International Experience with Specialized Municipal Finance Institutions and Lessons for the Philippines

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International Experience with Specialized
Municipal Finance Institutions and Lessons for
the Philippines
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Most countries of the developed and developing
world have some sort of specialized institution
to facilitate borrowing by local governments.
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Examples from advanced economies

• USA 17 State Bond Banks
• Canada 6 Provincial Municipal Finance Corps
• Norway Kommunal Bankan
• Sweden Kommuninvest
• Netherlands Bank of Netherlands Municipalities
• Italy Crediop
• Denmark KommuneKredit
• Finland Municipality Finance plc
• Japan Finance Corp. for Muni Enterprises
• Etc.

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Examples from developing economies

• Columbia Findeter
• Parana State Paranacidade
• Tamil Nadu Tamil Nadu Urban Dev authority
• Tunisia Caisse des Prets et de Soutien des
  Collectivity Local
• Sri Lanka Local Government Loans Fund
• Jordan Banque de Development des Villes et
  des Villages
• Etc.

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In advanced economies LGs have options but bond
floatation favored

• Brings in institutional investors, insurance
  funds, etc, and often provides lower interest
  rates, longer maturities and larger debt size
  than bank loans
• Can lead to structured products including
  securitizations to fill special needs.

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• But
• Documentation and due diligence required is
  expensive since all investors need information
  on risks and likely performance of issue. High
  fixed cost of issuing a bond means that only
  large bonds have cost advantage over bank loans.
• Small and medium sized local governments cannot
  avail of bonds --- even in advanced economies

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Specialized financial intermediaries for local
government in developed economies fill a market
niche

• Function
• To help small and medium sized local governments
  take advantage of the more favorable terms of
  bonds by pooling borrowing needs and sharing
  risks

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Municipal finance institutions in advanced
economies

• Operations
• Aggregate the borrowing needs of member LGs on
  periodic basis
• Float a large bond in their own name and
  distribute proceeds through sub-loans to LGs
• Minimize interest rate and maturity risk by
  closely matching amount, tenor and timing of its
  borrowings with those of its sub-loans to LGs

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MFIs in Advanced Economies

• Enhancement of security to bond investors
• Over-collateralization through maintenance of
  reserve fund, e.g. equal to peak future year
  debt service amount
• Pledge of full faith and credit from borrowing
  LGs sometimes joint and several obligations.
• Other guarantees or security from LGs e.g.
  intercept, pledge of property tax receipts, etc.
• Due diligence is on structure of issue and on the
  MFI not individual LGs

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Nordic Countries

• Local Government Driven
• Local Government Associations were instrumental
  in establishing first MFIs in Nordic countries
• Operate similar to credit union
• Member deposits and the joint-and-several
  obligation of members provide security to
  investors in MFI bonds.
• Some require member LGs to pass eligibility test
  to join

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US State Revolving Funds for Water and Sanitation

• Federal and State level subsidies for water and
  sanitation are channeled to state revolving fund
  rather than applied to specific projects
• Several States use these subsidies to create
  dedicated reserve fund to collateralize pooled
  bond floatation to support needs of local
  governments in state. This creates leverage.
• Pooled SRF bonds of NY State are AAA rated even
  when many participating local governments have
  lower ratings or not rated at all.

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Municipal funds in developing countries are very
different

• Set up as simple pass-through revolving funds for
  Multilateral Bank lending
• Help create a credit culture among local
  governments
• Help establish track record of repayment
• Help encourage fiscal discipline among LGs

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But

• Neither the national government nor IFIs can
  satisfy all investment needs of local
  governments
• Foreign borrowing from IFIs and government funds
  are not leveraged. (IFIs should play a small but
  catalytic role.)

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Questions for many countries

• How to bring in domestic private capital and
  reduce the dependence of local government on
  national budgets
• How to foster competition among multiple lending
  sources for LGU business so that margins will be
  lowered and interest rates and tenors improved.
• How can MDFs evolve to play the market niche role
  played by such institutions in developed
  economies?
• How to use domestic subsidies and IFI funds to
  gain leverage in raising private domestic funds

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Three examples of enhancing access to domestic
private capital

• Columbia, and Czech Republic
• Second tier institutions that rediscount private
  bank loans to Local Governments
• Extend tenor of private bank loans and
  introduce private banks to LG market
• Tamil Nadu State Municipal Fund in India
• Private management
• Successful domestic bond floatation

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Lessons from International Experience

• Organization Corporate structures with Boards
  of Directors and independent management
• Security Collateral from borrowing LGs in form
  of intercept, reserve fund or other assets
• Competition Multiple sources and types of
  lenders to help extended tenor and lower i rates
• Special Privileges Private bank lending should
  not be discouraged by giving government lending
  institutions special advantages
• I rates Market determined to spur competition

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Establishing a lending Institution is not
sufficient in LDCs

• Maintenance of stable macro environment
• Domestic capital market regulation
• Solid legal framework, including strong LG code,
  regulation of banking and securities regulation
  of LG borrowing
• Local government reform budget, taxation,
  planning, project analysis, transparent
  procurement, use of private sector
• Clear, accurate, consistent, timely, information
  on LGs

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Philippines

• Decentralization supported by strong Local
  Government Code 1991
• Well defined system of transfers of centrally
  collected taxes to LGs
• Well defined own-source revenue base for LGs (
  but very poorly used)

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Philippines MDF Experience

• MDF established in 1984 as revolving fund for ODA
  to local governments. MDF is department of DOF
• NG allows intercept of its flows to borrowing
  local government as security
• MDF Staff review project feasibility and the
  paying capacity of LG borrowers
• Good lending record essentially zero arrears
  OED found loans to be productive.

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Other lending to LGs in the Philippines

• Government Owned Financial Institutions (GFIs)
  have significantly picked up lending to LGs in
  past 5 years

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Private lending to LGUs in Philippines

• No private bank lending to LGs local banks
  express need for protection from political risk
• 8 bonds issued in recent years supported by
  private bond guarantee, demonstrating some market
  appetite high cost of issuing bond compared to
  bank loans limits demand.

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Issues

• Only GFIs and MDF allowed to access intercept
• Only GFIs allowed to be LG depositories
• Government has matching grant program BUT only
  projects supported by MDF loans eligible
• All LG loans made by National Government
  institutions, using National Government flows as
  security
• As dept of government, MDF hamstrung
• Freezes that prevent hiring needed staff
• Budget rules hinder new lending
• All decisions made by public officials
• MDF role now being duplicated by GFIs
• Risks are too concentrated, there is limited
  choice by LGs

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Next Steps for Philippines

• Encourage gradual entry of private bank lending
  to better off LGUs by leveling playing field with
  GFIs better off LGUs should graduate to
  private sector.
• Convert MDF into market friendly institution that
  begins to facilitate LG access to domestic
  private capital markets, and leverages IFI and
  public funds.

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Key steps required to encourage private bank
lending

• Allow a limited number of accredited private
  banks to be depository banks of LGUs and obtain
  recourse to IRA intercept
• Re-examine matching grant program allow an LGU
  to obtain a loan for a project eligible for a
  matching grant from any source (including a
  private bank) and still receive grant.

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Bond market access for all but largest LGs will
depend on

• An intermediary that pools needs and risks of
  multiple LGUs and floats bonds on their behalf,
  or formation of an LGU credit union style
  institution

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Significant access to private capital will
require simultaneous and continuous efforts to
build capacity of LGUs

• Financial reforms including budgeting, planning,
  accounting, collections, and resource
  mobilization
• Improved project management and monitoring
• Better public information and consultation with
  community groups

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LGUs should have a choice.

• A healthy LG finance system in Philippines needs
  
• Private bank lending for better off LGUs
• Direct bond market access and
• Market oriented specialized financial
  intermediaries for smaller LGs
• Competition among sources and institutions is
  essential
• DOF needs to move simultaneously on several fronts

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Key Recommendations

• Allow a few accredited private banks to become
  depository banks for LGUs
• Corporatize MDF decide among market friendly
  options that will leverage IFI funds and tap
  domestic markets
• Expand capacity building for LGUs
• Reform Loan-grant-equity mix to have sustainable
  matching grants that apply to eligible projects
  no matter where LGU borrows.