World Bank Documentdocuments.worldbank.org › ... › pdf › multi-page.pdf · 8. The metal,...

Document ofThe World Bank

FOR OFFICIAL USE ONLY

Report No: 20149

IMPLEMENTATION COMPLETION REPORT

SRI LANKA

PRIVATE FINANCE DEVELOPMENT PROJECT

(CREDIT 2484-CE)

March 8,2000

Finance and Private Sector Development UnitSouth Asia Region

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

CURRENCY EQUIVALENTS

Rs. Per US 1.00 US$ Per Rs. 1.00

1993 48.32 0.0211994 49.42 0.0201995 51.25 0.0191996 55.27 0.0181997 58.99 0.0171998 64.59 0.0151999 (till May) 69.34 0.014

ABBREVIATIONS AND ACRONYMS

AASMB Accounting and Auditing Standards Monitoring BoardADB Asian Development BankAU Administrative UnitAWDR Average Weighted Deposit RateBOC Bank Of CeylonCBSL Central Bank of Sri LankaCCC Ceylon Chamber of CommerceCSI Contractual Savings InstitutionDFCC Development Finance Corporation of CeylonDFI Development Finance InstitutionEPF Employees' Provident FundETF Employees' Trust FundFIL Financial Intermediation LoanHNB Hatton National BankIDA International Development CorporationIFC International Finance CorporationKfW KfW-Kreditanstalt fur WiederaufbauMOFP Ministry of Finance and PlanningNDB National Development BankNIC National Insurance CorporationNSB National Savings BankOMO Open Market OperationsPB Peoples' BankPCAF Pollution Control and Abatement FundPCI Participating Credit InstitutionsPERC Public Enterprise Reforms CommissionPFDP Private Finance Development ProjectSCB State Commercial BanksSLIC Sri Lanka Insurance CorporationSMI Small and Medium IndustriesTA Technical AssistanceUSAID United States Agency for International Development

FISCAL YEARS

GOSL, National development Bank & Commercial Banks = January 1 to December 31Development Finance Corporation of Ceylon = April 1 to March 31

Vice President: Ms. Mieko NishimizuCountry Director- Sri Lanka: Ms. Mariana TodorovaSector Director: Ms. Marilou UyTeam Leader: Mr. Joseph PemiaTask Leader/Economist: Ms. Sriyani HulugallePeer Reviewer: Mr. Robert M. Buckley

FOR OFFICIAL USE ONLY


SRI LANKA

PRIVATE FINANCE DEVELOPMENT PROJECT(CR. 2484-CE)

CONTENTS

Page No.

Preface

Evaluation Summary ....................................................................i

Project Implementation Assessment .................................................................... 1

A. Statement/Evaluation of Objectives ................................................................... IB. Achievement of Objectives ..................................................................... 2C. Major Factors Affecting the Project ................................................................... 3D. Project Sustainability .................................................................... 4E. IDA Performance .................................................................... 5F. Borrower Performance ......................... ........................................... 6G. Assessment of Outcome .................................................................... 7H. Future Operations ................................................................... 15I . Key Lessons Learned ........................ ........................................... 16Implementation of Policy Measures Agreed at Negotiations .................. . 18

Statistical Tables

Table 1 : Summary of Assessments ........................................................ 24Table 2 : Related Bank Loans/Credits .................................................. ..... 25Table 3 : Project Timetable ........................................................ 26Table 4 Loan/Credit Disbursements: Cumulative Estimated and Actual ......... 27Table 5 : Key Indicators for Project Implementation ........................... .............. 28Table 6 : Key Indicators for Project Operations ................................................. 29Table 7 : Studies Included in the Project ....................................................... 31Table 8A: Project Costs ....................................................... 32Table 8B: Project Financing ............................................ , , 33Table 9 : Economic Costs and Benefits ............................................. 34Table 10: Status of Legal Covenants ............................................ 35Table 11: Compliance with Operational Manual Statements ....................... ........ 37Table 12: Bank Resources: Staff Inputs ............................................ 38Table 13: Bank Resources: Missions ............................................ 39

This document has a restricted distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

Page No.

Statistical Annexes

Annex 1 : Legislative Enactments Relating to Financial Sector Reforms ............ 40Annex 2 : Relative Size of the Financial Sector 1993 & 1998 .............................. 43Annex 3 Summary of Commercial Bank Performance ....................................... 44Annex 4 : Compliance of the Agreements: Bank of Ceylon and People's Bank .. 47Annex 5 : Investments of Contractual Savings Institutes (CISs) in

Non-government Securities .................................. .................. 48Annex 6: Credit Component .................................................... 49Annex 7 Pollution Control and Abatement Fund ................................................ 51Annex 8 Technical Assistance .................................................... 52Annex 9 Brief Report on Studies Conducted under the Project .......................... 55Annex 10: Compliance of Eligibility Criteria by PCIs . .......................................... 60Annex 11: Brief Note on Site Visits ..................... ............................... 61

Appendixes

A. Aide Memoire of August 1999 ICR MissionB. Borrower's contribution to ICR and comments


SRI LANKA


PREFACE

This is the Implementation Completion Report (ICR) for the Private FinanceDevelopment Project in Sri Lanka, for which Cr. 2484-CE in the amount of [SDR 43.2million] equivalent was approved on April 20, 1993 and made effective on August 2, 1993.Final disbursement took place on December 8, 1999 and a balance of SDR 3,794,514.33 wascanceled.

The ICR was prepared by Sriyani Hulugalle, Finance and Private SectorDevelopment Unit of South Asia and reviewed by Marilou Uy and Joseph Pernia.Robert M. Buckley was the peer reviewer for the ICR. The Borrower provided commentsthat are included as appendixes to the ICR.

Preparation of this ICR was begun during the Bank's final supervision/completionmission in August 1999. It is based on material in the project file. The Borrower contributedto the preparation of the ICR by providing data and information.


SRI LANKA


Evaluation Summary'

1. Introduction - The Private Finance Development Project (PFDP) was a follow-up ofseven industrial/financial credit lines from International Development Association (IDA) since1979, totaling US$212.8 million. It was the first credit line to deviate from being directed to aselected category within the industrial sector (e.g., small and medium or large scale industries).This was mainly because the IDA felt that Sri Lanka's financial sector had developed adequateinstitutional capacity to allocate resources fairly efficiently. The total cost of the project wasUS$153.0 million with the IDA contributing US$60.0 million. The balance was provided byUnited Nations Agency for International Development (USAID), KfW2, participating creditinstitutions(PCIs), entrepreneurs and the Government. The USAID and the KfW providedfunds under their bilateral lending programs even though at the appraisal stage they had agreedto co-finance.

2. Proiect Objectives - The main project objectives of the PFDP were: (a) improvingefficiency of financial intermediation by supporting policy and regulatory reforms in thefinancial sector; (b) assisting domestic resource mobilization for long term investment bystimulating the development of the local bond market; (c) enabling private sector to respond tothe changing economic environment by providing investment finance; and (d) help deepeningthe financial system and strengthening the key players in the financial sector. The main projectcomponents to support the above objectives were: (i) a credit component of US$138.8 million(IDA - US$57.2 million; PCIs and entrepreneurs - US$81.6 million) to provide investmentcapital for the industrial sector; and (ii) a technical assistance (TA) component of US$14. 5million (IDA - US$2.5 million; USAID - US$7.0 million, KfW - US$5.0 million) for, (a)establishing a viable domestic bond market; (b) preparing the state-owned commercial banksfor restructuring and recapitalization; (c) implementing the new accounting and auditingstandards, debt recovery legislation and strengthening the bank supervision function of theCentral Bank of Sri Lanka (CBSL); (d) continuing to upgrade the capabilities of ParticipatingCredit Institutions (PCIs); and (e) supporting implementation of environmental standards byentrepreneurs, PCIs and regulatory agencies. The USAID provided technical assistance mainlyfor capital market development (Para. 68), while the KfW funded the Pollution Control andAbatement Fund (PCAF) (Para. 63 & 64).

3. The PFDP project objectives conforned to the country assistance strategy and providedthe much needed investment capital for the private sector through the private banks. Theproject provided an impetus to creating a conducive legal framework for enhancing thedomestic resource mobilization capacity of the private financial institutions. It also helped inincreasing the supervisory role and the supervisory capacity of the CBSL and assisted capacitybuilding in the PCIs. The risks identified at the appraisal (e.g., macro economic stability and

I Provides cross-reference to paragraphs from Part I that provide more details.

2 KfW - Kreditanstaltfur Wiederaufbau

1

the conflict situation) affected the pace of policy reforms, especially the restructuring of thestate banks and insurance sector as well as the investment climate.

4. Implementation Experience and Results of Policy Reforms - The results of policycomponent of the project were unsatisfactory. Some actions were taken but in most cases theydid not result in achieving the desired outcomes as they addressed only the symptoms ratherthan the cause of the problems. The actions taken are reflected in the Attachment 1 of themain report. The Central Bank of Sri Lanka (CBSL) provided necessary legal framework tofacilitate issuing of long term debt instruments. It also enhanced the market orientation of thedebt market by introducing publication of information relating to treasury bill auctions (Para.29-32). In addition, preliminary work had been initiated to introduce scripless trading ofgovernment debt securities and develop the secondary market (Para. 33-34). Furthermore,during the project period, the CBSL has taken several progressive steps to increase thediversification of the investment portfolio of the Employees Provident Fund (EPF) and also toimprove the management efficiency of the EPF, thereby, bringing better returns to thebeneficiaries (Para. 37-38). However, the Government's deficit financing policy wouldcontinue to constrain the ability of the EPF's management to increase flexibility in theirinvestment decisions. The Government has taken several progressive steps towards increasinginvestment in non-governmental paper by the contractual savings funds. This is supplementedby measures to improve market orientation of open market operations (Para. 33 & 34).

5. The CBSL enhanced its supervisory capacity bringing the specialized licensed banks alsounder its supervision and improved the reporting systems (Para. 40-41). The MOFP and theCBSL also took positive steps to introduce disclosure policies that would improve the financialmanagement, in not only the banking sector but also in the corporate sector (Para. 56). Therequired legal framework and the institutional arrangements are in place to ensure monitoringcompliance. The banking sector continue to improve the technical expertise of their staff in theprivate as well as public sector banks to ensure sustainability of these reform programs.

6. However, the Ministry of Finance and Planning (MOFP) and the CBSL failed tocommence on a major restructuring program of the state banks to improve their financialperformance. They only had taken limited damage control measures to contain the expansionof the state banks (Para. 42-47). In addition, the Government could not finalize the newinsurance law that would enable setting up the regulatory authority to provide a level playingfield for the industry (Para. 48-49).

7. Implementation Experience and Results of the Credit Component - Theperformance of the credit component was rated satisfactory (Para. 58-62). The Governmentonlent funds directly to the PCIs, on a variable basis at the Average Weighted Deposit rate(AWDR)3. AWDR was selected as a reference rate specially to reflect the average cost offunds in the absence of a long-term yield curve. The credit was fully committed and thedisbursements amounted to 96% of the approved amount. Although the PCIs included threecommercial banks and the two Development Finance Institutions (DFIs), the DFIs accountedfor 95% of the total commitments. The private banks' liquidity position was favorable with theincrease in deposit mobilization and also due to a significant reduction in the CBSL' s statutoryreserve requirements. The project assisted in generating capital investment of US$138.8million in the industrial sector while the total employment generated was approximately12,184.

8. The metal, chemical and plastic sub-sector led the lending portfolio (20.7%) under thePFDP followed by the services (17.5%), hotels (16.0%), textiles and garments (11.6%) and

3 Please to refer Part I- Page I foot note.

.it

rubber and leather sub-sectors (9%) (Annex 6 -- Table 2). The funds were mostly accessed bythe services sector mainly because there were other lines of credit available for small andmedium scale industries from the IDA and the Asian Development Bank (ADB) during theinitial period. Of the approved sub-loans, 80% was concentrated in the Western Province.(Annex 6-Table 3.). The continuing ethnic conflict and inadequate physical and economicinfrastructure outside the Western Province contributed to this high concentration.

9. The textiles sector led the employment generation with 31% followed by metal, chemicalsector with 18%, services with 12%, rubber and leather with 10% and hotels with 9%. Thegeographical distribution of employment creation almost reflected a similar trend except forGalle where employment generation was significantly higher with 11% compared to the creditdisbursement of 3.4% (Annex 6: Table 2 & 3 ).

10. Most of the credit funds were committed ahead of schedule. In addition, with theeffective monitoring by World Bank Colombo Office and National Development Bank (NDB),the undisbursed loans were reallocated several times in consultation with the PCIs to optimizethe utilization of funds.

11. Implementation Results of the TA Component - The TA component was marginallysatisfactory (Para 65-73) as both the MOFP and the Central Bank took more time thannecessary to initiate the studies which were background work for some of the proposedreforms. Consequently the reforms in state bank restructuring, increasing domestic resourcemobilization capacity and development of the debt market got further delayed. With thesignificant depreciation of the dollar against the SDR, the amount available for TA wassubstantially higher than the original allocation. The TA component was fully committed anddisbursed by the close of the project. This was mainly due to the close coordination the IDAhad with the implementing agencies. In addition, the Bank missions closely monitored theprogress and ensured that the identified studies were prioritized and also ensured that properprocurement procedures were followed (Annex 8 - Table 1).

12. (a) Capacity Building of PCIs and other Financial SectorInstitutions - (US$921,232):The staff of the four PCIs, MOFP and CBSL participated in overseas training programs. Inaddition, Harvard University conducted two training programs on project appraisal which wereorganized by the two DFIs. It was an economical way of providing high quality training to alarge number. In total, 198 PCI staff were trained in various aspects of banking such as creditmanagement, financial management, treasury management, environment appraisal and projectrehabilitation (Annex 8 - Table 2). The training courses were approved on the basis ofrelevance to the institutions and also on the skills of the staff trained.

13. The staff who were trained under the project belonged to all categories; junior, middleand senior management. Training focussed more on academic courses and less emphasis wasgiven for exposure tours. In addition, the institutions were encouraged to select trainingcourses in the Region and also focussed on capacity building. All the institutions continue theirstaff development programs using their own budget, which makes these training programs,funded under PFDP sustainable in the long run. This reflects the emphasis the bankmanagement in Sri Lanka has placed on staff development.

14. (b) Domestic Resource Mobilization (Annex 9): Two major studies were conducted toimprove the domestic resource mobilization capacity. One was for the development of portfoliomanagement and capacity building in the Employees Provident Fund and the other was theautomation of banking activities and government debt securities market. Central Bank of SriLanka has taken a series of steps to develop the government securities market and this studyaimed at furthering these efforts. Both were successfully completed and the recommendations

iii

are being followed up by the Central Bank. The USAID provided technical assistance forcapital market development.

15. (c) Portfolio Audits of State Commercial Banks (Annex 9): The portfolio audits of thetwo state banks were completed on time despite the industrial action taken by the employees'unions during this period. The portfolio audits showed that with proper provisioning for badloans, one of the state banks would require substantial capital infusion. It reflected themagnitude of the problems faced by the two state banks and provided background material forthe MOFP and the CBSL to initiate a restructuring program in the state banks.

16. (d) CleaNet: One of the objectives of the TA provided under PFDP was to supportimplementation of environmental standards. With this in view, Pollution Control AbatementFund (PCAF) was established with funding from the KfW. In addition, the IDA also identifiedduring supervision that there was a need for creating a full service center on cleaner technologyproviding assistance to private industrial entities to complement PCAF activities. This facilityhas initiated the use of cleaner technology by the industrial sector and promoted strengtheningpublic and private sector partnership.

17. Project Cost, Financing and Time 3chedules - The project was implementedsatisfactorily without major problems. The project cost was estimated to be US$153.6 millionat appraisal and the actual cost was US$153.0 million (Table 8A & 8B). PFDP was prepared,signed and became effective as originally planned. The disbursements were well ahead of theappraisal estimates in FY 95 & 96. As all the funds were committed on time, the project wasclosed on the originally planned date.

18. Project Sustainability - The overall commitment by the govemment for the industrialsector continued despite the change of government in 1994 and private sector continued to bethe engine of growth. The internal efficiency and the strong financial performance of the PCIscontinued during the period under review. The CBSL improved its bank supervisory capacity,which also strengthened the commercial banking sector especially during the East Asian crisis.The sub projects visited during the implementation completion mission revealed that theprojects are financially viable and are planning expansion of their current operations. Inaddition, the PFDP also has strengthened the enforcement of environmental standards in theindustrial sector. Despite weak compliance monitoring by the environmental regulatoryauthorities, the industries themselves seem to have adopted cleaner technology and also haveintroduced waste treatment facilities. In addition, due to the success of the project, otherinternational financiers have been interested in the financial sector. Most of the other donorsexpect the IDA to take the lead in the financial sector reforms. However, the government'sreluctance to proceed with the privatization of the state banks and insurance companies has hadadverse implications on the financial sector development. The continued state dominance inthe banking and insurance sector raises concerns on the long term sustainability of the sector.

19. II)A and Borrower Performance - At the identification, preparation and appraisalstages the political scenario was more conducive for financial sector reforms. The IDA hadcorrectly identified the potential risks at the outset, which may affect the project. However, theproject was too dispersed and lacked focus and contained many disconnected activities.Consequently, supervision was loaded with the task of following up scores of activities acrossthe entire economy (Para. 19-23), thus, losing focus on policy reforms.

20. Initially the project was task managed by headquarters with support from the ColomboOffice. After the task management was transferred to the Colombo Office, the supervisionbecame more effective as there was close coordination between the implementing agencies andthe IDA. In addition, frequent monitoring alerted the Govemment when the progress slowed

iv

down. Especially with the close coordination with the PCIs, credit component was optimallyutilized. The TA programs were frequently discussed with the MOFP and the CBSL and inconsultation with the implementing agencies were modified to reflect the reform priorities andfinancial requirements. In addition, the task manager always sought technical advice fromheadquarters staff, which was promptly provided. The missions always demonstratedflexibility in reflecting the country's priorities and also coordinated well with the other donorsand played the role of the financier of last resort while never relinquishing the mantle of takingthe lead in the financial sector policy dialogue. The IDA, however, could not suspend theproject as it would have affected the private sector banks.

21. The increased importance placed by the IDA during the last two years on procurementprocedures indirectly slowed the procurement process of consultants. Major delays occurred inprocurement as the Government did not have a strong central unit to attend to procurement ofvarious consultants. As the security risk increased in the country after the Central Bank bombexplosion in 1996, they found it extremely difficult to obtain the services of consultants of highquality. Therefore, the implementing units had to spend a longer time searching forconsultants.

22. The Borrower's performance was satisfactory on the credit component but was less thansatisfactory on the policy implementation (Para. 24-28). Financial sector reforms committeewas initially headed by the Secretary, MOFP till 1996 and was supported by a secretariat withstaff dedicated for reforms. Subsequently, this function was brought under the CBSL and theDepartment of Financial Markets, in addition, to their routine work provided the secretarialsupport. Therefore, the coordination and monitoring was not as effective as the earlierinstitutional arrangement. Even though the project management of the TA component wasweak, financial management was very satisfactory and the audit reports for the project as wellas the PCIs were submitted on time.

23. The administration unit (AU) of the National Development Bank (NDB) handled thecoordination of the credit component. The role of the AU was efficiently executed by the NDBand quarterly reports were submitted regularly. They also maintained a comprehensivedatabase and administered the Pollution Control and Abatement Fund and coordinated theCleaNet sub-project (Para. 71). In addition, there was excellent coordination with the IDA,which helped, in optimal utilization of the PFDP funds.

24. Future/Follow-up Operations Findings and Lessons Learned - Following from thecurrent financial and civil service reform programs, the MOFP and the CBSL have identifiedthe urgent need for pension reform (Para. 74-76). In addition to addressing the demographicchanges, the Government is keen to create a better investment climate for the contractualsavings funds. The Government has commenced discussions with the IDA to design an overallreform program reflecting the priorities. The Bank has already responded positively to therequest by obtaining a PHRD Grant for pension reforms and is preparing an overall strategy forpension reforms to be discussed with the Govemment.

25. In addition, the Government has also requested the IDA to assist them in the secondphase of the financial reforms in further strengthening the regulatory environment whileproviding an intermediation loan. The IDA responded that if the Government is prepared toproceed with a private management contract for the two state banks, IDA would be happy to beassociated with the second phase of the reform agenda. CBSL has identified that they requirethe services of consultants for several studies, even though, funding arrangements have not yetbeen finalized. They are, (i) the preparation of legislation for supervision of merchant banks,(ii) the formulation of a legal framework for licensing and supervision of money and foreignexchange brokers, and (iii) OMO operations.

v

26. The PFDP provided an opportunity for the Bank to reflect the effectiveness of using aFinancial Intermediation Loan (FIL) to address policy reforms in the financial sector. Thefindings and lessons learnt (Para. 77-89) from PFDP for future Bank operations are summarizedbelow. On the positive side, PFDP demonstrated that the following measures contributed tothe success of the project:

Existence of an efficient administrative unit,Supporting reforms through different governments,

* Lead taken by the CBSL and MOFP in the policy dialogue,*\ . IDA's continuous coordination with the senior staff of the CBSL and MOFP,

Awareness of the need for reform among all the financial sector policy makers aswell as senior officials in the financial sector institutions, and

* Timely quarterly reviews.

27. While on the negative side, the following deficiencies adversely affected the impact ofthe project:

Lack of commitment by MOFP at the implementation stage,Lack of a central coordinating unit in the Central Bank with representation fromMOFP for sector reforms,Bureaucracy being too sensitive to the political environment,Absence of an overall framework for financial sector,Lack of coordination among departments within the same organization,Inability to set up strong regulatory authorities to improve governance, and

. Less leverage for reforms under a FIL.

vi


SRI LANKA


PROJECT IMPLEMENTATION ASSESSMENT

A. Statement/Evaluation of Objectives

1. The Private Finance Development Project (PFDP) was a follow-up of sevenindustrial/financial credit lines since 1979 from International Development Association (IDA),totaling US$212.8 million. It was the first credit line to deviate from being directed to a selectedcategory within the industrial sector, specially as the IDA felt that Sri Lanka's financial sector haddeveloped adequate institutional capacity to allocate resources fairly efficiently. The total cost ofthe project was US$153.0 million with IDA contributing US$60.Omillion. The balance wasprovided by United Nations Agency for International Development (USAID), KfWD, participatingcredit institutions (PCIs), entrepreneurs and the Government. The USAID and the KfW providedfunds under their bilateral lending programs even though at the appraisal stage they had agreed toco-finance.

2. The main project objectives were: (a) improving efficiency of financial intermediation bysupporting policy and regulatory reforms in the financial sector; (b) assisting domestic resourcemobilization for long term investment by stimulating the development of the local bond market; (c)enabling private sector to respond to the changing economic enviromnent by providing investmentfinance; and (d) helping deepening the financial system and strengthening the key players in thefinancial sector.

3. Project Components: To achieve the above project objectives, PFDP had identified thefollowing specific project components to be funded:

(a) Improvements in Policy Framework: The project was expected to support wideranging reforrns in the policy and regulatory environment in the financial sector,especially mobilization of domestic resources for investments through commercialchannels.

(b) Investment Credit Component (IDA-US$57.5 million, PCIs and entrepreneurs -US$81.6 million): This component was expected to provide funds to ParticipatingCredit Institutions (PCIs) for term loans to private enterprises, irrespective of theirsize or sub-sector. The Government on lent funds directly to the PCIs, on avariable rate at the Weighted Average Deposit Rate(AWDR)2. The project alsowas intended to increase domestic resource mobilization capacity of PCIs byfinancing only 60% of the loan amount. The project was also to create a PollutionControl and Abatement Fund to help existing industries to comply withenvironmental standards.

KfW- Kreditanstaltfur WiederauJbau2 AWDR - Represents the weighted average of the interest rates paid to depositors by branches in the greater

Colombo area of domestic commercial banks (other than national savings bank) on interest bearing termdeposits, as issued weekly by the Central bank of Sri Lanka, calculated on the basis of the previous 26week period.

1

(c) Technical Assistance (TA) Component (IDA - US$2.5 million, USAID - US$7million, KfW - US$5 million): The project was expected to provide assistance inpreparation and implementation of policy reforms including, (i) establishing aviable domestic bond market, (ii) preparing the state-owned commercial banks forrestructuring and recapitalization, (iii) implementing the new accounting andauditing standards, debt recovery legislation and strengthening the banksupervision function of the Central Bank of Sri Lanka (CBSL), (iv) continuing toupgrade the capabilities of PCIs, and (v) supporting implementation ofenvironmental standards by entrepreneurs, PCIs and regulatory agencies. TheUSAID provided technical assistance for capital market development while theKfW funded the Pollution Control and Abatement Fund (PCAF).

B. Achievement of Objectives

4. The objectives of the PFDP conformed to the Country Assistance Strategy. Whenextensive financial sector reforms were proposed in early 1 990s, there was political stability in thecountry. At the outset of the project in 1993 and 1994, the draft legislation -- relating tointroduction of long term debt instruments, increasing the scope of bank supervision by the CentralBank, increasing investments of National Savings Bank (NSB) and other institutional investors innon-government paper -- were prepared by the financial sector reforms committee. This was donein consultation with the stakeholders such as private and public sector financial institutions as wellas the industry to develop the long-term debt market (Annex 1). The legislations have assisted indeveloping the debt market introducing debt instruments of longer term maturities, bettersupervision of the banking sector by the Central Bank and increasing the ability of the bankingsector to mobilize resources in the domestic as well as international financial markets. However,with the assassination of the incumbent President in 1993 and a series of parliamentary andpresidential elections and the eventual change of Government in 1994, the reform program wasdelayed till 1995. Despite the change of Government, the Central Bank's and the Ministry ofFinance's focus of financial sector reforms, remained on improving the performance of the twostate banks and improving the regulatory framework for the financial sector, particularly, in thedomestic resource mobilization arena by continuing to provide the required legislative framework.

5. The PFDP line of credit catered to the much needed investment capital for the corporatesector. It complemented the Small and Medium Industries (SMI) IV Project which providedfinancial resources mainly to the small and medium industries and also Asian Development Bank's(ADB) Development Finance line of credit. The project could generate investments to the tune ofUS$137.0 million in the industrial sector while providing additional employment opportunities for12,184 during a period of six years.

6. The technical assistance provided for the capacity building of the PCIs and the otherfinancial institutions has been found effective. All these institutions continue with their staffdevelopment programs even after the close of the project, thus ensuring sustainability. In addition,it is remarkable that while in most countries the Development Finance Institutions (DFIs) failed,the two DFIs in Sri Lanka during the project, diversified their activities while maintaining the focuson development finance and became premier financial institutions in the country. At the end of theproject both were functioning purely as private sector companies.

7. The support in enforcing environmental regulations in the industrial sector, whichcommenced under SMI IV, was continued under PFDP by enhancing pollution control andabatement measures. In addition, the project also assisted in increasing awareness amongindustrialists, the need to introduce cleaner technology, which would eventually reduce cost ofproduction. High level of environmental awareness by industries was evident during the site visits.

2

8. During the implementation of the project, the main objectives were not changed.However, the desired level of success in reforms could not be achieved as the governmentcommitment slackened during the implementation stage due to the fact that some of the reformswere seen as politically sensitive measures. The financial sector reforrns were delayed but werepursued at a slower pace without any backsliding. The MOFP and the CBSL failed to commenceon major restructuring program of the state banks to improve their financial performance. Theyhad only taken limited damage control measures to contain expansion and the continued statedominance in the financial sector raises serious concerns about the long term sustainability of thefinancial sector.

C. Major Factors Affecting the Project

9. Factors not generally subject to Government Control: The Central Bank and the Ministryof Finance and Planning (MOFP) were affected twice by the terrorist bomb explosions, one in 1996and the other in 1997. These events severely affected the reform program as well as the technicalassistance program. In addition, the assassination of the incumbent President in 1993 and thesubsequent series of elections and the eventual change in Government in 1994, further delayed thereform program. The severe power outages in 1996 also had an adverse impact on the industrialsector and the disbursements and collections were affected slightly during 1997/98 (Table 4). Theconflict situation continued in the North and East and sporadic attacks in the main cities includingColombo, affected the investment climate in the country.

10. Factors subject to Government Control: There was overall commitment on the financialsector policy reforms from the inception of the project specially as the reform program was basedon recommendations of the presidential commission on financial sector reforms. However, theGovernment continued with deficit financing which lessened the ability of the pension funds todiversify their portfolio. Despite the Government introducing a favorable regulatory environmentfor the long-term debt market, the inability to maintain fiscal discipline adversely affected theimplementation capacity. However, there was lack of commitment on the part of the MOFP withregard to the proposed insurance law despite extensive consultations with the stakeholders. Inaddition, after 1995, the secretariat of the financial sector reforms committee was not as effectiveas the previous one. After it was absorbed by the Central Bank, the functions got diluted with theroutine bank work and with the bomb explosion in 1996, the staff also got displaced. However,most of the activities that came under the purview of the CBSL were effectively carried outeventhough with delays while the work that came under the purview of the MOFP was noteffectively coordinated by the secretariat. In addition, the MOFP was unduly concerned ofpossible bank employee trade union action and kept on deferring the decision to restructure the twostate banks.

I1. Factors subject to the Implementation Agencies Control: There was no stronginstitutional arrangement for the coordination of the technical assistance program. Therefore, theIDA had to take the lead in initiating the TA activities except for PCI training. With the signing ofthe performance agreements in 1993 and 1998 with the two state banks, more autonomy was vestedwith the state bank management. However, there is little evidence that the management of bothbanks exercising the autonomy they were granted under the agreements. The positive measuressuch as compliance with branch rationalization and staff recruitment were taken as damage controlmeasures rather than proactively restructuring the banks to improve efficiency. The MOFP alsodid not provide leadership to the reforms required in the insurance sector.

3

D. Project Sustainability

12. Finance Sector Policy reforms: The overall commitment by the Government for theindustrial sector continued even after the change of Government and adequate funds were madeavailable for SMI lending specially with both IDA and ADB funds. In addition, the two statebanks financed SMI sector with their own resources and PFDP funds were channeled to thecorporate sector. Especially during 1993/1994, the tourist industry improved significantly and theinvestments escalated in the services sector. The Government continued to consider the privatesector, the engine of growth. However, the Government's reluctance to proceed with theprivatization of the state banks and the insurance companies and the state dominance in these twomajor sub sectors raise serious concerns on the long term sustainability of the financial sector.

13. Participating Credit Institutions: The internal efficiency and the strong financialperformance of the participating private commercial banks and the two development financialinstitutions continued during this period. In addition, the supervisory capacity of the Central Bankwas also strengthened. Eventhough during 1998/99 there was some concern over the perfonnanceof few domestic banks, the CBSL is following closely the developments in the banking sector andcertain measures have been recommended to arrest any further deterioration. Since 1998, some ofthe private banks seemed to feel the lagged impact of the contagion effect of the East Asian crisis.

14. Industrial Sector: The recent site visits (Annex 1 1) undertaken by the implementationcompletion mission revealed, that except for one, all the projects visited would be sustainable in thelong run and also most of them are planning expansion of their current operations. In addition, theproject also has strengthened the enforcement of environmental standards in the industrial sector.Despite weak compliance monitoring by the environmental regulatory authorities, the industriesthemselves seem to have adopted cleaner technology and also they have introduced waste treatmentfacilities.

15. In addition, due to the success of the project, other international financiers have beeninterested in the financial sector. However, most of the other donors expect the IDA to take thelead in the financial sector reforms. Even the ADB and the OECF follow most of the tenns andconditions of the IDA. However, the continued absence of IDA in an active role for a long periodmight result in creating distortions in the financial sector. Unlike the IDA, other donors have atendency to fund ad-hoc TA sub projects in the financial sector without requiring the Governmentto carry out reform measures.

16. The Government has taken several progressive steps towards increasing investment in non-governmental securities by the contractual savings funds3. This is supplemented by measures toimprove market oriented open market operations (Para. 31 & 34). The MOFP and the CentralBank also took positive steps to introduce disclosure policies in the financial sector which willimprove the financial management, in not only the banking sector, but also in the corporate sector.The required legal framework and the institutional arrangements are in place to ensure monitoringcompliance. The banking sector continue to improve the technical expertise of their staff in theprivate as well as public sectors to ensure sustainability of this reform programs.

17. In addition, the impact of improvement of debt recovery legislation has reflected inincreasing the recovery of bad loans by exercisingparate execution powers. The project and theother donor-funded projects with their coordinated effort have been able to enhance the domesticresource mobilization capacity of the financial institutions. The financial institutions have startedmobilizing resources from the financial market issuing corporate debentures. During the last two

3 Employees Provident Fund (EPF), Employees Trust Fund (ETF), Insurance companies and NationalSavings Bank

4

years the corporate debentures of Rs. 3.9 billion have been raised in the market. In addition, theissue of commercial paper (Rs. 8.3 billion in 1999 up to June, Rs. 16.5 billion in 1998 and Rs. 11.1billion in 1997) too has increased significantly.

18. In May 1997, ADB guaranteed a loan of US$55 million to National Development Bank(NDB) for the SMI sector. Government signed an agreement with OECF for another loan ofUS$46 million for small and micro enterprises. KfW has also granted DM 2 million for microcredit to be channeled through the NGO system. In addition, NDB raised US$20 million for theindustrial sector on commercial terms from FMO, Netherlands Development Finance Company.Another loan of US$22 million from the OECF was obtained by the NDB to top up the PollutionControl and Abatement Fund. This facility extended the scope to existing as well as newcompanies addressing pollution abatement techniques while the KfW provided DM 5 million alsofor the PCAF in addition to the previous DM 5 million they had provided. Another US$1.2 millionhad been made available from USAID for capital market development in addition to the initialUS$7.0 million.

E. IlDA's Performance

19. At the identification, preparation and appraisal stage the political scenario was moreconducive for financial sector reform. The IDA had identified the potential risks, which may affectthe project but the project was too dispersed and lacked focus and contained many disconnectedactivities. Consequently, supervision was loaded with the task of following up scores of activitiesacross the entire economy. Therefore, the identification and preparation of the project cannot beconsidered satisfactory. (Table 1)

20. IDA's identification of the project was consistent with the Government developmentstrategy. It was commendable that even with a change of Government and current ruling partybeing a coalition of socialist parties, the MOFP and CBSL still continued with the proposed reformprogram. It was also commendable that the senior bureaucrats, who led the reform program priorto 1994, could convince successfully the new political leaders, the need for reform. Initially theproject was task managed by headquarters with support from the Colombo Office. After the taskmanagement was transferred to the Colombo Office, the supervision became more effective asthere was close coordination between the implementing agencies and the IDA. In addition,frequent monitoring alerted the Government when the progress slowed down. Especially with theclose coordination with the PCIs, credit component was optimally utilized with several rounds ofcancellations and subsequent replacements prior to the commitment deadline in March 1998 toremove slow moving subprojects. This project demonstrated the difficulty in using a financialintermediation loan as a vehicle for sector reforms as the suspension would have caused problemsfor the private banks and investors. The IDA, however, sent a strong message to the Governmentthat unless Government makes a firm commitment and proceed with financial sector reforms at afaster pace and minimize the role of the state in the financial sector, the IDA would limit itsfinancial sector operations to policy dialogue on sector reforms.

21. In addition, the TA programs were frequently discussed with the MOFP and the CentralBank and in consultation with them were modified to reflect the reform priorities and financialrequirements. With regard to the disbursement and implementation it was an effective mechanism.Supervision was more effective from Colombo office as quick decisions on procurement could betaken on time. In addition, the task manager always sought technical advice from headquartersstaff, which was promptly provided. The missions always demonstrated flexibility in reflecting thecountry's priorities and also coordinated well with the other donors and played the role of thefinancier of last resort while never relinquishing the mantle of taking a lead in the financial sectorpolicy dialogue. However, the Government perceived that the IDA' s interest in the country's

5

financial sector had lessened specially as the Bank did not frequently field high powered missionsduring the last few years and made use of the annual meetings in Washington to discuss thefinancial sector issues.

22. The increased importance placed by the IDA during the last two years on procurementprocedures indirectly slowed the procurement process of consultants. Major delays occurred,especially, as the Government did not have a strong central unit to attend to procurement ofconsultancy services. As the security risk increased in the country after the Central Bank bombexplosion in 1996, they found it extremely difficult to obtain the best services possible. Therefore,the implementing units had to spend a longer time searching for consultants.

23. Iii addition, the IDA worked very closely with the IMF to ensure that there was consistencywith the approach taken towards the financial sector reform. All the other donor agencies --- ADB,SIDA and USAID --- followed the leadership provided by the IDA creating a consensus on thereform program among the major donors.

F. Borrower Performance

24. Financial sector reforms committee was initially headed by the Secretary, Ministry ofFinance and was supported by a secretariat with staff dedicated for reforms till 1996.Subsequently, this function was brought under the Central Bank and the Department of FinancialMarkets in CBSL, in addition to their routine work, provided the secretarial support. Therefore,the coordination and monitoring was not as effective as the earlier institutional arrangement.However, despite delays, the Governor and the Senior Deputy Governor of the Central Bankcoordinated the reform program. Some of the activities that came under the purview of the MOFPhad been disappointing as there was lack of ownership of the reform program especially in theinsurance and state bank restructuring. (Para. 49 & 50)

25. The administration unit (AU) of the National Development Bank (NDB) handled thecoordination of the credit component. The role of the AU was efficiently executed by the NDBand quarterly reports were submitted regularly. The quarterly reports were also forwarded to allthe PCIs for their information. They also maintained a comprehensive database and administeredthe Pollution Control and Abatement Fund and coordinated the CleaNet sub-project (Para. 70). Inaddition, there was excellent coordination with the IDA, which helped, in optimal utilization of thePFDP funds. In addition, financial management of the project was satisfactory and all the auditedfinancial accounts of the PCIs and the audit report of the project were submitted on time.

26. The lending proceeded well. The funds were committed on schedule and with closesupervision by the IDA, the undisbursed loans were cancelled and the PCIs were given theopportunity to submit new applications, which increased the disbursement level. Of the eligiblePCIs, about 95% of the disbursements was handled through the DFIs as the commercial banks hadexcess liquidity during the project period due to increased deposit mobilization.

27. However, this project provided an opportunity for financial sector policy dialogue and themissions' findings were well appreciated by the Ministry of Finance and the Central Bank. Thesenior managers of both institutions as well as other public and private financial institutions werecooperative in providing information and discussing the issues with the IDA missions. Also duringthis period, despite the political resistance to reform, the senior management in these institutionshave commendably tried to proceed in the right direction.

6

28. The PCIs continued to meet -with the requirements of eligibility criteria and the collectionperformance of all the banks continued to be above the required minimum of 80% and all the PCIsmet the capital adequacy ratios.

G. Assessment of Outcome

Implementation Results of Policy Reforms (Attachment 1)

29. Strengthening Monetary Policy and Domestic Resource Mobilization: The MonetaryBoard approved a package of reforms in August 1995 to commence active market-based openmarket operations and to develop the secondary market for government securities. In order tointroduce these measures, a series of amendments to legislation governing these activities wereintroduced (Annex 1). The reforms addressed both short and long term debt instruments.

30. Short-term debt instruments were made more market oriented, with the commencement ofpublication of information relating to treasury bill auctions and the introduction of morecompetitive bidding through the primary dealers. In addition, Non Bank Financial Institutionswere excluded from the inter-bank call money market activities to ensure a level playing field forall participants.

31. As agreed the CBSL established an open market operations division and also a committeeto implement the proposed measures introduced through legislation. Open Market operations arebeing conducted on an increased scale and the CBSL is increasingly improving their daily liquidityassessment system linking with the commercial banks.

32. The most important step taken during the period under review was the introduction oflong-term treasury bonds commencing with the two year treasury bonds with fixed coupon rate ofinterest in March 1997. These are market based and are permitted to be transferred byendorsement. Since then, the CBSL has progressively introduced treasury bonds with longer-termmaturities reaching 6 years in 1999. This measure assisted in developing a medium term yieldcurve and as a result the number and the volume of corporate debenture issues have also increasedsignificantly during the last two years (Rs. 3.9 Billion). By increasing issue of more market basedlong term maturities, CBSL is planning to phase out rupee securities which however, had a thestock of Rs. 255.3 billion as at end of August 1999. By improving the trading system ofgovernment securities through dedicated primary dealers, the CBSL envisage promoting thesecondary market for debt instruments. In addition, the CBSL expects an active role by theprimary dealers in the debt securities market and intend to set up a primary dealer surveillancesystem funded by the IDA during year 2000.

33. CBSL has completed a feasibility study to automate the CBSL and inter bank transactionsin order to introduce a scripless trading system for government securities and set up Real TimeGross Settlement Systems (RTGS). These measures were aimed at strengthening the open marketoperations, improving the effectiveness of monetary instruments and the development of asecondary market for government debt securities (Annex 9). The proposed system in addition toquick settlement, would facilitate cheque clearing in districts outside Colombo. In addition, theCBSL finds it difficult to issue bonds with longer-term maturities exceeding six years withoutscripless trading. The expected foreign participation in government securities market would not bepossible with the current manual system.

34. This will inevitably increase the volume of transactions and the fund transfer system willsignificantly improve. At present due to the long transaction time taken, the transactions arelimited and create market distortions. In addition, the securities market has been confined to

7

Colombo. If the Central Bank expedite the automation of banking sector and scripless trading, themarket participants will also increase significantly.

35. The Cabinet has already approved amendments to the Monetary Law Act to, (a) makeprice stability the main objective of CBSL in order to avoid possible policy conflicts, (b) revise thedefinition of money supply to take into account "broad money", (c) remove the maximum andminimum limits on statutory reserve ratios, (d) provide more flexibility to the Monetary Board todecide the basis for computation of the required reserves, (e) enable payment of interest onreserves, and (f) enable imposition of reserve requirements on the financial liabilities other thandeposit liabilities. The Legal Draftsman is preparing the second draft and it is expected to besubmitted to the Parliament by end of 1999. However, as the legislative procedure takes a longtime it is likely to get postponed to the first quarter of 2000.

36. The CBSL has promoted the setting up of a Credit Rating Agency(CRA) in collaborationwith the International Finance Corporation (IFC). The Credit Rating Agency has been establishedas a joint venture public company with a leading international rating agency in USA and otherinternational and local financial institutions. The office has been established and the CEO and thekey staff have been recruited and been given initial training overseas by their internationaltechnical partner. This will assist in developing the debt market by servicing the investors and themarket expects an increase of foreign investor participation.

37. Another significant step for domestic resource mobilization was the decision of theCentral Bank to diversify the Employees Provident Fund's (EPF) investment portfolio. Aconsultant has prepared investment guidelines for the (EPF) and also the selection criteria forexternal fund managers. In addition, the PFDP provided partial funding for the development ofinternal portfolio management expertise and it is expected to be continued under the proposedPHRD Preparation Grant for pension reforms. The EPF is in the process of implementing therecommendations of the study. As the investment guidelines have been prepared, EPF intends tocontinue further diversifying its investment portfolio. EPF has also embarked on a computerizationand modernization program in order to improve its operational efficiency and keep abreast of thechanging technological development which will bring better returns to the savers.

38. In addition, proposals are being explored to amalgamate the EPF and Employees TrustFund (ETF) to minimize administration costs. The ETF is reportedly exploring possibilities ofconverting the ETF to a pension fund and also annuitizing the payments. However, it would beadvisable to take this measure after careful study and also conducting a proper actuarial assessmentto ensure the sustainability of such a scheme. Measures are also being taken by the EPF toeliminate double counting and eliminate a large number of dormant and multiple accounts onceLabor Department and the EPF complete the computerization exercise. In addition, in 1999, theEPF has been able to absorb all administration costs by the generated capital gains from operationsin the secondary market for treasury bonds and equities. The EPF performance has beenimpressive during the last few years and the Central Bank seems to be serious with the reformagenda.

39. The DFIs and the private domestic commercial banks continue to suffer from lack of lowcost funds. However the resource mobilization capacity of the banking sector has improvedsignificantly. The annual accounts for 1997 and 1998 reflect a significant increase in their depositbase by 24.3% and 22.4% respectively. In addition, there were medium term debenture issues byfinancial institutions to raise funds amounting to Rs. 3.9 billion during the last two years, whichwere all over subscribed. Most of the banks argue that they have a mismatch of funds; short termdeposits which need to be matched with long-term investment needs. DFIs are facing the problemof lack of funds specially as they are not deposit taking institutions, which had led them todiversify their activities. However, with the drying up of multilateral funds on concessionary terms

8

the banks are exploring possibilities of using innovative financial instruments to be morecompetitive in the financial sector.

Improving Efficiency in the Banking Sector

40. Bank Supervision by Central Bank: The 1995 amendments to the Banking Actstrengthened the supervisory powers for the CBSL and extended supervision to specializedlicensed banks 'and incorporated all prudential requirements based on international standards.CBSL continued its efforts in improving bank supervision especially in the light of the recent EastAsian financial crisis. Central Bank has improved the on-site and offsite supervision, making that aprimary function of the CBSL. By requiring financial disclosure polices, the CBSL has improvedthe financial discipline of the banks and has addressed the issues in a more systematic manner toavert any major crisis in the banking system. Central Bank is well aware of the need to monitorforeign exchange exposure of the banking sector to avoid a similar problem faced by the EastAsian countries. Central Bank is taking proactive measures to ensure bringing foreign currencybanking units under the supervision of the CBSL. The avenues of communication between theCBSL and banks have been remarkably strengthened by appointing compliance officers at thecommercial banks to ensure compliance in banking and other statutory requirements. In addition,the CBSL is planning to introduce a deposit insurance scheme to provide a level playing field forthe private banks. Central Bank also proposes to tighten the loan loss provisioning to ensure thefinancial viability of the banking sector.

41. The bank supervision department staff is at present about 80 of which 50 are professionalstaff. In mid 1998, setting up a faculty for bank supervision in the CBSL has intensified thetraining of examiners. Three specialists with commercial banking and bank supervision expertswere recruited. During the project period the Central Bank had taken significant steps towardsstrengthening the supervision capacity of the Central Bank and the Monetary Board has seen this asone of the most important functions of the Central Bank. In view of the recent East Asian crisis theCentral Bank has identified the need to keep the foreign exchange exposure of the banks also underclose scrutiny.

42. Performance of State Commercial Banks (SCBs): One of the main objectives of theproject was to down size the state banks through restructuring and eventual privatization. Due tostrong political resistance, the MOFP and the CBSL could not proceed with the privatization butthe share, in terms of total assets, deposits and advances of the state commercial banks, hadgradually declined.

43. The SCBs accounted for 55% of the total commercial bank assets in 1998 compared with64% in 1993. The share of the deposit base of the SCBs during the last 4 years has declined by7.0% reaching 56.6% while the advances have declined by 9% reaching 53.3% in 1998 (Annex 3).A notable feature is that the branch network of the state commercial banks has declined marginallyto 618 in 1998 from 620 in 1995 while the private domestic banks have increased the branchnetwork significantly by increasing the branches from 214 to 296 during the same period.

44. Comparing the efficiency ratios (Annex 3) it was observed that the net interest margins ofthe state banks (4.4%) were marginally higher than the private banks (4.1%) in 1998 while theemployee expenses were 2.5% for state banks while for the private domestic banks was 1.8% in1998. Non-performing ratio in state banks was 17.3 % while in the private sector domestic banks itreached 11.0%. The recent portfolio audits of the state banks revealed that this figure was muchhigher reflecting the need to address this issue immediately. Total employees in the statecommercial banking sector was 20,732 while private banks had 10, 223 in 1998. It is notable that

4DFCC, NDB, NSB, SMIB, Pramuka, SANASA and 6 Regional Development Banks

9

the average employees per bank branch is 34 for state banks while the private sector had 35 in1998. This is in the background of having a large internal security staff in the two state banks dueto the conflict in the country since the 1980s. However, it is creditable to note that the Ministry ofFinance and the Central Bank with their close monitoring and supervision had been able to containthe branch network and resist any political pressure for mass recruitment to the state commercialbanking sector despite a series of elections since the project commenced in 1993. This can beattributed to the agreements signed with the two state banks and also the continuous supervisionand dialogue the MOFP and the CBSL had with the banks and IDA despite its failure to make thetwo state banks more commercially viable.

45. During 1993 and 1996 there had been two rounds of capital infusion by the Government interms of long term bonds; Rs. 23 billion and Rs. 20 billion respectively. Despite the inability of thetwo state banks to comply with the targets set out in the two agreements, one in 1993 (Annex4:Table 1) and another in 1998, the MOFP had not taken any serious remedial measures due to thepolitical instability in the country. As seen in the Annex 4: Table 2, Bank of Ceylon (BOC) failedto reach the agreed targets on profits, return on assets and return on capital but achieved loanrecovery targets, staff and overhead costs. Peoples' Bank (PB) however has not achieved any of thetargets agreed except loan recovery for 1998. Non-performing loans has reached a significantlyhigh level and required provisioning would entail significant capital infusion.

46. According to the CBSL evaluation report the Government had not issued any directives toany of the two banks during 1998 and 1999. After an evaluation by a committee consisting ofCBSL and MOFP, both banks have been requested to adopt a uniform transfer pricing system.Even though the loss making branches have been reduced none of the loss making branches wereclosed due to political pressure.

47. The Central Bank and MOFP have taken measures to bring in advisors to the two statebanks with international commercial banking experience and also the BOC will conduct a study toexplore the possibility of restructuring the bank and there is a likelihood of a management contractfor the state banks in the future. The IDA has offered assistance to the Government if theGovernment is prepared to initiate a private management contract for the two state banks.However, the continued state dominance in the banking sector will have an adverse impact on thebanking sector and raises serious concerns on the sustainability of the financial sector in the longrun.

48. Improving Competitiveness in the Insurance Sector: Government has not beenconsistent with the decision to privatize the two state insurance companies. At last in 1999 after along delay, a steering committee to restructure National Insurance Corporation (NIC) was set upwith representation from PERC, MOFP, NIC, CBSL which can be considered a significant step inthe right direction. On their recommendation, the Cabinet approved divesting up to 39% of NICand also there is no restriction on foreign investor participation. It was also reported that thecommittee had initiated discussions with the employees of NIC to ensure their support forrestructuring. If this proves to be successful, the GOSL is likely to proceed with the divestment ofSri Lanka Insurance Corporation Ltd. too.

49. Insurance Act: After the initial drafting of the new Insurance Law in 1996, the taskforcewas extremely slow in finalizing it. It has been reviewed by various stakeholders over the past fouryears causing undue delay mainly due to lack of leadership provided by the MOFP. The proposedamendments would improve regulatory framework, enable insurance companies to pursue morediversified portfolio management, reduce market segmentation and increase competition. The draftLaw also provides for an autonomous regulatory authority for insurance. At present, the InsuranceController functions on a part time basis and is unable to obtain the required technical staff underthe present institutional structure. The Controller's office lack the capacity to regulate and

10

supervise the industry and cannot attract qualified staff in its present form. The agreed target dateof presenting the Insurance Bill to Parliament keeps getting postponed indefinitely. The industryfeel that the passage of the new Insurance Law would provide an opportunity to establish a strongtechnical secretariat to supervise the industry. Recent missions of the World Bank who visited SriLanka during April and also in June 1999 to assist the Finance Ministry in setting up a RegulatoryAuthority for Private Pension Funds advised them that due to lack of qualified people in this field itwould be better to set up a single regulatory authority for both pension/provident funds andinsurance. Despite repeated assurance given by the MOFP during the last few years, the law hasnot yet been enacted.

50. Diversifying investment portfolio of Contractual Savings Institutions (CSls): The CSIswere expected to diversify their investment portfolios by investing minimum previously agreedamounts in non-government securities (Annex 5).

51. EPF: At the commencement of the project it was proposed that the EPF Act should beamended to permit the EPF to invest in non-government securities. There was resistance from thetrade unions. Subsequently, the CBSL managed to obtain a ruling from the Attorney Generalconfirming that the EPF Act provides for investment in non-government securities and decisionmaking powers are vested with the Monetary Board. EPF invested Rs. 300 million in 1995 andabout Rs. 712 million in DFCC and NDB long-term debentures in 1996. In addition, EPF investedabout Rs. 418 million in 1998 and Rs. 417.0 million in 1999.

52. ETF: Setting up the ETF was to increase share ownership of the employees in privatecompanies. However, due to lack of fund management capabilities of the ETF board ofmanagement, returns on investments had not been better than the EPF as most of the funds wereinvested in government securities.

53. NSB: According to the NSB Act 60% of their investment should be in governmentsecurities which allow them to invest up to 40% in non-government securities. The investments innon-government securities have gone up from 11.1% in 1993 to 19. 4% in 1998.

54. Insurance: Both insurance companies' investment in the non-government securities havebeen in the region of 35-56% during 1993-98.

55. The contractual savings institutions seem to lack fund management expertise and hence theinvestments are made for short-term gains. Either in-house fund management capacity needs to beenhanced or experienced external fund managers should manage the funds with a propersurveillance system in place. This is the approach EPF is taking presently with regard to portfoliomanagement and other institutions will also need to follow their strategy, which will provide animpetus to the capital and debt market. In addition, the fund management of the CSIs should beinsulated from any external pressure.

56. Better Accounting andAuditing Standards: Accounting and Auditing Standards Act waspassed in 1995 which provides for Institute of Chartered Accountants of Sri Lanka (ICASL) tolegally enforce accounting standards adopted by ICASL. Law provides for an accounting andauditing standards committee whose task is to recommend to ICASL the adoption of standards. Italso mandates the Accounting and Auditing Standards Monitoring Board (AASMB) to monitorcompliance with the standards. Both committees have been appointed and the AASMB wasconstituted in January 1997. In 1999 February, all the standards were gazetted and all thecompanies listed or specified in the regulations were required to comply with the standards for theannual audits of 1999. The secretariat of the AASMB was constituted after some delay but still hasa skeleton staff. However, the effectiveness of monitoring compliance by this institution is yet tobe seen as they have not yet commenced official monitoring. They have already prepared the

11

procedures for compliance monitoring. In'addition, both Central Bank and the Securities ExchangeCommission (SEC) require the banks and listed companies respectively to follow the gazettedaccounting standards to in the corporate and financial sectors. It is important that staff ofregulatory authorities be compensated adequately if they are to function effectively. If thegovernment does not act to provide adequate compensation, it will hamper not only the recruitmentof qualified and competent staff for AASMB but also for all the other existing and proposedregulatory authorities. These measures will invariably improve corporate governance.

57. Taxation Incentives for Financial Instruments: Announcements were made in the 1998and 1999 budgets to reduce taxation of the financial instruments to develop the capital and debtmarkets. The removal of most of the taxes on debt instruments helped the creation of a levelplaying field for both debt and the equity markets. This has been evident in the increase ofcorporate debenture issues by financial institutions in 1998 and 1999.

58. Implementation Results of the Credit Component: This was the first of a series ofcredit lines made available to the industrial sector as IDA was moving away from directed creditand the funds were on-lent by the GOSL directly to PCIs, on a variable basis at the AverageWeighted Deposit rate(AWDR). AWDR was selected as a reference rate specially to reflect theaverage cost of funds in the absence of a long-term yield curve.

59. By March 31, 1998, the credit component was fully committed; (68% above free limit; theaverage loan size was about Rs. 8.8 million). The current disbursements amounted to US$54.6million or 96% of the approved amount. Although the PCIs included three commercial banks andthe two DFIs, the DFIs accounted for 95% of the total commitments (NDB 46%, DFCC 49%). Theprivate banks' liquidity position was favorable with the increase in deposit mobilization and alsodue to a significant reduction in the Central Bank's statutory reserve requirements. According tothe number of subloans approved, DFCC accounted for 62% while the NDB accounted for 33%(Annex 6: Tablel). The project assisted in generating capital investment of US$137.1 million inthe industrial sector while the total employment generated was approximately 12,184.

60. The metal, chemical and plastic sub-sector led the lending portfolio (20.7%) under thePFDP followed by the services sector (17.5%), hotel sector (16.0%), textiles and garments (11.6%)and rubber and leather (9%) (Annex 6 - Table 2). This was mainly due to the availability of othercredit lines from IDA and Asian Development Bank (ADB) during the initial period. At the laterstages except for the DFIs other banks had excess liquidity with the slump in the stock market aswell as with the reduction in reserve requirements of commercial banks by the Central Bank. Ofthe approved sub-loans 80% was concentrated in Colombo, Kalutara and Gampaha districtsfollowed by 11.2% in Kandy and Matale, 3.4% in Galle and 3.2% in Anuradhapura. (Annex 6-Table 3.). The continuing ethnic conflict and inadequate physical and economic infrastructureoutside the western province contributes to this high concentration. Same trend has been reflectedin other lines of credit as well. In addition, it'has also been reported that the companies find itdifficult to attract professionals out of the Western Province due to lack of infrastructure facilities.

61. The textiles sector led the employment generation with 31 % followed by Metal, Chemicalsector with 18%, services with 12%, rubber and leather with 10% and hotels with 9%. Thegeographical distribution of employment creation almost reflected the same trend except for Gallewhere employment generation was significantly high with 11 % compared to the creditdisbursement of 3.4%. (Annex 6: Table 2 & 3 )

62. Most of the credit funds were committed ahead of schedule. In addition, with theColombo office and NDB's effective monitoring, the undisbursed loans were cancelled severaltimes in consultation with the PCIs and they were requested to submit new applications, whichimproved the level of utilization of the credit.

12

63. Pollution Control and Abatement Fund (PCAF) : PCAF was a fund established toprovide investment funds at low cost to industrial enterprises for waste minimization, resourcerecovery, pollution control and abatement. This component was originally to be co-financed by theGovernment of Netherland. However, their assistance program was pruned down and KfW agreedwith the government to co-finance PCAF. This was available for industrial enterprises establishedbefore January 1995. In 1994 by law, all the new institutions were required to obtainenvironmental protection licenses from the Central Environmental Authority. Therefore, on thepremise that all new industries would ensure compliance with environmental standards at the outsetitself, the existing industries were provided with financial assistance at zero real interest rates toensure pollution control and abatement.

64. Initially KfW, provided GOSL with US$5.0 million for the PCAF which NDBadministered on behalf of the GOSL. The fund became operative in April 1995 and was fullycommitted (Rs. 331.4 million for 88 projects). Of the total projects, they are distributed evenlyamong all sectors; textiles, food and beverages, agro-industries and fisheries, rubber, plastic andleather and hotel sector (Annex 7-Table 1). Of these, 52% were located in Colombo, Gampaha andKalutara while the other significant area was Puttalam where prawn farms were concentrated(Annex 7-Table 2). In addition, KFW provided an additional US$3.5 million for the PCAF.Another credit line of US$22.0 million has been signed up by the OECF called "E-friends". Thescope of the OECF project is broader than the PCAF. In addition, to the new projects they havealso included energy conservation. The PFDP;s involvement in environmental subprojectsgenerated interest of other donors as well.

65. Implementation Results of the TA Component: The TA component was marginallysatisfactory as both the MOFP and the Central Bank took more time than necessary to initiate thestudies which were background papers for some of the proposed reforms. With the significantdepreciation of the dollar against the SDR, the amount available for TA was substantially higherthan the original allocation. The TA component was also fully committed and fully disbursed bythe close of the project. This was mainly due to the close coordination, the IDA had with theimplementing agencies, especially the Central Bank and National Development Bank. In addition,the missions closely monitored the progress and ensured that the identified studies were prioritizedand also ensured that proper procurement procedures were followed. Most of the studies had to bepostponed as the bomb explosion in 1996 adversely affected the Central Bank reform activities.Some of the staff who were involved in those activities were killed or badly injured. With thedislocation of the Central Bank the work could not be continued on a normal scale. (Annex 8 -Table 1)

66. Capacity Building of PCIs and otherfi-nancial sector institutions: (US$921,232) Thefour participating credit agencies, NDB, DFCC, Sampath Bank and Hatton National Bank staffparticipated in overseas training programs. In addition, Harvard University conducted two trainingprograms on project appraisal which were organized by the two DFIs. In total, 198 PCI staff weretrained in various aspects of banking such as credit management, financial management, treasurymanagement, environment appraisal and project rehabilitation (Annex 8 - Table 2). The Harvardcourses on project appraisal that were held in the country trained about 70 PCI staff and theorganizers felt that it was a cost effective way of providing high quality training to a large number.The participants also have reported that the courses were useful and helped in enhancing theirknowledge. In addition, international training was provided for staff in the Ministry of Finance,Institute of Policy Studies, Central Bank and the Inland Revenue Department. The training courseswere approved on the basis of relevance to the institution and also to suit the skills of the stafftrained.

67. The staff who had been trained were junior, middle and senior management. Trainingfocussed more on academic courses and less emphasis was given for exposure tours. In addition,

13

the institutions were encouraged to select training courses in the region and also focused oncapacity building. All the institutions continue their staff development programs using their ownbudget, which makes these training programs, funded under PFDP sustainable in the long run.This reflects the emphasis the bank management in Sri Lanka has placed on staff development.

68. Domestic Resource Mobilization ( Annex 9): Most of the technical assistance came fromthe U SAID for the development of debt market in the form of consultants. Under the USAIDFinancial Markets project, technical assistance was provided for ICASL, CSE, SEC and CBSL to,(i) improve quality of capital market information, (ii) draft legislation for long term debtinstruments, (iii) design a computerized system for bank supervision, (iv) improve analyticalcapability of market participants by conducting Chartered Financial Analysts programs, and (v)capacity building. Some of the draft legislation relating to developing domestic resourcemobilization were supported through these technical assistance programs. Under the IDATechnical assistance component two major studies were carried out. One was for the developmentof portfolio management and capacity building of the Employees Provident Fund and the other wasthe automation of banking activities and government debt securities market. The Central Bank hastaken series of steps to develop the government securities market and this study aimed at furtheringthese efforts. Both were successfully completed and the recommendations are being followed bythe Central Bank.

69. Portfolio Audits of State Commercial Banks (Annex 9): The portfolio audits of the twostate banks were completed on time despite the industrial action taken by the employees' tradeunions during this period. The portfolio audits show that with proper provisioning for bad loans,one of thie state banks would require capital infusion. In order to improve the managementcapacity, the Ministry of Finance has advertised for management advisors with internationalcommercial banking experience to assist the two state banks. The MOFP is yet to launch a majorrestructuring programs for the two state banks and raises concerns on the financial viability of theseinstitutions which will have adverse implications on the overall banking sector.

70. CleaNet: One of the objectives of the TA provided under PFDP was to supportimplementation of environmental standards. With this in view the PCAF was established with co-financing. In addition, the IDA also identified during supervision that there was a need for creatinga full service center on cleaner technology providing assistance to private industrial entities tocomplement PCAF activities. The CleaNet is to assist clients to identify the most cost effectiveoption for meeting environmental regulations and improving production efficiency throughclearing house and information brokering, networking and training, facilitating pollutionprevention audits and eventually promoting waste exchange among industrial units. The mainactivities undertaken were: (a) Training: Training was provided for the implementing agencies tofamiliarize with the management and networking systems required for an informationclearinghouse function and attended international seminars, (b) Public awareness: Both CCC andITI engaged in advertising to draw attention of the industrialists to the availability of this facilitythrough different forms of media. (c) Outreach: The function was to widen the out reach, whichwas successfully accomplished by the project unit.

71. Impact of the CleaNet activities: The Internet connections provided by the CleaNetsignaled the genesis of virtual outreach activities. Clients could request information in electronicform. The envisaged waste exchange program was also launched in cyberspace. CleaNet is wellequipped to facilitate potential waste exchange. The training provided under the CleaNet for staffof the implementing agencies provided opportunities to ascertain the positive and negative aspectsof this facility in other countries. Visits to other countries reveal that without external support thisactivity cannot be sustained and therefore the CleaNet focussed on revenue generating activitiessuch as workshops and seminars. The CleaNet also has established international links withdatabases. The CCC has also signed a memorandum of understanding with the Confederation of

14

Indian Industry (CII) to facilitate information and training and would be able to facilitate cost-effective Indian technology to Sri Lankan industries. A list of sources of audio visuals on cleanerproduction case studies, clean technology data bases, a comprehensive listing of internet resourceshave been compiled for use of industrialists.

72. The outreach activities have created a keen awareness among the industrialists and it isevident from the inquiries received by the CCC. Also through increased coordination the clientsare informed of the PCAF facilities. It is evident that the two institutions have been able to reachthe industrialists and have achieved the objectives of this sub project. In addition, the businessmanager has been absorbed into the CCC and also the ITI continue these activities as part of theirwork plan which show the commitment of these two institutions in improving environmentalstandards of the industrial sector in the country. The project has been able to create a core group ofstaff in both these institutions who will continue with the functions after the close of this project.They have created a website to disseminate information on cleaner technology. Both CleaNet andPCAF had promoted the industries to be more self regulated in pollution control and created anawareness for adopting cleaner technology projects.

73. With the close of the PFDP CleaNet has requested funds from the Environmental Action 1Project funded by IDA. In keeping with the original scope of work to become a full service centerfor private industries, CleaNet is expected to design and deliver activities in the following areas:

(a) Environmental Policy Services : to facilitate industry representation on variouspolicy-making fora of the government.

(b) Training and Advisory Services : to continue with one-on-one advisory services andcontinue with training seminars.

(c) Information Dissemination and Outreach Services: to continue with strengtheningthe databases, publications, and CleaNet newsletter.

(d) Information and Clean Technology Brokering Services : to facilitate technologytransfer to business entities and act as a middleman to assist industries contactingpossible suppliers of clean technology.

(e) Facilitation of Pollution Prevention and Audits: Actively promote the benefits ofcleaner production through training and awareness programs.

(f) Waste Exchange Program : Facilitate waste exchange by industrialists.

H. Future Operations

74. Following from the current financial and civil service reforn programs, the MOFP and theCBSL have identified the urgent need for pension reforms. In addition to addressing thedemographic changes the Government is keen to create a better investment climate for thecontractual funds. The Government has commenced discussions with the IDA to design an overallreform program reflecting the priorities. The Bank has already responded positively to the requestby obtaining a PHRD Grant for the pension reforms and is preparing an overall strategy for pensionreform to be discussed with the Government.

75. In addition, the Government also has requested the IDA to assist them in the second phaseof the financial reforms in further strengthening the regulatory environment while providing anintermediation loan. The Bank responded that if the Government was prepared to proceed with aprivate management contract for the two state banks, the IDA would be happy to be associated withthe second phase of the reform agenda.

76. The CBSL has identified that they require the services of consultants for several studieseventhough, funding arrangements have not been finalized. The areas are: (i) the preparation of

15

legislation for supervision of merchant banks, (ii) the formulation of a legal framework forlicensing and supervision of money and foreign exchange brokers, and (iii) assisting OMOoperations.

I. Key Lessons Learned

77. EfficientAdministrative Unit: Setting up an efficient administrative unit(AU) made avery significant contribution to the success of the project. This unit has been identified not only bythe IDA but also by other donors such as ADB, KfW and OECF as the AU to execute theirprojects.

78. Supporting Reforms through different governments - If IDA can identify championsfor "reforms" in the bureaucracy, reform programs are sustainable even through different politicalregimes.

79. Lead taken by the CBSL and MOFP in the Policy Dialogue: In the areas where politicalresistance was less, these two institutions took progressive steps and also managed to keep thereform program on track.

80. IDA's continuous coordination with the senior staff of the CBSL and MOFP: Itprovided an opportunity for IDA to bring to the notice of the senior policy makers the issuesrelating to the slow progress in the financial sector.

81. Awareness of the needfor reform among all the financial sector policy makers as wellas officials in the financial sector institutions : There was enthusiasm on the part of the seniormanagement on policy issues. In addition, the officials of the CBSL and few senior officials of theMOFP were aware of the need and made every effort to implement the reform measures despitepolitical resistance.

82. Timely Quarterly Reviews: The regular quarterly reviews enabled the credit funds to bedisbursed effectively. This is a practice the IDA needs to replicate in all projects. This not onlyhelped in better supervision but also the institution became identified with the project. In addition,there was capacity building in project management.

83. Lack of Commitment by MOFP at the implementation stage: The decision makingprocess in the MOFP was rather slow which affected the reform program. In addition the policymakers did not adequately impress upon the political leaders the need for reform measures in thestate banks. That was mainly due to the absence of regular meetings by the financial sector reformcommittee. Despite the fact that MOFP came under the direct purview of the President, theFinancial Sector Reform Committee did not make that an opportunity to forge ahead with thereform program.

84. Lack of a Central Coordinating Unit in the Central Bank with representation fromMOFP: At the inception of the project the secretariat was headed by senior well accepted officialsin the financial sector. However, with the transfer of the secretarial work to the Central Bank, evenminor issues had to be cleared with the top management of the CBSL. In addition, the CBSLbelieved that they had no mandate to coordinate reform measures outside the CBSL. Therefore, infuture IDA should require that the government set up a strong full time coordinating unit to ensureeffective follow-up.

85. Bureaucracy being too sensitive to the political environment: The MOFP and the CBSLcould have prepared technical papers to convince the political leaders the need for reform in many

16

sectors. Therefore, the financial sector reform committee should periodically keep the cabinet andparliament informed of the reform agenda.

86. Absence of a Framework for Financial Sector: Due to the absence of a reforrnframework, the Government had the tendency to approach reforms in an ad-hoc manner whicheverthey believed were politically feasible. Hence, some of the activities, which had no strongownership by implementing agencies, were not pursued eventhough they played a major role in theoverall program such as insurance.

87. Lack of Coordination among Departments within the Same Organization : This is aweakness in Sri Lanka in general. However, lack of coordination also created resistance fromdifferent departments of the same organization. It would have been more effective if the staff ofthe implementing institutions were well briefed of the overall financial sector development strategyand what their specific role was.

88. Inability to set up Strong Regulatory Authorities to improve Governance: TheGovernment's inability to offer adequate compensation for staff of the regulatory authoritieshamper establishment of strong regulatory authorities to improve good governance.

89. Project Leverage small but ownership by reformers was strong although diminished overtime: This project reflected that the difficulty of using a financial intermediation loan as a vehiclefor sector reforms. If the project funds were suspended the private sector banks and investorswould have been affected.

17

Attachment 1

Implementation of Policy Measures Agreed at Negotiations

Agreed Conditions Reform measures taken Compliance RemarksRating

Improve domestic The Monetary Board approved a package of reforms in August 1995 to Legal frameworkresource mobilization commence active market-based open market operations and to develop the - satisfactory.

secondary market for govermnent securities. Measures included closure of thesecondary treasury bill window and repurchase window, commencement of openmarket operations at market rates, activating the bank rate, exclusion of non-bankfinancial institutions (NBFIs) from inter-bank call money market and grantingpermission for non-bank primary dealers to maintain accounts at the CBSL forthe purpose of settling securities transactions.

Increase market Since May 1995, CBSL has been publishing the maturity structure of the Marginally The Central Bank wasorientation of short term Treasury Bills at each auction on a weekly basis together with the average yield satisfactory cautious implementing asdebt instruments rates to make the short term debt instruments more market oriented. Competitive they did not have the

bidding by captive sources such as National Savings Bank (NSB) and expertise. In addition, theEmployees' Provident Fund (EPF) commenced in May 1995. The captive bomb explosion and the re-sources were phased out from direct bidding to bidding through the primary location of the bank alsodealer system. In addition, non-bank financial institutions were excluded from had an adverse impact onthe inter-bank call money market activities to ensure a level playing field for all the performance.participants.

To ensure that the rules governing OMO operations are legally enforceable theguidelines for open market operations certain regulations are being drawn up bythe Central Bank. Regulations relating to OMO for outright sales, purchases,repurchase and reverse repurchase of Treasury bills and bonds and CBSLsecurities are being currently drafted by the CBSL and are expected to begazetted in early 2000. In the interim, the CBSL has re-introduced the reverserepurchase facility for treasury bills and bonds for commercial banks andprimary dealers from November 1998 at a pre-determined rate. The secondarytreasury bill window and repurchase window at pre-determined rates will be

18


replaced when market oriented OMO commences. The bank rate has also beenactivated as informed earlier.

Introduce long terni debt The CBSL publishes the treasury calendar for the treasury bonds, every quarter Satisfactoryinstruments and improve in advance, to provide market information for the primary dealers. During 1997the secondary debt the government had issued Rs. 10 billion worth of treasury bonds, mostly two-market for government year bonds. Treasury bonds to the tune of Rs. 39.0 billion were issued in 1998securities and about Rs. 67.5 billion would be issued by end of 1999 of which Rs.4. billion

would be with 5 year maturities. Six-year treasury bonds were issued inSeptember 1999 for the first time. CBSL is also taking measures to expand thevolume of treasury bonds to match the rate at which rupee securities are maturingand eventually the rupee securities will be phased out. However, at the momentthe stock of rupee securities amounts to Rs. 255.3 billion as at end of August1999.

The CBSL has approved accepting treasury bonds as collaterals for reverserepurchase which promotes developing the secondary market for the long-termgovernment securities. In order to enforce requirements for creating a marketand specifying a minimum level of participation in the primary auctions andsecondary markets, the public debt department has issued guidelines onminimum level of participation for primary dealers in treasury bill and bondauctions, which are being monitored continuously. Inactive primary dealers arebeing de-listed.

Primary dealers have formed an association (PDA). The CBSL requires theprimary dealers to set up their own separate company, which will develop thegovernment debt securities market; primary and secondary. They are to bededicated only to trading in government securities. At present most of them arecommercial banks and there is conflict of interest in promoting debt instruments.At present, CBSL has a stock of Rs. 200 Billion worth of short and long termngovernment securities for trading. However, in the long run, the primary dealersshould also be permitted to trade corporate bonds as well to develop thesecondary market. In addition, the primary dealers are in the process of

_ preparing a code of conduct. A study on primary dealer surveillance was

19


expected to commence in September 1999 but has been postponed due to thenon-availability of some of the consultants proposed. However, CBSL is keen toset up a surveillance system to monitor the primary dealers as they play a majorrole in government securities market. Therefore, this study is an integral part ofthe main reform program and the development of the debt market. A privatecompany has developed a trade matching system for the primary dealers, whichwill be purchased by them, once the new companies are formalized.

Consultants assisted the CBSL to design a system and drawing up technicalspecifications for hardware and software in order to set up a scripless securitiessettlement system and electronic fund transfer system. However, the CBSL feelsthat the current volume of transactions is not sufficient to justify initialinvestment that is required. Therefore, the CBSL is exploring other options.

Improving Bank The following measures have been taken: Satisfactorysupervision capacity

• Preparation of on-site supervision manual in 1997 with the assistance of aninternational consultant.

* In order to introduce better accounting standards in the banking sector, arevised prescribed format for preparation and publication of annual accountsof Licensed Commercial Banks (LCBs) --- incorporating Sri LankaAccounting Standard No 23 --- has been made operative since January 1998.An accounting format is being designed for Licensed Specialized Banks(LSBs) who would be made applicable from the financial year 1999.

* In order to strengthen off-site surveillance of LCBs, seven new reportingformats --- relating to non-performing advances, classified advances,investments in shares, accommodation to directors and close relatives,accommodation to companies in which directors have a substantial interest,share ownership of banks, and returned cheques and post dated chequesaccepted as securities --- were issued in December 1997 and have beenoperative since April 1998.

20


* Nineteen directives relating to prudential requirements have been issued tothe Licensed Specialized Banks.

* To increase public disclosure of financial data relating to the LCBs, formatswere designed and instructions were issued to LCBs to publish in the presstheir annual audited accounts and half yearly accounts beginning fromDecember 1998 and is in operation. It is proposed to extend theserequirements to the LSBs as well.

* CBSL approved and compiled a panel of auditors for conducting bank auditsin May 1998. In addition, auditing guidelines have been issued to externalauditors. The banks are meeting the stipulated requirements.

* The banks were requested by CBSL in September 1998 to appointcompliance officers at a senior level to ensure compliance in respect ofbanking and other statutory requirements. All LCBs have appointedcompliance officers and LSBs. Avenues of communications have improvedsignificantly and the Central Bank has planned a seminar to get a feed backfrom all the compliance officers during the third quarter of 1999.

* CBSL issued rules and regulations on pawn broking for commercial banks inSeptember 1998.

* In October 1998, CBSL revised regulations relating to ownership of banksincreasing the maximum level to 25% for promoters and 20% for a companyand its aggregates.

* Consultants funded by SIDA completed a feasibility study for banksupervision including upgrading the regulatory mechanism, supervisorycapacity and staff development. USAID consultants are helping the CSBLto develop a software package to facilitate data processing for off-sitesurveillance for LCBs. The first phase has been completed with theautomation of 14 reporting formats. It is proposed to reactivate this program

21


under the second phase in collaboration with the SIDA consultants. TheCentral Bank requires the consultants to computerize all formats and alsoconsolidate and streamline the formats. However, with the Y2K remedialactivities being given high priority this is getting delayed.

* A scheme, for bringing Foreign Currency Banking Units' (FCBU)operations under the Banking Act, has been finalized and will be gazettedbefore the end of 1999. A policy paper on the applicability of the provisionsof the Banking Act and Monetary Law Act (MLA) and issues relating to theintroduction of prudential regulations for FCBUs is under discussion.Monitoring banks' foreign exposure is considered high priority in CentralBank's agenda following the recent East Asian crisis.

* Bank Supervision Department (BSD) prepared formats for monitoring theforeign exchange exposure of banks. These formats were discussed with thebanks, pilot data are being collected on a 3-month trial basis and once thesedata are evaluated final formats will be introduced to the banks. In addition,the Central Bank will also issue routine guidelines to the banks before theend of 1999.

* The draft amendments to the Banking Act relating to licensing procedures,revocation of licenses, fit and proper test for bank management, appointmentand removal of bank directors and senior management, merger of banks,cease and desist orders, liquidation and closure of banks will be forwarded tothe legal authorities. The draft amendments are expected to be presented tothe Cabinet before the end of 1999.

* An USAID consultant has completed a feasibility study for setting up amandatory deposit insurance scheme for all commercial banks. The ensuingrevisions made by the consultants are being reviewed. The CBSL expects toimplement a mandatory deposit insurance scheme once the action plans hasbeen prepared which may take more than a year and the scheme is likely tobe operative by during the year 2001.

22


Create a level playing * CBSL also proposes to tighten prudential guidelines relating to loan loss Unsatisfactory The Insurance task forcefield for the Insurance provisioning in line with international practice. Draft the new insurance law and the MOFP follow tillsector to set up a regulatory authority. recently after the initial draft

stage.

Restructure and privatize Setting up a committee to initiate privatization of the two state enterprises Unsatisfactory This was mainly due tothe two state banks Recapitalization of the banks in 1993 and 1996 political resistance. The

Signing of the Performance Agreements in 1993 bureaucracy could notSigning of the performance Agreements in 1998 convince the politicalCurtailing Treasury guarantee to state enterprises leaders on this issue. Only

damage control measureswere taken.

Improve Accounting and Conducting annual financial audits by reputed international accounting firms Marginally Delay in gazetting theAuditing standards Conducting diagnostic studies of the two state banks Satisfactory accounting and auditing

Enactment of the Accounting and Accounting standards Monitoring Board Bill standards and setting up theGazetting of all the accounting and auditing standards AASMB delayed theEstablishing the AASMB for compliance monitoring compliance monitoring .Central Bank requiring disclosure of audited accounts by the banks from 1998Securities exchange Commission requires all listed companies to comply withthe accounting and auditing standards from 1999

23

Table 1: Summary of Assessments

A. Achievement of Objectives Substantial Partial Negligible Not applicable

Macro Policies D F D z

Sector Policies [: D []Financial Objectives D 0 0

Institutional Development z L [IIPhysical Objectives LI LIPoverty Reduction [ Cl L L

Gender Issues L L ] [

Other Social Objectives L L L L

Environmental Objectives LI LI

Public Sector Management L L IPrivate Sector Development z L L IOther (specify) L L LI FI

B. Project Sustainability Likely Unlikely Uncertain

zOO

C. Bank Performance .ihi

satisfactory Satisfactory Deficient

Identification :1 0 IPreparation Assistance [] L °

Appraisal [ [ Cl

Supervision L LI

D. Borrower Performance Higysatisfactory Satisfactory Deficient

Preparation L] I 3

Implementation El EL Covenant Compliance I z LOperation (if applicable) LI z

E. Assessment of Outcome Higbly Highlysatisfactory Satisfactory Unsatisfactory unsatisfactory

24

Table 2: Related Bank Loans/Credits

Loan/credit title Purpose Year of Statusapproval

Preceding operations

1. Small and Medium Industries Promote private industrial development focusing on SMI's 6/1979 Closed onPro. (SMI-I) US$16 million assistance through addressing constraints hindering their rapid 06/30/85Credit 942-CE growth in order to increase their contribution to employment

generation, export expansion, and economic growth.

2. Second Small and Medium To support and expand on the SMI -I objectives. 10/1981 Closed onIndustries Pro.(SMI-II) 12/31/87US$28 millionCredit 1182-CE

3.Industrial Development Project Provide term credit through DFIs to assist in strengthening the 7/1983 Closed on(IDP-I) US$25 million system of industrial financing, assist in trade and industrial 09/30/88Credit 1401 -CE reforms, and provide technical assistance to improve selected

PMEs.

4. Second Industrial Complement previous and on-going industrial sector operations; 5/1986 Closed onDevelopment Project (IDP-II) to provide credit through banking system to medium - and 06/30/94US$20 million large-scale private industrial enterprises, support oneCredit 1692 - CE implementation of GOSL's policy reforms and institutional extension

strengthening. of 6 months

5. Third Small and medium Complement and expand previous industrial sector operations 12/1987 Closed onIndustrial Project (SMI-III) by: (i) providing credit to the SMI private manufacturing 06/30/93US$20 million enterprises; and (ii) make a further contribution to policy reformCredit 1860 - CE and institutional strengthening in the areas of tariff

administration, export promotion and financial sectoroperations.

6. Third Industrial Development Provide credit through banking system to medium and large 7/1988 Closed onProject (IDP-IIl) scale industries & support GOSL's industrial policy with areas 06/30/95US$43.8 million of tariff administration, import promotion, capital markets andCredit 1948-CE technology development.

7. Public Manufacturing Support the reform program to commercialize, modernize and 11/1990 Closed onEnterprise Adjustment Credit privatize public manufacturing enterprises to promote efficiency 11/95(PMEAC) US$120 million and growth.Credit 2185 -CE

8. Fourth Small and Medium Complement and expand previous industrial sector operations 5/1991 Closed onIndustries Project (SMI-IV) by (i) improve financial sector efficiency by institutional 06/30/1997US$45.0 million strengthening and improved debt recovery policies andCredit 2250 - CE procedures (ii) provide support to GOSL's policy with areas of

tariff administration, promote exports and SMI development,assist central environmental authority (iii) provide creditthrough the banking system, for long term capital investment.

Following operations

I.Energy Services Delivery Provide investment capital to grid connected and off-grid 1997 On goingProject US$30.1 million connected energy services using environmentally sustainable,Credit 2938-CE renewable energy technologies, support Electricity Board on

demand side management implementation and improve publicand private sector performance to deliver energy services.

2.Y2K Project US$29 million To assist the Govemment on an urgent basis in its efforts to 2/1999 On goingCredit 3162-CE prevent possible business disruption in country's economic and

financial sectors as a result of Y2K problems.

3. PHRD Grant for Pension 9/1999 On goingReforms US$391,000 TF 025994

25

Table 3: Project Timetable

Steps in Project Cycle 1 Date Planned [ Date Actual/[ Latest Estimate

Identification (Executive Project Summary) November 19,1992 November 19,1992

Preparation July 1992 July 1992

Appraisal January 5,1993 December 1992

Negotiations March 5,1993 March 5,1993

Letter of Development Policy (if applicable) March 5, 1993 March 5, 1993

Board Presentation May 1993 April 20,1993

Signing May 7, 1993 May 7, 1993

Effectiveness August 2,1993 August 2,1993

First Tranche Release (if applicable) NA NA

Midterm review (if applicable) January 1996 April 08, 1995

Second (and Third) Tranche Release (if applicable) NA NA

Project Completion December 31,1998 December 31,1998

Loan Closing June 30,1999 June 30,1999

26

Table 4: Loan/Credit Disbursements: Cumulative Estimated and Actual(US$ million)

FY94 FY95 FY96 FY97 FY98 FY99 (June 30)

Appraisal Estimnate 6.6 20.4 41.4 54.6 60Actual' 5.8 24.9 46.6 53.3 56.5 57.9Actual as % of Estimate 87.8 122.0 112.5 97.6 94.2 96.5

Date of Final Disbursement: December 8, 1999

Note: The difference is due to the exchange rate fluctuations between historical SDR and various currenciesduring the life of the project

27

Table 5: Key Indicators for Project Implementation

I. Key ImplementationIndicators in SAR/ Estimated ActualPresident's Report

1. Subloan financing 1. Utilization of the credit 1. Fully utilized. Details of thecomponent of US$57.5 mn. utilization of the credit component

is in Annex 6: Table 1

2. Capital formation and 2. Expansion and new 2. Achieved to a large extent.employment generation investments in various industrial Details in Annex 6

subsectors.

3. Financial performance of 3. Improving the PCIs project 3. Achieved to a large extent.the PCIs and their loan financing operations, satisfactory Details in Annex 10recovery rate. profitability, effective

assets/liability management, andminimum 80% collection ratio.

4. Subproject performance 4. Strong demand, effective 4. Achieved to a large extent.utilization, creating jobs, Details in Annexes 6 & 11 increasing exports, newestablishments.

5. Sectoral distribution of 5. Fair distribution in all sectors. 5. Achieved. Mostly servicessubprojects sector as there were other lines of

credit available for small andmedium scale industries. Detailsin Annex 6: Table 2

6. Geographical distribution 6. Availability of credit fund in 6. The Sub-loans were mostlyall districts. concentrated in Western Province

due to inadequate physical andeconomic infrastructure outside itand the ethnic conflict. Details inAnnex 6: Table 3

II. Modified Indicators Not Applicable Not Applicable(if applicable)

mII. Other Indicators Not Applicable Not Applicable

(if applicable)Note: Implementation indicators were not identified and estimated in SAR. The ICR provides the above indicators

which are commonly used for financial intermediation operations

28

Table 6: Key Indicators for Project Operations

Key Operating Estimated StatusIndicators in

SAR/President's Report

(a) Restructuring of state Amend the Bank of Ceylon (BOC) Complied. The amendmentsowned commercial banks Ordinance and the Peoples Bank (PB) were incorporated in the(SCBS) Act to enable SCBs to function as agreements signed with the

autonomous commercial organizations. two state banks.

Establish a mechanism for dealing with Achieved. Recovery of badthe larger bad loans of SCBs. loans had been significant but

not adequate.Control the Administrative costs of the The targets were revised in theSCBs, improve credit discipline in their 1998 agreements. Howeverlending, reduce their intermediation the first review revealed thatcosts, achieve profitability levels the two state banks have notcomparable to those of the private complied with thebanks operating in Sri Lanka within two performance targets agreed.years of their recapitalization. IDA has indicated to the

GOSL to initiate privatemanagement contracts.

(b) Institutional Further reduce its direct and indirect Achieved. Both are majorityStrengthening of shareholding in the National private sector owned.Development Finance Development Bank (from 39%) to lessInstitutions (DFIs) than 20%. Reduce the number of board

members representing public sectorshareholders.

(c) Development of Increase the volume and the maturity of Achieved with delay.Government debt market its competitively priced debt

instruments so that by 8/30/94 at leastRs. 4 billion worth of such securitieswill have been issued and the volume ofsuch instruments will by 12/31/95, havebeen increased to Rs 10 billion.Removal of adverse effects of Achieved.withholding tax to develop thesecondary trading of financialinstruments.

(d) Portfolio EPF and ETF to invest at least 5% of Achieved. See Annex 5diversification of The their annual inflow in non-governmentEmployees Provident securities in 1993, rising to 10% byFund and Employee Trust June 1995.Fund and National Savings NSB to invest atlas 10% of itsBank investments in non-government

securities.

29

Key Operating Estimated StatusIndicators in

SAR/President's Report

Build portfolio management capacity in EPF is planning to subthe contractual savings institutions. contract fund management to

private fund managers whilebuilding in-house capacitywith the help of consultants.Not achieved.

(e) Improvements in Introduce a new Insurance Act to Not achieved.Insurance sector strengthen the regulatory framework.

Reduce market segmentation and Achieved to an extent.promotion of competition. Mandatory ceding removed

and institutional agentabolished.

Commence privatization of thee two Not achieved. The cabinet hasstate insurance companies by December approved divesting of 39% of1993. the National Insurance Co.

l ~~~~~~~~~~~~~LTD.(f) Improvements in Bank Strengthen the laws and regulations. Achieved.Supervision and regulation(g) Improvements in Improve enforcement of the standards Not achieved yet though theAccounting Regulations and set a monitoring Board. Board has been set up.and Financial Disclosures

(h) Improved Debt Improve debt recovery. Achieved. But adequate.Recovery Measures

(i) Introduction of To introduce more market-oriented Achieved.Variable Interest Rates rates by encouraging on-lending at

variable rates.

30

Table 7: Studies Included in the Project

Study Purpose as Defined Status Impact of Studyat Appraisal/Redefined

1. Financial review of Evaluate the financial Completed in Provided a basis forBank of Ceylon performance 1993 the 1993

agreements

2. Financial review of Evaluate the financial Completed in Provided a basis forPeople's Bank performance 1993 the 1993

| I agreements

3. Actuarial assessment of Possible privatization Completed in Marginal impactSri Lanka Insurance 1993corporation

4. Actuarial assessment of Possible privatization Completed in Marginal impactNational Insurance 1993Corporation

5. Financial review of Sri Possible privatization Completed in Marginal impactLanka Insurance 1994Corporation

6. Financial review of Possible privatization Completed in Marginal impactNational Insurance 1994Corporation

7. Bank Supervision Improve supervision capacity Completed in Good. HaveDepartment Study 1997 implemented

recommendations.Refer Para. 41 ofthe report

8. Study of Automation of To support streamlining of Completed in See Annex 8banking activities and banking operations and providing 1998government debt security a central depositary formarket Government debt securities. Also

to provide a transfer system withreal time gross settlement (RTGS)facilities.

9. Study of development of To design investment guidelines Completed in Good. See Annex 8portfolio management of and develop a selection criteria for 1999Employees Provident external fund managersFund

10. Diagnostic review of Review the portfolio performance Completed in CBSL intends toBank of Ceylon 1999 restructure the bank

Slow progress

11. Diagnostic review of Review the portfolio performance Completed in CBSL intends toPeople's Bank 1 1999 restructure the bank

31

Table 8A: Project Costs

Appraisal Estimate (US$M) Actual/Latest Estimate(US$M)

Item Local Foreign Total Local Foreign TotalCosts Costs Costs Costs

1. Credit 81.6 69.5 139.5 79.5 69.6 149.1

2. Technical 0.0 2.5 2.5 0.8 3.1 3.9Assistance

TOTAL 81.6 72.0 153.6 80.3 72.7 153.0

32

Table 8B: Project Financing

Appraisal Estimate (US$M) Actual/Latest Estimate(US$M)

Local Foreign Total Local Foreign TotalSource Costs Costs Costs Costs

IBRD/IDA 0.0 60.0 60.0 0.0 60.7 60.7

Co-financiers* 0.0 12.0 12.0 0.0 12.0 12.0

PCIs 38.3 0.0 38.3 38.4 0.0 38.4

Entrepreneurs 43.3 0.0 43.3 41.1 0.0 41.1

Government 0.0 0.0 0.0 0.8 0.0 0.8

TOTAL 81.6 72.0 153.6 80.3 72.7 153.0

* USAID and KfW provided funds under their bilateral programs.

33

Table 9: Economic Costs and Benefits

Ex-post ERR was not calculated for the sub-projects

34

Table 10: Status of Legal CovenantsSri Lanka

Private Finance Development Project

Agreement Section Covenant Present Original Revised Description oftype S fulfillment fulfillment covenant

date date

Credit Article 4 02 C Four Borrower to provide to IDA records of(b-i) months project/ Special Accounts and SOEs audited

after each in accordance with sound auditing principlesfiscal year by independent auditors no later than four

months after the end of each fiscal year.

Article 02 C Four The PCIs to provide to IDA their audited4(b-ii) months financial statements no later than 4 months

after each after the end of each fiscal year.fiscal year

Article 4 02 C Annually Each PCI shall comply with eligibilitycriteria, ratio requirements and exposurelimit: minimum cash collectionratio(principal and interest) of 80%,maximum portfolio infection ratio of 20%,minimum DSCR of 1.25 times; minimumreturn on equity of 9%, maximum debt/equityratio of 8:1; minimum capital adequacy ratiosof 4% and 8% for tier 1 and 2.

Schedule C Continuous The Borrower undertakes that subloans will3( 2and be made in accordance with the procedures3.a) and terms and conditions set forth in schedule

3 of the DCA and that procurement of thegoods and services shall be governed byprovision set forth in schedule 5.

Schedule C Continuous The Borrower maintain the Project Unit with4(1.a) responsibilities and staff satisfactory to the

Association.

Schedule CD December The Borrower shall take necessary measures4 (4) 1994 to increase the volume and maturity of debt

December instruments (T-bills and rupee securities) sothat by August 30, 1994 at least 4 billion

1995 worth of such securities issued and the

volume such instruments will by December31, 1995 increase by Rs. 10 billion.

Schedule CP 1994 The borrower shall carry out, for contractual4(5) savings institutions, an investment portfolio

diversification plan.

Schedule 10 C The Borrower shall carry out activities under4 (2) Parts B and C of the Project, in accordance

with a program and timetable satisfactory tothe association.

35

Agreement Section Covenant Present Original Revised Description oftype Stats fuflulment fulfillment covenant

date dateSchedule 10 C No date The Borrower shall by August 31, 1994 or4 (3) indicated such other date as the association shall

determine, conduct a review with theassociation with regard to the actions takenpursuant to the statement and theimplementation of the project.

Schedule 10 CD No date The Borrower shall implement a plan4 (6) indicated satisfactory to the Association, for

improvements in the enforcement of auditingand accounting standards.

Schedule 10 CD October January The Borrower shall in accordance with terms7 (a) 1993 1996 of reference satisfactory to the Association:

(i) commence a banking supervision study byOctober 31, 1993; and (ii) complete suchstudy March 31, 1994.

Schedule 10 CD March The Borrower shall, in accordance with7 (b) 1993 terms of reference satisfactory to the

Association: (i) commence a insurance studyby March 31, 1993; and (ii) complete suchstudy March 31, 1994.

Covenant types:

i. = Accounts/audits 8. = Indigenous people2. = Financial performance/revenue 9. = Monitoring, review, and reporting

generation from beneficiaries 10. Project implementation not covered3. = Flow and utilization of project funds by categories 1-94. = Counterpart funding 11. = Sectoral or cross-sectoral budgetary5. = Management aspects of the project or or other resource allocation

executing agency 12. = Sectoral or cross-sectoral policy/6. = Environmental covenants regulatory/institutional action7. = Involuntary resettlement 13. = Other

8. Present Status:

C = covenant complied withCD= complied with after delayCP = complied with partiallyNC= not complied with

36

Table 11: Compliance with Operational Manual Statements

There was no incidence of non compliance with Operational Manual Statements.

37

Table 12: Bank Resources: Staff Inputs

Stage of Project Cycle Planned Revised Actual

Weeks US$ Weeks US$ Weeks US$

Preparation to Appraisal

Appraisal-Board

Negotiations through BoardApproval l

Supervision 124.36 282.04

Completion

TOTAL 124.36 124.36

* Balance information not available in project files.

38

Table 13: Bank Resources: Missions

Performance Rating

Stage of Month/ Number Days Specialized Implementa- Development Types ofProject Cycle Year of in Staff Skills tion Objectives Problems

Persons Field Represented Status

ThroughAppraisal

Appraisalthrough BoardApproval

Initial Summary 05/93 2 0.0 Sr. Financial AnalystOperations Officer

Supervision 04/94 2 Operations Officer The rating was TheSr. Operations satisfactory developmentAnalyst throughout the impact and

project implementa-09/94 2 0.0 Operations Officer implementation tion progress

Sr. Operations Officer were

04/95 4 Sr. Operations satisfactoryAnalystEnvironmentalSpecialistOperations OfficerSr. Operations Officer

01/97 1 15.0 Sr. OperationsEconomist

12/97 2 22.0 Industrial EconomistEnvironmentalEconomist

12/98 2 16.0 Industrial EconomistEnvironmentalEconomist

Completion 08/99 2 21.0 Industrial Economist Satisfactory DevelopmentProject Analyst project objectives

performance achieved andtheimplementa-tion progresswassatisfactory

39

Annex 1(Page 1 of 3)

LEGISLATIVE ENACTMENTS RELATING TOFINANCIAL SECTOR REFORMS

1. Sri Lanka Accounting & Auditing Standards Act No. 15 of 1995: The Act providesstatutory force to the accounting and auditing standards adopted by the institute of CharteredAccountants of Sri Lanka(ICASL). The law requires all "specified business enterprises" toprepare its accounts in compliance with the Sri Lanka accounting standards and ensure that itsaccounts are audited by professionally qualified chartered accountants in accordance with theSri Lanka auditing standards. The ICASL will be assisted by an Accounting StandardCommittee (12 members) and an Auditing Standards Committee (8 members) whose task is tomake recommendations to the ICASL on the adaptation of accounting and auditing standards.The Act provides for the establishment of an Accounting and Auditing Standards MonitoringBoard (AASMB) which is responsible for monitoring and enforcing the standards. Thestatutory board consist of 13 members (representing the Registrar of Companies, Departmentof Inland Revenue, Securities and Exchange Commission, Central Bank, ICASL, CharteredInstitute of Management Accountants (CIMA), Bar Association, Chamber of Commerce,Bankers Association and University Grants Commission). Offenses under the Act will carry afine not exceeding Rs. 500,000/-.

2. Credit Information Bureau of Sri Lanka (Amendment) Act No. 8 of 1995: Theamendment to the Act provides for leasing companies, merchant banks, finance companies tohave access to the Credit Information Bureau.

3. Recovery of Loans by Banks (special provisions)(Amendment) Act No. 24 of1995: The amendment provides for the extension of the application of the Act to the Bank ofCeylon and the National Savings Bank.

4. National Savings Bank (Amendment) Act No. 28 of 1995: The amendments providefor the capitalization and restructuring of National Savings Bank (NSB). The NSB will haveauthorized capital of Rs. 10 billion divided into 1 billion shares of Rs. 10/- each. The issuedcapital of NSB would be determined from time to time by the Minister of Finance. TheSecretary to the Treasury would be the sole shareholder of NSB on behalf of the GOSL. Theamendments also enable NSB to undertake a much wider range of functions such as -promoting and mobilizing savings, purchasing and trading in any securities, debentures,Treasury Bills and financial instruments guaranteed by the GOSL, lending in the interbank callmoney markets, wholesale lending to banks and financial institutions, undertaking retaillending against the security of deposits, providing housing loans on security mortgages ofimmovable property and participation in loan syndication. the Board of Directors of NSBshould consist of 7 members (5 appointed directors and 2ex-officio directors). The amendment also lay down the required level of qualifications andexperience of the directors.

40


5. Monetary Law ( Amendment) Act No. 26 of 1995: Two new sections have beenincorporated in the Act. The first amendment clause empowers the Central Bank to purchaseshares in companies for the promotion of human resources and technical development in thebanking and financial sectors. The second amendment clause will enable the Central Bank toprovide facilities:

a) to non-commercial bank primary dealers to maintain accounts at the Central Bank forthe purpose of settling securities transactions.

b) to direct participants to maintain accounts at the Central Bank for the purposes ofholding scripless securities and clearing and settling transactions in scripless securities.

6. Local Treasury Bills (Amendment) Act No. 32 of 1995: The amendment providesfor the issue of scripless Treasury Bills. Procedures relating to the maintenance of records andtransfers of scripless Treasury Bills are also covered. The one year limitation on the maturityof Treasury Bills has also been reintroduced.

7. Registered Stocks and Securities (Amendment) Act No. 32 of 1995 : Theamendment provides for the issue of Treasury Bonds with fixed coupon rate of interest andmaturities over one year. The Treasury Bonds can be sold by auction or can be transferred byendorsement. The Treasury Bonds can be issued at par or at a premium or discount and inscripless form.

8. Banking (Amendment) Act No. 33 of 1995: Several amendments were made to theBanking Act in order to strengthen the supervisory power of the Central Bank and to extendsuch powers over development banks and savings banks, thereby, creating a more competitivebanking environment. The Banking Act of the 1988 contained provisions to license andregularly supervise only commercial banks and Regional Rural Development Banks.Specialized banks such as development banks and savings banks were not required to belicensed and supervised. However, the distinction between commercial banks and specializedbanks is disappearing as many of the specialized banks engage in conventional bankingbusiness like the acceptance of deposits from the public and provision of short-term credit.The latest amendment provide for the licensing of specialized banks such as the NationalDevelopment Bank, Development Finance Corporation of Ceylon, National Savings Bank andthe State Mortgage & Investment Bank. The Central Bank is also empowered to supervise andgive directions to specialized banks. Amendments have also been introduced to authorize theCentral Bank to supervise the activities of Foreign Currency Banking Units (the Offshorebanking units of commercial banks). The Central Bank had previously had announced certaincapital adequacy, loan classification and provisioning requirements based on internationalstandards. These requirements however were not included in the Banking Act. Thereforeamendments have been introduced to incorporate all prudential controls on commercial banksinto the Banking Act. The section dealing with types of activities commercial banks canundertake has also been amended in order to remove the special privileges according tostate commercial banks. All commercial banks can now engage in pawn-broking , a line ofbusiness which was earlier permitted only for state banks. Amendments have also beenintroduced which deal with the vesting of a licensed commercial bank by the Central

41


Bank under special circumstances. The provisions relating to the operation of numberedaccounts have been repealed.

9. Regional Development Banks Act, No. 6 of 1997: This Act provides for theestablishment of development banks in specified regions for the purpose of development inthat region by providing for the development of agriculture, industries, trade, commerce andother development activities.

42

Annex 2

RELATIVE SIZE OF THE FINANCIAL SECTOR 1993 & 1998

1993 1998

Financial sector component Total Assets Share Ratio to Total Assets Share Ratio toRs. bn % GDP'% Rs. bn % GDP2 %

Central Bank 133.6 18.5 26.7 188.7 14.5 18.6

Commercial Banks 243.9 33.8 48.8 501.7 38.6 49.4State-owned Banks 155.4 21.5 31.1 277.4 21.3 27.3Private Dom. Banks 50.0 6.9 10.0 167.0 12.9 16.5Foreign Banks 38.5 5.3 7.7 57.3 4.4 5.6

Foreign Currency Banking Units3 56.2 7.8 11.2 103.5 8.0 10.2

National Savings Bank 44.4 6.2 8.9 90.9 7.0 9.0

DFIs (DFCC/NDB) 19.0 2.6 3.8 55.0 4.2 5.4

State Mortgage Bank 3.2 0.4 0.6 6.6 0.5 0.7

Finance Companies 9.0 1.2 1.8 26.1 2.0 2.6

EPF/ETF 75.8 10.5 15.2 191.1 14.7 18.8

Insurance Companies 12.4 1.7 2.5 23.8 1.8 2.3

Stock Market Capitalization 123.8 17.2 24.8 112.1 8.6 11.0

Total 721.3 100 144.3 1299.5 100 128.0

Note:1 GDP at current market prices in 1993 Rs. 500 billion2 GDP at current market prices in 1998 Rs. 1,015 billion3 Desegregation is not available.

Source: Economic Research Department - Central Bank of Sri Lanka

43


SUMMARY OF COMMERCIAL BANK PERFORMANCE

STATE PRIVATE FOREIGN ALL BANKS

1995 1996 1997 1998 1995 1996 1997 1998 1995 1996 1997 1998 1995 1996 1997 1998

RELATIVE SIZE

No. of branches Nos. 620 622 621 618 214 240 267 296 0 39 42 39 834 901 930 953

No of employees Nos. 20,835 21,120 21,074 20,732 7,953 8,532 9,633 10,223 0 2,057 2,017 2,151 28,788 31,709 32,724 33,106

Market share of the total 62.1 59.9 58.1 56.0 26.5 28.9 30.2 32.8 11.4 11.2 11.7 11.2 100 100 100 100

assets %

Market share of the total 63.5 61.7 58.8 56.6 26.6 28.6 30.7 33.5 9.8 9.7 10.5 9.9 100 100 100 100

deposits %

Market share of the demand 74.9 63.0 60.5 59.9 25.1 22.0 24.3 24.8 - 15.1 15.1 15.2 100 100 100 100

deposits % I

Market share of advances % 62.3 56.0 54.5 53.3 26.6 32.2 34.2 36.4 11.1 11.8 11.3 10.2 100 100 100 100

INCOME STATEMENTDATA (Rs Mn)Interest Income 23,195 26,664 29,186 30,272 9,321 12,365 14,700 15,651 4,254 5,457 6,280 6,501 36,770 44,486 50,166 52,424

Interest expense 13,544 17,247 18,600 17,963 5,895 8,254 9,586 9,340 2,474 3,213 4,165 4,318 21,913 28,714 32,351 31,621

Net Interest margin 9,651 9,417 10,586 12,309 3,426 4,111 5,114 6,311 1,780 2,244 2,115 2,183 14,857 15,772 17,815 20,803

Other Income 4,483 5,299 6,946 6,506 2,113 2,341 2,950 3,433 1,459 1,436 2,024 2,406 8,055 9,076 11,920 12,345

Total net Income 14,134 14,716 17,532 18,815 5,539 6,451 8,064 9,744 3,239 3,680 4,139 4,589 22,912 24,847 29,735 33,148

Employee expenses 4,959 5,008 6,225 7,047 1,521 1,681 2,215 2,794 653 731 921 1,075 7,133 7,420 9,361 10,916

Other expense 3,756 4,522 4,964 5,537 1,810 2,454 3,087 3,837 1212 1,393 1,608 1,745 6,778 8,369 9,659 11,119

Provision for doubtful debts 2,184 1,151 1,847 3,537 380 465 641 801 141 163 855 629 2,705 1,779 3,343 4,967

Profit before taxes 3,235 4,035 4,096 2,694 1,828 1,848 2,121 2,312 1,233 1,393 755 1,140 6,296 7,276 6,972 6,146

Extra ordinary items 0 400 0 0 3 3 0 -49 3 0 0 -46 406 0

Tax 383 1,168 817 1,150 479 449 432 492 545 556 313 370 1,407 2,173 1,562 2,012

Profit after Taxes 2,852 2,867 3,279 1,544 1,349 1,399 1,689 1,820 688 886 439 770 4,889 5,152 5,407 4,134

AS A % OF AVG. TOTALASSETS I

Interest Income 11.8 11.1 11.5 10.9 10.5 10.7 11.5 10.1 11.1 12.1 12.8 11.6 11.0 11.1 11.7 10.7

Interest expense 6.9 7.2 7.3 6.4 6.6 7.1 7.5 6.0 6.5 7.1 8.5 7.7 6.5 7.2 7.5 6.5

Net Interest margin 4.9 3.9 4.2 4.4 3.8 3.6 4.0 4.1 4.7 5.0 4.3 3.9 4.4 3.9 4.1 4.3

Other Income 2.3 2.2 2.7 2.3 2.4 2.0 2.3 2.2 3.8 3.2 4.1 4.3 2.4 2.3 2.8 2.5

Total net Income 7.2 6.1 6.9 6.8 6.2 5.6 6.3 6.3 8.5 8.2 8.4 8.2 6.8 6.2 6.9 6.8

Employee expenses 2.5 2.1 2.5 2.5 1.7 1.5 1.7 1.8 1.7 1.6 1.9 1.9 2.1 1.9 2.2 2.2

44




1995 1996 1997 1998 1995 1996 1997 1998 1995 1996 1997 1998 1995 1996 1997 1998

Other expenses 1.9 1.9 2.0 2.0 2.0 2.1 2.4 2.5 3.2 3.1 3.3 3.1 2.0 2.1 2.2 2.3

Provisions for doubtful debt 1.1 0.5 0.7 1.3 0.4 0.4 0.5 0.5 0.4 0.4 1.7 1.1 0.8 0.4 0.8 1.01

Profit before taxes 1.7 1.7 1.6 1.0 2.1 1.6 1.7 1.5 3.2 3.1 1.5 1.2 1.9 1.8 1.6 1.3

Tax 0.2 0.5 0.3 0.4 0.5 0.4 0.3 0.3 1.4 1.2 0.6 0.7 0.4 0.5 0.4 0.4

Profit after Taxes 1.5 1.2 1.3 0.6 1.5 1.2 1.3 1.2 1.8 2.0 0.9 1.4 1.5 1.3 1.3 0.8

BALANCE SHEET DATA

Total assets Rs. Mn 208,491 239,587 267,1 4 290,357 89,117 115,790 138,977 169,913 38,181 44,914 53,803 57,803 335,789 400,291 459,894 518,073

Total deposits Rs. Mn 157,348 176,118 195,277 210,496 65,908 81,850 101,750 124,530 24,366 27,696 34,810 36,884 247,622 285,664 331,837 371,910

of which demand deposits 27,599 30,319 32,071 34,531 9,260 10,571 12,893 14,294 0 7,262 8,008 8,775 36,859 48,152 52,972 57,600Rs. MnTotal advances Rs. Mn 115,663 133,316 151,055 166,949 49,285 76,566 94,869 114,030 20,681 28,028 31,316 32,027 185,629 237,910 277,240 313,006

Total Capital Rs. Mn 11,834 13,553 15,504 15,006 6,925 8,700 10,039 11,137 4,493 4,779 6,131 6,557 23,252 27,032 31,674 32,700

Contingent liabilities/assets 62,921 72,945 91,141 100,491 32,421 43,700 51,020 42,849 30,308 28,720 38,936 35,591 125,650 145,365 181097 178,931

Rs. Mn I IDeposits/Total assets % 75.5 73.5 73.1 72.5 74.0 70.7 73.2 73.3 63.8 61.7 64.7 63.8 73.7 71.4 72.2 71.8

Demand deposits/total 17.5 17.2 16.4 16.4 14.0 12.9 12.7 11.5 0.0 26.2 23.0 23.8 14.9 16.9 16.0 15.5

deposits %Advances/total assets % 55.5 55.6 56.6 57.5 55.3 66.1 68.3 67.1 54.2 62.4 58.2 55.4 55.3 59.4 60.3 60.4

Capital/Total assets % 5.7 5.7 5.8 5.2 7.8 7.5 7.2 6.6 11.8 10.6 11.4 11.3 6.9 6.8 6.9 6.3

Advances/deposits % 73.5 75.7 77.4 79.3 74.8 93.5 93.2 91.6 84.9 101.2 90.0 86.8 75.0 83.3 83.5 84.2

Contingent liabilities/Tot. 30.2 30.4 34.1 34.6 36.4 37.7 36.7 25.2 79.4 63.9 72.4 61.6 37.4 36.3 39.4 34.5

assets %RATIO ANALYSIS-FINANCINGInterest on advances Rs Mn 17,740 20,221 19,390 20,260 9,321 10,922 12,868 14,065 4,254 3,928 4,794 4,666 31,314 35,071 37,052 38,991

Interest on advances/total 15.3 15.2 12.8 12.1 18.9 14.3 13.6 12.3 20.6 14.0 15.3 14.6 16.9 14.7 13.4 12.5

advances % IInterest on deposits Rs. Mn 9,872 13,490 14,159 13,104 5,895 7,718 8,911 8,591 2,280 2,053 3,057 3,228 18,047 23,261 26,127 24,923

Interest on deposits/Total 6.3 7.66 7.25 6.23 8.94 9.43 8.76 6.90 9.36 7.41 8.78 8.75 7.29 8.14 7.87 6.70

deposits %Interest spread % 9.1 7.5 5.6 5.9 10.0 4.8 4.8 5.4 11.2 6.6 6.5 5.8 9.6 6.6 5.5 5.8

Non-interest income/total 16.2 16.6 19.2 17.7 18.5 15.8 16.5 18.0 25.5 20.3 23.3 27.0 17.5 16.8 19.0 19.1

income % I ITot. operating exp. (net of 7,835 9,530 11,189 12,585 3,322 4,135 5,302 6,628 1,865 2,124 2,530 2,820 13,022 15,789 19,021 22,033

prov.) Rs. Mn I_ __

45




1995 1996 1997 1998 1995 1996 1997 1998 1995 1996 1997 1998 1995 1996 1997 1998

Tot. operating exp./Tot assets 3.8 4.0 4.2 4.3 3.7 3.6 3.8 3.9 4.9 4.7 4.7 4.9 3.9 3.9 4.1 4.3

%Profit after tax/capital % 24.1 21.2 21.1 10.3 19.5 16.1 16.8 16.3 15.3 18.5 7.2 11.7 21.0 19.1 17.1 12.6

Profit after tax/total income % 10.3 9.0 9.1 8.2 11.8 9.5 9.6 9.5 12.0 12.9 5.3 8.6 11.0 9.6 8.6 6.4

RATIO ANALYSIS -EFFICIENCY I

Employee expense/Tot. net 35.8 34.0 35.5 37.5 27.5 26.1 27.5 28.7 20.2 19.9 22.3 23.4 31.5 29.9 31.5 32.9

income %

Employee 0.2 0.2 0.3 0.3 0.2 0.2 0.2 0.3 - 0.4 0.5 0.5 0.2 0.2 0.3 0.3

expense/employees( Rs. Mn)

Emp. & Other 33.8 35.7 38.3 41.7 35.7 33.1 35.6 42.4 43.8 41.0 40.8 51.0 35.4 35.7 37.8 43.0

expenses/interest income %

Total assets/employee Rs. 10.0 11.3 12.7 14.0 11.2 13.6 14.4 16.6 - 21.8 26.7 26.9 11.7 12.6 14.1 15.6

MnEmployees/branch(person) 34 34 34 34 37 36 36 35 53 48 55 35 35 35 35

Nos.Total assets/ branches Rs. 336.3 385.2 430.1 469.8 416.4 482.5 520.5 574.0 1,151.6 1,281.0 1,482.1 402.6 444.3 494.6 543.6

MnTotal net income/branch Rs. 22.4 23.7 28.2 30.4 25.9 26.8 30.1 32.9 94.4 98.5 117.7 27.2 27.6 32.0 34.8

MnAccumulated provisions Rs 12,134 13,122 13,919 16,665 3,623 1,763 2,116 2,564 1,220 593 1,397 1,670 16,977 15,478 17,432 20,899

MnNon-performing loans Rs. 9,486i 22,537 26,396 28,880 4,697 9,408 10,487 12,574 2,155 2,417 3,223 3,945 16,338 34,362 40,106 45,399

Mn I

Provisions/total advances % 10.5 9.8 9.2 10.0 7.35 2.30 2.23 2.25 5.90 2.12 4.46 5.21 9.15 6.51 6.29 6.68

Provisions/non-performing 127.9F 58.2 52.7 57.7 77.1 18.7 20.2 20.4 56.6 24.5 43.3 42.3 103.9 45.0 43.5 46.0

loans %Non-performing loans/tot. 8.2 16.9 17.5 17.3 9.5 12.3 11.1 11.0 10.4 8.6 10.3 12.3 8.8 14.4 14.5 14.5

advancesCapital adequacy ratio % - N/A N/A 10.5 8.6 N/A N/A 11 12.5 N/A N/A 13.1 13.9 N/A N/A 11 10.7

avg. I_ _ _ _ __ _ _ __I _ _ _ __ _ ___I_ _ _ _

Average Total assets Rs. Mn N/A 239,587 253,350 278,735 N/A 115,790 127,384 154,445 N/A 45,027 49,139 55,899 N/A 400,404 429,873 489,079

Note: Non -performing loans of People's Bank are not included (Information not available)Source: Bank Supervision Department - Central Bank of Sri Lanka

46

Annex 4

COMPLIANCE OF THE AGREEMENTS: Bank of Ceylon and People's Bank

Table 1: Compliance of 1993 Agreements

Criterion 1 Bank of Ceylon People's Bank

International audits Yes YesNon performing 11.8'% 25.0%loans/advancesPBD 11%Loan provisioning 96.9% 31.9%PBD 20%Management action plans and Management action plans are Management action plans are preparedCorporate plans prepared every month. Corporate every month. Corporate plan is also

plan is also prepared as agreed. A prepared as agreed. A quarterlyquarterly management management information report isinformation report is submitted to submitted to the Bank Supervisionthe Bank Supervision Department Department of the Central Bank.of the Central Bank.

Introduction of rigorous credit A credit appraisal system, risk A credit appraisal system, risk assetstandards asset review and credit audits review and credit audits have been

have been introduced and they introduced but they are not effective ashave been effective as expected. expected.

Freeze cadre position as at 9,873 10,8591991 level except for skilledpositions(BOC 10,299: PB 11,209)Ratio of staff expenses/total 2.1 3.1assets(private dom. Banks 1.8 in1998)Branches 1991+approvals 293 325granted up to 1993 March

(1991 -289) (1991 - 320)ROA after provisioning 0.8 0

Before provisioning 2.5 1.2PBD 1.2

Note: I This was higher in the Portfolio audit report.

Table 2: Compliance of 1998 Agreements

BOC PBPerformance indicators L Targets Actual Targets Actual

1998 1998 1998 19981. ROA % (after loan loss provisions) 2.5 0.8 1.5 0

ROA % (before loan loss provisions) 2.5 1.22. ROE % (after loan loss provisions) 33.0 12.2 40.0 0

ROE % (before loan loss provisions) 38.4 31.23. Staffcost to average assets % 2.1 2.1 2.1 3.14. Recovery of Non-performing Advances as at 850 1919 2592 2795

31.12.97 (Rs. Mn)5. Overhead Cost to Average Assets % 1.1 1.2 0.8 1.856. Rationalization of Branches (Nos.) 5 - 57. No. of loss making Branches 15 21Source: Department of External resources - Ministry of Finance and Planning.

Bank Supervision Department - Central Bank

47

Annex 5

INVESTMENT OF CONTRACTUAL SAVINGS INSTITUTES (CSIs)IN NON-GOVERNMENT SECURITIES

Institution 1993 1994 1995 1996 1997 1998

Amount As a % of Amount As a % of Amount As a % of Amount As a % of Amount As a % of Amount As a % ofRs. Mn Total Inv. Rs. Mn Total Inv. Rs. Mn Total Inv. Rs. Mn Total Inv. Rs. Mn Total Inv. Rs. Mn Total Inv.

Employee's Trust Fund 149 17.6 3,071 28.7 3,656 28.0 6,035 38.2 6,011 32.1 6,366 29.1

National Savings Bank 4,439 11.1 5,790 11.0 9,490 16.3 14,560 21.5 13,517 17.4 16,597 19.4

Employee's Provident 85 0.3 N/A - 460 1.4 900 2.2 0 0.00 560 1.0Fund

National Insurance 584 50.7 718 56.4 196 13.4 281 18.6 1,100 68.6 545 30.5Corp.

Sri Lanka Insurance 2,395 35.6 3,902 48.5 5,686 51.7 6,577 52.5 7,088 49.3 7,546 44.6Corp.

Sources: Employee's Trust Fund, National Savings Bank, Employee's Provident Fund,National Insurance Corporation, Sri Lanka Insurance Corporation

48


Table 1 Commitments & Disbursements of PCIs as at June 3 0 th 1999

Commitments Disbursements

No. Amount Average No. Amount AverageRs. Mn Rs. Mn

DFCC 214 1,513.3 7.1 210 1,430.1 6.8NDB 116 1,352.0 11.7 114 1,326.1 11.6HNB 12 132.0 11.0 11 124.6 11.3SAMPATH 3 24.6 8.2 3 24.6 8.2

TOTAL 345 3,022.9 8.8 338 2,905.4 8.6

Table 2 Sectoral Distribution as at 3 0 th June 1999

Sector No. of Employment As a %of Average As a %ofSector projects mploymenti total Loan Size totalemployment Disbursed

potential

Food, Beverages & Tobacco 33 453 3.7 6.1 6.8Construction Material 4 19 0.2 4.2 0.6Agriculture, Agro business & 8 481 3.9 8.3 2.3FisheriesTextile & Garments 64 3,767 30.9 5.3 11.6Wood & Paper Products 28 658 5.4 6.9 6.6Rubber & Leather Products 38 1,242 10.2 7.0 9.0Metal, Chemical, Machinery, 82 2,251 18.5 7.6 20.7Plastics & EquipmentHotels 14 1,141 9.4 33.9 16.0Service industries, Transport, 51 1,560 12.8 10.5 17.5Storage & CommunicationMiscellaneous 16 612 5.0 14.9 8.9

TOTAL 338 12,184 100 8.6 100

49


Table 3: Geographical Distribution as of June 3 0th 1999

District No of No of Average As a % ofProjects Employees loan size total

DisbursedAnuradhapura 3 325 31.1 3.2Badulla 1 0 1.2 0.04Colombo 218 5992 7.6 57.2Galle 14 1323 7.0 3.4Gampaha 58 1604 8.6 17.2Kalutara 10 582 15.1 5.2Kandy 15 1068 11.4 5.9Kegalle 2 109 4.2 0.3Kurunegala 3 184 2.1 0.2Matara 1 42 2.1 0.1Matale 4 515 38.3 5.3Nuwara Eliya 2 57 19.5 1.3Puttalam 4 65 2.4 0.3Ratnapura 2 50 2.4 0.2Trincomalee 1 268 5.8 0.2

TOTAL 338 12,184 8.6 100

Source: National Development Bank

50

Annex 7

POLLUTION CONTROL AND ABATEMENT FUND

Table 1: Sectoral Classification -Approvals & Disbursements

Sector Cumulative Approvals Cumulative Disbursements

No. of Amount No. of Amountprojects Rs. Mn projects Rs. Mn

Food, Beverages, Tobacco, 6 26.7 6 21.6Animal Husbandry Horticulture& AquariumConstruction Material 1 0.8 0 0(Mineral Based)Agriculture Agro Industries & 20 61.9 14 43:4FisheriesTextile & Garments 15 72.2 1 1 39.8Wood and paper products 6 19.1 6 18.9Rubber, Leather & Allied 13 46.1 10 36.6productsMetal, Chemical, Plastic 13 48.7 1 1 38.4products including manufactureof fabricated metal, machineryand equipmentHotels 13 51.6 5 18.6Service industries( Civil - - -

construction, Transport &Communication)Miscellaneous 1 4.5 0 0

TOTAL 88 331.6 63 217.3

Table 2: Geographical Distribution of Loan ApprovalsDistrict No. of projects Amount

Rs. MnAmpara 1 10.0Anuradapura 0 0Badulla 0 0Colombo 23 79.7Galle 6 11.9Gampaha 13 66.0Kalutara 10 51.5Kandy 2 7.8Kegalle 4 14.8Kurunagala 1 0.4Matara 0 0Matale 1 9.6Nuwara Eliya 1 1.9Puttalam 23 71.8Ratnapura 3 6.2Trincomalee 0 0TOTAL 88 331.6

Source: National Development Bank

51


TECHNICAL ASSISTANCE

Table 1: Policy related Technical Assistance

Name of the study/activity Duration Responsible agency Approved TotalAmount US$ US$

Domestic resource mobilizationStudy of the automation of banking activities and Govt. 2 1/2 months Central Bank 265,512

debt security mkt.Development of portfolio management of EPF 6 months Central Bank 359,932

Sub-total 625,444

Banking SectorDiagnostic review of Bank of Ceylon 3 months Bank of Ceylon / Central 330,208

BankDiagnostic review of People's Bank 3 months People's Bank / Central 365,406

BankFinancial review of Bank of Ceylon 93 Bank of Ceylon 143,690

Financial review of People's Bank: 93 People's Bank 222,174

Bank supervision Department study 165,000

Sub-total 1,226,478

Insurance SectorActuarial assessment & Financial review of NationalInsurance Corporation 92&93 114,690

Actuarial assessment & Financial review of Sri LankaInsurance Corp.92&93 186,496

Financial review of Sri Lanka Insurance Corporation 94 105,755

Financial review of National Insurance Corporation 94 32,733

Sub-total 439,674

Capacity building of PCIsNDB 36 NDB 187,202

DFCC 48 DFCC 219,447

HNB 39 _ HNB 140,233

52


Name of the study/activity Duration Responsible agency Approved Total_________________________ Amount US$ US$

Sampath Bank 5 Sampath 46,750Harvard Training Programme on Project 3 weeks DFCC 149,200Appraisal for Banking sector staff 35 trainedHarvard Training Programme on Project 1 week National Development 71,650

BankAppraisal for Banking sector staff 35 Trained

Training and capacity building of other financial Central Bank & Ministry of 109,677institutions Finance and PlanningSub-total 924,159EnvironmentCleaNet Ceylon Chamber of 100,000 100,000

Commerce& CISIR

TOTAL 3,315,755

53


Table 2: Capacity Building of PCIs (Training)

PCI No. Trained Areas of Training General Policy On Staff Training

HNB 39 Banking & Finance Continuing basisCredit Management Available to all categories of staffGeneral Management Own training school classes held regularly.Marketing Management Overseas training provided for executivesHuman Resource ManagementManaging Change

DFCC 48 Environmental appraisal Firmly committedLegal Available to all categories of staffFinancial managementExecutive developmentPublic relations managementValuation of companiesInvestment/ Merchant BankingTreasury ManagementGeneral ManagementIT ManagementHuman Resource managementProject RehabilitationFund Portfolio ManagementDevelopment Banking

NDB 37 Project finance Draws out the training need after a careful training needInfrastructure Finance analysis done annuallyInformation Technology Overseas management training for officers with higherTrade Finance managerial potentialPortfolio ManagementLegal aspects of project financeTreasury managementDevelopment managementConsultancies such as Restructuring, valuing & pricing of enterprises

Sampathf Technical In house training and on the job trainingBank Human Resource management

Development of conceptual skillsSources NQational Development Bank, Sampath Bank, Hatton National Bank, DFCC Bank

54


BRIEF REPORT ON MAJOR STUDIES CONDUCTED UNDER THE PROJECT

A Study on the Automation of Banking Activities andthe Government Debt Securities Market

1. Scope of Work: The Central Bank intends to install a payment system with theappropriate communication network linking with the banks, other financialinstitutions including the finance companies and primary dealers by streamliningbanking operations and providing a central depository for government debt securities.This will also provide a transfer system with real time gross settlement(RTGS)facilities. This is expected to lead to a scripless trading system.

2. The consultants were also required to identify the software and hardware and thenetwork infrastructure, provide indicative cost estimates for the financial institutionsfor link up, provide different back-up and disaster recovery systems, estimate costsfor proposed systems, identify legal issues related to operating these systems, prepareshort and medium term implementation plans, provide a pricing structure and alsoundertake a financial evaluation of the proposals to examine the financial viabilityand prepare a RFP for the installation of the system.

3. Duration: 2 V2 months

4. Recommendations: The consultants have covered all the areas indicated in theTerms of Reference. The main recommendation is to set up a RTGS for on-lineinterbank funds transfer, conduct of scripless government securities trading andautomation of the general ledger of the Banking Department of the Central Bank.

5. The cost of implementing this system is expected to be around US$ 10 million and thevolume of current levels of transactions are not sufficient to make this projectfinancially viable.

6. The Central Bank(CB) is already testing an interim solution for trading in scriplessgovernment securities and the link up to an automated current account of the BankingDepartment. When the proposed system becomes operational CB believes the buildof transactions would justify the scale of operations for the required investment. CB isalso exploring the possibility of linking up this project with a shared network ofATMs which might make the initial investment financially viable. This system willminimize the settlement time and is currently being used in about 26 countries. It isalso expected to promote open market operations.

7. Next Steps: Central Bank believes that the volume of transactions would not justifythe initial investment of US$ 10 million. However the Central Bank has developedsoftware for the linking all commercial banks and scripless trading and has postponedthe RTGS to later date.

55


Development of Portfolio Management of the Employees' Provident Fund

8. Scope of work: The consultants were expected to review the past investmentperformance, investment needs of the fund, development of a Fund ManagementPolicy, recommend a portfolio structure, examine alternative approaches ofimplementing the recommended structure and policy, review the information systemand reporting system, design internal controls and reporting arrangements, reviewapplicable legislation, procedure, organizational structure, development of proceduresfor selecting fund managers, development of a comprehensive portfolio managementtraining manual and propose trading limits and turnover rates.

9. Duration: 6 months

1 0. Recommendations: Fund management policy proposed by the consultant is to earnthe highest level of total investment return, net of expenses that is reasonablyachievable under the prevailing market conditions in the long term. The targetsspecified are recommended to be reviewed by the Monetary Board and the investmentcommittee annually.

1 1. The study proposed that the long term performance of the internal and externalmanagers to be evaluated against market based bench marks.

12. The study also highlighted that the asset allocation depends on CBSL intention tophase out rupee securities. The consultants believe that EPF can build a diversifiedportfolio maintaining afn exposure to the Rupee loans and include treasury bills andequities. They pointed out that the framework is constrained by the size of the sharemarket

13. Considering the uncertainty regarding the Monetary Board's ability to delegateinvestment decisions, active management by the external fund managers may not befeasible. They proposed that the internal mangers to follow " buy and hold strategy"while external mangers could create a healthy and competitive investmentenvironment.

14. They have proposed an independent Board of trustees to insulate the EPF fromoverall policies of the government. Also they have proposed a regulatory agency tooversee adherence of the EPF Board's fiduciary duties. They propose that the Boardshould act "solely in the interest" of the EPF members. They have recommended theadoption of a manual of internal policies and procedures to define and prevent undueconflicts of interests and ethical violations by the Board and the key staff.

15. The study also proposed a detailed, in-depth evaluation of managers' investmentperformance and transaction costs on a quarterly basis, portfolio valuation,reconciliation and guidelines compliance monitoring at least on a monthly basis. Inaddition they proposed that annual reviews be conducted of each fund manager'sgeneral organizational and financial conditions to ensure that the bench marks andguidelines remain valid.

56


16. A training program has been proposed for the staff to evaluate the performance ofexternal fund managers and also for managing the internal fund managementportfolio.

17. They have also proposed that the EPF needs to change the organizational structure toreflect a modern public pension fund management company with separate divisionsfor investment in equities and debt instruments.

18. Next Steps : Central Bank is in the process of implementing the recommendationsproposed. In addition, they are coordinating with the Labour Department to use theNational Identity number to minimize multiple accounts. They also plan to recruitexternal fund managers and restructure the EPF department to improve governanceand efficiency.

Diagnostic Review of Bank of Ceylon

19. Scope of Work: The scope of work included the assessment of loan portfolio,assessment of the investment portfolio, risk management, capital structure and capitaladequacy, financial analysis, corporate governance and training.

20. Duration 3 months

21. Recommendations: The auditors commented that the bank did not have a clear orcoherent investment strategy and all analysis were highly judgmental. Theinvestments consist of 4.5% of total assets in securities, equity and equity investmentin subsidiaries and associated companies. BOC had made substantial losses on itstrading portfolio and needs to develop, document and utilize a formal investmentstrategy and should have personnel to monitor the portfolio on an continuous basisand report to AGM - investments. Also they should make arrangements to obtaintimely information.

22. The BOC has an asset and liability management committee but the informationavailable was not adequate for efficient management. The BOC needs to review theirinformation system to ensure that the data follows a controlled flow and is reconciledbetween non-connected systems. The need for a formalized process to identify andmanage risk was highlighted by the auditors and proposed that the tolerated risk levelbe communicated to the managers.

23. If the proposed loan loss provisions are made in full, the bank would need an infusionof capital of Rs. 699 million and Rs. 2,683 million to reach 8% and 10% adequacyratios respectively.

24. Governance and Autonomy: The state influences the BOC in areas of appointmentof Board, dividend policy, credit activities, investments, recruitment andremuneration. Although the Board is highly skilled in management, legal and publicsector they had little direct experience in the banking sector or banking operations.

57


25. Management Information System: The consultant proposed that BOC review thecurrent management reports to determine whether the information was sufficient torun the bank efficiently and effectively.

26. Consultants observed that the BOC had no clear direction. This was mainly due tothe lack of active direction by the state which is a shareholder. Although the bankhad developed mission and vision statements, both had lost their impact over theyears. The auditors recommended that the BOC review its current position and inconsultation with all interested parties develop and implement a clear strategy. Theconsultants also proposed that the bank review its business plan regularly so that it isinline with it's strategies and that its short term plans are coordinated with the longterm goals.

27. The auditors recommended that the BOC introduce a number of new products inorder to diversify lending operations, addressing sectors potential growth sectors.This need to be done after a thorough analysis of market potential, target customers,business position and industry positioning. The auditors proposed that bank pay moreattention to customer service. It was proposed that a SWOT analysis and an actionplan be developed and implemented for each branch.

28. Human Resource Management: Many of the employees of the bank are in themiddle age and the bank has difficulty in retaining young people. A stronger andmore effective HRM is recommended and manpower plan should be prepared.Remuneration policies should take into account the functional specifications of theemployees. The consultants proposed that a large proportion of the remunerationcould be in the form of bonuses so that the overhead cost of the bank would reduce.

People's Bank(PB) Diagnostic Review

29. Scope of Work: The scope of work included the assessment of loan portfolio,assessment of the investment portfolio, risk management, capital structure and capitaladequacy, financial analysis, corporate governance and training.

30. Recommendations: The consultant had reviewed the loan portfolio andrecommended the appropriate levels of provisioning that needs to be done. Thereview reflected that the provisioning had been 42% (1996), 48% (1997) and 58%(1998) below the required level according to the Central Bank criteria. If.international provisioning requirements are followed in 1998, PB was below 63% ofthe required level. If the proposed loan loss provisioning was followed the PBrequired to be recapitalized by Rs. 8.0 -10 billion to reach a 8% capital adequacyratio.

58

Annex 9(Page S of 5)

31. The investments consisted of 2% of the total assets which included debt securities,equity investments, short and long-term as well as equity investments in subsidiariesand associated companies. The consultants had indicated that PB follows the termsand conditions of the agreement signed with the government in 1998 July whichprecludes them from making any new investments in subsidiaries and associatedcompanies. The investment portfolio was static with the majority of investmentsmade before 1995 with the exception of investments in fixed income instruments.There were no formal policies or procedures on making investments exceptcompliance with CBSL regulations.

32. Corporate governance: The government appointed Board of management hadstrong business and legal backgrounds but minimal experience in banking. Eventhough the audit committee as agreed with the GOSL had been set up, the consultantsrecommended that the role, duties and and the reporting relationship of the internalaudit should be clarified and support be given to make it operational. PB had no asset-liability committee (ALCO) to monitor non-loan risks across the bank. Despite theattention paid to the loan portfolio, it was possible to lose sight of the other inherentrisks in banking business. The consultants recommended an ALCO for this purpose.

33. Policies and Procedures: PB has documented credit policies and procedures but notall activities. PB's MIS and reporting structure were not an integral part of theexisting documented policies. The consultants proposed that the existing formalpolicies and procedures should be expanded and updated. Subsequently they shouldbe incorporated in the documented policies and procedures. Formal policies,procedures and controls should assign responsibilities and deadlines and includedocumentation requirements in respect of compliance.

34. Management Information Systems : PB produced various reports which were usedas a tool for management decisions but were not integrated. The consultantsproposed that a MIS needed to be readily available to assist the management inmanaging decisions.

35. Next Steps: The Ministry of Finance had called for expression of interest fromqualified persons in international commercial banking for the post of advisor to thestate banks. In addition, both banks need to prepare a restructuring plan. The centralbank and the MOF are in the process of submitting their proposals to the President forthe restructuring of the banks.

59

Annex 10

COMPLIANCE OF ELIGIBILITY CRITERIA AS AT 3 0 TH JUNE 1999

Criteria DFCC NDB HNB SAMPATH

March 99 Dec. 98 Dec. 98 Dec. 98

Collection Ratio (Principal) 89.9 88.8 NA 88.6Collection Ratio (Principal + Interest) 85.7 86.1 NA 83.9After tax profit as a % of average 13.9 15.8 20.9 23.3shareholder fundsDebt Service Cover Ratio 1.6 2.2 NA 9.0Portfolio Infection Ratio 7.3 11.7 7.0 10.9Debt Equity Ratio 2.7 4.8 3.8 7.1Capital Adequacy -Tier 1 20.6 16.5 8.2 11.4Capital Adequacy - Tier 2 20.6 14.4 11.4 12.5Single Sector Exposure 17.2 26.0 62.3 8.6Single Borrower Exposure 3.0 NA 2.9 2.3

Source: Audited Accounts of National Development Bank, DFCC, Hatton National Bank andSampath Bank

This represents export, import, trading, financial, housing, consumption and miscellaneous.

60


BRIEF NOTE ON SITE VISITS

1. The PFDP administration unit at the National Development Bank (NDB) assisted in identifying arandom sample of eight companies representing sub sectors funded under the PFDP and organizedsite visits. The sub sectors covered by the site visits were ceramics, garments, food processing,packaging, rubber and hotel sectors. Mr. S. Doranegoda from the NDB also joined the mission.The mission specially focussed on the long term sustainability of the sub projects visited andissues relating to environment, gender and child labor. The projects visited were as follows:

2. Eden Hotel Limited: The hotel was established in 1994 in Kalutara District. It has 158 roomsand caters to an up-market foreign clientele (80%), mostly from Germany and other Europeancountries. They have entered into an agreement with SAGAR international on marketing. Theturnover for the past 3 years had an annual average of US$2.8 million, with a net profit of about 4-5%. The occupancy rate during the off-season was about 65% while occupancy during the seasonreached 100% and was always well above the breakeven occupancy rate.

3. Labor: The hotel had a cadre of 310 employees during season and 275 employees during offseason. 30% of the staff were females and had a large number of casual workers. The laborturnover was reported to be a high 20%, way above the industry average of 10%, mainly becauseof the demand for trained staff in Colombo and Maldives. The hotel management had placed highpriority on staff development such as literacy improvement and client relations. Meals andaccommodation are being provided. The average monthly wage was around US$140 withovertime and service charge. The average age of staff was about 25 years.

4. Environment: The management seemed to be aware of current environmental practices and hadalready introduced an energy conservation system, a heat recovery system and waste watertreatment plant.

5. Tropic Frozen Foods Ltd. (TFFL) : The company commenced operations in 1996 as a BOIcompany and had been exporting tuna fish for the "sashimi" market in Japan and Europe. Inaddition to exporting, they had diversified into deep sea fishing in order to obtain high quality fishrequired by the Japanese market. Their annual turnover had been between US$4-7 million. Theyalso had a marketing strategy of providing for Japanese and European markets while the residualwas marketed locally. They had 3 fishing vessels and had acquired modem technology to retainthe freshness for 30 days and had Japanese technical experts to advise them on new techniques tomaintain high quality. They plan to expand their fleet as they have gauged that there is highmarket potential for this product in the future. According to them, the commercial banks had beenreluctant to provide credit to high-risk, new industries while the development banks had assistedthem in project financing.

6. Labor: The company had 75 - 80 employees, all ex-navy officers. This being a strenuous job themonthly wages were relatively high and ranged from US$120 - 415 which could be consideredattractive in Sri Lanka. This is mainly a male-dominant industry.

7. Environment : They maintain high quality standards required by the Japanese market. Thefactory visited by the mission reflected excellent hygienic standards required of a food processingplant. They also had an arrangement to dispose of their daily waste.

61


8. Lux Shirts (Pvt.) Ltd.: The company had been incorporated in 1986 but had obtained BOI statusin 1992. This company specializes in ladies wear. Mast International has 50% equity shares in thecompany. They supply well known labels such as Liz Claiborne, Sag Huggers and Marks &Spencer. The group had also diversified into manufacturing accessories ( buttons, hangers) inorder to increase value added. The total turnover during 1998 was US$11. 4 million with a netprofit of 8%. The company was 100% export oriented and the markets are in USA, Canada andEurope.

9. Labor: Of the total staff of 850, 90% are female. The company had three houses foraccommodation for about 100 employees from distant places. The minimum monthly wage wasabout US$48. They also provided performance based incentive payments. Company had its owncafeteria and meals were provided at subsidized rates. They had also set up a training schoolspecially as the skilled labor was expensive. The labor turnover of 5% was seen as a majorproblem. As there were many garment factories in the area, they found it difficult to retain theemployees unless they were provided with an attractive compensation package. The managementwas in the process of training their supervisory staff on behavioral aspects. The management waswell aware of the new human resource development techniques and they had a participatorymanagement style.

10. Environment: It is not a polluting industry. They have subcontracted the disposal of waste.

11. Manchester Yarn & Thread (Pvt.) LTD (MYTL): The company manufactures thread and yarnand has a market of 30% in Sri Lanka. They provide their products as inputs to export orientedindustries and therefore they are considered indirect exporters and is eligible for BOI status. In1998/99 their annual turnover was US$5.6 million with a profit of 10%. They also intend toexpand their production capacity and proceed with automation of the factory. This is a strategy toaddress labor shortage. In addition, they also plan to set up a plant in Bangladesh. They haveexported a small proportion of their products to India and Middle Eastern countries. MYTL hasAmerican & Efird, Inc. as their international technical partner and Mast as their equity partner.They had set up a Marks & Spencer accredited laboratory for testing the quality of yarn.

12. Labor: Of a total of 220 employees, 95% are male. Staff turnover was around 2%. Unlike in thegarment industry, the employment opportunities for the skilled labor in this sector was limited.The employees have been given production incentives. Minimum monthly wage with over time isabout US$50 (after statutory deductions) and average wage for low skilled labor is about US$70.They are also taking part in a 5S productivity contest which seems to have made the workersimprove their level of productivity.

13. Environment- They were well aware of environmental regulations and had a water recyclingplant.

14. Ceylon Biscuits Ltd.(CBL): They manufacture biscuits mainly for the local market and 10% isfor exports. The annual turnover in 1998 was US$17.0 million with an annual profit of 10%.Profits have been on an upward trend during the last few years. They claim to have a market shareof 45% in Sri Lanka and exports are to USA, Canada, Middle East and India. They have plans toset up three plants in India to penetrate the Indian market. They work through a nation-widedistribution system and also train their dealers how to maintain the quality of their products. Theyalso claim to import most of their requirements (wrappers, labels, cartons) as they do not seem tobe satisfied with the standards of the local products.

62


15. Labor: Of a total of 655 employees, 595 were female. They seemed to maintain 40% of theircadre on casual basis. Accommodation had been provided to female workers. The factory was inoperation for 24 hours with three shifts. The average monthly salary was about US$100 and theemployees got three month's salary as an annual bonus. The company had provided training inJapan for their plant managers.

16. Environment: The mission noted that the hygienic standards required for a food processing plantis not maintained. However, they have an incinerator to bum all the waste.

17. Micro Packaging Pvt. Ltd. (MPPL): The company was established in 1995 as a BOI company.They are manufacturing corrugated cardboard boxes exclusively for export companies. Thecompany is labor intensive and caters to small and medium exporters who need a small quantities.The turnover of 98/99 was US$1.3 million with a profit of 5%. They are in the process oflaunching an expansion project and purchasing more modern equipment to produce betterproducts.

18. Labor: Out of a total of 100 employees, only 8 were females. Minimum monthly wage wasabout US$60. Two bonuses have granted annually as well as performance based incentives. Theaverage age of employees was 35 years. Training was provided locally and the company is amember of the National Chamber of Industries. In addition, free breakfast is provided for thestaff.

19. Environment: The waste is disposed efficiently. However, the mission observed that theexpansion of the project will lead to noise pollution in the neighborhood.

20. Samson Sportswear Ltd.: The company was established in 1997 and produces rubber shoes,slippers, and PVC shoes. The products were meant for exports, however due to competition fromChina and Indonesia they had not been able to penetrate the export market. Currently they arenegotiating with a buyer and also had participated in trade fairs in China, Australia, Japan andDubai. Currently they are marketing their products in the local market and are planning to launchan expansion project and increase export production.

21. Labor: Of a total 210 employees, only 22 were male. 98% of the employees were from theneighboring village. The location was chosen to create employment in the area. The managementhad an agreement with a private bus company to provide transport to the employees. A subsidizedbreakfast was provided to all the employees. In addition to their wages, the employees receive anincentive bonus which was a percentage of the profits. They also provided incentives forattendance and productivity. Management maintained savings accounts for all employees whichthey could use as collateral for obtaining loans after three years. Management style wasparticipatory. Employees had been encouraged to express new ideas which are considered forpromotion and higher compensation. Team work is always encouraged. They also participate in5S productivity contest. The management is well aware of modern management techniques tomotivate the staff. The machine repairs and renovations are done by few girls under the guidanceof qualified technicians which is very impressive. They seem to have a close relationship with theneighboring village which provided security and they also carried out community work in thevillage.

22. Environment: Waste rubber had been recycled. They have used innovative ideas to maintain acleaner production floor. As they obtain their raw material from another company they are not ahigh polluter.

63


23. Lanka Ceramics Ltd. (Negombo Ceramics Factory (NCF)): The company manufacturesceramic tableware and insulators. The loan funded under PFDP was taken to set up a plant tomanufacture insulators for Ceylon Electricity Board and Lanka Telecom. Since the plant was setup in collaboration with a Japanese company, the quality of the product was specified according toJapanese standards which was expensive. However, the buyers' standards are much lower and theproducts are not competitively priced any more. Unfortunately with their previous life as a statecorporation they seem to believe they could still use political influence to get orders. Thiscompany either needs to enter into a joint venture with a foreign company or else close theinsulator plant and concentrate on tableware and ornaments which are profitable operations.

24. Labor: Of a total of 517 employees, 67 were in the manufacturing of insulators. Only 19 werefemales. 70% - 80% of the employees were from the neighborhood. The average monthly wagewas US$35-65 and they are provided with meals, travel and an attendance bonus. There was amedical center within the premises for emergency treatment.

25. Environment: They treat waste water and were aware of pollution measures. NCF is planning toset up pollution control systems using PCAF.

26. Findings of the Mission:

27. Sustainability: Except for one company (NCF), all the other companies would be sustainable inthe long run. Despite the fact that economic conditions are sluggish and there is stiff competitionfrom imports, all the companies are making average profits and are in the process of expandingtheir operations further. It was also notable that companies are well aware of the marketconditions specially the international markets and are geared to face competition either by cateringto a niche market (TFFL, MYTC) or joining up with foreign technical and equity partners. Somecompanies have relocated some of the operations in foreign countries (CBL, MYTC). Except forNCF, none of the companies indicated that that they require support from the government which isa positive indication. The mission believes that all the projects visited have long termsustainability except for NCF.

28. Labor: The mission noted that most of the companies faced high labor turnover, especially thehotel and gannents sectors. Therefore, the management seemed to have adopted incentives suchas free meals, accommodation and training to retain staff. In addition, they also have adoptedmodern management techniques to motivate the staff, especially a participatory approach inimproving the work environment. In one of the companies, the employees who providedinnovative and cost effective ideas had been rewarded and had been considered for promotions. Inaddition, most of them participated in productivity improvement contests and the employeesseemed to enjoy doing their tasks.

29. Environment : The awareness of environmental issues was impressive. Especially in the hotelsand garments factories, the companies themselves had undertaken the initiative of introducingpollution control measures. However, the mission noted that the environmental regulatoryauthority had not visited the companies on a regular basis and the compliance monitoring was veryweak. This can be considered a major constraint in introducing better pollution control methods inthe country. However, the awareness of the public on environmental issues seems to be highwhich serves as a deterrent to the polluters. Another remarkable feature is that the work force iswell educated and the management seems to be considering pollution control and abatement as amechanism to minimize production cost. However, most of the factories indicated that thegraduates do not like to work in the private sector and they consider employment in the private

64


sector as a stop-gap. In addition, the recent (1999) wave of recruitment of graduates by thegovernment also had given wrong signals to the collage graduates.

30. Safety Measures: Even though safety equipment had been provided in the factories, theworkforce had opted not to use them claiming discomfort. The workers should be educated on usesafety equipment for their personal safety.

31. Gender Issues: It was quite notable that the labor seem to be enlightened on their rights. Mostof the managers seem to realize that in order to curb high labor turnover they need to motivate theworkers. They also have provided equal opportunity for women workers. At the rubber productscompany the mission observed that from management downwards the operations are handled bywomen. In addition, they have even recruited women for machine fabrication and repairs.Women seem to feel empowered and there is labor mobility. However, there seems to be apreference for unmarried women in most of the factories (garment, rubber products) and we alsonoted that no facilities are provided for young mothers which is a common factor in Sri Lanka.This may be an issue that needs to be addressed with the increasing female workforce.

32. Child Labor: None of the companies had children working in their factories as it is illegal in SriLanka. Even though the workforce is young specially in garments and rubber, the average agewas around 25-30.

65

Appendix A

Sri LankaPrivate Finance Development Project (PFDP Cr.2484-CE)

Supervision Mission - August 1999

Aide Memoire

1. A World Bank mission comprising Ms. Sriyani Hulugalle and Ms. Madhuwanthi Opatha(consultant) conducted an implementation completion mission of the above project from August 10-31. Weappreciate the hospitality and the cooperation extended to the mission by the Govemment of Sri Lanka(GOSL), the Ministry of Finance and Planning (MOFP), the Central Bank (CBSL), the NationalDevelopment Bank (NDB), Bank Supervision Department, Financial Markets Department (FMD), PublicDebt Department and Banking Department of CBSL, Private Enterprise Reform Commission (PERC) andall other state and private financial institutions. This aide memoire reflects the mission's findings and issubject to review by IDA management.

2. The project supports: (i) financial sector policy and regulatory reform to improve the efficiency offinancial intermediation; (ii) domestic resource mobilization for long term investments by stimulatingdevelopment of local bond markets; (iii) the private sector by providing investment finance; and (iv)deepening of the financial system and strengthening the key players including CBSL, MOFP, andcontractual savings institutions (CSIs). The mission reviewed progress made on the elements necessary tofulfill the objectives of the credit, identified and discussed the issues and made recommendations. Inaddition, the mission discussed the process of preparing the Implementation Completion Report (ICR) withthe relevant government agencies.

Investment Credit Component

3 . By March 31, 1998, the credit component was fully committed; (68% above free limit; theaverage loan size was about Rs. 8.8 million). The disbursements amounted to US$ 54.6 million or 96% ofthe approved amount. Although the PCIs included three commercial banks and the two DevelopmentFinance Institutions (DFIs), the DFIs accounted for 95% of the total disbursements (NDB 46%, DFCC49%). According to the number of subloans approved, DFCC accounted for 62% while the NDB accountedfor 33%( Annex 1: Tablel). The project assisted in generating capital investment of US$ 137.1 million inthe industrial sector while the total employment generated was approximately 12,184.

4. The metal, chemical and plastic sub-sector led the lending portfolio (20.7%) under the PFDPfollowed by the services sector (17.5%), hotel sector (16.0%), textiles and garments (11.6%) and rubberand leather (9%) (Annex 1 : Table 2). At the outset, the disbursements were slow as there were other linesof credit available for small and medium scale industries from IDA and Asian Development Bank(ADB)during the initial periods. At the later stages except for the DFIs, other banks had excess liquidity with theslump in the stock market as well as the reduction in reserve requirements of commercial banks by theCentral Bank. Of the approved sub-loans 80% was concentrated in Colombo, Kalutara and Gampahadistricts followed by 11.2% in Kandy and Matale, 3.4% in Galle and 3.2% in Anuradhapura. (Annex 1:Table 3). The continuing ethnic conflict and inadequate physical and economic infrastructure outside thewestern province contributes to this high concentration. Same trend has been reflected in other lines ofcredit as well. In addition, it has also been reported that the companies find it difficult to attractprofessionals out of the Western Province due to lack of physical and social infrastructure facilities.

5. The textiles sector led the employment generation with 31 % followed by Metal and Chemicalsector with 18%, services with 12%, rubber and leather with 10% and hotels with 9%. Geographicaldistribution of employment creation almost reflects the same trend except for Galle where employmentgeneration was significantly high with 11 % compared to the credit disbursement of 3.4%. (Annex I : Table2 & 3 )

6. As agreed with the last mission, the NDB had coordinated with the participating credit agencies(PCIs) and expedited the disbursements to ensure optimal utilization of funds.

7. As shown in Annex I:Table 4, the DFCC , NDB and Sampath Bank continue to meet theminimum required cumulative collection ratios of 80%. Except for HNB, all others provided the collectionratios and they have improved substantially over the previous year. All met the minimum debt servicecover ratio of 1.25. All of them continue to be above the required minimum capital adequacy ratios (Tier1- 4% Tier II - 8%) and are below the maximum portfolio infection ratio of 20%. All the PCI auditedannual accounts and the project account for 1998 were submitted. All the PCIs submitted audit certificationof eligibility criteria as requested. All have complied with the required conditions except for HNB. Thegovernment and the CBSL need to follow-up the performance of the HNB very closely to ensure that theyfollow the single borrower and sector exposure limits

Policy Framework Component

8. Insurance Sector: There was progress reported in this sector during 1999. According to PERC,the National Insurance Corporation (NIC) is expected to be privatized in 1999. However, the mission feelsthat it will be postponed to year 2000. A steering committee to restructure NIC has been set up withrepresentation from PERC, MOFP, NIC, CBSL which can be considered a significant step in the rightdirection. The Cabinet has approved divesting up to 39% of NIC and also there is no restriction on foreigninvestor participation. It was also reported that the committee had initiated discussions with the employeesof NIC to ensure their support for restructuring. If this proves to be successful, the GOSL is likely toproceed with the divestment of SLIC too.

9. The progress in terms the Insurance Bill has been exceedingly slow. The final legal clearance hasbeen obtained and the Bill is expected to be presented to Parliament before the end of 1999. The Missionwishes to express serious concern about this delay. Despite repeated assurance given by the MOFP duringthe last few years, the law has not been enacted The mission noted that there seems to be lack ofleadership for this activity unlike for the rest of the activities in the financial sector reform program.

10. Accounting and Auditing Standards: The Accounting and Auditing Standards MonitoringBoard (AASMB) has been established and a Director General has also been appointed. The Act providesfor the AASMB to be responsible for monitoring compliance with the standards. In 1999 February, all thestandards were gazetted as informed and all the companies listed or specified in the regulations arerequired to comply with the standards for the annual audits of 1999. The secretariat of the AASMB wasconstituted after some delay and has a skeleton staff. However, the effectiveness of monitoringcompliance by this institution is yet to be seen as they will commence compliance monitoring officiallyonly in year 2000. They have already prepared the procedures for compliance monitoring. In addition,both Central Bank and the Securities Exchange Commission (SEC) require the banks and listed companiesrespectively to follow the gazetted accounting standards to bring in better financial management as agreedearlier. A cess is to be imposed on all companies to generate revenue for the Board but has not decided onthe amount. AASMB plans to commence with reviewing annual accounts at the initial stage. The salariesof the staff of the AASMB have been referred to the Treasury for clearance. A recent cabinet decisionrequires salaries and cadre of all statutory boards be reviewed by the Treasury. The mission emphasizedthat it is important that the staff of regulatory authorities be compensated adequately if they are to functioneffectively. The mission feels that this decision will hamper not only the recruitment of stafffor AASMB butalso for all the other existing andproposed regulatory authorities. If competitive salaries are not offered,the Board will not be able to attract qualified and competent people and would not be able to function as itintends to be.

II. State Commercial Banks (SCBs) : Both SCB performance in terms of the performance contracthas been unsatisfactory. As seen in the Annex 1 : Table 5, Bank of Ceylon (BOC) failed to reach theagreed targets on profits, return on assets and return on capital but achieved loan recovery targets, staff andoverhead costs. Peoples' Bank (PB), however, has not achieved any of the targets agreed except loanrecovery for 1998. Non-performing loans have reached a significantly high level and required provisioningwould entail significant capital infusion. This would be the third capital infusion during a period of 6years.

12. According to the CBSL evaluation report, the government had not issued any directives to any ofthe two banks during 1998 and 1999. After an evaluation by a committee consisting of CBSL and MOFP,both banks have been requested to adopt a uniform transfer pricing system. Even though the loss making

2

branches have been reduced none of the loss making branches were closed during the year due to politicalresistance. However, the option of achieving economies of scale by rationalizing the branch networkthrough mergers of branches has been exercised and PB has merged six branches into three.

13. The portfolio audits were completed by the consultants in June 1999. The Central Bank andMOFP, have taken measures to bring in advisors to the two state banks with international commercialbanking experience and also the BOC is planning to conduct a study to explore the possibility ofrestructuring the bank and there is a likelihood of a management contract for the state banks in the future.The Central Bank's assessment is that BOC is aggressively marketing their services to retain their marketshare trying to improve their competitiveness and have prudent levels of provisioning. The mission feelsthat the appointment of consultants would not be effective as they have no decision making capacity andIDA has already conveyed its concerns and proposed other options for the government to considerimproving and resurrecting the two state banks. The government delegation is expected to discuss thisissue further at the annual meeting in Washington in September.

Implementation of Legislative Amendments

14. Amendments to the Banking Act: The 1995 amendments to the Banking Act strengthened thesupervisory powers of the CBSL and extended supervision to development (DFCC, NDB, SMIB) andsavings banks (NSB, Pramuka Savings bank and Sanasa Savings and Development Bank) and incorporatedall prudential requirements based on international standards. CBSL continued its efforts in improving banksupervision, monetary policy environment and domestic resource mobilization in 1999 too.

15. Measures Taken to Further Improve Bank Supervision by CBSL: In 1999 other specializedbanks such Pramuka, SANASA and 6 regional banks were also brought under the supervision of the CBSLand CBSL continued its efforts in improving bank supervision specially in the light of the recent EastAsian financial crisis. The following measures have been introduced to strengthen Bank SupervisionDepartment(BSD) since the last IDA supervision mission in January 1999.

a To increase public disclosure of financial data relating to the Licensed Commercial Banks (LCBs),formats were designed and instructions were issued to LCBs to publish in the press their annualaudited accounts and half yearly accounts beginning from December 1998 and is in operation. It isproposed to extend these requirements to the Licensed Specialized Banks (LSBs) as well.

e CBSL approved and compiled a panel of auditors for conducting bank audits in May 1998. In addition,auditing guidelines have been issued to external auditors. Their performance is closely monitored bythe CBSL.

* The banks were requested by CBSL in September 1998 to appoint compliance officers at a senior levelto ensure compliance in respect of banking and other statutory requirements. Compliance officershave been appointed by all LCBs and LSBs. Avenues of communications have improved significantlyand the Central Bank has planned a seminar to get a feed back from all the compliance officers duringthe fourth quarter of 1999.

* Consultants funded by SIDA completed a feasibility study for bank supervision including upgradingthe regulatory mechanism, supervisory capacity and staff development. USAID consultants are helpingthe CSBL to develop a software package to facilitate data processing for off-site surveillance forLCBs. The first phase has been completed with the automation of 14 reporting formats. It is proposedto reactivate this program under the second phase in collaboration with the SIDA consultants. TheCentral Bank requires the consultants to computerize all formats and also consolidate and streamlinethe formats. However, with Y2K remedial activities being given high priority, this is getting delayed.

* A scheme, for bringing Foreign Currency Banking Units' (FCBU) operations under the Banking Act,has been finalized and will be gazetted before the end of 1999. A policy paper on the applicability ofthe provisions of the Banking Act and Monetary Law Act (MLA) and issues relating to theintroduction of prudential regulations for FCBUs is under discussion. Monitoring banks' foreignexposure is considered high priority in Central Bank's agenda following the recent East Asian crisis.

3

* Bank Supervision Department (BSD) prepared formats for monitoring the foreign exchange exposureof banks. These formats were discussed with the banks, pilot data are being collected on a 3-monthtrial basis. Once these data are evaluated final formats will be introduced to the banks. In addition, theCentral Bank will also issue routine guidelines to the banks before the end of 1999.

* The draft amendments to the Banking Act relating to licensing procedures, revocation of licenses, fitand proper test for bank management, appointment and removal of bank directors and seniormanagement, merger of banks, cease and desist orders, liquidation and closure of banks will beforwarded to the legal authorities. The draft amendments are expected to be presented to the Cabinetbefore the end of 1999.

* An USAID consultant has completed a feasibility study for setting up a mandatory deposit insurancescheme for all commercial banks. The ensuing revisions made by the consultants are being reviewed.The CBSL expects to implement a mandatory deposit insurance scheme once the action plans havebeen prepared which may take more than a year and the scheme is likely to be operative during theyear 2001.

16. The BSD staff is at present about 80 of which 50 are professional staff. The training of examinershas been intensified by setting up a training faculty for bank supervision in the CBSL in mid 1998 andthree specialists with commercial banking and bank supervision expertise were recruited. CBSL continuedwith training in 1999. In addition, four workshops on (a) Supervision of credit risk, (b) Intemal Controls(c) Foreign exchange management and identification of foreign exchange risk and (4) Early warningsignals were held in 1999. Twelve professional staff received overseas training while 49 attended localtraining courses up to end of August 1999.

17. During 1999, the Central Bank had further stepped up their supervision capacity of the CentralBank and the Monetary Board has seen this as one of the most important functions of the Central Bank. Inview of the recent East Asian crisis the Central Bank has identified the need to keep the foreign exchangeexposure of the banks also under close scrutiny. In addition, the BSD is to be re-organized by establishingspecialized units.

Measures taken by CBSL to Strengthen Monetary Policy Management and Domestic ResourceMobilization

18. The Central Bank continued its efforts in 1999 in improving domestic resource mobilization stillfurther. As informed, a new methodology for liquidity assessment based on daily automated datatransmission has been introduced. Already the open market operations (OMO) are being conducted at anincreased scale and currently data on liquidity are received from about 20 banks. However, all the banks donot submit required information on a daily basis as agreed. Therefore, the Banking Department of theCBSL needs to still make their own liquidity estimates. The delay and non-compliance can be partlyattributed to the computer systems being subjected to Y2K readiness. In addition, the banks seem to behaving data transmission problems. The industrial action taken by the bank employees' unions during thefirst part of 1999 contributed to data transmission problems. However, the Banking Department of theCentral is exploring ways and means of enforcing this mandatory requirement for them to obtaininformation on a regular basis to further improve open market operations.

19. The most important step taken during the period under review was the introduction of long termtreasury bonds commencing with the two year treasury bonds with fixed coupon rate of interest in March1997. Treasury bonds to the tune of about Rs. 67.5 Billion would be issued in 1999 of which treasurybonds with 5 year maturities amounting to Rs. 4 Billion would be issued. Six year treasury bonds are to beissued in September 1999 for the first time. CBSL is also taking measures to expand the volume of treasurybonds to match the rate at which rupee securities are maturing and eventually the rupee securities will bephased out. However, at the moment the stock of rupee securities amounts to Rs. 255.3 Billion as at end ofAugust 1999.

20. The CBSL has also approved accepting treasury bonds as collateral for reverse repurchase whichpromotes developing the secondary market for the long term government securities. In order to enforce

4

requirements for creating a market and specifying a minimum level of participation in the primary auctionsand secondary markets, the public debt department has issued guidelines on minimum level of participationfor primary dealers in treasury bill and bond auctions which are being monitored continuously. Inactiveprimary dealers are being de-listed.

21. The CBSL has requested the primary dealers to set up their own separate companies in order todevelop the government debt securities market; primary and secondary. They are to be dedicated only totrading in government securities. At present most of them are commercial banks and there is conflict ofinterest in promoting debt instruments. At present, CBSL has a stock of Rs. 200 Billion worth of short andlong term government securities for trading. However, in the long run, the mission proposed that theyshould be permitted to trade corporate bonds as well to develop the secondary market. In addition, theprimary dealers were required to prepare their code of conduct. As it had not yet been done, CBSL isplanning to draft them while USAID informed the mission that they are in the process of drafting them. Astudy on primary dealer surveillance was expected to commence in September 1999 but has beenpostponed due to the non availability of some of the consultants proposed. However, CBSL is keen to setup a surveillance system to monitor the primary dealers as they play a major role in government securitiesmarket. Therefore, this study is an integral part of the main reform program and the development of thedebt market. A private company has developed a trade matching system for the primary dealers which willbe purchased by them once the new companies are formalized. CBSL indicated that they would requireinternational technical assistance at the initial stage of their market oriented OMO operations.

22. CBSL has completed a feasibility study to automate the CBSL and inter bank transactions in orderto introduce a scripless trading system for government securities and set up Real Time Gross Settlementsystems (RTGS). These measures are aimed at strengthening the open market operations, improving theeffectiveness of monetary instruments and the development of a secondary market for government debtsecurities. Consultants assisted the CBSL to design a system and drawing up technical specifications forhardware and software in order to set up a scripless securities settlement system and electronic fundtransfer system. Mission was informed by the CBSL that the current volume of transactions is notsufficient to justify initial investment that is required. Therefore, the CBSL is exploring other options.However, the proposed system in addition to quick settlement, would facilitate cheque clearing in districtsoutside Colombo. In addition, the CBSL finds it difficult to issue bonds with longer term maturitiesexceeding 6 years without scripless trading. Foreign participation in government securities would also notbe possible with the current manual system. Even though the CBSL is in the process of developingsoftware to establish a scripless system with the expertise available in-house, with the other priorities suchas Y2K remedial measures in the banking sector, the work will proceed slowly. Hence, it would have beenbetter to set up the system proposed by the consultants as soon as possible. This will inevitably increase thevolume of transactions and the fund transfer system will significantly improve. At present due to the longtransaction time taken the transactions are limited and create market distortions. In addition, the securitiesmarket has been confined to Colombo. The mission feels that if the Central Bank expedite the automationof banking sector and scripless trading, the market participants will also increase significantly.

23. The Cabinet has already approved the proposed amendments to the Monetary Law Act to (a)make price stability the main objective of CBSL in order to avoid possible policy conflicts (b) revise thedefinition of money supply to take into account "broad money", (c) remove the maximum and minimumlimits on statutory reserve ratios, (d) provide more flexibility to the Monetary Board to decide the basis forcomputation of the required reserves (e) enable payment of interest on reserves, and (f) enable impositionof reserve requirements on the financial liabilities other than deposit liabilities. The Legal Draftsman ismaking minor revisions after receiving observations the Attorney General and amendments are expected tobe submitted to the Parliament by end of 1999. However, as the legislative procedure takes a long time, themission feels that it is likely to get postponed to the first quarter of 2000.

24. CBSL has promoted the setting up of a Credit Rating Agency(CRA) in collaboration with theInternational Finance Corporation (IFC) as informed earlier. The CRA has been established as ajointventure public company with a leading international rating agency in USA and other international and localfinancial institutions. The office will be operational from October 1999 and the CEO and the key staff havebeen recruited and been given initial training overseas by their international technical partner. This is

5

expected to assist in developing the debt market by servicing the investors and there is a possibility ofpermitting foreign investor participation.

25. Another significant step for domestic resource mobilization was the decision of the Central Bankto diversify EPF investment portfolio. A consultant has prepared investment guidelines for the EmployeesProvident Fund (EPF) and also the selection criteria for external fund managers. In addition, the PFDPprovided partial funding for the development of internal portfolio management expertise and it is expectedto be continued under the proposed PHRD Preparation Grant for pension reforms. The EPF is in theprocess of implementing the recommendations of the study. As the investment guidelines have beenprepared, EPF intends to further diversify its investment portfolio. EPF has also embarked on acomputerization and modernization program in order to improve its operational efficiency and keep abreastof the changing technological development.

26. In addition, proposals are being explored to amalgamate the EPF and Employees Trust Fund(ETF) to minimize administration costs. The ETF is reportedly exploring possibilities of converting theETF to a pension fund and also annuatizing the payments. However, the mission proposed that it would beadvisable to take this measure after careful study and also conducting a proper actuarial assessment toensure the sustainability of such a scheme. Measures are also being taken by the EPF to eliminate doublecounting and eliminate a large number of dormant accounts once the computerization exercise is completedby Labor Department and the EPF. In addition, in 1999, the EPF has been able to absorb all administrationcost by way of capital gains from operations in the secondary market for treasury bonds and equities.

27. The DFIs and the private domestic commercial banks informed the mission of the absence of lowcost funds and also the issue of raising funds in local as well as international markets. The annual accountsfor 1997 and 1998 reflect a significant increase in their deposit base by 24. 3% and 22.4% respectively. Inaddition, there were medium term debenture issues by financial institutions to raise funds amounting to Rs.3.9 Billion during the last two years. Most of the banks argued that they have a mismatch of funds; shortterm deposits which need to be matched with long term investment needs. Development FinanceInstitutions (DFIs) are facing the problem of lack of funds specially as they are not deposit takinginstitutions. However, with the drying up of multilateral funds on concessionary terms, the banks areexploring possibilities of using innovative financial instruments to be more competitive in the financialsector.

28. Y2K Readiness: CBSL has already obtained a loan of US$ 29 million from IDA to address Y2Kissues in the banking and other critical government agencies. CBSL has already set up a Y2K Unit andwith staff drawn from the bank supervision and information technology departments have startedmonitoring and assisting the banks to ensure that they will be compliant. By August, 5 domesticcommercial banks and 4 specialized banks were reported Y2K compliant. In the case of foreign banks,their Y2k projects are controlled by their parent company. Except for 2 foreign banks, all others hadcompleted remediation and implementation of their Y2K activities. At present an independent audit ofY2K activities is in progress. All the banks were required by the CBSL to publish their Y2K readiness intheir annual audit report for 1998 which has been complied with. In addition, the CBSL is preparing acontingency plan for the financial sector while all the banks are also in the process of preparing individualcontingency plans for their own organizations. With the leadership given by the CBSL, Mission is satisfiedwith the progress so far.

Technical Assistance Component

29. The total technical assistance available under PFDP has been fully committed (Annex 2). As ofAugust the total disbursements reached US$ 3.1 million. The US$ component has increased with theincreased depreciation of the Dollar against the SDR. In addition, KfW provided US$ 5 million for PCAFand USAID provided US$ 6.2 million for capital market development which came to a close in October1997.

30. As agreed with the mission, the Central Bank completed all 4 consultancy assignments despite thetight time schedule and industrial action by the banking sector trade unions. The banking automation studyand the EPF portfolio management study were completed as agreed. The portfolio audits of the two statebanks were also carried out due to the close cooperation provided by the staff of the two state banks despite

6

trade union action. In addition, funds were also made available for CBSL, MOFP and PCI training duringthe first half of 1999 which was reported by the participants to have been very effective.

31. CBSL has already initiated the procurement process of obtaining the services of consultants for:

* the preparation of legislation for supervision of merchant banks.* the formulation of a legal framework for licensing and supervision of money and foreign

exchange brokers and,

However, the funds are not available under any of the on-going projects.

Environmental Sub Component

32. Pollution Control and Abatement Fund (PCAF): KFW, provided GOSL with US$ 5 millionfor the PCAF. The NDB administered this fund on behalf of the GOSL. The fund became operative inApril 1995 and was fully committed. Already they have approved Rs. 331.4. million for 88 projects. Ofthe total projects, they are distributed evenly among all sectors; textiles, food and beverages, agro-industries and fisheries, rubber, plastic and leather and hotel sector. Of these, 52% were located inColombo, Gampaha and Kalutara while the other significant area was Puttalam where prawn farms wereconcentrated. fn addition, KFW provided an additional US$ 3.5 million for the PCAF. Another line ofcredit of US $ 22.0 million has been signed up by the OECF called "E-friends". The scope of the OECFproject is broader than the PCAF. In addition, to the new projects they have also included energyconservation.

33. CleaNet: CleaNet was set up to support PCAF through awareness and technical support. Asagreed with the mission, the funds committed for the CleaNet were fully committed and disbursed. Withthe guidance and close monitoring of the advisory committee headed by the NDB, the funds were utilizedfor outreach programs, training, equipment and public awareness. Both implementing agencies; CeylonChamber of Commerce and Industrial Technology Institute, during the last one year had effectivelyfunctioned to create a core technical team. They have already approached another IDA fundedenvironment project to fund their future activities and the proposal is being reviewed by the governmentcounterpart organization.

42. Preparation of the Implementation Completion Report (ICR): The Borrower has beeninformed of the ICR process, specially that the government need to prepare the borrower's report. Themission was informed that the implementing agencies have been requested by the Department of ExternalResources to prepare the borrower's report. The draft ICR will be circulated to the government and theother team members by end of October 1999. In addition, already a beneficiary survey form has beenadministered to 100 companies funded under the PFDP. The mission also plans to visit a selected numberof projects to ascertain how the companies address child labor, gender and environmental issues. Thepreparation of the ICR is on schedule.

7

Attachment 1SRILANKA

PRIVATE FINANCE DEVELOPMENT PROJECT (PFDP)(LK-PE-10419)

Progress in Implementing Financial Sector Policies(As of August 30, 1999)

Description of Agreed Actions Original/ Revised Status CommentsPrevious Targettarget date Date

1. As per GOSL's Statement ofFinancial Sector Policy (SFSP) datedMarch 5,1993

(a) Restructuring of state ownedCommercial banks(SCBS)

Amend the Bank of Ceylon (BOC) None March 31, Complied The initial draft of theOrdinance and the Peoples Bank (PB) 1998 proposed amendments wereAct to enable SCBs to function as approved by the Cabinet inautonomous commercial organizations October 1994. But, the

presentation to the Parliamentwas deferred on variousissues considering itpolitically sensitive. Theamendments wereincorporated in theagreements signed with thetwo state banks.

Strengthen the SCBs' Board of None Partial BOC complied.Directors by appointing three new compliance PB not complied.members (with relevant professionalqualifications and/or extensivebusiness experience) on the Board ofBOC with total strength of 7 membersand 3 new members on the PB Boardwith total strength of 10 membersEstablish a mechanism for dealing with None Complied They have set up special unitsthe larger bad loans of SCBs. to recover bad debt. Both

have increased their recoverylevels.

Control the Administrative costs of the 1995 Partial The targets have been revisedSCBs, improve credit discipline in Compliance in the new agreements.their lending, reduce their However the first review hasintermediation costs, achieve revealed that the two stateprofitability levels comparable to banks have not complied withthose of the private banks operating in the performance targetsSri Lanka within two years of their agreed. IDA has indicated torecapitalization the GOSL to initiate private

management contracts.

Although the following are not Partial Annual audits: complied.specifically stated in SFSP, IDA's Compliance Management action plans aresupervision missions monitored SCBs' prepared and discussed withfulfillment of conditions for the the management monthly.recapitalization in 1993 agreed Annual corporate plans arebetween the GOSL and the SCBs. prepared and quarterly MISThese include : annual audits by reports are submitted to theinternational auditors, submission to bank supervision departmentthe authorities of SCBs quarterly and department of financialmanagement action plans, introduction markets. Branchof strict credit standards, freezing of rationalization is still on-cadre positions at 1991 level, branch going but the 1991 staffrationalization to close the loss making levels have been reached.branches, and reduction of personnel ROA of BOC is better thanexpenses as a percentage of average PDBs but have not reducedtotal assets to match that of the private the employee costs to thedomestic commercial banks agreed levels.

(b) Development Finance Institutions(DFIs)0The GOSL's SFSP outlined the actions Complied.already taken to strengthen theresources base of DFIs and reduce thepublic sector role in DFIs. Speciallymentioned the following:

Select the new chairman as provided None Compliedfor in the amended NDB ActGOSL further reduce its direct and None Complied.indirect shareholding in the NationalDevelopment Bank (from 39%) to lessthan 20%. Reduce the number ofBoard members representing publicsector shareholders

(c) Increase the maturity structure ofgovernment market borrowings

Specific targets, while not mentionedin GOSL's SFDP, are stated in para 4of Schedule 4 (ImplementationProgram) to DCAThe targets in Schedule 4 are as 8/94 and Complied after Amendments to thefollows: 12/95 delay Registered Stock andIncreased the volume and the maturity Securities Ordinance (RSSO),of its competitively priced debt Monetary Law Act(MLA)instruments so that by 8/30/94 at least and Local Treasury BillRs. 4 billion worth of such securities Ordinance (LTBO) enacted inwill have been issued and the volume 12/95 provide for issuance ofof such instruments will by 12/31/95, long term treasury bonds.

have been increased to Rs 10 billion Since March i7 Rs.10Billion worth of 2 yearTreasury Bonds have beenissued. In 1999 Treasurybonds worth of Rs 67 billionhave been issued.

In the context of development of None Compliedsecondary trading of financialinstruments, SFSP states:Remove adverse effects of withholdingtax

(d) The Employees Provident Fund andEmployee Trust Fund and NationalSavings Bank

EPF and ETF to invest at least 5% oftheir annual inflow in non-govermnent 6/95 Complied In 1999 EPF invested Rs. 417securities in 1993, rising to 10% by Million in 1999.June 1995

NSB to invest at least 10% of its 12/93 Complied after In 1999, NSB had 19.4% ofinvestments in non-government delay its investments in non-securities government securities.

GOSL to allow complete autonomy for None No legal restriction for ETFthese institutions or EPF to invest in non

government securities. NSBneeds to invest at least 60% in

___________ government securities.

(e) Insurance companies

Introduce a new Insurance Act to None 31 March Not complied All legal clearance obtained.strengthen the regulatory framework 1998 (As Slow progress.

permission12/97)

Allow insurance companies to pursue None Partialmore sophisticated portfolio compliancemanagement techniquesReduce market segmentation and None Partial Mandatory ceding removedpromotion of competition compliance. and institutional agent

abolished.Commence privatization of the two 12/93 Not complied The cabinet has approved astate insurance companies by proposal by PERC to permitDecember 1993 divesting of 39% of the

National Insurance Co. Ltd.

(f) Bank Supervision and regulationStrengthen the laws and regulations None Complied Amendments to Banking Act,

Recovery of Loans Act andNational Savings Bank Actwere introduced in 1995.Directions were issued tocommercial banks,specialized banks.

Strengthen supervision capacity None Partial Training is provided on athrough rationalizing organizational Compliance continuos basis.structure of supervision departmentsand upgrading of the technical capacityof the staff(g) Accounting Regulations andFinancial DisclosuresImprove enforcement of the None Partial All international accountinginternational accounting and auditing Compliance and auditing standards havestandards adopted by the Institute of been adopted by ICASL andChartered Accountants of Sri Lanka the Act of 1995 provides for(ICASL), through giving these legal enforcement of thestandards legal force and extending the adopted standards. Thesecoverage of these standards have been gazetted. The

monitoring of standardscompliance will commencefrom year 2000.

Set up an Accounting Standards Board None Partial The board has beenas a statutory body and staffed with Compliance constituted and work hastechnical experts commenced officially.Examine the feasibility of introducing None Not applicable Study was not undertaken.compulsory malpractice insurance forauditorsAgreed actions under the Side letterstated in II-g are essentially the sameas above

(h) Debt Recovery Measures None Complied Special debt recovery courtEstablish special courts exclusively for has been set up and the banksdebt recovery are exercising parate

execution powers.(Please see II-(f) below which statesthe agreed action under the Side Letter)(I) Introduction of Variable Interest None Not applicable PCIs did not require a studyRates and were comfortable inProvide technical assistance to the introducing variable rates.

OPCIsfrom the proceeds of the Credit toencourage the on-lending at variablerates and, if the lending done at fixedrates, to enable them to monitor andcontrol their interest risks and todevelop appropriate instruments forhedging

(Please see II-(d) below which statesthe agreed action under the Side Letter)_

II. As per Side letter dated May 7,1993

None Complied Amendments to the RSSO,(a) Strengthen the system of issuing MLA and LTBO werethe appropriate long term debt enacted 12/95 to provide forinstruments, including the issuance of long term treasurydevelopment of a trading and bonds. Process was delayedsettlement infrastructure due to the 1996 bomb

explosion but since 3/97 thelong term bonds are beingissued.

(b) Develop and implement a None Partial All required legislation inregulatory framework, covering both compliance place.primary and secondary markets forTreasury Bills and Rupee securities(c) Build portfolio management None Not Complied EPF is planning to subcapacity in the contractual savings contract fund management toinstitutions private fund managers while

building in-house capacitywith the help of consultants.Work has alreadycommenced.

(d) Provide training programs for:--- for various agencies involved in the None Complied Not requiredbond market;--- for PCIs in the pricing and Not applicablemanagement of variable rate loans anddevelopment of MIS Partial Already reported in Section---for the Central Bank in compliance 11(c)strengthening its bank supervisionfunction(e) Strengthen SCB's credit None Partial Already reported in Sectionmanagement, rationalize the branch compliance II(a)network, improve staff utilization andconduct an international comparisonsalaries in the banking sector inconjunction with the measures taken torestructure the SCBs(f) Implement the provisions of the None Complied Amendments to the recoveryrevised debt recovery legislation of Loan Act were passed in

3/8/00_______________________________________ 10:53:21__ AM_____________ 1995.3/8/00 10:53:21 AM

MANIK NAGAHAWATTE CENTRAL BANK OF SRI LANKADEPUTY. GOVERNOR . 30, Janadhipathi Mawatha

Co!ombo 1Telephone 477555 Sri Lanka.Fax 346268E-mail cbsldges§sltnet.lk

January 11,, 2000Ref: 27/01/004/0001/002

Ms Sriyani HulugalleIndustrial EconomistThe World BankColombo office1st Floor, DFCC Bldg.,73/5, Galle RoadColombo 3.

Dear Ms Hulugalle,

Private Finance Development Project (PFDP) : Cr.2484--CEImnlementation Completion Report (ICR)

We refer to your letter dated January 6, 2000 addressed to the Governor

on the above subject, with which you have forwarded a copy of the

Implementation Completion Report in respect of the above Project for our

observations. We give below our observations on the contents of the

report, in particular on matters concerning the Central Bank.

2) The report states that while the results of the policy

component of the project were only marginally satisfactory, the

performance of the credit component was rated satisfactory. Having

regard to the fact that the report itself acknowledges that the bulk of

the policy aspects have been adequately addressed, the shortcomings

mentioned in the report with regard to the policy component have been

confined largely to the following matters;

a) the delay in the enactment of the insurance legislation,

b) the decision not to restructure the state commercial banks through

privatisation or private management contracts, and

c) inadequate coordination of the project by the CBSL after the

function was taken over from the Ministry of Finance in 1996.

Our observations with regard to the above are as follows;

(i) With regard to (a) above, a part of the delay was caused by

the decision to enact fresh legislation on the subject, instead of a few

amendments to the existing law as originally envisaged. The enactment

of fresh legislation required several aspects relating to insurance to

be examined comprehensively. For this, a Task Force was appointed by

the Ministry of Finance & Planning. It was also necessary to consult

the insurance industry before far reaching changes are introduced.

Once the draft legislation was ready, it had to be examined by the

*Hon Attorney General to certify that the legislation was consistent with

constitutional provisions. On the Attorney General's advice, further

revisions had to be made to the draft legislation.

The draft legislation has now almost reached finality. Action will

be taken to have the legislation enacted as a matter of priority. Once

enacted, the legislation will provide a comprehensive legal framework

for all matters connected with the insurance industry, including

regulation.

(ii) With regard to (b) above, you are aware that the

authorities did not consider that the time was opportune for

restructuring the banks for privatisation. Instead, it was considered

that substantial improvements could be achieved by performance

agreements between the government and the two state banks. As you know,

these performance agreements, apart from providing a substantial degree

of autonomy to the banks, also provided for the reduction of

administrative expenses of the banks and for financial targets to be

achieved by them. In fact, the requirement under the project was to

commercialise the banks by enforcing profit targets. The agreement with

the Bank of Ceylon has met with considerable success and the position is

expected to further improve in the future. The bank's profitability,

staff cost and overhead cost ratios are now comparable with those of

private sector domestic banks. The Bank of Ceylon is currently

preparing a strategic and structural reorganisation plan with the

assistance of foreign consultants to direct its future course of

operations. As regards the People's Bank, whose problems are more

complex, other options are now being considered to make it more viable,

since the agreement has not brought about the desired level of

improvement.

(iii) With regard to (c) above, the Financial Sector Reforms

Committee under the Central Bank comprises the members of the Monetary

Board which inclu;> the Secretary to the Treasury, and the Deputy

Governors of the C;;; ral Bank. The Chairmen of the two state banks are

associated with the Committee when matters relating to those banks are

considered. This committee has been regularly monitoring the

performance of the two state banks in terms of the agreements at regular

meetings. The members of the Monetary Board as well as the two Deputy

Governors regularly monitor and direct financial sector reforms at

Monetary Board meetings which are held at least once in two weeks. The

Committee pays adequate attention to reforms in the financial sector,

irrespective of whether such reforms have to be initiated by the

Ministry of Finance or the Central Bank. Under the guidance of the

Committee, the Central Bank prepared the performance agreements with the

two state banks. We believe that the observation in the report that

while the Committee's coordination of the activities which came under

the performance of the CBST. was carried out effectively, the

coordination of the activities carried out by the MFOP was deficient,

stems fran the delay in enacting the insurance law. It would be evident

from item (i) above that the reasons for this delay cannot be attributed

to a failure on the part of the Committee to coordinate the work.

4) The statement in paragraph 46 of the report that the MOFP

failed to take any serious remedial measures with regard to the

restructuring of the state banks due to political instability, could be

misleading. The proposal for privatisation or private management of the

state banks was not proceeded with, as the issue was very sensitive and

it was decided to explore other avenues as indicated in item (ii) of

paragraph (2) above.

5) We shall be grateful if the above facts are taken into

account when finalising your observations in the Implementation

Completion Report.

Yours faithfully,

Coca= I G~~~~~~~ ~ ~~~~~~~~od qoem QiU)aCu A 421251 Stu& 1860.Telephone J My No. )

e5i 1 0@ _oqm 1

Telegrams J PORAID Your No.

aOoeo 1 FORAID &Om* O 603 AN (3PAS a)

CQCsQRI( F Colombo 0Q so aIoam q _s3w Q,ujjom (3fiab mima)Telex J 21232 QQ6SErtL( 611186 00iolmd) The Secretariat, (3Y Floor)

pS 9LLIBL a.iRJ&1uS l DEPARTMENT OF EXTERNAL RESOURCES nw. 277. oa* 01

Quado 447633 Ministry ofFinance and Planning a.Qu .t.277, QnFIbu 01.Fax J P.O. Box 277, Colombo 1.

1 9 /

11 h February, 2000

Ms. Sriyani HulugalleIndustrial EconomistWorld Bank OfficeColombo

Dear Ms. Hulugalle

Private Finance Development ProjectImplementation Completion Report (ICR)

Please refer to your letter of 8`h February, 2000 on the above subject.

We could not submit the borrowers report as we have not received the report form the CentralBank. We have received the report from Central Bank only on 1 Oth February, 2000.

We forward herewith the reports submitted by NDB and Central Bank for necessary action.

Your's sincerely

N. MadanayakeDirector/World Bank DivisionFor DG/ERD

Cc: I. Mr. P.T. Sirisena - Ref. Your letter of 9h February, 2000Director/Finance Markets DeptCentral Bank of Sri Lanka

2. Mr. R. D. GunapalaSenior ManagerSMI Unit Manager

BORROWER'S REPORT

IDA - PRIVATE FINANCE DEVELOPMENT PROJECT - CR 2484 CEIMPLEMENTATION COMPLETION REPORT

ON THEPOLICY REFORM COMPONENT

(I) Project Objectives

The objectives '4 the project were to -

(a) improve the efficiency of financial intermediation by supporting policy andregulatory reforms in the financial sector;

(b) assist in domestic resource mobilization for long term investment by stimulatingthe development of local bond markers;

(c) enable the private sector to respond to the changing economic environment byproviding investment finance; and to

(d) help deepen the financial system and strengthen the key players, including theparticipating credit institutions (PCIs), the State Commercial Banks (SCBs), theCentral Bank of Sri Lanka (CBSL), the Ministry of Finance & Planning (MOFP),the contractual savings institutions (CSIs) and insurance companies.

(2) Project Components

The project consisted of -

(i) a credit component of US$ 57.5 million which provided funds to PCIsfor lending investment finance to private sector enterprises, and

(ii) a technical assistance component of US$ 2.5 million, for -

(a) institutional strengthening of the PCIs;

(b) studies related to the restructuring of SCBs and State owned insurancecompanies;

(c) a study to strengthen the bank supervision function of the CBSL;

(d) a study on the automation of the inter-bank funds transfer system and a scriplessgovernment securities transfer system;

(e) a study to develop the portfolio management capacity of the Employees'Provident Fund (EPF); and

(i) supporting the implementation of environmental standards by industrialists. PCIsand regulatory agencies.

1

(3) Implementation of Policy Reforms

This report will cover the implementation of financial sector reforms, which come underthe purview of this project.

All legal covenants as specified in Schedules 3 and 4 of the Development CreditAgreement have been complied with.

Overall, the results of the policy reforms were satisfactory. Considerable progress wasmade in strengthening the bank supervision function, improving the effectiveness ofmonetary policy and in developing the capital market.

The series of reforms implemented relating to bank supervision include strengtheningand expanding the legal framework for the regulation of all banks, stipulating prudentialrequirements in line with the Bank for International Settlements (BIS) standards,upgrading on and off-site surveillance of banks with an early warning capability,increased public disclosure requirements and use of external auditors and closermonitoring of foreign exchange exposures of banks.

The enforcement of accounting and auditing standards and the monitoring of complianceby the newly established statutory authority was another important achievement in theregulation of financial markets.

The legal framework for the regulation of primary dealers has been prepared and will beimplemented shortly. Draft legislation has also been prepared for the supervision ofmerchant/investment banks, which is expected to come into effect in 2000. In addition, anew finance leasing law has been finalised and will be presented to Parliament duringthe year. The legal framework for the regulation of private pension and provident fundshas also been drafted and is scheduled to be submitted to Parliament in 2000.

The introduction of market oriented open market operations was a progressive step inimproving the effectiveness of monetary management. The Monetary Law Act will alsobe amended in early 2000 to make price stability the principal objective of the CBSL.The other proposed amendments to this law relate to broadening the definition of moneysupply and to eliminating certain anomalies with regard to the statutory reserverequirement.

Perhaps, the most significant of the debt market reforms was the introduction of mediumterm government securities at market determined rates of interest. The auctioning ofTreasury Bonds commenced in 1997 and we now have Treasury Bonds with maturities of2 years to 6 years in the market. This has stimulated the private debt market by providinga benchmark interest rate for corporate debt. Issues of corporate debentures haveincreased markedly in the past two years. Private debt securities are now traded on theColombo Stock Exchange. The groundwork for the implementation of a scriplessgovemment securities trading system and an electronic funds transfer system has beencompleted and these systems will come into operation in 2000. Several measures havebeen implemented to develop the primary dealer system and the secondary market forgovemment securities.

The taxation of private and government debt securities has been rationalized to removethe bias against debt instruments vis-a-vis equities. The investment portfolios of CSIs

2

have been diversified, and the process is progressively continuing. Measures have alsobeen taken to improve the portfolio management capacity of the EPF. The establishmentof a credit rating agency has also contributed to capital market development.

The delay in the enactment of the new insurance law was the main shortcoming in theimplementation of the policy component. The delay was partly caused by the decision toenact fresh legislation to cover the entire insurance sector instead of making a fewamendments to the existing law as originally envisaged, as the existing law wasconsidered inadequate. This entailed a comprehensive examination of several aspectsrelating to insurance. The drafting of this law was done in close consultation with all keyparticipants. Hence, reaching a consensus has taken time. The draft law had also to berevised extensively, following certain observations made by the Attorney General withregard to its consistency with constitutional provisions. The Bill is now being revisedfollowing the recommendations made by an ADB consultant. Action is being taken toenact the legislation as a matter of priority. The Bill is now scheduled to be submitted tothe Parliament in early 2000.

The strategy to restructure the SCBs was through performance agreements signedbetween the government and the SCBs, which provided operational autonomy to thebank management and required the banks to achieve stipulated financial targets andrationalize operations. There were mixed results in restructuring SCBs. Theperformance of one bank has improved significantly to the extent that its profitabilityand administrative cost ratios are comparable with private domestic banks. The otherbank has complex problems and has not achieved the desired level of improvement.Therefore, other options are now being considered, such as private management contractsor a strategic partner.

The implementation of reforms were, in some cases, delayed due to the inability ordelays encountered in obtaining suitable consultants. The implementation of an effectivesurveillance system for primary dealers is a case in point. A consultant was required toassist in preparing formrats and manuals and for training staff. However, the search for aconsultant took over an year. The consultants have now been commissioned and work isin progress.

Over ten legislative enactments have been passed during the project. In certain cases, theimplementation of reforms was held up, primarily because of delays in the enactment oflegislation. The list of legislative enactments relating to financial sector reforms is givenin Annex 1.

The MOFP and the CBSL are firmly committed to initiate and implement policymeasures to accelerate private sector growth and to develop an efficient, competitive andsound financial system. Further improvements to the policy framework relating tocapital market development, social security reforms, financial market regulation andmonetary management are in the pipeline.

3

More details on the implementation of reforms are given below.

(4) Regulation of Financial Markets

4.1 Bank Supervision

As banks play a dominant role in the financial system, a major objective of the financialsector reform program was the evolution of a sound, competitive and efficient bankingsector. Hence measures were taken to strengthen extemal supervision as well as theintemal governance of banks and market discipline. Considerable progress was achievedin strengthening the bank supervision capacity of the CBSL. The Banking Act wasamended in 1995 to strengthen and expand the legal framework relating to commercial,savings and development banks and off shore banking units. Prudential requirementswere raised to bring them in line with BIS standards. Both on-site and off-sitesupervision was upgraded and risk based supervision techniques were introduced. Acomputerized off-site surveillance system with an early warning mechanism is now inoperation. Other measures included the increased public disclosure requirements of bankdata and the imposition of accounting and auditing standards on banks. A manual for on-site supervision was also prepared with the assistance of a consultant financed by theproject. The capacity of the Bank Supervision Department of the CBSL was expandedand a training faculty was also established. The requirement for both commercial andspecialized banks to appoint Compliance Officers to facilitate compliance with statutoryrequirements was introduced to strengthen enforcement.

Prudential requirements are continually being upgraded. The CBSL has already issued adirection to increase the minimum capital adequacy ratio for all banks from 8 % to 10 %of risk adjusted assets from the year 2001. It is also proposed to impose stricterrequirements for specific loan loss provisioning i.e. from 3 months in arrears, from nextyear. At present, the requirement to maintain specific loan loss provisions is from 6months in arrears, while loans are classified as non- performning if principal and/ orinterest is overdue for 3 months.

A feasibility report pertaining to the establishment of a mandatory deposit insurancescheme has been prepared with the assistance of a consultant. This is being examined bythe CBSL.

The legal framework relating to banks will be further expanded by a new set ofamendments to the Banldng Act which were recently approved by the Monetary Board.The amendments would bring merchantlinvestment banks under the supervision of theCBSL and would further strengthen the supervisory powers of the CBSL in respect oflicensing procedures, amalgamation, liquidation & closure of banks, qualifications,appointment & removal of bank directors and senior management,etc.

4.2 Accounting and Auditing Standards

The legal enforcement of accounting and auditing standards was another important policyreformn implemented to improve the corporate governance and the regulation of financialmarkets and the private sector. The Sri Lanka Accounting and Auditing Standards Actwas passed in 1995 which provides statutory force to the accounting and auditing

4

standards adopted by The Institute of Chartered Accountants (ICASL). The law requires"specified business enterprises" to prepare accounts in compliance with the accountingstandards and have them audited by professionally qualified chartered accountants inaccordance with the auditing standards. The ICASL is assisted by two committees,namely the Accounting Standards Committee and the Auditing Standards Committeewhose task it is to make recommendations on the content and adoption of standards. TheAct also provides for an Accounting & Auditing Standards Monitoring Board which isresponsible for monitoring compliance with standards. Non compliance by enterprisesand auditors will constitute an offence, which will carry fines. The CBSL and Securitiesand Exchange Commission (SEC) made the standards applicable to all banks and thecompanies listed on the Colombo Stock Exchange from 1998. Other entities are requiredto comply in respect of accounts for 1999. The Accounting & Auditing StandardsMonitoring Board have prepared the procedures for monitoring compliance, which willbegin in 2000.

4.3 Insurance

The drafting of the new insurance legislation is now being finalised by the LegalDraftsman and is scheduled to be submitted to Parliament in early 2000. Arrangementshave already been made to set up the regulatory authority and the World Bank has agreedto finance consultants who will assist in this task. The consultants are expected tocommence work in March 2000.

The new insurance law will provide for the establishment of an autonomous regulatoryauthority for the insurance sector. The regulatory board and authority will be structuredon similar limes to the Securities & Exchange Commission. The insurance regulatorybody will regulate the operating environment of insurance companies, brokeringcompanies and agents. The minimum share capital and prudential requirements, such assolvency margins and reserves for insurance companies will be specified in the law. Thenew law will also provide for greater diversification of the investment portfolio ofinsurance companies by reducing the minimum level of investment in governmentsecurities. The qualifications of the directors and key staff in insurance and brokeringcompanies will be specified in the new law. There will be stricter requirements relating tothe actuarial valuations and audited accounts.

4.4 Leasing

At present there is no specific law relating to leasing. Banks and finance companiesengaged in leasing are supervised by the CBSL. However, other institutions carrying onfinance leasing business are not supervised. The Legal Draftsman has drafted the newlegislation. The Bill is scheduled to be submitted to Parliament in the first quarter of2000. The proposed finance leasing law will define the rights and obligations of parties toa finance leasing transaction and also provide a regulatory and supervisory frameworkfor the leasing industry. The CBSL will license and supervise companies engaged inleasing activities under the proposed legislation.

5

(5) Monetary Policy

Open Market Operations

In the area of monetary management, the CBSL took a decision to shift towards the useof market oriented monetary policy instruments with pro - active open market operations(OMO) being the principal tool. Consequently, the use of the statutory reserve ratio(SRR) for monetary policy purposes would gradually decline. The SRR has been steadilyreduced over the past five years.

The Monetary Board approved a package of reforms in August 1995 to commence activemarket-based OMO and to develop the secondary market for government securities.Measures included the commencement of OMO at market rates, closure of the secondaryTreasury Bills window and repurchase window, re-activating the bank rate, the exclusionof non-bank financial institutions (NBFIs) from inter-bank call money market andgranting permission for non-bank primary dealers to maintain accounts at the CBSL forthe purpose of settling securities transactions.

The OMO trading desk and the back office were set up and market interventions areconducted by the OMO trading desk. Repurchase (Repo) and reverse repos usingTreasury Bills are used for managing call market liquidity, while outright sales andpurchases of Treasury Bills and Bonds are used for longer-term reserve moneymanagement. The CBSL also set up an automated system linked to banks to estimatedaily liquidity requirements. Market oriented OMO have commenced and the CBSL hasbeen gradually increasing the scale of such operations. The CBSL proposes to implementseveral improvements during the course of this year.

To ensure that the rules governing OMO are legally enforceable, the CBSL has draftedregulations relating to OMO transactions, which will be gazetted in early 2000. Theregulations cover outright sales, outright purchases, repurchase and reverse repurchase ofTreasury Bills and Bonds and CBSL securities.

Amendments to the Monetary Law Act (MLA) have been prepared to improve theoperational effectiveness of the CBSL. The objectives of the CBSL will be amended toemphasise the maintenance of price stability as its principal object, in order to avoid anypolicy conflicts that may arise due to the pursuit of multiple objectives. Otheramendments are aimed at increasing the effectiveness of monetary policy, such asrevising the definition of money supply to take into account "broad money" removal ofthe minimum and maximum limit on the SRR, and widening the scope for the impositionof the SRR to cover liabilities other than deposit liabilities of a number of financialinstitutions, other than banks. The amendments have been finalized by the LegalDraftsman and are expected to be submitted to Parliament in the first quarter of 2000.

6

(6) Domestic Resource Mobilization

Government Debt Market

Perhaps the most significant of the government debt market reforms was the introductionof the medium term Treasury Bonds at market determined interest rates. The auctioningof Treasury Bonds provided an impetus to the development of the private debt market bysetting a market determined benchmark interest rate for private debt. Several issues ofcorporate debentures amounting to over Rs. 6 billion were traded in the market in the lasttwo years.

The Registered Stocks & Securities Ordinance and other governing laws were revised toenable 'this policy reform. The auctioning of coupon Treasury Bonds which can betransferred by endorsement to improve marketability, commenced in 1997 with theauctioning of 2-year bonds. Since then, the GOSL has been progressively extending thematurities of the Treasury Bonds auctioned and we now have 3,4,5and 6 year TreasuryBonds in the market. Treasury Bonds amounting to Rs. 10 Billion, Rs 39 Billion andRs 68 Billion were auctioned in 1997, 1998 and 1999 respectively. The intention is tofurther extend the maturities into the long term and replace rupee loans with TreasuryBonds.

The CBSL announces the programme of Treasury Bills and Bonds to be auctionedevery quarter, in advance to provide market information to primary dealers.

Several measures were undertaken at the beginning of the project to increase the marketorientation of Treasury Bills auctions. Competitive bidding by the "captive sources"started in May 1995. Since then, the Treasury Bill auctions are completely market driven.

From 1995, CBSL has been publishing the maturity structure of Treasury Bills at eachauction on a weekly basis, with the average yield rates to provide better marketinformation. Similar information is also provided for Treasury Bond auctions.

The system of bidding at primary auctions has been automated. In early 1999, CBSLintroduced a system of electronic bidding at primary Treasury Bill and Bond auctions.

The CBSL also proposes to introduce scripless trading and transfer system and a realtime gross settlement system (RTGS) for Treasury Bills and Bonds in order to developthe secondary market for government securities. The Monetary Law Act, the RegisteredStocks & Securities Ordinance and the Local Treasury Bills Ordinance were amended in1995 to enable the of issue and transfer of Treasury Bills and Bonds in scripless form.The World Bank financed the feasibility study and the CBSL has also developed thenecessary software for the system which is now being tested. Accordingly, steps arebeing taken to implement the scripless system and the RTGS, very early.

Several measures were taken to develop the primary dealer system. The Primary DealersAssociation was formed in 1997. The conduct of primary dealers was governed byguidelines issued by the CBSL. In order to develop market-making function, the CBSLenforced minimum participation rates for primary dealers at Treasury Bill and Bondauctions. Participation was closely monitored and inactive dealers were delisted. Primary

7

dealers also required to make two way quotes in order to develop the secondary marketfor Treasury Bills and Bonds.

The CBSL is now in the process of re-organising the primary dealer system. Primarydealers will be required to set up separate entities with dedicated capital to trade ingovemment securities. The CBSL has drafted regulations to establish an operating andsupervisory framework for primary dealers, which will come into force in February,2000. A system of more effective surveillance of primary dealer activities will also beimplemented in early 2000. For this purpose, the CBSL has engaged the services ofconsultants to assist in the task.

Many other measures have been taken to promote the government securities market,including fiscal incentives, training for market participants and investor awareness andeducation programs.

(7) Diversification of the investment portfolios of the Contractual Savings Institutions

There has been considerable progress in diversifying the investment portfolios of theEPF, ETF, National Savings Bank (NSB) and the state owned insurance companies SLICand NIC.

The EPF started its diversification program in 1995 and now invests in both private debtsecurities, as well as shares listed in the Colombo Stock Exchange. At the end of 1999,around Rs. 4 billion was invested in private sector debt (mainly debentures) and over Rs600 million in shares.

The EPF has also taken several measures to develop its portfolio management expertise.A consultant firn (financed by this project), has assisted in preparing investmentguidelines for the EPF. Staff have been recruited on contract and are now being trained infund management techniques. The EPF intends to continue to diversify its investmentportfolio and increase its presence in the capital market.

A project is also underway to upgrade and computerize the EPF systems and there is alsoa proposal to amalgamate the EPF and the ETF.

The NSB has also diversified its investments and has invested around 20 % of itsportfolio in non-govermnent securities during the past five years. The lack of attractiveinvestments (until recently) in the private debt market prevented further diversificationby the bank. The recent (1999) amendments to the NSB Act, permit the bank to invest inthe share market.

The two insurance companies, SLIC and NIC have on average invested over40 % of their portfolio in non-government securities.

(8) Credit Rating Agency

As part of the strategy to promote the private debt market, the CBSL took the initiative insetting up a credit rating agency. The credit rating agency, which was established inOctober 1999, is a joint venture between a leading U.S. credit rating company, the CBSL,

8

the International Finance Corporation and several local financial institutions. The firstrating issued by the local credit rating company - DCR Lanka was for a debenture issueof a recently privatized company.

(9) Tax Incentives to develop the Financial Markets

Several tax reforms were implemented to provide fiscal incentives to develop thegovernment and private debt market. A major thrust of the tax reforms was also toremove the tax bias that discriminated against debt securities vis a vis equities.This has helped to establish an even playing field for debt and equity securities. Some ofthe measures taken are

a) The withholding tax on government and private debt securities has been withdrawn.b) Banks and financial institutions, debt and equity securities are exempt from the

recently introduced Goods and Services Tax. The business turnover tax applicable tobanks was reduced to 1% in 1995 and will be phased out soon.

c) The government and private debt securities are not subject to capital gains tax;d) Treasury Bills and Bonds are exempt from stamp duty.e) Private debt securities, such as debentures, bonds and commercial paper listed on the

Colombo Stock Exchange are exempt from stamp duty.f) The stamp duty on debt instruments not listed on the Colombo Stock Exchange has

been substantially reduced so as not to be a disincentive. The stamp duties on theseinstruments will also be phased out.

g) The CBSL has recommended that the stamp duties on mortgages and other taxesaffecting asset securitization either reduced or abolished in 2000.

(10) State Commercial Banks

The strategy adopted for restructuring the SCBs was through performance agreementssigned between the Government of Sri Lanka (GOSL) and the Bank of Ceylon (BOC)and the People's Bank (PB). In terms of the first Agreements signed in 1993, the BOCand PB received government bonds amounting to Rs 24 billion for recapitalisation. TheAgreements were designed to provide the banks with operational autonomy and bankswere required to achieve certain financial targets for profits and staff expenses. TheAgreements also required the banks to cut costs by freezing staff levels and rationalizirtgthe branch network. The Agreements met with reasonable success in reducingadministrative costs by restructuring staff and branch expansion. The financialperformance of BOC improved, while the PB's performance was not satisfactory. Bothbanks, however, were plagued with large non-performing loan portfolios, whichincluded government guaranteed loans. In order to settle these obligations, the GOSLprovided the banks with another installment of govemment bonds amounting to Rs 20billion in 1996.

In terms of the 1993 Agreements, the GOSL agreed to amend the BOC and PB statutes toenable the banks to function as autonomous commercial banks on the same terms andconditions as their private sector counterparts. The amendments have not been enacted.Therefore, it was decided to execute another set of Agreements in 1998 in order to giveeffect to the important provisions of the amendment bills and to achieve other objectives.The main features of the 1998 Agreements are summarized below.

9

(a) Granting operational autonomy to the bank management.

(b) Stipulation of qualifications for members of the Board of Directors and theGeneral Manager.

(c) Appointment of an Internal Audit Committee consisting of members of theBoard of Directors.

(d) Quantitative targets for profits, administrative costs, loan recoveries and non-performing loans.

(e) Freeze on staffing levels.

(f) Rationalization of loss making branches.

(g) Restrictions on credit facilities to defaulters.

(h) Payment for non-commercial services undertaken by the bank on behalf of theGOSL.

(i) Stipulation of terms, conditions and procedures for granting credit facilities at therequest of the GOSL.

() Requirement for the Minister of Finance to present a statement to parliament onall GOSL guarantees provided to the bank.

The Agreements seek to improve the banks' internal govemance and financialperformance by providing the management with operating autonomy and by specifyingannual quantitative performance targets. These include profitability targets, such asreturn on assets and return on capital, efficiency targets such as staff costs and overheadcosts to average assets and financial soundness targets for loan recovery and non-performing loans. The Agreements are also aimed at reducing administrative andintermediation cost through branch rationalization and restrictions on staffing levels. Thebanks are required to submit quarterly performance reports to the GOSL and the CBSLon the achievement of targets and other requirements.

The Agreement has been reasonably successful in restructuring BOC. In 1998,-the bankachieved three of the six targets, i.e. the staff cost, overhead cost and loan recoverytarget. The bank could not meet the profit targets, as it had to make increased provisionsfor loan losses and fall in value of investments, due to under-provisioning in the previousyear, primarily on account of losses in a subsidiary - the Merchant Bank of Sri Lanka.By making adequate provision for all contingent losses, the bank was heading in the rightdirection and the decline in profits in 1998 is viewed as a temporary setback. Theportfolio audit indicated that BOC was required to maintain a higher level of loan lossprovision than that stipulated by the CBSL, as BIS standards were used (BIS standardsrequire loan loss provisions at 3 months arrears, while the CBSL requirement at presentis at 6 months).

The provisional numbers for 1999 indicate that the BOC's return on assets, staff andoverhead ratios are now comparable with private domestic banks. The number of loss

10

making branches has also declined to around 10 out of a branch network of 290. Theremaining loss making branches have only marginal losses and the bank is expected toclose those that cannot be tumed around in 2000. The BOC has already obtainedpermission to close one branch. The BOC is currently preparing a strategic and structuralre-organizational plan with the assistance of foreign consultants to direct its future courseof operations.

The position with PB is different. The bank is undercapitalized and has a large inventoryof non-performing loans. The bank was only able to achieve one of the six targets in1998. As the bank's problems are complex, other options such as private management ora strategic partner, are now being considered to make it viable, since the Agreement hasnot brought about the desired level of improvement.

11

ANNEX 1

LEGISLATIVE ENACTMENTSRELATING TO FINANCIAL SECTOR REFORMS UNDER THEIDA-PRIVATE FINANCE DEVELOPMENT PROJECT ( PFDP)

1. Sri Lanka Accounting & Auditing Standards Act No. 15 of 1995.

2. Credit Information Bureau of Sri Lanka (Amendment) Act No. 8 of 1995.

3. Recovery of Loans by Banks ( special provisions) (Amendment) Act No. 24 of 1995.

4. National Savings Bank (Amendment) Act No. 28 of 1995.

5. Monetary Law (Amendment) Act No.26 of 1995.

6. Local Treasury Bills (Amendment) Act No. 32 of 1995.

7. Registered Stocks and Securities (Amendment) Act No.32 of 1995.

8. Banking ( Amendment) Act No. 33 of 1995.

9. Stamp Duty (Amendment) Act No. 6 of 1996.

10. Inland Revenue (Amendment) Act No. 16 of 1996.

11. Goods and Services Tax Act No. 34 of 1996.

12. Stamp Duty (Amendment) Act No. 38 of 1996.

13. Regional Development Banks Act No. 6 of 1997

14. Inland Revenue ( Amendment) Act No 24 of 1997.

15. Goods and Services Tax (Amendment) Act No. I I of 1998.

16. Inland Revenue (Amendment) Act No. 52 of 1998.

17. National Savings Bank (Amendment) Act No. 22 of 1999.

12

BORROWER'S REPORT - CREDIT COMPONENT

PROJECT IMPLEMENTATION ASSESSMENT

EVALUATION REPORT OF THE PFDP PROJECT

1. Introducio

The PFDP commenced its opeation in October 1993 to achieve the following objectives:

a) improve the efficiency of financial intermediation in Sri Lanka by supporfing policy andregulatory reforms in the financial sector.

b) assist in domestic resources mobilization for long term investment by stimulating thedevelopment of local bond market.

c) erable the private se;tor to respond to the changing econmic enviromlnents by providing

investment finance and

d) help deepen the financial system and strergthens the key players including thecontractual Savings institutions, the CBSL the MOF and PCIs.

The project consisted of four parts in order to achieve the above objectives. While part A (EnterpriseCredit) was designed to achieve the objective as stated in (b) & (c) above parts B, C, D were designed toachieve objectives as stated tndcr (a) and (d) above. Part 13, C & D consisted of poLicy Fiame workimpToerveents & support system wid pollution control Leasures.

During the implementation period though there were changes in Govemments in Sn Lanka there was nomajor changes in the recognition of private sector as the engine of growth and development of the country.

The Credit Line consisted of foUowing components in terms of currency allocations for the project Theperformance achieved as against these allocations are also indicated belowv

Category Arrmount of Credit allocated Performance achieved in! _______________ | ______ (Mn)___ termsofUS S

I________________ |SDR USS SL Rs Utlisation %PartA Enterprise credit 40.9 57.5 2826.3 54.6 95%Part B,CD Policy 2.3 2.5 122.9 3.1 124%Frame work support systeni,_polution control measures _ _ _ __60_0

Total 43.2 60.0 2949.0

@ SL Rs 49.15 per US S in October 93.

2. Proect Implementadon

The project implementacon was carrid out through NDB. The NDB as the administrator of the projectestablished a Project Unit which fimctioned as an independent cell within NDB. The NDB through its pastexperience gained by successfully managing several SMI lines of credit was able to carry out its apex rolethrough supervision and necessary guidance to the participating credit institutions and other technicalservice agencies. The evaluation performance as discussed below indicates that the two leading DFI'soperating in the country have virtually committed the funds set aside for Enterprise Credit.

By the close of the credit Rs.3109.1 million have been disbursed under Parts A,B,C& D of the project (Rs2913.1 MnforPartAandRsl96.1 MnforPartB, C& D)

During the project operations supervisions were carried out regularly by NDB & PCIs. IDA ReviewMission visited at regular intervals and have randomly checked assisted projects. Steps were taken forrescheduEng where necessary by PCIs. A sample survey was carried out by NDB Project Unit andWorld Bank resident Mission officials. The sample survey included project in the three districts ofGampaha. Colombo and Kalutara and covered several sectors of the economy.

Implementation of enterprise credit was assisted through training programs amranged under TA Component110 officers of NDB, DFCC, HNB and Sampath Bank have participated in various overseas trainingprograms to enhance their Project Appraisal and Financial Analysis, Marketing and Managerialcapabilities. In addition two programs were conducted in association with Havard institute of IntemationalDevelopment on Investment Project Finance & Risk analysis for officers of PCIs, DFIs Central bank, &National Planning UJnit of the Ministry of Finance. The two programs were organised by the DFCC andNDB respectively.

The skils acquired by the officers will be useful in thte implementation of similar projects in the future.M0aturity on project lending, training and exposure gained on the subject, high cosmiitmrent and influenceof policy decisions were some factors that contributed to the success of the line of credit

3 (a) Performance of Partlciuating Credit Institutions under the Prolect - (Enterprise Credit)

th.e gross value of Sub l,oans approved iilider dhe project amounts to Rs. 7,470.3 Mn. in respec-t of10 * projects. The cornespondirsg refinance amounts to Rs.4387.7 Mn.

3 (a).1 Net Approvals

The net Refinance approved on the final date of conmiitnent (as at 31.03.98) wasRs.3182.8 Mn in respect of 349 projects. The Line of Credit was fully conmmitted in termsof prevailed exchange rates as on that date.

3(a).2 Cancellatons

Rs. 1204.9 Mn approved for 56 projects was cancelled at various stages of the project.The reasons for cancellations can be attibuted to delays in irmplementation, full or partilwithdrawal by clients and in extreme situations due to non-availability of satisfactorydocumenteto support expenditre.

The Project Unit of the NDB and the World Bank Resident Mission periodicallyreviewed the availability of Sri Lanka rupee resources under the project Between theperiod October 1993 to March 1998 the Sri Lanka rupee depreciated by 26.8%. Newapprovals were substtuted in place of cancellations or additional rupee resources thatwere available due to exchange fluctuations.

3(a).3 Disbursemelte

The total amount disbursed as on 28'l October 1999 amounts to Rs.2913 Mn. Of theintial allocation of US S 57.5 Mn made available for sub loans, US $ 54.64 Mn wasdisbursed by the closure of the credit This amount represents 95% utilization of theinitial allocatiorL

.3

3(a).4 Performtance of Particlpating Credit Institudons

Three private conmmercial banks namely Sampath, HNB and CBOC participated in thescheme in addition to the two DFIs. The two DFIs have absorbed 94.8% of the totalcredit indicatng their dominance in the long term credit market for project orientedlending. Total amount approved to pnvate commercial banks amounted to Rs.156.6 Mnfor IS projects. Applications were not received from the Commercial Bank even thoughthe Bank has signed a Participating Credit Agreement During the period in which theLine of Credit was in operation (1993-1998) three other Lines of Credit were alsoavailable through the same mechanism. The pnvate commercial banks opted for theseschemes in preference to the PFDP as they were concentrating more on the small andmedium scale industries as they were more otiented to this sector of the economythrough their net work of branches which were well spread out. Corporate clienLtsprefened DFis for their tong term borrowings due to flexibility in approach and the tunetaken for approval.

3(a).S Total investmert generated under tie Project

The participating credit institutions generally finance 60% - 75% of the total cost of theproject The experience suggest that the equity contribution on the average is around35%. The ratio of funding Linder the PFDP is 35:26:39 (promoter, Bank and PFY)P proiectrespectively). Ol this basis the total investmnent is in rhe regionr of Rs.7169 Nin.

'The average credit flow to the private sector during the perizd 1994 to 1997 is aro und Rs269 Bn per annum from all financial institutions. The impact of the PFDP oncornmercial banks is marginal. As the two DFIs have virtually used the credit it ismeaningful to compare the impact towards DFIs. The DFIs on the average have providedRs 26.5 bn per annum to private sector. PFDP has provided Rs 3 Bn during the sameperiod and therefore 4% of their funding has been sourced by the project annually.

3(b) Performance under Technical Assistance (Parts B, C & D of the Droiect)

3(b).1 Part B Policy frame work iprovement

Under this activity capacity building of the Central Bank was caried out specially m theEconomic Research Dept, Financial Market Dept, Automation of Banwkng Activities ofthe Govermnent Securites Market is another activity funded under the project. Areasmnproved includes Economc and Financial Analysts, Debt, Secunties Market, CapacityBuilding of Prirnary Dealers, Institutional and Corporate Investors. PortfolioManagement Expertise was also infused to Dept of EPF for Management of EPF.Officers from Department of Labour, Institute of Policy Studies and Department ofNational Budget participated in HID programs on Social Security and PensionsModeling. Another area covered under training is legal aspects of trade liberalization.

In order to strengthen financial structure of the two leading state Commercial Banksnamely People's Bank and Bank of Ceylon a portfolio audit was carried out in addition toa financial performance review. A farther activity undertaken was the assessment of thevalue of assets and actuarial valuation of reserves of the National nsurance Corporationand Sri Lanka Insurance Corporation Ltd. The World Bank resident mission in Sri Lankaevaluated the suitability of Consultants employed under the projects in most instances

4

and approved their employment. The project unit of the NDB approved reimbursementof the expdit on piusal of contacal documents and consultants reports.whichwere recommended by vanious miplementing agencies.

3(b).2 Part C Support System

intitution Development of Cental Bank, NDB, DFCC MOF and other PrivateCommercial Banks were carried out by the expome of the officer attached to thesemsttutions either through participation in overseas training programs or local trainigprograms. Area of exposue includes managerial skill developments, informationtechnology, iastructure finance, financial markets, legal issues on mtemnational bankguarantees, advanced credit analysis, project appraisal' and risk management, EuroMoney Training Programs, Bank Marketing, total quality Management, Savins & RuralCredit, Rural Banking, Appraisal of Agricultural lending etc.

3(1).3 Part D Polution Control

'fle activities under this sub head was implemented by CleaNet program supervised byNDB Environmental Unit. Initially US S 100,000 was allocated to Itmin Ltd to cany outthe program. However, due to slow progress achieved, the activities were latertransferred to the Ceylon Chanber of Commerce and Industrial Technology Institute.CleaNet is fumctioning as an Information Clearing house for Cleaner production toIndustrial Enterprises and Soft Loan to implement such measures were available throughPollution Control & Abatement Fund Managed by NDB. The two institutionssuccessfUlly implemented the program and established a web-site through Internet toprovide required information to industrialists. Ttu: technological and rnanagementcapabilities wrere aLso developed throurgh pTocurement ol necessary equipment andparticipatiorn ii overseas training programs. A web server was ho.ted and conigured atboth rl' & CCC. Case study data, a list of Enviromnental Consultants and otherrelevant information that would be sourced by industries is being accommodated andhosted on web site. The activites carried out by the two institutions can be categonzedas Environmental Policy Services, Providing trainmg services, consultancy services,information dissemination services and technology brokering services.

4. Operational experieuce

Deviaing from the practice of submittng withidrawal applications to Central Bank of Sri Lanka through theGeneral Treasury, under the PFDP, applications were directly submitted to Central Bank for withdrawal offunds from the Line of Credit This procedure reduced the time gap for withdrawal of funds and passeddown the benefit of low cost funds to the ultimate borrower without delays. The procedure is stronglysupported by NDB as a method to be folowed in the future. NDB as the apex agency for implementationalso wish to place on record that for larger projects implementation time has to be flexible within the framework of the commitmnent and disbursement period and the PCIs should be given a free hand to decideeither to withdraw or cancel without restricting a period for I" draw down. As high as 37% projects werecancelled (18% No wise) at various stages of implementation. Around 58% of the projects faU into acategory where sub loan size was over Rs 25.0 Mn. The experience suggests that the projectsbenefited are substantially larger projects and as such delays in implementation can beexpected on the grounds of technical, financial, econormical or management problems. As such flexibletime fiame for withdrawal can be justified. Around 11% of the quoted public companies listed in theColombo Stock Exchange have benefited from the project. Enhanced profitability through additionalcapital formation may have influenced the marketability of shares.

.5

The follow up activities by the two DFI's does not indicate any serious draw backs on most of the projectsand on an overall basis the projects have fared well A highlight of foUow up activities is the awareness ofthe modern manageent practices among the beneficiaries of the projects. This argues well for theimplementation of siinia projects in the future.

S. Relationship among the monitoring and implementing agencies

The World Bank Resident Mission in Sn Lanka extended an excellent support to the NDB Project Unitand other implementing Agencies and Participating Credit Institutions. Their contnbution for timelyapproval of sub projects and other services was invaluable. In addition, to reviewing of sub projects themission staff also evaluated technical services, proposals and facilitated the work of NDR Project Unit.The NDB Project Unit also wishes to place on record the expeditious manner in which disbursements wereeffected b , the DisbursementgM if World Bank with minimum clarifications.

The Cent-al PBank of Sri Lanka expedited withdrawal applications efficiently and made available ttherequired docu;nents for recording and reporting with a mrinimum timne lag.

All cechitcal services agencies have extended their support to the NDB Project Unit when effectingdisbuisenonts for varims goods and services procured under the project. The work carried out by CeylonChamber of Conmnerce and Industrial Technology Institute under the CleaNet Project (vested withoperating a tformtion clearing house by providing information to industrialists to mncrease productivity byintroducing cleaner technology options and thereby reducing the emission of pollutants to the enviromnent)requires soecial appcafion.

World Bank Documentdocuments.worldbank.org › ... › pdf › multi-page.pdf · 8. The metal,...

Documents

Transcript of World Bank Documentdocuments.worldbank.org › ... › pdf › multi-page.pdf · 8. The metal,...