tier one" capital. In undertaking this calculation, only subordinated debt over five years' term may be counted 100 percent. The value of subordinated debt with less than five years remaining to maturity is discounted 20 percent for each year or part of a year (e.g. 3.5 years remaining would be counted 60 percent), even for issues with bullet maturities. Reserve Requirements 5. BCRA regulations currently require banks to maintain the following reserve requirements in respect of their customers' deposits in pesos or US$: Current accounts 32% Savings accounts 32% Fixed-term deposits from 30 to 89 days 3 % Fixed-term deposits over 90 days 0% Deposits for exchange operations 100% Depositors have a priority claim on banks' reserve requirements up to US$5,000 per depositor per bank. Loan Classification and Loan-Loss Provisioning 6. A much improved loan classification and loan-loss provisioning system for banks was introduced by BCRA Comunicaci6n 2216 of June 9, 1994. Under the old classification system, borrowers were classified mainly on the basis of their payment record, and the guarantees given to lenders. Under the new loan classification system, which is more comprehensive, each borrowing client, together with all its outstanding liabilities is classified in one of the five sub-categories listed below, based on the borrower's solvency and liquidity. In the case of companies, the classification is based primarily on cash flow and balance sheet analyses, whereas for personal loans it is based on the timing of payments. 7. The level of provisioning varies depending not only on the risk category of the borrower but also on whether or not the loan is guaranteed. In respect of the banks' loan portfolios as of December 31, 1994, banks have until July 1, 1995 to increase their loan-loss reserves to the required minimum levels according to the provisioning matrix below. - 56 - ANNEX I Thereafter, new provisions according to the loan classification criteria must be made immediately following a bank's periodic portfolio review, which must be undertaken by auditors independently of its lending officers. LOAN CATEGORY WITH WITHOUT GUARANTEES GUARANTEES Normal 1% 1% Potential Risk 3% 5% Substandard 12% 25% Doubtful 25% 50% Loss 50% 100% 8. The larger a bank's exposure to a borrower, the more frequent must be the review of the borrower. Exposures in excess of 5 percent of a bank's capital must be reviewed at least quarterly, and those in excess of 1 percent of a bank's capital (or US$1 million, whichever is less), must be reviewed at least semi-annually. In addition, at least 50 percent of a bank's portfolio must be reviewed by the end of each six months', and all other borrowers by the end of the bank's fiscal year, so that the whole portfolio is reviewed at least once every fiscal year. Operations with Affiliated Companies 9. The BCRA regulation intends to avoid the moral hazard which may be present in the relationship between financial institutions and their parents or affiliate companies or owners. For this purpose the term "affiliate" is defined on the basis of the degree of control (usually 25 percent or higher participation in capital). 10. The regulation restricts lending to affiliates to 5 percent of bank capital for each affiliate, and 20 percent for the whole group of affiliates. Banks cannot extend credit to related companies unless the borrower has an adequate credit rating (rated BB or better by a credit agency or normal by another bank). Consolidation 11. BCRA Comunicaci6n "A" 2227 establishes detailed rules for the consolidation for accounting purposes of the subsidiaries in Argentina and overseas of financial entities. The definition of subsidiary covers three alternatives: (i) companies in which the financial entity owns more than 50 percent of the voting shares, directly or indirectly; - 57 - ANNEX I (ii) companies in which the financial entity exerts effective control; and (iii) companies in which the majority of the directors are also directors of the financial entity. 12. This regulation is very important, given the number of Argentine banks which own domestic operating subsidiaries and offshore banks or finance companies. Internal and External Auditing 13. BCRA has issued comprehensive regulations covering the scope of periodic inspections by banks' internal auditors, the requirements for quarterly auditing of banks' accounts and the content of reports by external auditors. As of January 1, 1995 all banks will be required to close their accounting year on either June 30 or December 31 of each year. Banks are required to produce full accounts quarterly, and externally audited accounts semi- annually. Diversification of Credit Risk 14. The amount of equity participation in, and credit (including guarantees) that a commercial bank may grant to a client is subject to the following maximum limits based on the bank's equity capital: LOANS WITH WITHOUT COLLATERAL COLLATERAL Corporate and 15% 25% Individual Clients Domestic Financial 25% 25% Institutions Foreign Financial 25% 25% institutions (AAA) Foreign Financial 5% 5% Institutions (others) HOLDINGS IN OTHER LIMIT ON BANK'S LIMIT ON COMPANY'S NET COMPANIES CAPITAL WORTH Non-complementary companies 15% 12.5% Complementary companies 10% 100% Total shares and stocks 50% -58- ANNEX I 15. In addition to the above limits on the bank's capital, loans and other financing cannot, as a general rule, exceed a client's own capital. Risk concentration, defined as the sum of loans that individually represent more than 10 percent of the bank's capital, cannot exceed three times the bank's capital. - 59 - ANNEX J ARGENTINA BANK REFORM LOAN BANKING SUPERVISION PROCEDURES 1. Banking supervision in Argentina is undertaken by the Supervision Division of the Superintendencia de Entidades Financieras y Cambianias (SEF), which is a department of the BCRA. In 1994 the Supervision Division was completely restructured and the entire supervision program of off-site surveillance and on-site inspections was upgraded. 2. The main points of the banking supervision upgrade program are as follows: inspection staff numbers were increased in July 1994 from 160 to about 300 (out of a total SEF staff of 500) by hiring at various levels from the universities, banks and accounting firms; new compensation structure to attract and keep quality staff; comprehensive training program for staff at all levels, involving internal courses run by BCRA instructors, external courses in Argentina run by foreign banks, accounting firms, the Bankers' Association and the U.S. Federal Reserve Bank, and participation in U.S. courses run by the U.S. Federal Reserve Bank/World Bank; creation of six on-site inspection groups specializing in different types of financial institutions (1 for state-owned banks, 1 for small banks and non-bank financial entities, 2 for wholesale and foreign banks, and 2 for large and medium sized domestic banks). One of these groups is also responsible for systems auditing; preparation of detailed inspection manuals, with technical assistance from the New York Federal Reserve Bank; on-site inspections of all "large" financial institutions (around 120) annually, and of "small" financial institutions (around 80) every 18 months, based on "CAMEL" criteria (capital, asset quality, management, earnings and liquidity); rating of all banks into one of five risk categories (1 to 5) as per description in paragraph 6 below; daily monitoring of banks which are borrowing from BCRA under the rediscount facility or from BNA under the "safety net" facilities, a group now numbering around 70 banks (Attachment 1); - 60 - ANNEX J monthly off-site surveillance of all banks according to financial statements and other relevant data supplied to the SEF; publication of monthly financial statements for all banks. 3. Since the Supervision Division was restructured and the new inspection procedures were implemented nine months ago, 84 banks and other financial institutions have received a full inspection, and a further 20 partial inspections are underway. This comprises around half the institutions by number and about 60 percent in terms of total assets. Since the onset of the liquidity crisis after December 20, 1994 the Supervision Division has been forced to modify its timetable of regular periodic inspections in order to undertake daily monitoring of bank borrowing from BCRA and BNA, and to make available crisis management teams to be sent to banks which have been suspended (under procedures for bank restructuring and reorganization described elsewhere). 4. The periodic full on-site inspections of banks cover, inter alia, the following areas; - capital adequacy, capital accounts and dividends; - money market investments and bonds for own account; - money market investments and bonds for clients' account; - review of policies and procedures for credit assessment and loan administration; - credit review of the customer loan portfolio; - review of impaired credits and sufficiency of loan-loss reserves; - analysis of operating results; - review of asset/liability management (treasury); - review of the obligations and responsibilities of the bank's directors; - overall review of the bank's administration with emphasis on adherence to BCRA norms and regulations; - assessment of the bank's overall situation, and its future prospects. On the basis of the inspection the bank is given a rating on a scale of 1(best) to 5 (worst) according to the rating criteria described in paragraph 6 below. Currently, around 100 financial institutions have been formally rated, i.e. about half the number in the whole system. - 61- ANNEX J 5. Since the intervals between formal on-site inspections are at least 12 months, the SEF also depends heavily on off-site surveillance, which comprises a detailed analysis of monthly financial statements and other indicators, to monitor the health and progress of financial institutions in a timely manner. These monthly analytical reports cover, inter alia, - the month's operating results, compared with the previous month; - the structure of the end-month balance sheet, with particular focus on deviations from the nonn, and significant changes from the previous month; - adherence to BCRA prudential regulations covering such matters capital adequacy and loan-loss provisioning; - adherence to other norms and regulations of BCRA; and - review of a series of ratios covering, e.g., liquidity, solvency, and profitability. 6. SEF's "CAMEL" ratings for banks. The SEF has instituted a rating system for banks based on the "CAMEL" criteria used in the on-site inspections. The ratings, as described by the SEF inspection manual, are as follows: Rating 1 - the banks in this group are fundamentally sound in all respects; the observations made in the inspection are minor and may be handled in a routine manner. Such institutions can cope much better with adverse changes in economic and financial conditions than lower-rated institutions, so they do not need surprise inspections or monitoring beyond the customary procedures. Rating 2 - the banks in this group are also fundamentally sound, but they may show moderate deficiencies, which can be corrected in the normal course of operations. As the nature and seriousness of the deficiencies are not significant, the institutions can cope with economic fluctuations. Although the deficiencies may become worse, the replies of the inspectors are limited to recommendations that adjustments be made in the normal course of operations. Rating 3 - The entities in this category show a combination of financial, operational and compliance deficiencies which range from moderately serious to unsatisfactory. When the deficiencies relate to the financial situation, such entities may be vulnerable to the onset of adverse commercial conditions, and they may quickly deteriorate if concerted measures are not taken to correct the deficiencies. Institutions which are in significant non-compliance with laws and BCRA regulations will also receive this rating. Generally such entities require closer inspection to deal with the deficiencies. Nevertheless the overall financial stability and capacity of the institution are such that it is unlikely to become unviable. - 62- ANNEX J Rating 4 - The institutions in this category have an excessive number of serious financial deficiencies or a combination of other problems which are not being adequately dealt with. These difficulties may endanger the future viability of the institution and indeed constitute a threat to the interests of the depositors. There is a greater risk of the institution becoming unviable, but it is not imminent or pronounced. Entities in this category require rigorous attention from the SEF, financial monitoring and a formal plan of corrective measures. Rating 5 - This category is reserved for entities with a high risk of failure in the short term or the immediate future. The number and gravity of the deficiencies, or the insecure and unacceptable situations encountered, are so severe that urgent financial assistance is required from the shareholders or other private sources. In the absence of urgent and decisive corrective measures, institutions in this situation will probably undergo liquidation, merger or acquisition by another institution. Attachm,-n I |RPC NOV 94: - DAILY' REPORT ON BANKS WHICH ARE BORROWING FC to AmeX 1 br ..es'dente: FROM BCRA UNTDER DISCOUNIT FACILITY OR FROM Gerente General BNA L-;DER "SAFETY NET" Pnncioales Accionistas - - - Cartera vencilda desd. 24J1 2194 a la fecha: 2 7Cartera Venible a la IfcFa: _ _ DE?05srOS 4906 4432.70 210.40 1224 9961 8602 Vanacjdn al 30-Nov-94 -17 92%. -57 11% t75 06% -79 70% -8247%1 -83 CALL 7CMADO 42.00 34.31 33 14 27.60 21.15 19.781 PASES TOMAOOS 39.14 2Z94 14.61 2.20 LINEAS DE CREDITO DEL EXTERIOR sdd SJd sJd 5.00 5.00 5.00 OELIGAC:ONES NEGOCIABLES 152.00 152.00 152.00 150.00 148.00 14t.00 1 C7RAS~ ~ ~ ~ ~ CSI.PR NEM fNN 3.3 77 sid 20.20 1.110 TUO TA L PAS. FiN. 1.058.27 889.66 459.0 is8. 409.16 387.85 38 CALL 3NA 3S0r23 29 76 REDESCUENTOS 3CRA 9.50 '0-50 MSt.50 41t5Y PASESBCRA 5.50 4.~~ ~ ~~~~~~~40 10.50 13.70 116.0 ITOTAL PAS. FIN. 1.6.7 896 5.5 384 0.6 3T8 CARTERA ACT 57723 556.92 433.65 254.12 195.4J 202.37t 2- CARTE-RA ACT. Y TITUJLOS EN GARANTI sid sid sid 149.16 193.35 187.813 CALL OTORGADO 72.06 23.37 15.65 14.56 14.17 5.399 PASES OTORGAOOS 24.SS 21.75 16.30 10.72 2.40 2.40 QTROS CREDITOS POR INTERM. FfNAN. 332.40 281.07 aid sId SId 3.409 |ISPONIBILIDADES 101.41 64.48 30.06 2.43 21.34 3.77- TITULOS PUBLICOS 52.91 4.3.40 10.44 0.07 0.52 0.561 TITULOS PRIVADOS 45.97 32.00 sid 1.43 0.57 0.681 TOTAL ACT. FIN. 1.206.86 1.022.99 506.10 450.49 427.83 406.401 41. PLAZOS FIJS 0.05 0.42 0.25 0.37 0,11 1,20 CALL TOMADO 3.30 0.2t 6,00 9.51 CALL TOMAOO BNA 1 15.00 0,60 10.00 25,60 CALL TOMADO RED 2.79 2.72 PASES TOMADOS 12.22 Z22 PASES TOMADOS BCRA 16.32 16,32 REDESCUENTOS ECRA 1.30 1.30 OBLIGACIONES NEGOCIABLES ; 0° OBLIGACIONES CON EL EXTERIOR 0.30 0.32 0,62 OBLIG. Cl ACCIONISTAS, VINCUL ETC. . 00_ _ OTRAS 03LIG. POR INTERM. FINAN. 0.005i EGRESCS FINANCIEROS 22.76 17.25 9.07 0.37 10.11 ,9.56 11 CARTERA ACTIVA 3.34 3.47 2.12 5.02 0.60 15.05 CALLOTORGACO 3.11 1,50 4C1 PASES OTORGADOS _ 0.00 FiNANCIAC:ONES DEL EXTERICR __ 0,00 FINANCIACICNES DE ACCIONISTAS, ETC_ 0 0 OTROS CREDITOS 1.70 INGRESOS FINANCIEROS 8.65 3.47 3.62 5.0o 0.50 21.36 p^1S. * ~.. * . , k ,-- MEL S. *. . Vencimiences 0.36 6.09 16.60 2.62 Altas 0,05 13 89% 000% 0 00% 000% 0 00% 000% Renovaciones 0.09 6.09 16.32 1.30 2500% 10000. 0.00% 9831% 4962% 0.00% CBSERVACION: Las c:fras consolidadas no incluyen las bajas e incorporaciones contenidas en la propuesta de fusion. con respecto al incremento de cartera activa del 18/04. el mismo se produce con moUvo de registrar la cancelac.on de prefinanc. czr on redesc. cel BCRA 53.43 mill. y renovacion por S1.64 mill. a ncmbre de E: incremento de dispcnioilidades se debe a la actualizacion ce titulos puoliCoS y privados 55.10 mill. Aumen,o ce cartera activa del 19/04: te molivaco por la actualizacion de la cartera cedida en S8.91 mill.. Cartera activa y cit. en garantia: dismmnuye S1O.31 mill. (bala de la cartera cecida S8.91 mill. mas S1.4 mill. de actualizac. de tit cedidas en 6CO ~~Evolucion ce iOS aeoosio-s i7rTiiTmeciaa lai7gn-daoi .- RAUw 100 I <.o osa ~~~~~~~~- N .co~~~~~~~~ ---5c.- zGo -N ~~~~~~~~~~~~~~~~~o_ =- - 64 - ANNEX K ARGENTINA BANK REFORM LOAN SUMMARY OF DIFFERENCES BETWEEN BCRA ACCOUNTING RULES FOR BANKS, ARGENTINE GAAP AND UNITED STATES GAAP 1. The following is a description of the principal differences between BCRA rules and Argentine generally accepted accounting principles ("Argentine GAAP"), and those applicable in the United States under generally accepted accounting principles ("U.S. GAAP"). Also included are references to the United States Statements of Financial Accounting Standards (SFAS). 2. Inflation. Under Argentine GAAP, banks' financial statements recognize certain effects of inflation, including revaluation of fixed assets. This was particularly relevant during the many years of high inflation up to 1990, although of less significance since the Convertibility Plan of 1991 has come into effect. The inflation adjustments under Argentine GAAP are consistent with International Accounting Standard ("IAS") 29. Under U.S. GAAP adjustments are not made for inflation. However in their presentation of Argentine banks' accounts for listing in the U.S. market, Argentine auditors have not reversed the effect of inflation under Argentine GAAP in the reconciliation with the U.S. GAAP, since doing so would introduce large distortions. 3. Income Taxes. BCRA regulations and Argentine GAAP require income taxes to be recognized on the basis of amounts actually due and payable in accordance with Argentine tax regulations, rather than on the deferred method used under U.S. GAAP (SFAS 109). 4. Commissions on Loans. Under Argentine GAAP origination fees on loans, credit card advances and acceptances are recognized when collected. Under U.S. GAAP, loan origination fees and certain direct loan origination costs should be recognized over the life of the loan as an adjustrnent to the yield (SFAS 91). 5. Intangible Assets. BCRA regulations permit banks to amortize over three to five years the losses incurred in sales of assets (e.g. branches) and indemnities paid to employees laid off during restructurings. Argentine and U.S. GAAP require such costs to be expensed as incurred. Under Argentine GAAP, deferred expenses for setting up branches may be amortized over the term of the related lease agreements, up to a maximnum of 60 months. Under SEC rules, such expenses should be amortized over a shorter term (up to 2 years). 6. Loan Loss reserves. Until mid-1994 loan classification and loan loss provisioning in Argentine banks was governed by BCRA Comunicaci6n A 1112, which differed significantly from U.S. GAAP. However the new BCRA regulations issued in October 1994 (Comunicaciones A 2216 and 2218), which are fully effective for all financial statements as of December 31, 1994 onwards, have introduced a new methodology for loan classification and provisioning which is consistent with U.S. GAAP. Under the new methodology, -65 - ANNEX K specific provisions identified for individual loans or pools of loans are supplemented by general provisions for inherent loan losses not specifically provided for. Another important change arising from Comunicaciones A 2216 and 2218 is that interest income on non-accrual loans is no longer recognized, and any interest accruals made before a loan is past due are reversed out of profit and loss once a loan becomes 90 days overdue. This new treatment is consistent with U.S. GAAP. 7. Troubled Debt Restructuring. Banks sometimes enter into arrangements with their loan customers which represent a concession to the borrower. Under Argentine GAAP, banks account for such arrangements as new loans and charge off the difference between the old loans outstanding and the principal amounts due on the new loans. Certain of these arrangements may qualify as troubled debt restructuring under SFAS 15 of U.S. GAAP, which establishes accounting requirements for a modification of terms. Generally SFAS 15 requires that under a modification the effects of the restructuring would be accounted for prospectively and that the carrying amount of the loan would not be changed unless that amount exceeds the total cash receipts specified by the new loan agreement. 8. Acquisitions. In situations in which the consideration paid for an acquisition is less than net book value, Argentine GAAP allows the difference to be recognized in net income. U.S. GAAP does not allow this accounting treatment, but requires amortization over future years of such "good will". 9. Forward Contracts and Swaps in Securities and Foreign Currency. Purchase and sale forward contracts are accounted for under Argentine GAAP differently than under U.S. GAAP. According to Argentine GAAP, under a forward contract, banks recognize a receivable and payable at the time of the agreement which reflects the amount of cash and securities or currencies to be exchanged at the closing date. The receivable or payable is stated at the quoted market value of the securities or currencies. Under U.S. GAAP (SFAS 52 and 80), banks would not recognize a receivable or payable, but would instead recognize the difference between the change in the market price of the securities or currencies to be received or delivered if the transaction did not qualify as a hedge. - 66 - ANNEX L ARGENTINA BANK REFORM LOAN CENTRAL BANK RESTRUCTURING, CLOSURE, AND TRANSFER PROVISIONS Legal Source 1. Law 24,485 of April 17, 1995, which created the Deposit Insurance System, also amended the Organic Charter (Charter) of Central Bank of the Argentine Republic (BCRA) and the Law on Financial Entities (LFE) so as to enhance the legal framework within which the banking system could be restructured. This measure was taken so that crises may be more aptly resolved and bank depositors better protected in the future. The Charter - Liquidity Crises 2. Two paragraphs in Art. 17 (c and e) of the Charter have been amended and a new one was added to give the BCRA more powers to solve crises arising from the illiquidity of a financial entity. Art. 17, para.(c) Extension of Facilities 3. In ordinary circumstances, BCRA rediscounts of up to a bank's net worth are extended for 30 days. With the new amendment, the absolute majority of the members of the Board of Directors of the BCRA may extend the 30-day term and exceed the net worth limitation when BCRA deems it necessary to supply liquidity to the financial system or when general and extraordinary circumstances make it advisable, provided that the freely convertible reserves which support the monetary base are not compromised. Pledge of Shares and Consent to Restructuring 4. When such extraordinary rediscounts are granted, the shareholders must pledge at least a controlling number of shares in/of the grantee entity in favor of BCRA, in addition to asset-based guarantees, and must consent to the eventual application of the legal provisions on bank restructuring contained in new Art. 35 bis of LFE (see paras. 11 to 19 below). 5. In accordance with general legal provisions on the matter, the right to vote on the pledged shares is retained by the pledgor shareholders, whereas the right to receive dividends may be assigned to the BCRA if so agreed by the parties. - 67 - ANNEX L Disposal of Assets 6. Article 17, para. (e), a new paragraph, empowers the BCRA is empowered to assign, transfer and sell the credits it may have acquired from the financial entities affected by liquidity problems. 7. Also, a new paragraph b) is inserted in Art. 18 of the Charter authorizing the BCRA to entrust fiduciary trusts (to be established by the Executive Power) or specially authorized financial entities with the management and transfer of financial assets and liabilities. Total or Partial Transitory Suspension of a Financial Entity 8. Art. 49 of the Charter has been amended and restated to provide that the Superintendent of Financial Entities may, if prior authorization is obtained from the chairman of the board of directors of the BCRA, resolve the total or partial transitory suspension of operations of one or more financial entities, for a maximum term of 30 days. This term may be extended for up to 90 days if proposed by the Superintendent and approved by the Board of the BCRA. Some Effects of Suspension 9. While the suspension term is current no attachments or executory actions can be brought against the suspended entity. Likewise, during the suspension period any undertaking or obligation which may increase the liabilities of the entities shall be null and void; and the demandability of liabilities and accrual of interest shall be suspended, except for those corresponding to debts with the BCRA. The transitory suspension shall in no case give the creditors the right to claim damages against the BCRA or the State. Revocation of Authority to Operate 10. The Superintendent may ask the Board that the authorization given to a financial entity to operate be revoked. The Board has a maximum term of 15 calendar days from the date of the Superintendent's petition within which to resolve the question. The 15- day term could be extended once only for a period of up to 30 calendar days. - 68 - ANNEX L Bank Restructuring - Amendments to the Law on Financial Entities (the Law) Revocation of Previously Approved Transactions 11. Under the new provisions of the Law, the BCRA is empowered to approve or disapprove negotiations by directors, members of the surveillance committee and inspectors of accounts, on shares of the financial entities or other circumstances which may produce a change in the classification of the entity, or alter the structure of the respective groups of shareholders. BCRA may revoke authorizations previously granted when fundamental changes may have occurred in respect of the basic conditions taken into account. Restructuring of Banks 12. An entirely new Chapter IV consisting of Art. 35 bis is now incorporated the restructuring of banks into the Law. When in the sole judgement of the absolute majority of the members of the board of directors of the BCRA, a financial entity is found in any of the situations foreseen in Art. 44 of the Law (e.g., insolvency) for the revocation by the BCRA of the authorization to operate, the BCRA may, in defense of the depositors, authorize the restructuring of the affected financial entity, prior to revocation of the authority to operate ("35 bis restructuring"). Is to be noted however that, as indicated in para. 10 of this Annex, the BCRA has a maximum aggregate term of 30 calendar days to take a decision on the revocation of the authorization. Restructuring Operations 13. Under Article 35 bis, the BCRA may resolve any of the following, or a combination thereof: 14. To Decrease, Increase or Transfer capital * BCRA determines losses against total or partial provisions on assets that,in the sole opinion of the BCRA, are difficult to collect, sell, or liquidate and decreases capital and/or makes the reserve allocations accordingly. * BCRA grants a term within which the entity has to increase its capital and reserves, which would need be subscribed and paid in during the such term. * BCRA revokes the authorization given to all or some shareholders of the financial entity so that they cannot continue as such, in which case a term of no less than 10 days is granted to them for the disposal of their shares. - 69 - ANNEX L * BCRA sells or entrusts the sale of the financial institution's capital and the rights to subscribe capital increases. To this end the institution and its shareholders must consent to the necessary transactions and deposit their stock certificates at the BCRA. 15. Exclusion of assets and liabilities and transfer of same to other financial entities * BCRA excludes assets and segregates them from the balance sheet of a financial institution for a value equivalent to the liabilities to be similarly excluded; * BCRA excludes liabilities to match the excluded assets, as indicated above. BCRA credits are also excluded after taking into account privileged creditors (secured labor claims and depositors). * BCRA may authorize and entrust the transfer of excluded assets and liabilities to other financial institutions, provided that the equivalence of assets and liabilities is maintained in each transfer. 16. The BCRA may also extend extraordinary rediscounts in cases of regularization of financial institutions (see para. 3 above) and approve proposals aimed at improving the liquidity of the institution through synchronizing the maturities of assets and liabilities. Legal intervention 17. The BCRA may ask a court that a legal interventor, be appointed to carry out any of the alternatives described above. The interventor may substitute for management with full powers as required. Self-Liquidation/Court Liquidation 18. The Law also provides new rules to allow self-liquidation of a financial institution, or its winding up through a court-appointed liquidator, in which case several rules in the Bankruptcy Law will apply. Special Privileges on Deposits in Cases of Judicial Liquidations 19. The Law has been amended to provide the following special privileges to depositors: * up to $5,000 per person per deposit, for deposits of any kind, to be covered by the bank's reserves; * remaining reserves cover all deposits with terms exceeding 90 days; -70- ANNEX L * any remaining reserve balances are assigned to depositors in prorata shares. Advance Payment to Depositors 20. At the time of resolving the revocation of the authorization to operate, or during the period of transitory suspension, the BCRA may require payment to depositors pursuant to the privileges indicated above. General Privilege 21. A general and absolute privilege is granted to depositors over all other credits, except for those secured by a pledge or mortgage. The revocation resolution may authorize the financial institution to pay depositors in proportion to available liquid funds after the senior obligations have been paid. Bankruptcy of the Financial Entity 22. While the financial institution is under judicial liquidation, the liquidator must petition for bankruptcy if he determines that the institution ceases to pay its obligations. The court may also declare the bankruptcy. Survival of Depositors' Privileges 23. The special and general privileges in favor of depositors survive in case of bankruptcy of the financial institution, and prevails over BCRA credits. Legal Stability of Restructuring Acts Preceding Bankruptcy 24. The Law further provides stability to the acts carried out or authorized by the BCRA in a 35 bis restructuring and related transactions, stating that they shall and cannot be revoked or declared without legal validity, even if the financial institution is ultimately declared in bankruptcy. Bill of Amendment to Bankruptcy Law 25. Finally, a bill has already been discussed and approved by the Senate and is now pending in Congress, to amend and restate the Law on Bankruptcy. The bill provides for shorter terms, in general, for the bankruptcy procedure; introduces modem concepts and applies to new business situations; and limits the action of the court in favor of that of the creditors. - 71- ANNEX M ARGENTINA BANK REFORM LOAN FINANCING NEEDS FOR PRIVATE BANK RESTRUCTURING 1. By February 1995, 81 private banks have used total liquidity advances of US$1,633 million (BCRA: US$1,165 million and BNA: US$468 million). The safety net advances are being rolled over monthly due to the banks' inability to repay. These 81 banks are the most distressed, and all are potential candidates for merger, acquisition, or liquidation. They include virtually all domestic cooperative, wholesale, regional, and small national banks with risk-weighted assets (RWA) of US$10.2 billion. Several of these banks with RWA of US$8.0 billion were already involved in mergers by April 1995, as are many others outside the safety net with additional RWA of US$2.3 billion. The following table describes the private banks in safety net borrowings or in a merger process. Private Banks Involved in Safety Net Borrowings and/or Mergers (February 1995) (million pesos) Banks in Safety Net - Banks in l _ ll ~~~~~~~~~~~Mergers (4/95) In All Retail Cooper Whol Total Safety atives esale Net No. of banks 33 35 13 81* 11* 46 Risk-Wtd Assets 5101 6547 2308 13956 8070 10371 Actual Capital 587 865 377 1829 982 1317 Capital Shortfall 120 NA NA Deposits 2632 3578 607 6818 4330 5521 Provisions 391 305 57 753 534 682 Branches 377 775 34 1186 827 965 Employees 10336 15112 1807 27255 18370 21979 * The 11 banks are included in the 81 banks in safety net. _ 2. The demand for BCTF funding can be estimated as the sum of: (i) refinancing of BCRA/BNA safety net advances overdue, and (ii) the shortfall in statutory capital of sold (as against going concern) banks. The latter is the sum of the existing capital shortfall, deficit in existing provisions, additional provisions to cover changes in asset classification as on the sale date and the value of guarantees, the seller's expenses relating to sale/liquidation, and the "haircut" to compensate buyers for the risks and costs of collecting assets of - 72 - ANNEX M another originator, the costs of merger or acquisition itself and the costs of integrating businesses, branches, personnel, and systems. 3. As discussed in Annex I, the revised portfolio classification and provisioning norms have been implemented in a phased manner. Thus compliance with the existing provisioning standards is expected to be fully implemented by July 1995. The following Table shows the minimum capital needed to comply with the 11.5 percent capital adequacy guideline and current provisioning norms based on classification of assets as of February 1995.' Additional provisions to correct errors or overvaluation are estimated under three scenarios: downgrading, by one class, of 25 percent, 50 percent, and 100 percent of assets in each class. Financing Needs of Private Banks (US$$ million) l Banks Banks In Assisted Merger Total Outside Safety Net Capital and Provisioning Shortfall 120 108 228 Provisions for 1-class downgrading of A. 25 % of Assets 61 61 122 B. 50% of Assets 143 127 270 C. 100% of Assets 373 269 642 TOTAL CAPITAL REQUIREMENTS A 181 169 350 B 263 235 498 C 493 377 870 BCRA/BNA Advances 1633 0 1633 TOTAL FINANCING NEEDED A 1814 169 1983 B 1896 235 2131 C 2126 377 2503 Note: Banks outside safety net and not involved in any merger are also reported to have a capital or provisioning shortfall of US$164 million which is expected to be corrected by the relevant shareholders. 4. These estimates show that as of February 1995, the liquidity-assisted and merging banks had extraordinary liquidity assistance of US$1,633 million, and a statutory capital shortfall of US$228 million. Thus minimum 1. There are five portfolio classes: normal, potential risk, sub-standard, doubtful, and loss. They require provisions of 1, 5, 25, 50, and 100% and about half that much if asset is guaranteed. - 73 - ANNEX M restructuring funding requirements of the banks either receiving extraordinary assistance and in the process of merging US$1,861 million. Allowing for a downgrading of all of the assets by one class will require additional provisioning of US$642 million, raising the total capital requirements to US$870 million and total funding requirements to US$2,503 million. These may be underestimates if the value of assets has fallen even more sharply than is assumed in Scenario C. Dealing only with BCRA assisted banks, for example, yields recapitalization requirements of as much as US$493 million (assuming a 100 percent decline in assets by 1 category) and a total need for financing of US$2,126 million, when refinancing of past credit lines is included. These estimates should be considered conservative in light of current asset values. 5. Clearly, there is great uncertainty surrounding funding requirements. The prevalence and degree of distress depends on future deposit withdrawals; the asset values on interest rate changes, real sector problems, and market value of stocks, bonds, and other collateral; and the difference between sale price and book value on quality of record-keeping, problems of due diligence, familiarity of the buyers with institution and assets sold, and cooperation in and speed of negotiations. Also, besides BCTF financing, it is also possible to plug these funding requirements with either the existing "surplus" capital of the top banks which obviously cannot be accurately calculated in the light of reduced quality of all assets during the crisis), by raising additional capital in the course of mergers/acquisitions, and by allocating some of the losses to creditors or depositors of the selling banks. 6. Nonetheless, the above estimates (between US$2.0 to 2.5 billion) indicate the magnitude of financing that may be needed and the importance of the proposed loan in filling any gap. The identified resources up to this point include US$2.0 billion from patriotic domestic and foreign bonds, the proposed Bank loan of US$500 million, and some proportion of the excess capital of the stronger banks involved in such transactions. -74- ANNEX N ARGENTINA BANK REFORM LOAN THE BANK CAPITALIZATION TRUST FUND Legal Source 1. Law 24,441 (Housing and Construction Financing Act) established trusts and financial Trusts. These institutions are new to the Argentine civil law system. Under the new law, the Bank Capitalization Trust Fund (BCTF) was created to assist financial institutions in capitalizing and strengthening the Argentine financial system. Management 2. The Fund is managed by a five-member Committee composed of the Secretary of Finance, Banks and Insurance of the Ministry of Economy (chair); a Director of the Central Bank (appointed by the Chairman of the Board of the BCRA); a representative of the Ministry of Economy; one representative each of the resident and non-resident holders of 1998 Argentina Bonds. Funding 3. The Fund is financed by: (i) the transfer in trust by the Treasury of the proceeds of the 1998 Argentina Bonds; (ii) financial resources from multilateral lending institutions; (iii) income from its operations; and (iv) other resources obtained for the purposes foreseen in the trust agreement between the State and Banco de la Naci6n Argentina (BNA). Under the Trust Agreement, the BNA acts as managing agent of the Fund. Objective 4. The Fund was established for the following purposes: * subscribing and making capital contributions or extending convertible or non-convertible loans to financial institutions; * buying and selling shares of financial institutions; -75- ANNEX N * gradual divesting of its acquired assets; and * carrying out tasks and transferring financial assets and liabilities at the request of the BCRA in accordance with the terms and conditions of the Fund's constitutive Decree 445 and pursuant to the Trust Agreement. Operations 5. The Fund's operating procedures are described in Annex F. The operating procedures of the Fund's Managing Committee have been established as an internal regulation of the Fund. In addition to deciding on BCTF assistance to banks, the Committee will prepare a plan for the realization of the assets that the Fund may acquire which would be subject to the following: * Shares or equity participations in financial institutions, subscribed or received in payment of loans or convertible bonds, will be disposed of at an auction, or through bids or public or private offerings in the capital market; * Real estate must be sold through public or private bidding, or at a public auction; * Other assets shall be sold in accordance with market practice. Dissolution 6. The Fund shall be dissolved in two years or once its objective has been accomplished, whichever occurs first. Oversight Authority 7. The oversight authority is the Ministry of Economy and Public Works and Services. - 76 - ANNEX 0 ARGENTINA BANK REFORM LOAN THE LEGAL PROVISIONS OF THE DEPOSIT INSURANCE SYSTEM 1. The Deposit Guarantee Insurance System was created by Law 24485 of April 17, 1995. The Deposit Guarantee Fund is special joint stock company, Seguro de Dep6sitos Sociedad An6nima (SEDESA). SEDESA's shareholders will be the State, with at least one share, and a fiduciary trust established by financial institutions authorized to operate in Argentina, as the majority shareholder (Trust). However, contributions by financial institutions as participations in the Fiduciary Trust are optional are not mandatory but optional, although participation in the Trust would entitle them to their share in the income, if any, that the Trust may receive as shareholder of SEDESA. The BCRA will determine the proportion in which financial institutions participate in the Trust. The BCRA also designates the depository of the contributions and other income received by SEDESA as manager of the Fund. 2. SEDESA will be remunerated for its managing services and will distribute its net profits in cash to its shareholders. SEDESA will also perform advisory services to the BCRA and has to render its opinion on whether a financial institution has credit and business policies of a higher-than-normal risk. Any amendment to the constitutive documents or change in the capital of SEDESA would require the favorable vote of the State. Funding 3. The BCRA will determine the ordinary monthly contribution that each financial institution obligated to make to the Fund, within the range of 0.03 to 0.06 percent of the average daily balances of deposits in pesos and foreign currency. Additional or extraordinary contributions may be established by BCRA for each institution on the basis of risk indicators determined by BCRA. In no case can the additional contribution by an institution exceed its normal premium. Some contributions to the Fund were due as of April 1995. Timely payment is a condition that financial institutions must meet to continue to operate in Argentina. 4. The BCRA may at any time request that the financial entities advance to the Fund the payment of up to one year of monthly ordinary contributions. The BCRA is authorized to directly debit any amounts due by the institutions to their deposits at the BCRA. 5. Immediately after the end of each calendar year the BCRA will establish each participating financial institution's interest in the Trust and in the Fund. The -77- ANNEX 0 shareholding of the Fund in SEDESA and the participating institutions' quotas in the Fund would be reallocated accordingly. 6. Once the Fund reaches an amount of US$2 billion or 5 percent of the total amount of deposits of the financial system, whichever is higher, the BCRA may suspend or reduce contribution obligations to the Fund. The standard obligations would be reinstated when the Fund's resources drop below the maximum funding indicated above. Investment and Reporting 7. Rules are provided for the investment of the monies of the Fund and for monthly reporting of the Fund to the public and to the Superintendency of Financial Entities. Coverage 8. The Deposit Insurance System covers deposits at participating institutions, including checking, savings, and fixed-term deposits. Fixed-term deposits will qualify only if made or renewed as of April 18, 1995. The following deposits are expressly excluded from coverage: * deposits of financial entities with other intermediaries, including fixed- term certificates purchased in the secondary market; * deposits made by persons directly or indirectly related to the institution, according to rules to be established by the BCRA; * fixed-term deposits of securities, acceptances or guarantees; * deposits made after July 1, 1995 on which the annual interest rate is 2 percentage points higher than the interest rate on equivalent deposits at Banco de la Naci6n Argentina (BNA) on the day prior to the transaction; * other deposits which the BCRA may exclude in the future. Insured Amounts 9. The amounts guaranteed by the insurance system are: * Up to US$10,000.- in respect of sight deposits and less than 90-day fixed term deposits; * Up to US$20,000.- in the case of 90 or more-day fixed term deposits. - 78 - ANNEX 0 Payment - Sufficiency/Insufficiency of Funds 10. Insurance payments up to the limits indicated above are due only as a supplement to the amounts obtained by depositors under the general deposit protection and privilege system, established by amendment to the Law on Financial Entities (see Annex G); and as such would be effected within 30 days following the day after the revocation of the authorization enabling the entity to operate, as funds in the Fund become available. The 30-day term could be extended by the BCRA at the request of SEDESA. 11. If the resources of the Fund are insufficient to fully pay the depositors what they are due under the Deposit Insurance System, payment would be effected on a pro-rata basis with the available funds. The unpaid balance would be settled within 30 days as of the date the Fund reports on the availability of new funds. 12. If the authorization to operate is revoked to more than one financial institution, payment to depositors would be made in chronological order, starting on the date the first payment was due under the Deposit Guarantee Fund. Interest Payment 13. The Fund will not pay or recognize any interest on qualifying deposits for the period of time between the original due date of the deposit and the date of payment under the Deposit Insurance System. To overcome the argument that "the original due date" could fall days/months after the revocation of the authorization to operate a financial institution--or even after the insurance settlement date -- the general provisions of law stating that interest accrual stops when the owing entity ceases payment of its obligations would forcibly apply. Qualifications - Preferences 14. All persons --physical or corporate-- qualify under the Deposit Insurance System on an equal standing. All qualifying deposits of a person with a financial institution would be aggregated and considered as one only as at the date of the revocation of the authorization to operate, for the purpose of determining the insurance supplemental amount due. In the case of a concurrent depositor, payment on sight deposits and on fixed term deposits with less than 90-day maturities would come before payment on fixed-term deposits with maturities of 90 days or more. Subrogation of Rights and Privileges 15. SEDESA acquires by subrogation all the rights and privileges established by the Law on Financial Entities in favor of the depositors, and may exercise such rights and claim the privileges in respect of payments made under the Deposit Insurance System. - 79 - ANNEX 0 Operating Rules 16. The BCRA is empowered to issue rules for the interpretation and application of the norms contained in the Decree. -80- ANNEX P ARGENTINA BANK REFORM LOAN LIQUIDITY, CAPITALIZATION, AND CLASSIFICATION OF PRIVATE BANKS A. The Present Situation of Private Banks 1. The private banks in Argentina may be conveniently divided into the following five categories: (i) large domestic retail banks with a territorial network; (ii) foreign banks; (iii) wholesale banks; (iv) cooperative banks; and (v) regional retail banks. The liquidity crisis since December 20, 1994 has not only reduced the deposits of the entire banking system, but has led to a significant change in the composition of deposits, liquidity and assets among the various groups of banks. Fundamentally the large domestic banks and foreign banks have gained market share at the expense of the wholesale banks, cooperative banks and regional retail banks. Large Domestic Banks 2. As of February 28, 1995 the six largest domestic retail banks' accounted for 35.7 percent of the total assets of the private banking system, compared with 32.4 percent as of 12/31/94. During the same period their share of total deposits increased from 28.5 percent to 34.4 percent, while their share of customer loans rose from 32.0 percent to 33.9 percent. Although the largest banks have been cautious in originating new loans to their existing customers, owing to their need to maintain high levels of liquidity, they have acquired assets from the smaller banks, notably from the so-called "wholesale banks"as part of the first "safety net" operation arranged by BCRA in early January 1995. 3. The six largest domestic retail banks had an aggregate capitalization of $2,200 million as of February 28, 1995, around 35 percent of the capitalization of the entire private banking system and comfortably in excess of the minimum capital requirement of US$1,531 million according to BCRA regulations (11.5 percent of risk-weighted assets). These banks had all l These are: Galicia, Rio, Frances, Credito Argentino, Roberts and Quilmes - 81 - ANNEX P made loan-loss provisions close to or in excess of their classified loan assets, indicating that they are presently well provided, although a worsening of their loan portfolios in the months ahead may require additional provisioning which would reduce their capital surpluses. 4. The major domestic banks have weathered the liquidity crisis well maintaining comfortable cushions of liquidity with BCRA and banks abroad, and making a large contribution to the second "safety net" in late January 1995 which involved the transfer of 2 percent of 25 banks' deposit base as of November 30, 1994 from liquidity reserves to a special account with the Banco de la Naci6n. 5. The branch networks of the major domestic banks range in size from Galicia (179 branches), Rio (172) and Credito Argentino (120) to Quilmes (90), Frances (67) and Roberts (35). These banks' branches are heavily concentrated in the Federal Capital and the Province of Buenos Aires and rather sparsely represented in the other provinces, except in the major cities. None of the banks has a large branch network, considering the size of Argentina and its population. The major banks do not envisage expanding their networks significantly in the interior by organic growth of their existing operations, although acquisition of regional banks might be pursued as a way of building denser branch networks in some of the major provinces outside Buenos Aires. Foreign Banks 6. The four largest2 of the 31 foreign banks with operations in Argentina accounted for 16.7 percent of the private banks' total assets as of end-February 1995, 18.0 percent of customer loans and 19.2 percent of deposits. They had a capitalization of US$924 million, well in excess of the BCRA minimum requirement of US$826 million and some 16 percent of the private banks' aggregate capitalization. The foreign banks gained deposits during the early weeks of the crisis, especially in dollars, and continued to increase their market share during March and April 1995 when all banks suffered a decline in deposits. The foreign banks have maintained relatively high levels of liquidity, and have restricted their lending mostly to renewals, although several have acquired loan assets from the wholesale banks which have been forced to sell down the best of their portfolios to realize liquidity. Most of the foreign banks have medium sized branch networks (25 to 45 branches each) concentrated in Greater Buenos Aires, with relatively few offices in the interior. Several are now considering taking the present opportunity to acquire not only assets but also branches from small domestic banks, but such purchases are likely to be highly selective. Wholesale Banks 7. When the liquidity crisis began in late December 1994 there were about 25 "wholesale" banks operating in Argentina, typically with one branch located in the Federal 2 Citibank, Boston, Deutsche and BN Lavoro. - 82 - ANNEX P Capital and specializing in niche activities such as bond and equity trading, money market business, consumer credit, foreign exchange and trade finance. These banks depended heavily for their funding on large corporate and individual deposits, lines of credit from banks abroad and borrowing on the local call market from the large retail banks. 8. These wholesale banks have been severely affected by the systemic decline in deposits during the past four months. Typically such banks have lost 40 to 75 percent of their peso deposits and 25 to 50 percent of their deposits in foreign currency since December 20, 1994. Part of the deposits lost has been transferred to the large domestic and foreign banks in Argentina, the remainder has mostly been remitted abroad. Owing to the institutional nature of such deposits, they are unlikely to return to the wholesale banks in the foreseeable future. The wholesale banks have also lost ready access to credit lines from correspondent banks abroad and to call money lines in pesos, except in the context of the "safety net" operations mentioned in paragraphs 2 and 4 above. Several of the wholesale banks have been forced to borrow from BCRA under special "financial assistance" arrangements. 9. The wholesale banks have responded to this situation by restricting their new business to non-funds based activities and by selling off their asset portfolios, mostly to the large domestic and foreign banks. Inevitably they have been obliged to sell the better parts of their portfolios, notably consumer credit, often at substantial discounts, in order to restore adequate liquidity. Despite these efforts four wholesale banks3 have already been suspended by the BCRA and required to submit a refinancing plan or face liquidation. Others are likely to follow the same route during the coming months unless acquired by another bank, although a number of the better capitalized wholesale banks may be able to survive until more propitious conditions return. Cooperative Banks 10. As of end September 1994 there were 31 cooperative banks in Argentina, of which 20 were affiliated to Federaci6n de Bancos Cooperativos de la Repuiblica Argentina (Febancoop) and eight affiliated to Instituto Movilizador de Fondos Cooperativos. In addition, around half were either shareholders or affiliates of Banco Federal S/A together with some 15 regional retail banks (see paragraphs 14 and 15 below). During the last quarter of 1994 a number of cooperative banks arranged mergers either among themselves or with regional retail banks. During the first quarter of 1995 this process gained momentum, actively encouraged by BCRA, as a response to the liquidity crisis. As of mid-April 1995 there were 11 remaining cooperative banks, 5 mergers involving cooperatives only and 4 mergers involving cooperatives and regional retail banks. These are listed in Annex F. 11. Owing to the recent frenzied pace of merger activity, and the fact that four of the mergers have involved acquisitions by, or mergers with, regional retail banks, it is difficult 3 These are: Extrader, Fiiansur, Basel and Multicredito - 83 - ANNEX P to present recent aggregate statistics of the cooperative banks. However as of end February 1995 the cooperative banks accounted for around 14 percent of private banks' aggregate assets and about 16 percent of total capitalization4. 12. The cooperative banks typically have medium sized branch networks (20 to 40 branches) in one geographical region of a province, a characteristic they share with the regional retail banks. Since the onset of the liquidity crisis they have typically lost 15 to 20 percent of their peso deposits and 0 to 5 percent of their dollar deposits. However because it has been difficult for these banks to call in their loans, which are predominantly to the agricultural and small business sectors, their current liquidity has declined more than proportionately, and several have been obliged to borrow from the call market (where available) or from the BCRA/BNA "safety net." Overall, the portfolio quality of the cooperative banks appears to be rather poor, owing to the effect of the recession on the interior, particularly in certain provinces (e.g. Santa Fe), and many of these banks show shortfalls in their provisioning levels. 13. Banco Federal S/A, which is a consortium bank owned by 25 cooperative and regional retail banks, has suffered a decline in deposits of over 25 percent, putting severe strain on its liquidity and obliging the bank to borrow heavily from BCRA/BNA. Banco Federal is likely to be one of the first candidates for restructuring under the Trust Fund. Regional Retail Banks 14. This final group of around 20 banks is varied, ranging from Banco Buen Ayre, a medium-sized bank with a branch network in Greater Buenos Aires, to smaller regional banks in Mendoza, C6rdoba, Santa Fe and Buenos Aires provinces. Many of the smaller banks in this group have been rather slow to modernize their premises, update their information technology and retrain their staff and consequently they have been gradually losing market share to the large retail banks with a territorial network. 15. Several of the smaller regional retail banks, notably those which are members of the Federal Group, have participated in the series of recent mergers described in paragraph 10 above. Several of these banks show capital deficiencies if shortfalls in provisions are taken into account. Most of the regional retail banks have suffered declines in deposits and liquidity similar to those of the cooperative banks. B. Capitalization of Banks 16. The potential capital shortfall in the domestic private banking system has been estimated by comparing the figures for actual capital with those for the minimum capital required by BCRA and making adjustments for shortfalls between actual loan-loss 4 Cooperative banks' total assets were US$ 6,193 million and total capitalization was around US$1 billion. - 84 - ANNEX P provisioning and the classification of the banks' loan portfolios according to the latest BCRA prudential regulations (Comunicaciones A 2216 and 2218). This method has provided the likely minimum capital shortfall of banks with a capital deficiency. The total estimated shortfall amount to US$392 million. 17. There are several banks with capital above minimum requirements. The six large domestic retail banks account for over 50 percent of the excess capital in the private banking system. This demonstrates that they would be best placed from a capital viewpoint to act as acquiring banks in merger transactions. The foreign banks as a group have relatively little excess capital, but of course they could call upon capital transfers from abroad to fund interesting acquisitions. The cooperative and regional retail banks show small capital surpluses before adjustment, and in many cases capital shortfalls after adjustments for additional provisioning. Most of the wholesale banks show capital surpluses, even after adjustment, reflecting the reduction in their minimum capital requirements following their asset sales and consequent shrinkage in their balance sheets. C. Classification of Banks 18. For purposes of analysis, the private domestic banks in Argentina have been classified into five ratings, using 14 parameters measuring liquidity, solvency, capital adequacy, portfolio quality, provisioning, profitability and operational efficiency. The detailed methodology is described in Section D below. 19. The descriptions of the bank ratings are as follows: A Very liquid, solvent, very strong capital position, good management - could acquire other banks without financial assistance; B 1 Liquid, solvent, strong capital position, good management - could acquire other banks but could require some financial assistance to do so; B 2 Some deficiencies in liquidity, adequate capital, adequate management - less likely to be able to acquire banks except without substantial financial assistance / could survive alone but would probably benefit from merger with a stronger bank; B 3 Serious deficiencies in liquidity, solvency and/or capital adequacy, probable poor management - strong target to be acquired by a strong bank; C Very poor liquidity, solvency, capital adequacy, and/or management - liquidation candidate unless taken over by a strong bank. - 85 - ANNEX P 20. These descriptions are similar to those used by the SEF in its own 5 category rating system (1 to 5). SEF ratings are unavailable to the public. Categories A and B 1, which coincide fairly closely with the SEF's categories 1 and 2, are the most appropriate to be acquiring banks in the merger and acquisition program, although some banks in category B 2 (SEF's category 3) may be suitable candidates, given credible merger plans and appropriate assistance from the Trust Fund. 21. The table below shows the numbers of domestic private banks in each rating category, based on data as of end February 1995, but reflecting mergers and acquisitions consummated or agreed up to mid-April 1995. The foreign banks are not included in this table, because only the 10 largest of the 31 were rated (of which A four, B1 three, B2 two and B3 one). RATING PRIVATE S/A COOPERATIVE MERGERS5 TOTALS A 5 1 6 Bi1 5 16 B 2 18 4 6 28 B 3 12 3 6 21 C 9 3 3 15 TOTALS 49 12 15 76 D. Bank Rating Calculation Methodology 22. The bank ratings A through C were calculated using a composite scoring system of 14 weighted parameters measuring liquidity, solvency, capital adequacy, portfolio quality, provisioning, profitability and operational efficiency. These parameters are specified in detail in the table following paragraph 24 below. 23. Method of Calculation. Values of each of the 14 parameters were calculated, and point counts were assigned to the ranges of values of each parameter. The points scored for each parameter were then weighted: (i) according to the following scheme * liquidity 40% * solvency 30% * assets 20% * results 10% 5 Of the 15 mergers during the last six months, eight of the new institutions are legally constituted as cooperative banks and seven as commercial companies ( S/A - Sociedades An6nimas). However it is likely that a number of the cooperative banks will be converted into commercial companies in the months ahead. -86- ANNEX P and (ii) according to the period to which the data refers: * 1/31/95 30% * 2/28/95 70% The resulting weighted values were then adjusted by a "subjective factor" reflecting the consultants' qualitative knowledge about each bank's management, present situation and likely prospects. This subjective factor varied from 0.6 for the worst performing banks in the sample to 1.1 for the leading domestic banks and 1.3 for the foreign banks. The higher subjective factor for the foreign banks reflects, inter alia, their access to capital injections from abroad. 24. The resulting composite scores were then used to assign a bank rating according to the following scale: Range Rating 0 < composite score < 3 C 3 < composite score < 5 B3 5 < composite score < 7 B2 7 < composite score < 8 B3 composite score < 8 A - 87 - ANNEX P Table 1 - Parameters and Formulas PARAMETERS FORMULA Liquidity I-Immediate Liquidity Cash/banks + quoted public bonds Deposits Liquidity 2 - Cash Money/Reserve Requirement (pesos, $ + BONEX) Average Call money granted - Average call money received Reserve requirements Liquidity 3 - Structural Liquidity Net worth-fixed assets-other assets-intangible assets-overseas branches- Investments in quoted companies Total liabilities Liquidity 4 - Rediscounts BCRA loans total liabilities Solvency (Liabilities/Net Worth) Total liabilities Net worth Capital-Excess or Deficit of Minimum Capital/Net Worth Excess or Deficit of Minimum Capital Net worth (including profit & loss) Assets-Irregular Portfolio/Net Worth Overdue portfolio-self liquidating guarantees-50% preferred guarantees Net worth (including profit & loss) Assets-Irregular Portfolio less Provisions/Net Worth Overdue portfolio-self liquidating guarantees-50% preferred guarantees-provisions Net worth (including profit & loss) Assets-Irregular Portfolio/Borrowing Overdue portfolio-self liquidating guarantees-50% preferred guarantees Borrowing Return on Assets Monthly result Total Assets Return on Equity Monthly result before tax Net Worth Efficiency-Costs less Commission/Liabilities Administrative Costs-Service Revenue + Service Costs Total Liabilities Efficiency-Costs/Liabilities Administrative Costs Total Liabilities Efficiency-Deposits/per head Total Deposits Staff Complement - 88 - ANNEX 0 ARGENTINA BANK REFORM LOAN ILLUSTRATIVE COMPONENTS FOR INSTITUTIONAL DEVELOPMENT PLAN Diagnostic Phase 1. External assessment of bank's financial situation including, inter alia; * Asset Quality. Assessment should cover at least 70 percent of portfolio and should consider the: (i) nature of classified assets, (ii) nature of non-performing assets and rollovers, (iii) adequacy of valuation reserves, (iv) current collection capacity, (v) credit concentration, and (vi) potential insider lending. - Profitability. Assessment should include profit/loss analysis based on adjustments for provisioning, refinancing of non- performing loans, and overdue interest income. * Debts to BCRA. Assessment of rediscounts and advances received from the BCRA and the time schedule for repayments. 2. Management Review. 3. Staff Review, including skills deficiencies and overstaffing. 4. Existing Bank Policy Review, including: * Credit Policies. Assessment of credit analysis, lending decision-making, asset classification and loss provisioning methodology, and collection procedures. * Internal Audits. Formats for monitoring related borrowers, classified exposures, loan concentration, and reporting of past due accounts. Reporting relationships and enforcement power of auditing function. * Risk Management. Assessment of asset and liability management -- foreign exchange risk management, and interest risk management. * Administrative Procedures. Identify technology and information gaps. Organizational review. Decision-making hierarchy. - 89 - ANNEX 0 Preparation of Business Restructuring and Institutional Development Plan 1. Business Plan includes reforms to be undertaken to restore bank profitability, include, inter alia: Business Base and Strategy. Capital Plan. Funding Policies. Liquidity Management Plan. Agreed Restriction and Prohibitions. 2. Institutional Plan includes changes in structure, management, and personnel, including, inter alia: Organizational Changes. Management Reform. Overhaul of Staffing. Compensation Review. Information, Monitoring, and Projections. Implementation and Performance Monitoring Steps include: Plan Approval. Agreement on Implementation Timetable and Scheduled Monitoring. Periodic Assessment of Agreed Milestones. Joint Review and Plan Revision. Sanctions for Non-performance. 41 -90- ANNEX R ARGENTINA BANK REFORM LOAN DRAFT LETTER OF DEVELOPMENT POLICY June 26, 1995. Mr. James D. Wofensohn President The WVo,d Bank Washington, D.C. Dear Mr. Wolfensohn: 1. This letter of Development Policy describes the economic reform program of the Argentine Govemment as well as specific steps to deepen further the reforms in the financial sector. To implement these roforms, the Govemment requests continued financial assistance from the World Bank. The Bank's assistance is parUcularly needed at this juncture, as a result of the adverse impact thal external developments, including the disruption of Mexico's economy, have had on capital tnflows and the stability of the domestic financial sector. We vwuld like to take this opportunity to also present the macroeconomic framework which complements the reform program. .. Macroeconomic Framework 2. Price stability and sustained growth remain the centerpieces of the Govemment's economic program, The Govemment has made important progress since 1991. To eliminate fiscal deficits that were fueling inflation, the Govemment initiated profound stnrctural reforms. As a result, monthly price increases dropped from over 30 percent at the beginning of 1991 to intemational rates in the second semester of 1993. Inflation during 1994 was only 3.9 percent. 3. By laying the basis for price stability, the Govemment has charted an agenda for the future with the follovwng objectives: * the consolidation of stabillty through sttict compliance with Law N° 23928 of March 27. 1991 (the Convertibility Law), the preservation of fiscal equilibrium and the operaton of a market economy wtth deregulated and unrestricted competitive markets, and regulation by the state of non-competitive markets; * the strengthening of economic growth (annual GDP grovAh rates inoreased from 0.1 percent in 1990 to an average of 7.7 percent during 1991-1994) through Increased levels of savings. Investment, productivity, pnvatization of public enterprises, private sector development and exports, and an Intensification of trade, financial and technological integration of the Argentine economy into world markets; and * the achievement of hlgher levels of employment and a more equitable distribution of income, both at a personal and regional basis, through consolidation of economic stability and growth, substantially increased public investment In human resource development and social services, and measures to promote regional development. * - 91 c 4 e de. F a fL a m s, a ANLiEX R 4. Sustained economic recovery and improvements in welfare will continue to be achieved by undertaking lasting structural reforms in the public sector, improvement in national savings, and policy reforms that would continue to promote private sector activity through gains in productivity, lower domestic taxes, and factor market Improvements. To ensure that the private sector remains the leading expansionary force in the economy, the Govemment is committed to maintain flexible and open markets free of domestic regulations and major external trade banters, and with a strong financial sector to improve intermediation. The Govemment's program of market reforms covers the following areas: (a) Open market economy: The government has totally eliminated controls on prices, wages, interest rates, and capital nows as well as a complex network of subsidies and implicit taxes. The Govemment Is committed to maintain such policles. Additionally, to facilitate more ratlonal allocation of resources In the economy, and Improve international competitiveness through the reduction of production costs and improvement of Incentives for productive investment, the Govemment Is committed to promote structural reforms by introducing and supporting legislation for (a) liberalizing labor markets; (b) streamlining banknrptcy legislation; (c) reforming the health Insurance cooperatives; and (d) encouraging the reform of provincial finances, including the reduction of inefficient taxes. (b) Trade Liberalization: The Govemment has made rapid stiides towards opening the economy, in terms of flows of trade, capital, and technology. Tle import tariff structure has been simplified and the average tariff rate was lowered to approximately 14 percent. To the extent that additional tarilffs uere reimposed for fiscal reasons, it is the govemment's intention to remove them as soon as practicable. Export laxes have been neariy eliminated, and most quantitative restrictions and other procedures that slowed tihe entry of trade, capital and technology have been removed, The Government will keep the economy open to Intemational competition and will keep Argentina's antidumping provisions in line vith the respective GATT code. Moreover, the MERCOSUR treaty came Into full effect in January 1995. As specifled in the Treaty of Asunci6n, the Govemment eliminated most intra- MERCOSUR tariffs, dropped all other Intra-market trade barriers, and established a common extemal tariff covering 85 percent of the positions in January 1995. (c) Financial Sector Reform: Financial sector reforms have been aimed at increasing financial deepening and the efficiency of financial intermediation. Following interest rate liberalization in 1987 and the eliminaton of directed credit by the Central Bank, the Govemments strategy has been to increase depositor and investor confidence. Under the Convertibility Law price stabilization, liberalized Interest rates, and tighter regulation and enforcement of liquidity, capital adequacy and provisioning requirements were the chief reforms that permitted financial deepening (M4) to increase from a low of 7 percent of GDP in 1990 to 19 percent In 1994. SImilarly, capital market reforms, including the elimination of transaction taxes on securities trading and improvements in the regulation of public offerings, encouraged the development of a major emerging market. Banks and non-bank corporations raised US$9.9 billion In equity Issues and registered USSd.5 billion In bond issues during 1990-1993. The Govemment Is committed to maintain liberalized interest rates and to refrain from directing credit allocation of financial institutions, and to further strengthen banking supervision. S. In the aftermath of the Mexico crisis, the Govemments immediate aim is to sustain past achievements through deepening reforms. The Govemment has already taken far-reaching steps that will consolidate stability and deflect the spillover effects from the crisis. Foremost among these changes are a deepening of public and financial sector reforms. These will strengthen confidenrce In soverelgn aebt, the financial sector, and the sustainability of the Convertibility Law The following sections discuss these reforms as well as upcoming steps of the refonrn program. e - 92 - ANNEX a 11. Public Sector Finances The Federal Govemment 6. The Govemment has undertaken a major effort to improve revenues through the implementation of a much-broader and uniform VAT. The Govemment is also committed to further improve the efficiency of the tax administration by Improving substantially audits and controls. The increased reliance on more efficient taxes wll continue to allow the Govemment to eliminate or reduce distortlonary taxes, while observing the fiscal targets established in paragraphs 8 and 18. The Govemment obtained Congressional approval of a law broadening the coverage of the personal assets tax, submittod to Congress legislation to further restructure the public sector, and limit expenditures to the social security system. 7. The Govemment believes that the Impact on Argentina of the external shock that is affecting Latin America will be contained and transitory In nature, as the fundamentals of the economy remain strong. The reform process is deeply rooted, fiscal and monetary policies are sound and Ilte country's medium term prospects have been strengthened. Exports are rising and investment increased by 18 percent In 1994. Nevertheless, the Govemment recognizes that the Intematlonal situation remains uinsettled and that the decline in private capital inflows is likely to reduce GOP growsthi. The Govemment has recast its fiscal program for 1995 so as to withstand a reduction in capital inflows and continue lo service its maturing obligatlons. 8. The 1995 budget was drawn up in the framework of a decline in the ratio of public expenditure to GDP and a strong effort to reduce tax evasion. This budget also incorporated the government's intention to further rationalize the national administration, including the privatization of nudear power stations. Fiscal policies have been adjusted to generate an overall surplus In the national non-financial public sector (excluding provinces) of Arg$2 billion, a surplus that will be used to amortize public debt. In addition, the Govemment expects to raise US$2.4 billion during 1995 from privatization. including sales of the Govemment's remaining holdings In a number of already privatized enterprises and the sale of petrochemical plants and hydroelectric and nuclear power plants. The fiscal measures announced by the Government in late February and March 1995 will yield some Arg$6.3 billon (2 percent of GOP) in the remainder of 1995. or Arg$8.5 billion (2.75 percent of GDP) on an annual basis. These measures were presented by the executive and approved by Congress In only two weeks, a clear signal of decisiveness and political consensus. The measures Included: a. expenditure cuts, including reductions in salanes of public employees eaming $2.000 a month or more, with an expected yield of Arg$1.0 billion in the remainder of 1995, b. a temporary Increase (to be excluded frorm revenue- sharing w4th the provinces) of 3 percentage points to 21 percent in the Value Added Tax rate vAth an expected yield of Arg$2.2 billion; c. Import tariff Increases with an expected yield of ArgSO.7 bIllion; d. a partial roll-back of certain previous reductions in social security contributions for agriculture, Industry, and tourism, coupled %tlh a lowering of contribuUon rates for the services sector, with an expected net yield of Arg$O.4 billion; and 4h - 93 - e. a broadening of the base of the VAT and income taxes, a broadening of the bass and lowering of the rate oF thle wealth tax. new failities for regularizing tax arreows, and a number of smaller measures, largely In the area of social security, with an expected overall yield of ArgS2.0 billion for 1905. If required by circumstances, the Govemment will adopt furtner expenditure restraints to achieve the basic principle of maintaining equilibrium in the public finances. 9. The govemrnment's program for 1995 will maintain ancl deepen structural reforms. The Congress is presently considerlng important laws which (i) modify the regulations on collective bargaining contracts and associated employment risks, thereby improving the flexibility in the labor market and reduang labor costs; and (ii) govem the reorganization of enterprises In bankruptcy proceedings. The newly approved Social Security Solidarity Law, will reestablish maxlmum llmits for all beneficiares, eliminate the automatic adjustment of benefits, apply the provisions of the Convertibility Law to the determination of pensioners, and modify the associated legal proceedings. It vwill also allow the establishment of a limit, that will dedcine as the number of pensions under the former social security systern diminishes, on pension outlays, which have been an important cause of macroeconomic instability in recent years. The program of provinGial reforms discussed below should reduce distortions In the tax system and result in a permanent reduction in the size of the public sector that will Improve the allocation of resources and increase overall economic efficiency. These and other reforms, together with the progressive extension of instItutlonal changes to all govemmental jurlsdlctlons. will help to further strengthen the profound institutional transformation of our country. The Provincial Govemments 10. Throughout the 1980s, deficits generated by provincial govemments vere major contributors to the chronic instability of the Argentine public sector. Over the last three years. fiscal adjustment, essential to she recovery of the economy, has occurred mainly at the federal level. The increase In provincial govemment expenditures has exceeded the rise in revenues received from the Federal Treasury under the revenue sharing arrangements and from their own resources, resulting in operational primary deficits in the provinces of about 0.7 percenl of GOP in 1993 and 1994. At the same time that provincial governments have lagged in making necessary fiscal adjustments, their role within the economy has grovm as the result of the decentralization of many federal functlons. notably secondary education and public health. Provinces are now the major providers of core public services in health, education, security, water and sanitation, electricilty, and other infrastructure. However. most provinces are ill-prepared to fulfill their Increasingly Important role, with negative implications for future economic growth and meeting the needs of the poor. 11. A major adjustment of provincial finances is expected for 1995, for sources of provincial deficit financing are now exhausted. Provincial deficits in 1993 and 1994 were largely finaliced by the reguilarization of debts oved by the National Administation to the provinces, by their shiare of the proceeds from the sale of YPF, and in 1994 by issues of Treasury bonds amounting to ARG$0.6 billion, .secured by shared revenues. These sources are now exhausted. In view of the current situation, the Tressury will issue no bonds from now onwards on behalf of, or directed to the provinces. Moreover, the Central Bank will not approve any addItional domestic borrowing by the provinces, including loans guaranteed by shared revenues. Issues of debt for regularization of federal arrears will be lirnited to an amount that does not exceed reductions in outstanding debt through the new tax moratorium. disctiarged with public bonds, and debt-equity swaps from piivaUzations In excess of the US$2.4 billion mentioned above (para. 8). 4 . 94 - aD'A6'&o&o< C Uooooms ANNsEX R 12. To assist in the adjustment of provincial finances, the Federal Govemment in the early lOgos launched a concerted effort to regulaaize the transfer of co-participated federal revenues; reduce unconditional discretionary transfers that reward poor fiscal performers; improvc local resource mobilization; modemize and downsize public administration, Improve the provision of social seivices in health and education; assume responsibility for, and reform, provincial social security systems: privatize or close inefficient public enterprises; eliminate Central Bank rediscounts; promote pnvatization of provincial banks; and more generally Improve the efficiency of allocation of resources In the provincial public sector. 13. To attain these objectives. the Federal Government's strategy for provincial reforms is based on: (a) the Transformation Fund approved In April 1993; (b) the "Fiscal Pact" signed on August 1993: (c) the Provincial Development Trust Fund (discussed in Section 1II). 14. The Transformation Fund. In April 1993, a Transformation Fund funded chiefly tby the World B1ank was estabilshed to finance stnictural adjustment measures in the provinces, funded, inter alia, by further privatizatlons at the federal level. To gain access to the Transformation Fund, adjusting provinces must enter Into an agreement with the Ministry of Interior taking measures aiming at. (a) improvements In local resource mobilization: (b) Improvements in the efficiency of expenditures; and (c) reduction in the size of the provincial banking sector. 15. Fiscal Pact. In August 1993, the Federal Govemment proposed a "Fiscal Pact", w4hich principally calls for reforms In provincial tax systems to reduce producer costs. and increase local tax revenues, consistent vwth the earlier proposed Transforrnation Fund. In retum, the Federal Government agreed to Increase minimum co-participated transfers, postpone, and possibly forego, certain provincial debt obligations, and take over responsibility for funding provincial social security .systems. 16. To reducc tax and other regulatory distortions and Improve the fiscal situation and performance of the provinces, the Federal Govemment, in context of the 1993 "Fiscal Pact", is seeking from provinces to: a. substitute the tumover tax by a consumption tax in order to reduce the cascading nature of the provincial tumover tax; b. eliminate the highly distortlonary provincial stamp tax; c. reduce property taxes to 1.2 percent for rural properties, 1.35 percent for- semi-rural properties, and 1.5 percent for urban properties. The maximum fiscal value of properties Is fixed at 80 percent of their market value; d. eliminate provincial labor, financial, and energy taxes; e. use co-participating transfer exceeding an agreed amount, to cancel debt obligations, finance investments, or provincial adjustment programs that have been approved by the national govemment; f. intensify tax collection and control, witli piovinces adopting a uniform system of tax reporting and collection, as developed by the national tax directorate (the DGI); and * -95- 6/ ~~~~~~~~~~~~~ANNEX R 6. deregulate professional activities, eliminate restrictions on wholesale and retail sales, further deregulate the transport sector, and make compatible federal and provincial regulations of the medicine and food markets. 17. In t(ne context of the Fiscal Pact, the Federal Govemment has the obligation to accepl the transfer of provincial social security sy.stems, and harmonize contributions and pensions witth tle newly approved national social security system. Additionally, the Federal Government will support the privatization of public enterprises, and reduce the role of provincial banks through privatization of ownership and control. Consolidated Public Finances 18. To sustain low levels of Inflation, and the stability of the financial system, the federal authorities are committed to seeking a consolidated (including provinces) puAblic sector fiscal balancc, or better, excluding privatization revenues, over the 1995-97 period. 19. To further strengthen fiscal accountability at the provincial level, the Federal Govemment by end of 1995 will seek to standardize budgetary reporting from all provinces, Including both current and capital expenditures, and their financing, according to the principles contained in Law of Financial Management and Performance Control (Law N 24.156). Standardized provincial financial statements vwen available will be made publicly available by the Federal Govemment. which wil also present on an annual basis the financial conditlon of the consolidated public sector. Ill. The Financial Sector 20. Argentina's financial sector Inciudes 3 federal banks, 29 provincial banks in considerable distress, about 31 foreign-owned banks, some 20 cooperatives, and about 57 private banks. Thiere are significant differences in size, with the top 20 banks accounting for about 60 percent of deposits. There are major differences in profitability, with the provincial banks showing the lowest rates of return. Differences in profitability are largely due to differences in costs and credit pollcies. Small banks and provincial banks tend to have higher costs, and pubilc banks tend to have a higher non-performing portfolio. The Govemment believes that privatization of public commercial banks and consolidation Will be healthy for the banking system, by enhancing efficiency and financial soundness. The policies described below wilt implement an orderly process of privatizatlon of provincial banks and strengthening of the bani'ng system- 21. Thess policies are particularly urgent in view of recent event in intemational capital markets. Argentina's financial and capital markets suffered a major setback as a result of the disruption of Mexico's economy in late 1994. The spillover effects on depositor and investor confidence led to a 20 percent decline in bank deposits betveen December 20, 1994 and March 21. 1995, to a standstill In corporate bond issues and to Wide swAngs in the stock market. The outflow of deposits led to sharp increases in interest rates, with prime rates rising to 33 percent in U.S. dollars and 49 percent in Argentina pesos in mid-March (increases of 25-33 percentage points since December), and call money rates which at times reached over 70 percent. Despite progress achieved In raising the capital adequacy of financIal Institutions, some institutions In certain segments of the banking system, including small wholesale banks, credit cooperatives, and provincial banks, were affected by the loss of depositor confidence. 22. To help banks meet deposilt losses, the Central Bank created some Arg$5.8 billion in additional liquidity, through lowering reserve requirements In several stages. creating a facility for assisting distressed banks through Banco de la Naci6n. and extending swaps and rediscounts. Average reserve 4 - 96 - w T6SXsy 6s,,6f 8SG ANNEX R holdings (including cash-in-vault) declined from 21 percent at end-December 1994 to about 14 percent In mid-March 1995. About Arg$4 billion in liquidity w"re provided through these reductions. To fund the facility managed by Banco de la Naci6n, the Central Bank assigned 2 percentage points of reserve requirements (equivalent to about Arg$800 million in additional liquidity). Finally, additional liqajidity of Arg$1 billion has been supplied through Central Bank swaps and rediscounts. Liquidity assistance through Central Bank rediscounts was leveraged by amending the Central Banks Charte- to allow the Central Bank to extend rediscounts for periods exceeding 30 days and for amounts in excess of each commercial banes net worth. All liquidity assistance has been extended within the constraints Imposed by the Convertibility Law. 23. The Govemment's aim is to ensure that commercial banks will be stronger than they have been to withstand the shocks that may come from time to time as a result of extemal events. The recent crises prompts a unique opportunity for a commerclal bank restructuring program that strengthens confidence in the system. 24. To restructure the banking system, the Govemment will Implement: (i) a trust fund to pnvatize provincial banks and (II) a trust fund to assist in the restructuring of private banks. The Government expects to finance these funds with new loans from the World Bank, IDB, with bonds (Bono Argentina) In the amount of $2 billion being floated In the domestic market and abroad, and possibly with loans obtained through pledging YPF shares. The authorities have earmarked these resources to finanee privatization of provinclal banks and consolidation and restructuring of private banks. 25. The Govemment's long-term vision is for a more efficient, strengthened. and competitive financial sector. To achieve this aim, the Government Wil consider further reforms to develop: (I)mutual money market funds, (ii) the leasing Industry, (iii) a deeper and more transparent stock market, (iv) the private placement market, (v) more efficient trading and settlements system, (vi) secondary markets for govemrnent debt, and (vil) the market for asset-backed securities. The Govemment is aware of the recommendations made in the Bank's Capital Markets Report (Rep. No. 12903-AR) issued in December 1994 and plans to give active consideration to measures which can strengthen and develop tle capital market. Provincial Bank Privatizaio 26. One central objective of the Govemment's financlal sector restructuring policy program is to achieve privatization of provincial banks. It is the policy of the Government to encourage provincial govemments to sell all of their shareholdings In provincial banks, If possible. In all cases the percentage sold to the private sector will exceed 51 percent In most cases this percentage wil not fall below 60 percent to assure reasonable robustness of the privatization as provincial govemments will continue to exercise addled influence by virtue of remaining the most important customer in many cases. 27. Privatizatlon Will be implemented through the Provincial Development Trust Fund (Fondo para el Desarrollo Provincial). This fund will extend adjustment loans to provinces or provincial banks that agree to sell a majority share and transfer full control of their banks to private shareholders. The timetable for privatization of provincial banks cannot be specified as It depends on sovereign provincial decisions. Nevertheless. given the incentives to be provided by the Provincial Development Trust Fund, the Government expects that some fifteen provincial banks will be privatized within the next two years. The authoritIes have set a two year limit for the Provincial Development Trust Fund which appears desirable and achievable. However, should the envisaged limit prove to be Insufficient to cornplete the pnvatization of all targeted provincial banks, the Trust Fund's operations would be extended as appropriate. The first three provinces to prlvatize their banks are likely to Include Mendoza, Misiones and Formosa. 4n - 97 - ANNEX R 28. The Provincial Development Trust Fund Wil carefully review privatization plans which include exclusive arrangements for newly privatized banks to manage the finances of the provinces. If such arrangements are contemplated, these should be extended for a maximum of three to five years and their pricing should be part of the bidding process. 29. Pnvatization vwll address the long-standing poor performance of provincial banks, %kich undermined financal sector efficiency and made fiscal balance more difficult. Accounting for 25% of assets in the banking system, these banks not only have higher costs of operation, but also have followed imprudent lending polcies. These have translated into losses to provincial govemments, further undermining their owin very poor financial performance. Further, slo8er overall deposit growth in 1994 and major deposit withdrawals during January-March 199 severely undermined their liquidity positions. 30. Pubilc ovnership has preempted arms-length decisions In lending and other operations and has not provided a managerial commitment or an overriding interest in profit maximizatioin. Through privatization it is expected that the newly emerging private banks will focus on profit maximization and financial soundness and that the Central Bank supervision and enforcement of liquidity, capital adequacy, and provisioning requirements for these banks wil be more offective. The newly privatized banks wall be subject to the regulatory framework established by the Superintendency of Fiunancial Entities, w4iich will have the power to close the prlvatized banks. Stronger management and supervision of provincial banks wiil reduce the risk that these banks generate systemic runs on bank deposits. Stronger supervision will be supported by continuing improvements of the regulatory framework and Institutional development of the Superintendency of Finanuial Entities, vhich will continue to seek technical assistance as needed. Furthermore, pnvatiza(ion will Improve provincial finances by eliminating the continuirng losses that provincial bank generate. 31. If privatization does not materialize and provincial authoritles do not act on closure, the Central Bank will promptly (within one year) apply sanctions, Including wthdrawal of the provincial bank from the clearing mechanism, to provincial banks that do not meet required liquidity or capital ratios. Furthermore, the Central Bank will not extend operating licenses to new provincial government banks. Privatization or closure Is expected to brIng about a downsizing as only a limited share of assets and liabilities is likely to be acquired by the private sector. All non-privatizable assets and liabilities would be transferred to a residual entity which the provincial govemments would liquidate. Special attention will be given to the timely and efficient disposal of any residual assets and llabilities. Provincial Govemments will be requested to define specific additional financing plans, should the assigned financing (para. 24) be Insufficient to cover all residual liabilitles. Private Bank Restructurinu 32. A major objective of the Government's financial sector restructuring policy program Is to strengthen (he efficiency and long-term financial position of private banks. A number of private banks have been under distressed financial conditions as a result of the Mexico cnsis. The govemrnment has introduced a program to sirengthen private banks by inducing restructuring and consolidation. These will be achieved where necessary through recently enacted legislation empowering the Central Bank to mandate the transfer of assets and liabilities of failing institutions to other institutions and throughi the newiy created Bank Capitalization Trust Fund (Fondo Fiducieaio de Capitalizacik.n Bancana). The Fund will be liquidated following Implementation of Its objectives or two years after Its establishment; however. Its life may be extended. 33. The private bank recapitalization pmgram will assist In the ongoing consolidation of Argentina's banking system. Only 20 of Argentina's 100 or so private commerclal and cooperative banks have assets above Arg$250 millon and only 6 banks have assets in excess of Arg$1 billion. Consolidation has beeni induced by liquidity problems of the smaller banks caused by investor reallocation of deposits 4s - 98 - C?d {& ,t#j. a'z o^5f˘;. t(Mom4*b y l jhrc ,; &&o Yg^s06 e 6'4;oef ,ANNEX R to the larger and better banks. Many cooperatives have already consolidated through mergers and some wholesale banks. which suffered particularly acute deposit Withdrawals, have been selling their assets to prime private commercial banks. The Capitalization Trust Fund is aimed at producitig an orderly consolidation cum capitalization of the banking sector without crealing further crises of :onfidence. The Fund will support mergers and acquisitions that result in stronger banks. 34, The Govemment is committed to ensure that bank consolidations result in strong institutions. To Implement this commitment, the Central Bank Wil not approve and the Capitalization Trust fund will not support acquisitlons or mergers in which the acquiring bank is weak or has lower than minimum capital requirements. To qualify for Tnrst Fund support, banks must fully meet tier one capital requirements, as determined by updated credit reviews. in addition, the Central Bank Will ensure that the merger ownership and managerilal structure of these institutIlons meet stringent "fit and proper" criteria, and will closely monitor the progress of these institutions in meeting their development targets. 3S. To provide further confidence and protection to depositors, the Central Bank has established a private Deposit Insurance Fund (DIF). The Dlf provides limited coverage per person per Institutlon up to a maximum of $20,000. The DIF has been established with mandatory contributions trom all financial Institutions. Contributlons will be different acmss banks according to risk ratings assigned by the Superintendency. In addition, the govemment has strengthened the protection to depositors provided by Article 48 of the Law of Financial Entities. The new provision asslgns the total amounts deposited at the Central Bank under reserve requirements to cover deposils up to $5,000 per person. The Government Is committed to seek acceleration of mandated commercial bank contributions to the DIF 36. It remains govemment policy to revoke (he operating license of a financial institution that fails to meet liquidity and capital requirements. In defense of depositors, the government has allowed the Central Bank to restructure a falling financial Institution prior to revoking its license. Two Instruments are provided. One allows the Central Bank to mandate Increases of the institution's capital as well as lihe sale of equity shares to other authorized investors or shareholders. The other allows the Cenlral 13ank to exclude assets and liabilities from a financial institution to transfer them to another institution and lo approve proposals to match the maturities of assets and liabilities financial Institutions. The Government is committed to implement these provisions without delay on institutlons that fail to redress shortfalls In capital requirements. Central Bank liquidity assistance is extended only to viable banks. In that connection, Govermment Will seek means to see that situations Involving outstanding cxtraordinary liquldity assistance are quickly resolved and that any bank receiving BCTF assistance will not require new liquidily assistance beyond the normal limits of the SCRA. Triust Fund Operations 37. The Govemment has established the Bank Capitalization Trust Fund to deal With the restructuring of weak or distressed banks willing to abide by Trust Fund rules goveming acqulsitlons or mergers or restructuring. These principles wAIl be issued in appropriate Ministerial and BCRA Resolutions 38. The Trust Fund itself derives Its resources from the proceeds of the issue of Argentina bonds pJaced domestically and abroad, and totallilng $2.0 billion, as well as $500 million requested from the World Bank. The Fund will make loans for (a) recapitalization (debt of maturities between 5 and 8 years), and (b) refinancing of outstanding extraordinary assistance from or on behalf of the OCRA (loans of up to 3 years maturity). The Trust Fund will not offer any loans or refinancing in the absence of a valid acquisition, merger or recapitalization transaction following the agreed Operating Pnnciples and Procedures (OPP). The Trust Fund will, depending on its actual loans, consider its maturity structure and seek additional longer-term funding as deemed necessary. 4 - 99 - ANNE 39. It is the intention of Govemment to ensure that all banks receiving assistance from the BCTF fully meet capital adequacy requirements. In providing recapitalizatlon from the BCTF, the limits will be 10% of nsk-adjusted assets for restructuring, 15% for mergers, and 25% for assets acquired In acquisitions. It is understood that no more than 10 percent of total BCTF resources will be devoted to restructurings. The authorities agree to consult the World Sank prior 1o undertaking any transaction which appears to belong to point 12 of the OPP agreed with the Bank, and to limit any suc) transactions to a maximum of 5 percent of BCTF resources. 40. The authorities are mindful of the Inherent rilsks of the Trust Fund and actively seek to minimize them. In this regard, the Central Bank and the Trust Fund will closely scrutinize the quality of merger transactions. The authoritles therefore agree that transactions involving at best a 3-rated bank will require special attention in the form of up-to-date external audits, a current valuation of capital adequacy based on current asset valuations, appropriate steps to increase tier one capital as needed to fully meet prudential requirements, and the preparation within 80 days of a Trust Fund transaction of a business plan by whiich the SEF can Judge performance. Merged banks will be subject to an Intensive supervision schedule. 41. The authorities do not intend to provide BCTF resources to banks not meeting minimum tier one capital requirements. It is understood that BCTF recapitalizatlon finance in a restructuring operation will be given on a one-to-one matching basis wth new ownership capital. Qualifying banks vill agree to undergo a financial and institutlonal diagnostic exercise, yielding a business development and InstitutIonal development plan, to be approved by the BCRA and be appropriately monitored and enforced. 42. The Govemment made a major commitment to upgrade the Superintendency by restaffing, seeking extemal technical assistance, and designing and Implementing new procedures. Since 1994, over 100 new bank examiners were hired and significant organizational changes were miade. New divisions for Information management and supervision followvng were created. As a result (the quality of supervision has dramatically Improved, and the BCRA Is committed to furiher Improvements. It intends to continue the cooperative relationship between the SEF and the Federal Reserve Bank of New York to help with training and internal assessment of progress. In addition, the SCRA intends tl undertake a joint assessment with the World Bank to arrive at appropriately agreed follow-up stops, to be Implemented as a action program. The Govemment firmly believes that strong supervision Is essential to preventing lapses in depositor confldence in the banking system. and that the maintenance of confidence is essential for the continued stability of the system. 43. The BCRA remains committed to its original goal of on-site Inspection of all banks during 1995. These inspections follow the new enhanced surveillance procedures enacted in parallel with tUe full CAMEL ratings In early 1994. In addition, the authorities agree that any financial entity receiving Trust Fund loans will be subject to intensive supervision and wVIl be required to meet all prudential regulations. The Central Bank will ensure compliance wlth pnrdentIal regulations by applying the enforcement action and resolution procedures that are provided by the Law of Financial Entities and the Charter of the Central Bank IV, Monetary Pollcy 44. Monetary policy will continue to be govemed by the Convertibility Law, which requires full backing of the monetary base wth intematIonal resefves. According to the law. U.S. dollar-denominated Govemment bonds held by the Central Bank can be used to cover up to 20 percent (33 percent in e -100- y %i e'o^, de g^ oo n0 o .m6 ANNEX R emergency situations) of the monetary base. Credit expansion by the Central Bank to tlie public sector and the financial sector will be limited in accordance with the Convertibility Law. 45. The Govemment Is confident that with the measures that have been taken to strengthen fiscal and financial policies - and the support of the IMF, the World Bank. the IDB, and other institutions -- confidence will be restored and capital outflows reversed, strengthening bank liquidity. In lhis context, the Central Bank during the balance of the year expects to reduce outstanding Swaps and redisoounts, and gradually restore legal reserve requirements so as to recover an adequate margin of liquidity, wiich would be reflected in a recovery in Its holdings of gross international reserves. It Is expected that the recent measure (March 10. 1995) allowing banks to hold part of the reserve requirements in the form of cash-in-vault will be reversed partly by end-June, and fully by end-November. V. World Bank Support 46. The above presentation demonstrates the depth ao the Govemment's overall public sector and financial sector reform programs. The Government belleves that financlal assistance from the World Bank is essential to implement financial sector s(ructural reforms. Implementation of the proposed measures would Improve the fiscal balance Of the provincial govemments and confidence in the financial sector, thereby reducing threats to rnacroeconomic stability. ODrri-ngo FelipeC Minister of IBRD 26842 70 BOLIVIA 60 | 5 PARAGUAY San Salvador 0 de Jujuy Salto @ ,Tucum6n Santiago Resistenc,o > B R AZ I L @ del Estero 00, Posaa Catamarca 0 La Rioia0E 30 30- 0an Juan S @ Santa Fe San Juan oC6rdaoba D 0 and Mendoza 0 0 @ San Luis Rasario 0 t URUGUAY CA BUENOS AIRES® 0 La Plata Santa Rosa @ Mar del Plato0 LU Bahia B anca Neuquen0 U A R G E N T I N A Carmende 0 Selected Cities 40- Pota gones Viedma 0 Province Capitals () SNational Capital Rawson@ Province Boundaries International Boundaries MILES 0 1 00 200 300 400 50 0 KILOMETERS 0 200 400 600 800 50 Rio Gallegos ~~~~~~~~~~~~~The boundaries, colors, 5 0>2_ denominations and any other information shown on this map do not imply, or the part of The World Bank Group, any judgment on the legol Lshiaio ~ ~~~~~status oDf any territory, kshuaio or any endorsement or acceptance of such boundaries. 80a 70o 60' 50' APRI L 1 99 5 IMAGING Repcort No: P-- 661 2 AR Type: PP