Document of The World Bank FOR OFFICIAL USEONLY Report No: 26937-TR PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN INTHEAMOUNT OFUS$303.10 MILLION TO THE T m E SINAI KALKINMABANKASIA.S. (TSKB) FOR THE SECOND EXPORT FINANCE INTERMEDIATION LOAN ( EFIL11) December 12,2003 Private andFinancial Sector Development Department ECCU6 Europe andCentral Asia Region This document has arestricteddistributionandmay beusedbyrecipients only inthe performance of their official duties. Its contents maynot otherwise be disclosed without World Bank authorization CURRENCY EQUIVALENTS (Exchange Rate Effective November 6,2003) Currency Unit = TurlushLira TurkishLira 1 = US$0.00000072 US$1 = 1,388,889 TurlushLira FISCALYEAR January 1-December 31 ABBREVIATIONS AND ACRONYMS ALM Asset andLiability Management BDDK BankingRegulationand SupervisionAgency BIS Bank for IntemationalSettlements CAS CountryAssistanceStrategy CEO ChiefExecutiveOfficer CBT CentralBank of Turkey CIRR CommercialInterest ReferenceRate CIS Commonwealth of IndependentStates DC Direct Contracting ECA Export CreditAgency or Europe& CentralAsia (Region) EFIL Export FinanceIntermediationLoan EFIL I1 SecondExport FinanceIntermediationLoan EU EuropeanUnion FSL Fixed Spread Loan FMR FinancialMonitoring Reports FMS FinancialManagementSystem FX ForeignExchange GOT Govemment ofTurkey IFRS IntemationalAccountingStandards ICB IntemationalCompetitiveBidding ICR ImplementationCompletionReport IF1 IntemationalFinancialInstitution IMF IntemationalMonetaryFund IPO InitialPublic Offering IT Information Technology ISA IntemationalStandardson Auditing ISP IntemationalShoppingProcedures LAC1 LoanAdministrationChangeInitiative NCB National CompetitiveBidding N S National Shopping OECD Organizationfor Economic CooperationandDevelopment OM Operations Manual PFI ParticipatingFinancialIntermediary(bank or leasingcompany) PIU ProjectImplementationUnit SCL Single Currency Loan SMP Staff MonitoredProgram SOE StatementofExpenditure TSKB Turkiye SinaiKalkinmaBankasi (the Borrower) Turk EXIMBank Turkiye IhracatKredi Bankasi (the Borrowerunder the first EFIL) TL Turkish Lira FOROFFICIAL USEONLY The Team for this operation consists o f Lalit Raina (Team Leader/Lead Financial Sector Specialist, ECSPF), Marie-Renke Bakker (Lead Financial Sector Specialist, ECSPF), Gurhan Ozdora (Senior Financial Sector Specialist, ECSPF), M a n u s Vismantas (Financial Sector Specialist, ECSPF), and Salih Kemal Kalyoncu (Procurement Specialist, ECSPS). D i l e k Barlas (Senior Counsel, LEGEC), Rohit Mehta (Senior Finance Officer, LOAG1) and Seda Aroymak (Senior Financial Management Specialist, ECSPS) provided legal, disbursement and financial management support respectively. Young Ok H o n g (ECSPF) is the Program Assistant for the project. This document has a restricted distribution andmay beusedby recipients only in the performance of their official duties. I t s contents may not be otherwise disclosed without World Bank authorization. PROJECT APPRAISAL DOCUMENT RepublicofTurkey SecondExportFinanceIntermediationLoan TABLE OFCONTENTS MAINREPORT ISTRATEGICCONTEXTANDRATIONALE.......................................................................... . 3 A.Country and Sector Issues...................................................................................................... 3 B.Rationale For BankInvolvement ........................................................................................... 5 C.Higher Level Objectives to which the Project Contributes ..................................................... 6 I1 PROJECTDESCRIPTION........................................................................................................ . 7 A.LendingInstrument................................................................................................................ 7 B.ProjectDevelopment Objective andKey Indicators.............................................................. 7 C.Project Components ............................................................................................................... 8 D.Lessons LeamedandReflected inthe ProjectDesign........................................................... 8 E.Alternatives Considered andReasons for Rejection.............................................................. 9 I11.PROJECT IMPLEMENTATION........................................................................................... 10 A.PartnershipArrangements.................................................................................................... 10 B.InstitutionalandImplementationArrangements.................................................................. 10 C.Monitoring andEvaluation ofOutcomesResults ................................................................ 10 D.Sustainability........................................................................................................................ . . . 11 E.Critical Risksand Possible ControversialAspects............................................................... 11 F.BoardPresentation Loan Conditions and Covenants .......................................................... 13 IV.APPRAISAL SUMMARY..................................................................................................... 14 A.Economic and FinancialAnalyses ....................................................................................... 14 B.Technical.............................................................................................................................. 14 C.Fiduciary............................................................................................................................... . . 14 D.Social.................................................................................................................................... 15 E.Environment - Category FI................................................................................................... 15 F. SafeguardPolicies ................................................................................................................ 15 G.Readiness ............................................................................................................................. 16 H.Compliance .......................................................................................................................... 16 TECHNICAL ANNEXES Annex 1: Country and Sector or Program Background.............................................................. 17 Annex 2: Major RelatedProjects Financedby the Bank and/or Other Agencies....................... 22 Annex 3: ResultsFramework and Monitoring............................................................................ 23 Annex 4: Project Description...................................................................................................... 24 Annex 5: Project Costs................................................................................................................ 31 Annex 6: ImplementationArrangements .................................................................................... 32 Annex 7: Financial Management. Audit andDisbursement Arrangements ............................... 50 Annex 8: Procurement Arrangements ......................................................................................... 58 Annex 9: Turkey's Export Growth. Export Loans and General FX LoanAvailability Analysis ................................................................................................................... 61 i Annex 10: SafeguardPolicy Issues............................................................................................. 65 Annex 11: Project Processing..................................................................................................... 68 Annex 12: Documents inthe Project File................................................................................... 69 Annex 13: Statementof Loans and Credits ................................................................................ 70 Annex 14: Turkey at a Glance .................................................................................................... 71 FIGURES Figure 1: Turkish Exports (US$ billion).................................................................................... 3 Figure 2: Turkish CompetitivenessIndicators (indices. 1990= 100)........................................ 4 Figure3: Total Turkish Bank Credit and Export Credit to the Private Sector .......................... 5 Figure4: Turkey Financial LeasingReceivables 1998-2002.................................................. 19 Figure 5: New Leasing Volume and GDP Growth 1998 .2002................................................ 20 Figure 6: TSKB Outstanding LoanVolume. USDmillion........................................................ 39 Figure 7: TSKB Balance Sheet -Composition of Liabilities.................................................... 40 Figure 8: TSKB Balance Sheet . Composition of Assets.......................................................... 41 Figure 9: TSKB Income Statement. Results as YOof Total Operating Income....................... 44 Figure 10: GDP . Local Currency .............................................................................................. 61 Figure 11: Export/GDP Development ........................................................................................ 62 Figure 12: Turkey's Export Performance................................................................................... 63 Figure 13: Cost ofEximbank's Short-Term Export Credit .% Spread over 6-monthUSD LIBOR..................................................................................................................... 64 Figure 14: Export Finance .......................................................................................................... 64 TABLES Table 1: Turkish Exports and Imports for 1997-2002 ............................................................ 18 Table 2: Other Services by TSKB in2002 .............................................................................. 40 Table 3: TSKB -Returnon AssetsEeturn on Equity............................................................. 44 Table 4: Banks satisfying thepre-qualification criteria rankedby (i) assets; and(ii) total export sector loans/total assets ................................................................................ 46 Table 5: Leasing companies satisfying the pre-qualification criteria rankedby (i) total lease receivables; and (ii) annual volume o f leasing............................................... 48 Table 6: Allocation of LoanProceeds(US$) ........................................................................... 56 Table 7: Project CostsbyProcurementArrangements............................................................ 60 Table 8: Thresholds for ProcurementMethods andPrior Review (inUS$ million) ...............60 Table 9: Exports of goods and services (% of GDP, 2001) ..................................................... 62 Table 10: Turkish Banking Sector Data 2000 - 2002 ................................................................ 65 .. 11 REPUBLICOF TURKEY SECONDEXPORTFINANCE INTERMEDIATIONLOAN(EFIL 11) PROJECTAPPRAISAL,DOCUMENT Europe and CentralAsia Region Private and Financial Sector Development Department Country Director: Andy Vorkink Sectors: FinanciaVPrivate Sector Director: Ani1 Sood Themes: Export development and Sector Manager Khaled Sherif improved access to finance Project ID: PO82801 Lending Instrument: Financial Project Financing Data: [XILoan [ ] Credit [ ] Grant [ 3 Guarantee [ ] Other: For Loans/Credits/Others: Total Project Cost (US$ million): TBD Cofinancing: Not Applicable Total Bank Financing (US$ million): 303.1 Source Local Foreign Total TSKB 0 0 0 IBRD/IDA 0 303.1 303.1 PFIs & Sub-borrowers* TBD 0 TBD Borrower: Tiirkiye Sinai KalkinmaBankasi (TSKB) Responsible Agency: Turkiye Sinai KalkinmaBankasi (TSKB) Guarantor: * x Project implementation period: FY04-FY09 Expectedeffectiveness date: March2004 Exnectedclosing date: Sentember 2009 Does the project depart from the CAS in content or other significant o Yes o No respects? Does the project require any exceptions from Bank policies? Have these o Yes o & been approved by Bank management? oYes o N o I s approval for any policy exception sought from the Board? oYes oNo Does the project include any critical risks rated "substantial" or "high"? o= o N o Does the project meet the Regional criteria for readiness for o oNo implementation? 1 Proiect development obiective (i) Provisionofmediumandlong-termworkingcapitalandinvestmentfinancetoprivate exporters, and contribute to further facilitating export growth inTurkey; and (ii) Improvement in the quality, and safety of, and access to, finance through development o f financial intermediation in the Turkish private financial sector by banks and leasingcompanies. Proiect description The project will provide a credit line, backed by the Bank loan o f 16 years o f maturity, including a 6-year grace period, and guaranteed by the Turkish government on behalf o f the Republic o f Turkey, to TSKB, a private Turkish investment and development bank, for further on-lending to eligible financial intermediaries - banks and leasing companies. The financial intermediaries will further on-lendthe credit line finds to eligible exporters. Which safeguard policies are triggered, if any? None. [Environmental issues for sub-borrowers, if any, will be addressed through the sub-loan environmental eligibility criteriaprocess on a case by case basis] Significant, non-standard conditions, if any, for: Boardpresentation: At least two PFIs have been selected and have submitted an expression of interest inwriting for participation inEFIL 11. The Operations Manual, including the environment guidelines for the sub-loans and leases, has been adopted. Loadcredit effectiveness: At least 2 PFIs have undergone the qualification procedure and have signed subsidiary loan agreements. Covenants applicable to proiect implementation: None * While iti s expected that both PFIs and sub-borrowersthemselveswill contributeto the financing of individual sub-projects, the precise amount of such financing to be provided cannot be determined ex ante, as the loan design does not envisage the use of predeterminedcofinancingrequirements. Instead,maximum exposureto individual sub-borrower limits for PFIs and debt equity anddebt servicecoverage ratio requirementsfor sub-borrowers will drive the amountof cofinancingto be provided. 2 I.STRATEGICCONTEXTANDRATIONALE A. COUNTRYAND SECTORISSUES 1. Recent Macroeconomic Developments and their Impact on the Turkish Export Sector. A combination o f natural disasters and macroeconomic volatility in Turkey during the 1999-2002 period created an unfavorable and uncertain environment for exporting companies. In 1999,the massive destruction resulting from earthquakes impeded domestic production and led to a contraction in domestic demand. In2000, the Government's IMF-backed stabilization program initially led to an expansion in imports and a contraction in exports (Figure 1). The current account worsened quickly, in part due to the anchoring o f the exchange rate which eroded Turkey's competitiveness (Figure 2), but also as a result o f an increase in oil prices and US$/Euroexchange rate developments which favored importers. Figure1: Turkish Exports(US$ billion) I I 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 Source; Turkish Statistical Office 2. The worsening fiscal and current account performance generated pressures on the fixed exchange rate system, and incombination with longstandingunderlying structural banking sector problems triggeredbanking crises inNovember 2000 and February 2001. InFebruary 2001, the fixed exchange rate regime collapsed. The Turkish Lira was allowed to float and depreciated sharply, improving the competitiveness o f Turkish exports (Figure 2). Many banks and local businesses were caught up in foreign exchange short positions and suffered significant losses. The magnitude and frequency o f exchange rate fluctuations in the period immediately following the start o f the floating exchange rate regime added to business uncertainty. Besides Forex mismatches, maturity mismatches between assets and liabilities o f many banks added to the banking sector's distress. Non-performing loans increased, and it became increasingly difficult 3 for many firms to finance their operations. Domestic demand dried up and the economy shrank significantly during 2001. 3. For a large number o f companies, especially for those with limitedexport sales, 2001 was a period where they had to overcome difficulties in meeting working capital financing requirements and generating sufficient funds to maintainprofitability and a sustainable financial structure in a shrinking economy, and uncertain macroeconomic and political environment. However, the depreciation o f the currency in 2001 did create incentives for exporting activities, and some businesses could benefit from the price advantage. Firms, which could continue to produce, and which faced a rather price-elastic international demand, increased their export performance substantially, as some o fthe EFILbeneficiaries were able to. Figure2: Turkish CompetitivenessIndicators(indices, 1990 = 100) - CPI Based Real Effective - Exchange Rate (1995=100) --WPI Based Real Effective - - - Exchange Rate (1995=100) Unit Labor Cost $ Source: CentralBank o fTurkey 4. Inearly 2002, economic recovery started and continued throughout that year and during the first half o f 2003. GNP growth reached 7.8 percent in 2002, due among other factors to the strong growth in exports and tourism revenues following the 2001 exchange rate adjustment. Export growth continued steadily throughout 2002-03, despite a subsequent appreciation o f the real effective exchange rate reflecting increased confidence in the TL, due to a sharp fall inreal private sector wages after the crisis. 5. However, even though economic performance, mostly led by the export revival, continued to improve during the latter half o f 2002 and the first half o f 2003, the pick up in market sentiment has not ledto any significant increase inthe overall level o f bank credits to the productive sectors (Figure 3). Although the banking sector was significantly restructured and strengthenedinthe aftermath o f the crises, banks are still risk averse, and with real interest rates continuing to hover inthe 20% range, the high level o f government debt continues to crowd out private sector financing needs. While short term foreign currency bank financing is available to the best exporters at affordable US$-based interest rates, medium and long-term working capital 4 and investment finance is still very scarceinTurkey. Lease finance -which often is an important source o f longer-term investment finance for exporters in other countries - also has remained underdeveloped in Turkey, with the growth in lease receivables highly volatile and dependent on macroeconomic performance. Both the banking and leasing sectors lack access to medium and long term funds, which provides the principal rationale for the Bank's involvement and the EFILI1(see Annex 1for a more detailed discussion). Figure3: TotalTurkishBankCreditandExportCredit to the Private Sector 50,000 45,000 40,000 ~ 30,000 359000 ~ 25,000 20,000 15,000 10,000 Mar- Jun- Sep- Dec- Mar- Jun- Sep- Dec- Mar- Jun- Sep- Dec- Mar- 00 00 00 00 01 01 01 01 02 02 02 02 03 =Ex~ort Credits (US$ million) +Total Bank Credits (US$ million) ~ I Source: Central Bank o f Turkey/ Banking Regulation and Supervision Agency (BDDK) B. RATIONALEFORBANKINVOLVEMENT 6. Following the recent financial crises and a subsequent downturn in the enterprise sector, the Government o f Turkey has demonstrated its commitment to policies and strategies intended to revitalize Turkey's real sector, and export-oriented industries in particular. The Government is also continuing its efforts to implement banking sector reforms in cooperation with the banking community, while trying to clearly convey the message that recovery from this deep crisis will be a long term process highly dependent on real sector recovery and growth. This, therefore, is one o fthe principle objectives o fthe Government for 2003 and beyond. 7. The proposed project is consistent with the new FY04-06 CAS for the Republic o f Turkey (CAS number R2003-0181, discussed by the Bank's Executive Board on November 6, 2003). As stated in the new CAS, an important part of the process o f recovery from the crises will be revitalizing the real sector, which is currently suffering from a credit crunch as a result o f the banks' increased awareness o f credit risks and tightened loan loss provisioning requirements inthe wake oftheir re-capitalization, as well as a sharp post-crises decline in syndicated lending by international banks to Turkish banks, reducing their foreign currency lending capacity. The 5 CAS'Skey priorities for the medium term include completing the banking and financial sector reforms and revitalizing the real sector by filling the current gap in accessing credit facilities, which will be also supported by this proposed project. 8. The current credit squeeze is affecting both (i) demand side, where even the most the creditworthy private sector borrowers find it hard to tap international capital markets and are reverting back to domestic credit markets, with the Government simultaneously experiencing similar difficulties in rolling over its existing foreign currency debt, and (ii)the supply side, where the domestic banking system i s reducing both the volume and maturity o f its real sector lending in response to the reduced volume and maturity o f its own funding. Under these circumstances, the Turkish authorities have requested the Bank for an export credit line, which would be provided through the financial system and would support private sector exporters. The project team supports this request and believes a financial intermediary loan for exporters i s a product o f choice in the current circumstances (primarily a very thin supply o f longer-term funds) facing Turkish financial intermediaries and private enterprises - large, medium, and small alike. The success o f the predecessor EFIL project provides a good basis for such positive consideration. 9. The proposed EFIL I1project will substantially maintain the design o f its predecessor EFILproject. Evenbefore its formal closure, the first EFILhas provedto be a successful project, as it provided a timely and focused response to the unmet demand from banks and exporting companies for medium- and long-term funding, both during the pre- and post-crisis periods. The EFIL credit line was almost fully disbursed by the closing date o f end-August 2003. With interest rate levels on Turkish Lira loans remaining prohibitively high, and loan maturities very short, demand for affordable longer-term funds from the real and financial sectors in Turkey remains strong. The Government's request for a successor EFIL I1credit line for exporters i s thus welljustified and timely. The project will support the current upward momentum inexport performance and, by extension, ingeneral economic improvement. c. HIGHER LEVEL OBJECTIVES TO WHICH THE PROJECTCONTRIBUTES 10. One o fthe mainbenefits o fthe proposed project will be faster private sector recovery and job creation, supported by a healthier and more developed financial system. In general, enterprise and financial sector performance i s expected to continue to improve in the short and medium term. Inthe longer run, export growth supported by the proposed operation i s expected to have an overall positive impact on poverty alleviation andprivate sector growth inTurkey. 6 11. PROJECT DESCRIPTION A. LENDING INSTRUMENT 11. The lendinginstrument proposed for this project is the Bank's Fixed Spread Loan (FSL) with a 16 year maturity, including a 6 year grace period. The instrument is fixed spread as compared to variable spread in the first EFIL, and is planned as a loan with a longer maturity both for the Bank loan to the Borrower (TSKB), and for the subsidiary loans from the Borrower to participating financial intermediaries. The longer maturity o f the credit line i s justified by the fact that, with a revival o f demand, lower inflation and GDP growth picking up, the operational and investment planning horizon o f private exporters is lengthening, and banks and other financial intermediaries are willing to provide increasingly longer term foreign currency finds (of which there is a clear shortage inthe market) to their well-performing clients. B. PROJECTDEVELOPMENT OBJECTIVE AND KEY INDICATORS 12. Traditionally, credit to the real sector has been crowded out over the years by the large and expanding demand for government borrowing. Even more so at this time, all firms, except blue chip firms or dedicated exporters, are facing a credit crunch. This is due to the after-effects o f the banking crisis in 2001, which resulted in the banks exercising increased caution in their lending operations after their re-capitalization in 2002, and the simultaneous decline in international syndicated lending to Turkish banks. The proposed project's main objective is to follow through on the achievement o f the predecessor EFIL project and continue to serve as a catalyst to support export and real sector growth in Turkey during the EFIL I1implementation period (2004-2009), and beyond using the EFIL I1reflows. To this end, the project will provide medium and long-term working capital and investment finance to Turkish private exporting enterprises, at the time when the economy is showing strong signs o f rebounding from a recent slump and export performance is on the rise-thus increasing the demand for longer term credit, while the financial sector is still unable to support these trends with very much needed longer term finds at a reasonable cost. 13. The secondary objective o f the loan is further improvement inthe ability o f the Turkish financial sector to provide financial resources to the enterprise sector, through further development o f intermediation by private financial institutions, including banks and leasing companies. The project, through inclusion o f leasing companies inaddition to banks as PFIs, will enable the Bank to start a dialogue with the leasing sector in Turkey, provide an opportunity to gain more insight into the sector, and enable the Bank to support its development. It needs to be noted that the inclusion o f leasing companies as financial intermediaries is an innovative aspect o f the project, not previously used in World Bank credit line operations in the ECA Region. As such, it contains a degree o f uncertainty in terms o f the ability o f the Turkish leasing sector to successfully absorb the funds available for intermediation, and channel them to eligible exporters. The Bank team has undertaken an initial assessment o f the leasing sector, including determination o f the sector's size, main players, its legislative and regulatory foundation, and its operational aspects (accounting, client base, average volumes, cost o f funds, etc.). Based on these initial findings, the team believes that selected leasing companies can become solid project counterparts with a strong operational experience and ability to successfully intermediate the EFIL I1funds, mostly to smaller exporting companies typically not serviced by the banking system. 7 14. The first EFILproject financed mostly mediumand large exporters, with the average sub- loan being close to US$2.5 million. The project team believes that by including leasing companies as a new class o f financial intermediaries in the project, more small and medium- sized exporters will be reached than if intermediation was done through the banks only. In fact, the initial assessment o f the leasing industry revealed that the average size o f a financial lease contract in Turkey i s around US$80,000. The expectation under the EFIL I1project is that the selected leasing companies would be able to reach a significant amount o f smaller exporters, i.e., those with annual revenues typically not exceeding US$3 million, and provide financial sub- leases inthe US$250,00O-1,000,000 range for acquisition o f productive assets (equipment and machinery for manufacturing and/or service companies). C. PROJECTCOMPONENTS 15. The proposed EFIL I1project will substantially maintain the design o f its predecessor EFIL project that has been successfully implemented during FY99-04. The credit line will be provided to TSKB, with a government guarantee, while TSKB will pass it on in the form o f subsidiary finance to participating financial intermediaries for further on-lending to eligible private exporters. The principal design changes inEFILI1will be as follows: - TSKB, a privately owned Turkish investment and development bank, will replace Turk EXIMBank as the borrower and implementing agency. Turk EXIM has indicated that it currently i s strategically focused on activities related to overseas project finance and that TSKB therefore i s better suited at this time as the Borrower o f the Bank loan and for wholesaling it to financial intermediaries; - Leasing companies, in addition to banks, will be allowed to become financial intermediaries under the project. This will support development o f the leasing industry and will allow World Bank funds to reach non-bank customers, primarily smaller exporting companies; and - The loan finds will be provided to the Borrower on FSL terms with 16 year maturity (including a 6 year grace period). This would extend the maturity available to the financial intermediaries and borrowing companies and appropriately respond to the increasing stability o f the Turkish economy and lengthening o f the investment planning horizons inthe enterprise sector. 16. The EFILI1will have a single component a credit line for exporters, and will provide the mediumand long-tenn funds to exporters through two distinct channels, or sub-components: (i) US$200 million through commercial banks inthe form of investment or working capital loans, and (ii)US$lOO million through leasing companies inthe form o f lease finance for acquisition o f productive assets (vehicles, machinery and/or equipment). No co-financing arrangements with other international agencies are envisaged. D. LESSONS LEARNED REFLECTEDINTHEPROJECTDESIGN AND 17. The main lesson learned duringthe last few years from Bank credit line operations inthe ECA Region and elsewhere is that the project design should be kept as flexible as possible, with a minimumnumber of, or no statutory requirements;e.g. avoiding constraints like minimumsub- loan size, maturity, currency denomination, sub-borrower co-financing requirements, sectoral lending focus, etc., but using sensible financial indicators for the selection o f both the PFIs and the sub-borrowershb-projects inline with established marketpractices. Restrictive procurement requirementsunsuitable for private sector borrowers, and the World Bank's previous currency pool loan features have also proven to be a hindrance to expeditious project implementation, and 8 wherever commercial practices and SCLs were used, these factors ceased to be a bottleneck. Another important lesson learned has been that the most successful formula for highquality and expeditious project implementation i s to combine the Borrower and Implementing Agency b c t i o n s in one and the same entity ifpossible. Finally, pre-committing financial intermediaries to borrowing a certain part o f a credit line (which involves paying a commitment fee on the pre- committed amount) provides a strong incentive to the intermediaries to be quick and effective in finding and financing eligible sub-projects, and leads to quicker disbursement o fthe Bank loan. 18. Lessons Learned from Previous Credit Line Operations in Turkey: The Implementation Completion Reports (ICRs) for the previous World Bank credit line operations in Turkey indicate that some o f these operations had to be restructured in mid-stream because the initial project design tumed out to be too inflexible (e.g., too many requirements in terms o f minimum sub-loan size, sub-loan maturity, sub-borrower cofinancing requirements, etc.). The ICRs indicate that, after restructuring, project implementation generally proceeded well. 19. The proposedproject design incorporates all o f these lessons learned, by usingTSKB as the borrower and implementing agency for the loan, by the use o f a clear, market-based set o f eligibility criteria for PFIs, sub-borrowers and sub-projects, by the use o f flexible loan terms and . suitable private sector procurement practices, and also by use o f formal expressions of interest from a minimum number o f the PFIs prior to Board Presentation to a specific portion o f the credit line. E. ALTERNATIVESCONSIDEREDANDREASONSFORREJECTION 20. A search for alternative approaches to the project was not necessary inthis case, as the EFIL I1is being undertaken as a repeater project, building on the success and structure o f the first EFIL project. During the preparation o f the first EFIL, however, alternative borrower and implementation arrangements (including using the Undersecretariat o f Treasury as the Borrower) had already been considered and rejected as less suitable than using Turk EXIM Bank as the Borrower and Implementing Agency for the project to ensure efficient project implementation. 21. There are, however, some minor design changes inthe case o fEFILI1as compared to the first EFIL. The borrower will be TSKB (Turkish Industrial Development Bank) rather than Turk EXIMBank. This was the preferred alternative to usingTurk EXIMBank inEFIL I1because o f EXIM's other operating preoccupations with country-to-country programs. Apart from a few operational changes (terms o f the loan, different borrowerhmplementing agency, and inclusion o f leasing companies as financial intermediaries) a similar set o f development objectives and implementation arrangements will be maintained. Given the absence o f any material changes from the first EFIL, EFIL I1qualifies as a repeater project, which will continue to serve the need o f exporters and PFIs for mediumand long-term investment and working capital funds. 9 111. PROJECTIMPLEMENTATION A. PARTNERSHIPARRANGEMENTS 22. As part ofbothproject preparation and implementation, the Bank team has built, and will continue to cultivate, close relationships with both national and regional exporters' organizations, the Turkish Bankers' Association, and the Turkish Association o f Leasing Companies, with a view to opening and maintaining a dialogue with the project beneficiaries, and to identify, where relevant, policy issues and constraints to further development o f exports as well as o f the leasing industry. Inthe case o f exporters associations, this dialogue will build on the relationships already developed in the context o f the first EFIL project. Relevant policy issues will feed into the Bank's overall sectoral dialogue with the Turkish authorities. B. INSTITUTIONALANDIMPLEMENTATIONARRANGEMENTS 23. TSKB, a non-deposit taking private investment & development bank owned by local conimercial banks and business groups, will be the borrower and the implementation agency for the project. A separate project implementation unit (PIU) has been established by TSKB under the supervision o f one o f its executive vice presidents to oversee the implementation of EFIL11. The PIU i s staffed with experienced management and staff, and, as the primary project counterpart for the Bank team, will provide the overall administration o f all aspects o f the credit line and requiredreportingto the Bank. c. MONITORINGEVALUATION OUTCOMES/RESULTS AND OF 24. Inpursuingits major developmental objectives, the project will target an increase inthe access to finance to exporters as measured through an increase in the amount o f aggregate exports o f the financed exporting enterprises, and number o f exporting enterprises benefiting from such improved access. An increase in the development o f financial intermediation in Turkey i s an important second development objective, as measured through (i) increase in the the breadth and depth o f participating financial intermediaries, and (ii) improvement o f the quality o f credit portfolio management. Increase in the volume o f transactions o f the participating leasing companies will also be an important target, as it would signal a growing strength o f financial intermediation through leasing which has the potential to reach small exporting enterprises at times overlooked by largerbanks. 25. Progress inachieving the development objectives will be measured on the basis of: - Increase in access to finance for exporters measured by the number o f enterprises andvolume of exports supported; - Improved depth and breadth o f financial intermediation as measured by the number o f additional PFIs (banks and leasing companies) that participate inEFIL I1different from those inthe first EFIL; and - Improvement o f quality o f credit portfolio management by measuring the level o f debt service and amortization performance o f sub-loans under EFIL I1 o f the participating banks and leasing firms. 26. Progress will be monitored through regular reporting by the Borrower/Implementing Agency, and through statutory project supervision missions. It i s envisaged that reporting under the EFIL I1 will be done through quarterly progress reports, with the reports specifically 10 distinguishing project transactions o f the two classes o f financial intermediaries - commercial banks and leasing companies. The Operations Manual describes the details o f the Project reporting. D. SUSTAINABILITY 27. Turkey's past export growth record, as well as the World Bank's own past experience with credit line operations in Turkey, the first EFIL being the most recent one, indicate that the private enterprise sector has the technical and managerial ability to successfully tap export opportunities, provided they have access to appropriate financing (e.g., in terms o f pricing and maturity). Thus, expansion o f existing and new export operations that will be financed by the fundingto be provided bythe proposed EFILI1have a very highlikelihood of self-sustainability. 28. Additionally, continued use by participating banks of high-quality loan and sub- borrower analysis requirements under EFIL 11, as well as the development o f the leasing industry as an important source o f longer-term investmentfinance for smaller exporters, will contribute to strengthening the overall intermediation capacity o f the financial system, which i s likely to sustain beyond the closing date o fEFIL. 29. Finally, by using TSKB - an established investment & development bank - as the Borrower and Implementing Agency for the project, TSKB's wholesale lendingfunction, already well established today, is likely to become more sophisticated, and therefore more effective in future in intermediating international bilateral and multilateral funding from a multitude o f sources, to the benefit o f the overall Turkishprivate sector. E. CRITICAL RISKSAND POSSIBLECONTROVERSIAL ASPECTS Risk RiskRating RiskMinimization Measure Generic Risks S The Turkish economy is still on the road to lasting stability, (e.g.9 and the possibility o f new financial crises cannot be fully macroeconomic neglected. However, the new Government has demonstrated its and structural commitment to sustained economic and political stability and reform risks, reforms, with the potential invitation to EU membership political negotiations serving as an overarching incentive. Furthermore, instability, etc.) the economy has become more adaptive to negative shocks following the floatation o f the Turkish Lira in2001. Turkey's private sector exporters' track record o f resilience to macro- economic instability i s also a strong risk-mitigating factor, well demonstrated on the occasion o fthe 2001 crisis. However substantial macro economic and structural reform risks remain that can derail the economic stability and the project environment in future. These are: (i)Large Government Debt Overhang. The net public debt to GNP ratio remains as high as 70-80% and continues to be a significant source o f macroeconomic risk in case the external or internal economic environment becomes uncertain-therefore needs to be carefully monitored; (ii)high current account deficit increases the risk of exchange rate downward adjustment and consequent impact on inflation; (iii) departures from the tight 11 primary fiscal surpluses can not be ruled out, and they increase the risk o fworsening inflation and government debt scenarios. An additional risk is causedby the delay inthe privatization o f the three state owned banks. Inherent liquidity pressures in the state-owned banks have the potential to create monetary policy and banking systemic instability in times of extemahtemal uncertainties and need to be constantly monitored. Timely implementation o f the privatization agenda also needs to be pursued to mitigate these risks. Similarly there are significant political risks derived from the Iraq situation and any potential perception o f lack o f progress inthe EUdialogue with Turkey. Bothofthese containinherent uncertainties in terms o f magnitude of economic impacts and will affect the overall risk environment. Project-specific N The Bank, throughout the last 3-4 years, has maintained a Risks (e.g., the close dialog with TSKB, the proposed EFIL I1borrower and Bank not implementation agency. TSKB has experience in managing having dealt foreign credit lines, including those from the World Bank. The directly with Bank team has strong confidence inthe financial, institutional, the Turkish managerial, and technical capacity o f TSKB to undertake the leasing sector, financial liability and administrative burden associated with participating the loan andproject implementation. intermediaries' onlending o f Inclusion o f leasing companies as a new class o f financial funds to non- intermediaries i s an innovative approach in ECA region credit viable export line operations, and as such will present a challenge not faced operations, in the predecessor EFIL project. There is a possibility that etc.) disbursements through the leasing company window may be modest in the initial stage o f the project, and even in later stages, until a close dialog between the Bank team and TSKB on the one hand, andthe participating lessors on the other hand i s firmly established. RiskRating-H(H Risk), S (Subs ntialRisk), M(ModestRisk),N(Negligibleor Low Risk) 1 12 F. BOARD PRESENTATION LOAN CONDITIONSAND COVENANTS 30. Board Presentation Conditions: 0 At least two PFIs have been selected andhave submitted anexpressiono f interest inwriting for participationinEFIL11. 0 The Operations Manual, including the environment guidelines for the sub-loans and leases, has been adopted. 31. Effectiveness Conditions: 0 At least two PFIs have undergone the qualification procedure and have signed subsidiary loan agreements, satisfactory to the Bank. 0 Satisfactory legal opinions on the Loan, Guarantee, and Subsidiary Loan Agreements havebeenreceived. 32. General Covenants: 0 TSKB to maintain satisfactory financial management systems, including records and accounts, and prepare financial statements satisfactory to the World Bank. Annual project accounts and an IFRS audit o f TSKB's financial statements to be provided within six months o f each year-end during the implementation period (audits to be carried out by independent external auditors in accordance with International Auditing Standards and International Financial Reporting Standards, under terms o freference satisfactory to the World Bank). 0 TSKB to maintain a PIUwith satisfactory staffing and other resources as required for effective project implementation. TSKB to monitor project performance inaccordance with the agreed performance monitoring indicators. 13 IV. APPRAISAL SUMMARY A. ECONOMICAND FINANCIALANALYSES NIA B. TECHNICAL NIA C. FIDUCIARY 33. TSKB has worked with the World Bank before and i s very familiar with the Bank's fiduciary requirements related to procurement, disbursements, and applicable safeguards (see Environment in D.5). The Bank team has full confidence in TSKB's ability to diligently follow these requirements. 34. During the last few years, the Turkish authorities have demonstrated a strong commitment to strengtheningthe financial system by establishing an independent, professional, and highly capable banking supervision institution (BDDK). This commitment and related efforts were encouraged and supported by the Bank through its policy advice and adjustment loans. As a result, the BDDK has established itself as a solid independent regulator, capable o f issuingand enforcingprudential regulations for the bankingsector. There is therefore, unlike the first EFIL, no need for detailed prudential guidelines and eligibility criteria for EFIL 11; instead these will be replaced by a single certification by a bank's external auditors that a bank i s in general compliance with the Turkish prudential standards for bankingoperations, as established and promulgated by the BDDK.' Therefore, monitoring o f participating bank eligibility will be simplified and done through: (a) a prudential regulation compliance certificate; and (b) annual audit reports. 35. Leasing companies have not been financial intermediaries in World Bank projects in Turkey inthe past, therefore rendering them an entirelynew financial intermediary class with a separate set o f eligibility requirements. The following are proposed eligibility indicators to be further specified duringappraisal, drawing largely on the requirements for the leasingcompanies specified in the 1996 Financial Leasing Law No. 3226 and the Regulation Concerning the Foundation and Activities o f Financial Leasing Companies: - a lessor will be duly registered and licensed by the leasing regulator and supervisor; - minimum equity capital o f a lessor will be no less than TL 1 trillion, (approximately US$670,000 equivalent); - the total sum o f lease exposures will not exceed 30 times a lessor's equity capital, while the total sum o f exposures to related parties will not exceed 15 times its equity capital; - a lessor will have been profitable for at least two out o f the last three years o f operations; and 'In case o f the first EFIL ,duringproject implementation the requirement of these eligibility criteria were amended to require compliance with the BDDKprudential guidelines duly certified by the extemal auditors of these banks. Thus EFILI1criteria are consistent with the ongoing first EFILprudential criteria. 14 - the participating leasing company shall, at the time o f selection and for the duration o f its subsidiary loan agreement with TSKB, for each year-end beginning with year-end 2003, present an audit reportwhich: Covers two full years o f operations; I s prepared by an internationally recognized external audit firm in accordance with International Auditing Standards and International FinancialReporting Standards (IFRS); and 0Contains an unqualified audit opinion. 36. Initial and ongoing compliance with the eligibility criteria for the leasing intermediaries will be assessed based on reporting by TSKB to the Bank, including quarterly project implementation reports prepared by TSKB and semi-annual external auditor compliance certificates and annual external audit reports o fthe participating leasingcompanies. D. SOCIAL 37. Private sector exporters are one o f the key stakeholders in this project. The project, through its support o f the manufacturing-for-export sector is, indirectly, supporting employment inTurkey. E. ENVIRONMENTCATEGORY - FI 38. TSKB will be responsible for ensuring that sub-projects financed under the EFIL I1 undergo environmental screening to ensure their conformity with Turkish environmental legislation and regulations and the World Bank's policies and procedures, as set forth in OPBP 4.01. The credit officers already appointed by TSKB to staff the PIU will perform this function. The PIU Operations Manual detailing, inter alia, the World Bank's requirements in respect o f environmentalassessment, will be preparedprior to loannegotiations. 39. The PFIs, according to the procedures outlined inthe Operations Manual, will undertake the environmental screening o f the sub-loan applications to determine the appropriate environmental risk category for the sub-borrowedsub-projects. The sub-borrowers will be responsible for carrying out any environmental analysis and for confirming that the proposed sub-projects comply with national environmental guidelines, and for obtaining the necessary clearance from the appropriate licensing authorities. Requirements in respect o f environmental analysis will also be written into the sub-loan agreements. F. SAFEGUARD POLICIES 40. Environmental Assessment policies (OPBP 4.01) will apply to EFIL 11. Environmental issues o f sub-borrowers and their sub-projects will be addressed through the sub-loan environmental eligibility assessment. Annex 10provides further details. 15 G. READINESS 41. The readiness o fthe Project for implementation: The completeness and readiness o f the N/A engineering design documents for the first year's activities The completeness and readiness o f the Procurement procedures are detailed inthe procurement documents for the first year's draft Operations Manual agreed with the activities Borrower The availability o f a satisfactory Project Draft Operations Manual has beenprepared Implementation Plan and agreedwith the Borrower Other NIA H. COMPLIANCE 42. The Project complies with all applicable Bankpolicies. 16 TECHNICAL ANNEXES Annex 1: Country and Sector or ProgramBackground A.1 Countrv and Sector Issues 1. Macroeconomicindicatorshave been improving.Following the 2000-2001 enterprise and financial sector crises and subsequent economic slump, the Turkish economy has registered a marked improvement in its performance. By the end o f 2002, interest rates on Government securities had fallen to the 55 percent range, compared with peaks duringthe post-crisis period o f well over 100 percent. The economic recovery has been stronger than expected, with GDP growth for 2002 o f 7.8 percent, well above the initial target o f 3 percent. Inparallel, inflation has fallen substantially. End-2002 CPI inflation was just under 30 percent, below the 35 percent target. The floating exchange rate regime has been successfully maintained, and an important degree o f exchange rate stability achieved. The current account registered a small deficit o f 0.8 percent. The positive macroeconomic outcomes have improved the public debt dynamics, with the stock o f net public debt falling by almost 14 percent of GNP in2002, to 80 percent of GNP. Fiscal policy, however, was weaker than expected, with the primary surplus o f the consolidated public sector reaching only 4.1 percent of GNP at end-2002, falling short of the 6.5 percent target, largely due to increased spending and weaker than expected fiscal revenues. In 2003, economic growth i s expected to reach 5%, in part due to the continued strong export performance, while CPI inflation decelerates to about 20% by end year. Based on current trends, the Government's target o f 6.5% primary surplus of the public sector i s likely to be achieved. 2. Turkish exports have been a major contributor to macroeconomic performance. Turkish exports (Table 1) have been an important economic success story in the recent years growing at an average annual rate o f over 12 percent, from US$2.9 billion in 1980 to US$35.8 billion in 2002. The share o f exports in GNP increased in the same period from 4.2 percent to nearly 20 percent. However, in the pre-crisis period exports were particularly hard hit by the combinedimpact of: (i) slowdown in growth inTurkey's export markets from an average o f the 8.9 percent in 1997 to 5.3 percent in 1998; (ii) disruption in the previously rapidly growing Russian and CIS markets; (iii)the sharp increase in domestic real interest rates which undermined the competitiveness of Turkish export products in foreign markets; and (iv) the severe credit and liquidity squeeze in Turkey due to non-availability o f reliable short and medium term finance. Consequently, export growth dropped from 13.1 percent in 1997 to an estimated 2.7 percent in 1998. The effect o fthe major earthquake in 1999 contributedto a further 1.4 percent decline inexports that year. 3. However, starting in 2000, export growth got back on a positive track, reaching 4.5 percent despite the December financial market crisis, and then, ledby increased competitiveness o f Turkish exports after the Lira devaluation in early 2001 and by increasing market confidence in sustainability of the crisis resolution measures undertaken by the authorities, jumped to 12.8 percent in2001 and 14.1 percent in 2002. Post-crisis economic recovery has clearly been export- led. Exports further grew over 30 percent in the first 6 months o f 2003, compared to the same period in the previous year and have reached nearly $29.8 billion for the first half o f the year as compared to $35.8 billion for the whole year in2002, thus demonstrating growth inboth volume and absolute value o f exports (for more statistics on export growth, export loan availability, etc. see Annex 9). 17 Table 1: Turkish Exports and Imports for 1997-2002 Source: Turkish Statistical Office 4. In case of EFIL sub-borrowers, export performance data over the loan disbursement period between 1999-2002 have been very positive. Export figures for the years 1999, 2000, 2001, and 2002 were, respectively, US$ 2, 2.8, 3.1, and 4 billion, much more than the projected figures o f US$ 0.1, 1.2, 1.7 and 1.9 billion for the same period. This corresponded to annual growth rates o f 40 percent, 11 percent, and 29 percent in the years 2000, 2001, and 2002, respectively. The main reason for this better-than-expected performance was the fact that the majority o f these companies were exporters with established markets. High export volume, increased profit margins and a strong equity base allowed them to sustain and improve profitable business activities, while maintaining a sound financial structure during both the pre- and post-crisis periods. In a few cases o f unsatisfactory performance, the main culprits were: (a) above-optimal financial leverage, (b) a relatively high percentage o f domestic sales within total sales, which were negatively affected by contraction in domestic demand throughout the economic crisis;(c) decreasing profit margins due to domestic competition, and/or decreasing capacity utilization as a result o f problems faced inobtaining working capital financing. 5. Overall, the financial performance o f the majority o f beneficiary EFIL enterprises during the EFIL implementation period can be regarded as satisfactory. The EFIL facility, which was small compared to the size o f the Turkish economy and export oriented enterprises, has nevertheless been very successhl in helping exporting companies in a country suffering from a severe crisis to continue and develop their export activities. 6. Medium- and long-term finance to exporters is, however, still very scarce. The banking sector has been restructured, but i s still dealing with the effects o f the crisis. In the banking sector, the emphasis o f the Government's reform efforts during the 1990s was on the development o f a basic legal and regulatory infrastructure to facilitate ease o f entry, and to increase competition and growth. This triggered a rapid expansion o f banking system assets in Turkey during the 1990s, and in spite o f the 1994-95 and 2000-01 banking crises, total system assets in absolute terms rose 250 per cent from US$51.9 billion in 1994 to US$ 128.9 billion as o f end 2002, and also increased substantially as a percentage o f GNP from 39.2 in 1994 to 71.67 in2002 signaling a deepening of financial intermediationcapacity. The rapidgrowth inthe size o fthe banking sector, however, also had some negative consequences. Prudentialregulations and enforcement capacity lagged behind, and there was a proliferation o f connected lending and concentration o f exposure and default risks. Lenient loan loss provisioning rules and enforcement allowed banks to understate their credit risks. Large FX open positions and asset/liability mismatches also created foreign currency and interest rate/liquidity risks in addition to credit risks. Additionally, growing public sector borrowing requirements during the years 1994-2002 encouraged banks to shift resources into Government securities that were 18 generating a relatively high-risk free real return. As a result, banks' lending activity declined in real terms. 7. Starting in December 1999, the Government with the help o f the Bank initiated a financial sector reform program to address the weaknesses. Despite successhl implementation o f these reforms, however, in late November 2000, Turkey experienced a banking system liquidity crisis, which was triggered by the need of a medium-size private bank (Demir) to refinance an excessive stock o f Government securities. In early December, interest rates briefly spiked to levels above 1,900 percent. InFebruary 2001, there was another, much more serious crisis that was ignited by the public airing o f tensions between the President and Prime Minister. This set off a new wave o f turbulence inthe financial sector as investors liquidated Turkish Lira positions and fled to U S dollars inexpectation o f a full-fledged political crisis. Interest rates once again spiked, this time as highas 6,200 percent, and with a rapid depletion o f the Central Bank o f Turkey's (CBT's) foreign currency reserves apparent, the authorities were forced to float the Lira leading to a sharp deterioration in its value. The combined effect of (i) rate losses; interest (ii) arisingfromtheLiradevaluation; and(iii) bookdeteriorationduetocorporate losses loan sector distress resulting from the crises eroded the banking system's capital. Total banking system assets also have shrunk from US$155.2 billion at the endofDecember 2000 to US$117.7 billion at the end 2001, a sharp reversal from the trend during 1994-2000, before recovering somewhat to US$ 128.9 billion at end-2002. The symptoms o f the banking sector distress, as well as its concomitant impact on the rest o fthe economy were still beingfelt inearly 2003. 8. Leasing sector small and volatile*. Contrary to the predecessor EFILproject where only banks were PFIs, leasing companies will be accepted as financial intermediaries in the EFIL I1 project. An opportunity will thus be created for the Bank to start a dialog with the leasing industry - an important non-bank segment o f the financial market with financing options particularly appealing to smaller companies. Figure 4: Turkey Financial LeasingReceivables 1998-2002 2,000 1,600 -g 1,200 E' 800 3 400 0 I 1998 1999 2000 2001 2002 Source: FIDER(TurkishAssociation o f Leasing Companies) 2 See for further detail also Turkey: Report on Capital Markets andNon-Bank Financial Institutions, report Number 25467-TU 19 9. Inmid-2002, there were 107players inthe leasing market, ofwhich 11were non-deposit taking investment & development banks, 5 special finance institutions, and 91 self-standing leasing companies. O f the 91 leasing companies, 4 were state-owned, and 8 were owned by foreigners. The industry i s rather small in size and highly concentrated. At end-2002, the total assets o f the sector were just below US$2 billion, down from US$3.15 billion in 2000, o f which the 10 largest companies held about 67 percent (the 10 largest also accounted for 78 percent o f new leasing volume in 2002). Assets o f the top 10 group were in the range o f US$58-250 million. US$. The number o f new leasing transactions typically fluctuates with GDP growth. Total equity in the sector was around US$400 million in 2002. The sector returned to profitability inthe first three quarters o f 2002, with net profit of US$81 million, following a loss o f US$ 6lmillion a year earlier. Leasing o f construction and textile machinery, tourism, office, and telecom equipment, land transportation vehicles, and computers represented the lion's share o fthe total new leasing volume duringthe last few years. Figure 5: New Leasing Volume and GDP Growth 1998 2002 - 2,000 - 1 -,uu 9 1,600 -- --g 1,200 8 -- C UY 800 -- 2 400 -- 0 1998 1999 2000 2001 2002 1.INew Leasing Volume (Left Scale) +GDP Growth (Right Scale) Source: FIDER(TurkishAssociation o f Leasing Companies) 10. The Turkish leasing sector is in an early stage o f development, with straightforward financial leasing beingthe primary instrument offered. Infact, the existing 1996 Law on Leasing pretty much discourages the other type - operational leasing -by setting a minimum lease term o f 4 years. A new leasing law i s beingconsidered by the authorities, which should eliminate this and other constraints, such as ambiguity regarding sale-and-leaseback, sub-leasing, and dispute resolution, to allow faster development of leasinginTurkey. 11. There are also some taxation issues applicable to leasing which warrant attention from the authorities. The leasing companies when borrowing locally from domestic banks, are not permitted to borrow directly in foreign currencies but only in Turkish Liras indexed to foreign currency. Any downstream TL leasing intermediation thereby exposes the lessors to exchange rate risk with the Resource Utilization Support FundPremium of 3 percent being charged on the exchange differentials (on the principle and the accrued interest on lease payments). This acts as a strong disincentive to leasing through local lines o f credit. The majority o f borrowings by Turkish leasing companies, therefore, are in foreign currencies from foreign banks or foreign 20 branches o f Turkish banks overseas, in which case all the above restrictions and downstream taxes do not apply and the intermediation playing field i s level with commercial banks. 12. Both bankingand leasing sectors lack access to term funds...Access by the banking system to medium and long-term funding sources has typically been limited during the past several years due to unfavorable macro-economic circumstances, and became virtually non- existent in the aftermath o f the 2000-01 crises. While market confidence has increased since, there i s certainly no abundance yet o f mediumor long term money on the market. All o f the top leasing companies are owned by banks, and suffer from the same hnding maturity limitations as their parents. For instance, despite the legally prescribed minimum lease term o f 4 years, the marketpractice is to frontload leasepayments into the first two years, and keeps the formal lease contract idle for the remainder o f the term. Constant rollover of short term fundingby the banks i s still the most popular way o f providing term finance to the enterprise sector ..., which provides the principal rationale for the Bank's involvement by providing medium and long-term funds to exporters via the participating financial intermediaries under the proposedEFIL 11. 21 Annex 2: Major RelatedProjectsFinancedby the Bank and/or Other Agencies 1. The proposed EFIL I1i s a repeater project o f the predecessor EFIL project. The EFIL was implemented during 1999-2003 and was very successful indisbursing nearly the full amount o f the Loan (US$ 252.5 million), reaching out to many different exporting industries all across Turkey by financing close to 100 exporting sub-projects, and strengthening the financial sector by having the project PFIs undergo a comprehensive risk management assessment and implement resulting recommendations, evenbefore risk management became an integral part o f the prudential requirementsfor the banks. 2. Both the first EFIL and the proposed EFIL I1are part o f the Bank's multi-year financial sector reform program for Turkey, which seeks to stabilize and support the further development o f the Turkish financial system for the benefit o f the private sector and economic growth. This program combines a series o f programmatic financial sector adjustment loans (some o f which also encompass public sector reform measures) supporting top-down policy reform with investmentloans like EFIL and EFIL 11, which facilitate bottom-up interaction with key players inthe financial sector. The program is underpinnedby several pieces of Economic and Sector Work, the most recent o f which (Report on Capital Markets and Non-Bank Financial Institutions) has pointed out the importance o f diversifying and deepening the financial system beyond banking. The inclusion o f leasing companies inthe proposed EFIL I1seeks to meet this objective. 22 Annex 3: ResultsFrameworkandMonitoring NarrativeSummary Key PerformanceIndicators Monitoring and Critical Assumptions Evaluation Sector-related CAS Goal: (Goalto World BankMission) Helpmeet privatesector financing Continuedimprovement in needs, to enhanceprivate sector Increasedaggregate exports Trade Statistics macro-economicandpolitical competitiveness stability. ProjectDevelopment Objective: (Objectiveto Goal) To provide mediumandlong-term working capital and investment Export Multiplier: Progress reports Continuationof the current finance to privateexporting preparedby TSKEi's floating exchangerateregime enterprises,to continue assisting Incrementalaverage aggregateannual PIU the Turkishexportingsector hurt exportsgenerated (measuredover 3 by the recentglobal downturnand years for all sub-borrowers)/total Supervisionmissions domestic financialcrises creditline disbursed To improvethe depth andbreadth of financialintermediationas measuredby the number of Range of Financial Intermediaries additionalPFIs(banks and leasing participation: Absence of amajorpublic debt companies)that participateinEFIL / financial sector crisis I1 Number of additionalPFIs participatingin EFIL I1differentfrom as comparedto first EFIL those inthe first EFIL To improvecredit management Sub-loan Performance Indicators: practices in financial intermediationbasedon sub- Amount of non-performingsub-loans borrowercreditworthiness criteria and leases; Interest andor principal defaults/totalamount of sub-loans and leasesdisbursed outputs: (Outputsto Objective) Goodcapitaladequacy of Provideeffective sustained Credit line Utilization Indicator: Progressreports TSKB, and effective mediudlong term financeto preparedby TSKB's project managementby exporters on atimely basis Amount of credit line actually PIU TSKB disbursedprojectedcreditline disbursementon a straight line basis Supervisionmissions Inputs:(budget for each ~~Project ComponentdSub- ~ (Componentsto components: component) Outputs) Credit Line US$300,000,000 Progressreports Timely disbursement preparedby TSKB's TSKB to set up andrunthe PIU, PIU usingpart ofthe onlending margin to finance the PIU's operatingcosts Supervisionmissions 23 Annex 4: Project Description 1. The Second Export Finance Intermediation Loan (EFIL 11) consists o f a single component - financing o f sub-loans and leases under the project in an aggregate amount o f US$300,000,000. Details are givenbelow. 2. Under the project, the EFIL I1will provide medium and long-term financing for the procurement o f goods and works by private exporters. The inputs could be procured locally or externally on commercially competitive terms and will, therefore, benefit both direct and indirect exporters. 3. Borrower and Implementing Anencv: The Borrower and ImplementingAgency for the EFIL I1will be TSKB, a privately owned investment & development bank, with the Government issuing a guarantee to the World Bank. It has been established by the World Bank team that Turkishlaws allow the Government to issue guaranteesto private non-deposit taking investment & development banks, although not to regular commercial banks. TSKB will act inthe capacity o f a wholesale institution and will onlend the loan funds through a group o f 4-6 private banks and 4-6 leasing companies which will be selected pursuant to criteria agreed between the Borrower and the World Bank (see Annex 6). TSKB will take the credit risk on the banks and leasing companies selected for participation. The participating financial intermediaries in turn will make sub-loans and leases to private exporting enterprises for procurement o f goods and works inorder to expand their current export volumes, or inexceptional circumstances to enable them to retain and maintain their current level o f exports. The onlending banks and leasing companies will take the credit risks on the borrowing enterprises. 4. Due Diligence o f TSKB: TSKB was one o f the PFIs inthe first EFILproject, therefore it i s well known to the World Bank team through regular exchange o f views on the implementation o f the EFIL and through reviews o f TSKB's audited reports and other financial reporting requiredunder the EFIL.A review o f TSKB's IFRS annual and audit reports for the years 2000- 2002 indicates that TSKB exceeds the minimum BIS risk weighted capital adequacy ratio o f 8 percent and maintains an overall sound financial and operational structure, and is fit to undertake the financial liability o fthe Loan and operational commitments to act as a PIU for the project. 5. Loan Terms: TSKB, based on its own funding mix and anticipated demandof exporters, has indicated a preference for a U S dollar Fixed Spread Loan (FSL), which it will thenon lendto participating banks and leasing companies for a period o f up to 7 years which will include a grace period o f up to 5 years. In order to offset its administrative and implementation costs as well as the credit risks involved, TSKB will charge an on-lending margin to the participating banks and leasing companies o f between 200-400 basis points over its cost o f funds under the World Bank loan, depending on the risk profile o f the borrowing intermediary. The subsidiary loans made by TSKB to the participating banks and leasing companies will be denominated and repayable in US dollars. The participating banks and leasing companies are expected to price their sub-loans and leaseswhich maybe denominated andrepayable inany foreign currency on a commercialbasis. 6. Selection o f Participating Financial Intermediaries: A preliminary list o f 14 banks and 9 leasing companies has been compiled from the universe o f around 20 private commercial 24 Turkish banks and around 100 private leasing companies using the following pre-screening criteria: For the banks - (i) assets during the last two years to exceed a minimum o f total US$500 million equivalent on average; and (ii) export loans-to-total loans ratios during each o f the last two years (for which data is available) to exceed a minimumo f 10percent on average. 1 For the leasing companies - (i) lease receivables during the last two years total (for which data are available) to exceed a minimum o f US$50 million equivalent on average; and (ii) new lease volume during the last two years (for which data are available) to exceed a minimum o fUS$30 million equivalent on average. 7. These criteria ensure that only financial intermediaries with an operational history, a viable asset base and an export sector lendingfocus are selected for hrther screening. From this group o f banks and leasing companies, a smaller group o f 4-6 banks and 4-6 leasing companies will be selected as final participating financial intermediaries for the EFILI1by TSKB based on: (i) acceptance by TSKB o f their credit risk, (ii) expression o f interest inparticipation inthe their project, and (iii)the following eligibility criteria: 1 For the banks - (i) general compliance with all legal and regulatory requirements applicable to the banking industry, including but not limited to such prudential regulations as minimum BIS risk-weighted capital adequacy ratio, maximum foreign currency exposure limits, maximum large exposure to single and connected clients and maximum insider lending limits, etc., duly certified by the banks' auditors every six months, and (ii) financial statements audited in IFRS accordance with International Standards o f Auditing (ISA) (see Appendix 4.3 - LikelyProfile o fPFIs, Pre-QualificationandFinalEligibilityCriteria). 1 For the leasing companies - (i) compliance with all legal and regulatory general requirements applicable to the leasing industry, including but not limited to such regulations as minimumequity capital o f a lessor o f no less than TL 1trillion, the total sum o f lease exposures not exceeding 30 times a lessor's equity capital, and the total sum o f exposures to related parties not exceeding 15 times the equity capital, duly certified by the leasing companies' external auditors every six months, (ii) IFRS financial statements audited in accordance with International Standards o f Auditing (ISA) (see Appendix 4.3 - Likely Profile o f PFIs, Pre- Qualification and Final Eligibility Criteria), and (iii) the leasing company should have beenprofitable for at least two out o f the last three years o f operations. 8. Eligible sub-borrowers: All private (private ownership more than 50 percent) exporters with foreign exchange earnings, irrespective o f their sector, will be eligible for participation as sub-borrowers on a commercial basis. The prospective sub-borrowers will have to prepare and present a complete sub-loan package consisting o f TSKB credit application form and such other information which TSKB and the Bank could reasonably request, as well as satisfy the procurement and environmental rules stated as part o f the World Bank loan conditions. The creditworthiness o f the sub- borrowers will be assessed by the PFIs, subject to the minimum requirement that the sub-borrowers maintain a maximum debt equity ratio o f 80:20 and 25 minimumdebt service coverage ratio of 1.2:l (both after receipt of the sub-loan and/or lease). The World Bank, in coordination with TSKB, will carry out a prior review of the first two sub- loan applications of each o f the participating banks and leasing companies to satisfy itself about the credit analysis process carried out bythese financial intermediaries. 26 Appendix4.1 Terms and Conditionsfor TSKB (Betweenthe WorldBankandTSKB) For TSKB, the following terms and conditions shall apply: 0 Initial and ongoing compliance with applicable laws and regulations issued by the Turkish authorities, as certified by independent external auditors on an annual basis; 0 For the duration o f the project implementation period, beginning with year-end 2003, submission o f an audit report, that i s (i)prepared in accordance with International Auditing Standards and International Financial Reporting Standards; and (ii)has an unqualified audit opinion, except as the World Bank shall otherwise agree; 0 TSKB will onlend the funds under the EFIL I1 to PFIs (selected according to the eligibility criteria agreed with the World Bank) using subsidiaryloan agreements. All subsidiary loan agreements are subject to prior review by the World Bank; 0 For the duration o f the project implementationperiod, maintenance o f the Project Implementation Unit (PIU), staffed with qualified personnel, capable to satisfactorily implement all aspects o f the EFIL 11; 0 TSKB will monitor the performance o f the project on a quarterly basis using performance indicators agreed with the World Bank, and will provide the World Bank with quarterly progress reports, giving the details o fthe progress made inproject implementation; 0 Timely preparation and submission o f EFIL I1project audit reports in accordance with International Financial Reporting Standards, International Standards o f Auditing, and agreed FinancialManagement Arrangements (see Annex 6 and Annex 7); and 0 TSKB will receive the funds from the World Bank on a 16 year maturity, at six months LIBOR plus a fixed spread; TSKB will pay the World Bank a front-end fee o f 1 percent and an annual commitment fee o f 0.85 percent on undisbursedbalances for the first four years, and 0.75 percent thereafter; the commitment fee will bepayable with effect from 60 days after loan signing. TSKB will also pay a one-time guarantee fee o f 0.25 percent o f the Loan amount to the Turkish Government. 27 Appendix 4.2 Terms and Conditionsof SubsidiaryLoans (Between TSKB and PFIs) The following terms and conditions will apply to the subsidiary loan agreements to be entered into between TSKB and PFIs: a Initial and continued compliance with the eligibility criteria for PFIs (see Annex 4); a US$ denomination; a Maturity o f the subsidiary loan o f up to 7 years with up to 5 years grace; Interest rate o f the cost o f World Bank funds to TSKB plus an onlending marginreflecting (a) TSKB's administrative costs; and (b) a credit riskmargin; One-time front end fee o f 1 percent o f the Loan amount, one-time guarantee fee o f 0.25 percent o fthe Loan amount, and commitment fee equivalent to the commitment fee payable by TSKB on the World BankLoan; a The funds available to PFIs will depend upon the availability o f hnds to TSKB from the World Bank; PFIs will be responsible for ensuring that the sub-borrowers comply with the World Bank's procurement rules for the procurement o f goods and works under EFIL I1 sub-loans and leases, applicable Turkish environmental legislatiodregulation, as well as the World Bank policy on environmental assessment; and PFIs will provide a fill set o f documentation for all sub-loans and leases to TSKB in order to enable TSKB to maintain all project records and make them available for ex-post review by the World Bankor by extemal auditors as necessary. 28 Appendix 4.3 Terms and Conditionsfor Sub-Borrowers,Sub-projectsand Sub-loansand Leases (Between PFIs and Sub-borrowers) The followingterms and conditions will apply: For sub-borrowers: 0 Private ownership (defined as more than 50 percent private ownership or private control); 0 Status o f an exporter; Maximum debt/equity ratio o f 80:20 (after receipt o f the sub-load lease); 0 Sub-borrowers, after receipt o f the sub-loadlease, should generate enough cash during the pay-back period of the sub-loadlease to maintain a minimumdebt service coverage ratio o f at least 1.2:1;and Certification from the relevant authorities that the sub-borrower and sub-project meet environmental laws and standards in force in Turkey. The World Bank policy on environmental assessment (available inthe Operational Manual for the EFIL I1to be prepared by TSKB's PIU) will also be compliedwith. For sub-projects: 0 Sub-projects must be targeted towards the generation o f exports consistent with the sub-borrower's export growth projections; 0 Goods and works on the World Bank's negative list will not be eligible for financing; and 0 Compliance with the World Bank's procurement procedures for the procurement o f goods and works to be financed under EFIL I1sub- loans and leases. For sub-loans and leases: Sub-loans and leases will be made for the financing o f raw materials, spare parts, plant and equipment, and works, both for working capital as well as investmentpurposes; Sub-loans and leases will be evaluated in accordance with the PFI's normal project and credit evaluation guidelines and in addition will be evaluated by TSKB using their own credit evaluation guidelines as agreed with the Bank and included inthe Operations Manual; Sub-loans and leases can be denominated inany foreign currency; Sub-loan and lease pricing and maturity will be determined by the PFI based on the needs o f the particular sub-borrower and sub-project 29 being financed, with the proviso that the interest rate must at a minimum be equal to the costs o f World Bank loan funds to the PFI plus an appropriate credit riskmargin; 0 The sum o f sub-loans and leases to any individual sub-borrower or group o f connected sub-borrowers from one or more PFIs will not exceed US$lO million; 0 For sub-loans and leases larger thanUS$5 million and for the first two sub-loans or leases for each PFI irrespective o f size, prior review by the World Bankwill berequired; and 0 All sub-loans and leases not subject to prior review, can be subject to post review by TSKB or the World Bank inorder to verify compliance with the subsidiary andsub-loan and leaseagreement terms. 30 Annex 5: Project Costs (InUS$) Project Component Local Foreign Total Credit line 300,000,000 300,000,000* Front EndFee 3,03 1,000 3,03 1,000 Unallocated 69,000 69,000 Premiafor interest rate caps and 0 0 collars Total 303,100,000 303,100,000* Total Baseline Cost PhysicalContingencies - - Price Contingencies - - Total Project Cost 303,100,000 303,100,000* *While it i s expected that both participating PFIs and sub-borrowers themselves will contribute to the financing of individual sub-projects, the precise amount of such financing to be provided cannot be determined ex ante, as the loan design does not envisage the use of predetermined cofinancing requirements. Instead, PFI maximum exposure to individual sub-borrower limits, debt equity and debt service coverageratio requirementsfor sub-borrowers and maximumsub-loan and lease limits will drive the amountofcofinancingto beprovided. 31 Annex 6: ImplementationArrangements A. InstitutionalandImplementationArrangements 1. TSKB will be the borrower for the EFIL 11, and the Undersecretariat o f Treasury will provide the guarantee to the World Bank on behalf o f the Government o f Turkey. TSKB will also be the implementing agency for the project, and will set up a Project Implementation Unit (PIU) within TSKB headedby an Executive Vice President. The PIU's responsibilities, functions and staffing details are givenbelow. B. OnlendingArrangements 2. TSKB, the Borrower, will wholesale the EFIL I1to a maximum o f 4-6 private banks and 4-6 leasing companies selected according to a set o fpre-qualification and final eligibility criteria. The on-lending will be carried out by means o f subsidiary loan agreements entered into with the selected banks and leasing companies (privately owned participating Financial Intermediaries - PFIs). The PFIs in turn will make sub-loans and leases to private exporters satisfying a set o f eligibility criteria, according to agreed sub-loan terms and conditions and procurement and environmental guidelines (see Annex 4). TSKB will take the credit risk on the PFIs and the PFIs will take the credit risks onthe sub-borrowers. C. ProjectImplementationUnit (PIU) -Responsibilities,FunctionsandStaffing 3. Responsibilities.. Project coordination and implementation will be done through a PIU within TSKB. The PIU will be responsible for: (i) coordination, communication and public information o f all aspects o f the EFIL I1with the World Bank, the Undersecretariat o f Treasury, PFIs and exporters' organizations; (ii) carrying out the initial and final selection o f the PFIs according to the agreed pre-screening and final eligibility criteria for participating banks and leasing companies; (iii) monitoring o f the performance andthe risks associated with the PFIs and periodic reporting to the World Bank based on the PFIs' audited financial statements; (iv) negotiating the terms and conditions o f subsidiary loan agreements with PFIs and entering into such agreements with PFIs on behalf of TSKB; (v) communicating, the sub-loan terms and conditions including minimum eligibility criteria and procurement and environment guidelines for EFIL 11, to the PFIs; (vi) reviewing the sub-loan applications through prior or post review to ensure that all the sub-loan terms and conditions have been complied with by the PFIs; (vii) submission to the World Bank o f those sub-loan proposals that require prior World Bank approval; and (viii) setting up o f a financial management, accounting and reporting system to handlethe informationflow between the sub-borrowers, PFIs, TSKB and the World Bank. 4. Functions. Based on the above project responsibilities the functions andtasks o f the PIU have beengrouped under three specific areas: (i) Performance and Risk Monitoring o f PFIs; (ii) Credit Operations Management; and (iii) Accounting and Reporting. The task details under each functional group are providedbelow: 0 Performanceand Risk Monitoringof PFIs: As part o f the Performance and Risk Monitoring function, the PIU will carry out the review o f the financial information provided by the PFIs in order to determine their eligibility for initial and final 32 selection and participation in the EFIL I1credit line based on the Eligibility Criteria agreed and coordinated with the World Bank. After the final selection o f the PFIs, and signing o f the subsidiary loan agreements with the PFIs, their continued compliance with the criteria and overall financial performance will be monitored by means o f semi-annual financial information, and complemented by full year-end financial statements, audited by independent external auditors in accordance with ISA and prepared on the basis o f IFRS. In addition, the PFIs will provide compliance certifications by their extemal auditors on a semi-annual basis. The objective o f this monitoring will be to evaluate the financial and operational performance o f the PFIs as part o f the credit risk assessment o f the PFIs and their continuing eligibility for participation inthe EFIL11. 0 Credit Operations: The PIU credit operation sections will provide assistanceto the PFIs and sub-borrowers on all aspects o f the terms and conditions and eligibility criteria o f the sub-loans and leases under EFIL 11, and will review all the sub-loan applications on a prior or post review basis in order to ensure their compliance with respect to the objectives, criteria and covenants as stated in the subsidiary loan agreements. Indoing this, the PIU inconsultation with the World Bank, will prepare an EFIL I1OperationsManual (OM, to be prepared on the basis o f the Operations Manual used in the first EFIL project) to explain all the operating procedures and guidelines governing the implementation o f the EFIL 11. The O M will include (i) terms and conditions and eligibility criteria for sub-loans and leases and sub- borrowers; (ii)credit evaluation guidelines for all sub-loans and leases; (iii) the applicable procurement guidelines and the prior review thresholds for sub-loans and leases; (iv) the environment guidelines and checklist for sub-loans and leases; (v) the operational process for the information, documentation, and payments flows; and (vi) the accounting, reporting and auditing requirements as applicable at different levels in the onlending process. The credit operations section o f the PIU will also monitor progress in the utilization o f the EFIL I1 loan funds, monitor the debt servicing performance o f the sub-loans and leases jointly with the PFIs, collect information on the incremental exports generated by the EFIL I1 in line with the agreed impact performance indicators, and prepare progress reports on these areas, for submissionto the World Bank. 0 Accounting and Reporting: The PIU will prepare and maintain the Financial Management System (FMS) required for the accounting and reporting o f all project related activities under the EFIL I1in consultation with the World Bank. The PIU under the supervision o f the Program Manager, will be responsible for: (i)the documentation and recording o f the transactions involving disbursements from the special account; (ii) recording the funds flow to the PFIs; and (iii) recording and all reporting related to preparation o f Financial MonitoringReports (FMRs) according to the formats agreed with the World Bank. In order to record, monitor and report on the transactions related to the project activities, specific balance sheet and income statement accounts for these transactions will be opened within TSKB's chart o f accounts. The main accounting system will be supplemented by a Management Information System (MIS) specifically designed for EFIL I1and the PIU would be able to generate information about the hnds flow in the project at any given time. 33 Entries to the M I S will be done under PIU authorization. The PIUwill monitor these transactions andwill prepare monthly account summaries inparallel with the monthly accounting cycle within TSKB, and, if requested, send these monthly reports to the World Bank. Through these accounts the PIU will compare the funds flow information with the PFIs and if needed with the sub-borrowers. Periodic reconciliation o f these accounts between TSKB, the PFIs and the World Bank will also be carried out by the PIU. The PIU will furthermore ensure that audits o f the financial statements and compliance certificates are submitted within the periods specified inthe loan agreement and the subsidiary loan agreements. 5. Staffing. The PKJis composed o f TSKB staff. TSKB has appointed its Executive Vice President, Mr. Orhan Begkok, as the Pronram Manager. The Program Manager will be responsible for the overall project management and coordination with the World Bank, PFIs, the Government, and the exporting sector. In addition, he will be responsible for the creation, appropriate staffing and fbnctioning o f the PIU. In this task, the Program Manager, will be assisted by 6 specialists, recruited from various divisions o f TSKB. The specific fbnctional responsibilities and related staffing are described inthe following paragraphs. TSKB PIUStaff Mr.OrhanBevkok (ExecutiveVicePresident-TechnicalServices) ProgramManager o f the EFIL I1Loan and responsible for: - The coordination, communication and public information o f all aspects o f the EFIL I1 with the World Bank, the Undersecretariat of Treasury, PFIs and exporters' organizations. Mr.BurakAkgiiq (DepartmentHead-CorporateMarketingDepartment) Responsible for: - Carrying out the initial and final selection o f the PFIs. - Negotiating the terms and conditions o f the subsidiary loan agreements to be signed with the PFIs. - Enteringinto such agreements with PFIs onbehalfo fTSKB. - Communicating the sub loan terms and conditions, including eligibility criteria and procurement and environment guidelinesfor EFIL 11, to the PFIs. Mr.KorkutUn(DepartmentHead-FinancialAnalysisDepartment) Responsible for: - Reviewing sub loan applications through prior or post review to ensure that the financial aspects o f all sub loan terms and conditions have been complied with by PFIs. - Monitoring the financial information o f PFIs and their continued compliance with the EFILI1eligibility criteria submission o frequisite reports. Mr.MuammerAkyiiz (DepartmentHead-EngineeringDepartment) Responsible for: 34 - reviewing sub loan applications through prior or post review to ensure that the procurement and environmental aspects o f all sub loan terms and conditions have been complied with byPFIs. Mr.RefikAlunci(DepartmentHead-EconomicsDepartment) Responsible for: - Submission to the World Bank o f sub loan proposals that require prior World Bank approval. Mrs.CigdemIGel (DepartmentHead-OperationsDepartment) Responsible for: Controlling the expenditure documents (invoices etc.) sent by the PFIs and storing them properly. Executing disbursements to the PFIs from the Special Account. Monitoring the Special Account and sending disbursement requests to the World Bank either for replenishment o f the Special Account or reimbursement o f the amounts paid to the PFIs. Preparingmonthly reports related to the Special Account statement. Preparingquarterly reports related to PFIs loan utilization. Monitoring repayments o f PFIs and executing the repayments o f the loan to the World Bank. Collecting information related to the exports generated by EFIL I1 from PFIs and submitting this informationto the World Bank. Mrs.EceUna1 (DepartmentHead-FinancialControlDepartment) Responsible for: - Providing informationrelatedto the financials o f TSKB. 35 Appendix 6.1 Profileof the borrower- Turkiye SinaiKalkinmaBankasi(TSKB) A. Introduction 1. TSKB (Turkish Industrial Development Bank), the proposed borrower and location o f the Project Implementation Unit (PIU) under the EFIL I1 Loan, was one of the PFTs in the first EFIL project. As such, it i s well known to the World Bank team through regular exchange o f views on the implementation o f the EFIL, and through reviews o f TSKB's audited reports and other financial reporting required under the EFIL. A review o f TSKB's IFRS annual and audit reports for the years 2000-2002 indicates that TSKB exceeds the minimum BIS risk weighted capital adequacy ratio o f 8 percent and maintains an overall sound financial and operational structure, and is fit to undertake the financial liability o f the Loan and operational commitments to act as the PTU for the project. 2. Since its foundation in 1950, TSKB has played an active role in every stage o f Turkey's economic development, facilitating a number o f "firsts" in the manufacturing industry and the financial sector. TSKB - through its support and extension o f medium-term loans for more than 3500 investment projects - has significantly contributed to the progress and development o f the private sector. Over the past 35 years, the bank also provided financing by way o f participating inthe sharecapitalofmore than 100companies. B. LegalFoundation 3. TSKB was established in 1950 with the support of the World Bank and the cooperation of the Govemment the Central Bank and the leading commercial banks o f Turkey. TSKB was founded for the purpose o f meeting the following objectives: (i) to provide assistance to private sector enterprises in all sectors o f the economy, with a primary focus on the industrial sector, (ii) to encourage and assist the participation of private and foreign capital incorporations established and to be established in Turkey, and (iii) to assist the development o f the capital market in Turkey. TSKB i s the first investment and development bank o f Turkey, and currently one o f several such banks, and enjoys the special status granted to such banks which, among other things, allows the banks to receive Government guarantees on their borrowings, and to provide lease finance from their own sources. TSKB i s a majority privately owned bank. As an investment & development bank, TSKB does not accept retail deposits. The activities o f TSKB are regulated by the Banks Act o f Turkey and the bank i s supervised by the BDDK. 36 C. CorporateGovernanceandOrganizationStructure 4. Board of Directors. The Board o f Directors o f TSKB is responsible for all decisions affecting TSKB's operations. It comprises 12 members, including the Chairman and one Vice- Chairman, 8 members, and 2 auditors. The Board includes TSKB's president as one of its members,andrepresents the current set of shareholders: I s Bank Group, 55.30% GarantiBank, 3.09% Akbank Group, 9.66% DisBank, 2.56% Vakif Bank, 8.38% Other shareholders, 12.82% Turk Ticaret Bank, 8.19% 5. Senior Management and StafJ: The President o f TSKB i s assistedby a Senior Executive Vice-president and five Executive Vice-presidents, each overseeing one o f the following TSKB hnctions: Planning & Coordination, Corporate Banking, Technical Services, Treasury & Capital Markets, Financial Control & Operations, and InformationTechnology & HumanResources. As o f July 2003, TSKB hada staff of 284, with an average lengthof service inthe bank o f 9.2 years, andan average age o f 36.1 years. 37 D. Productsand Services 6. Lending. TSKB, as an investment & development bank, maintains the objective to provide the market with medium and long term loans, mostly for the purpose o f investment.In fact, foreign currency denominated long-term loans dominate the asset side of TSKB's balance sheet. Such long term credit relations require a comprehensive analysis o f the borrowing companies besides a close cooperation with the clients. While providing medium and long term loans to entrepreneurs for their domestic and foreign investments, TSKB also extends short-term working capital loans to meet their financing requirement in the operating period. Furthermore, the bank provides to its clients all banking services in relation with foreign trade financing. Finally, TSKB also offers financial lease facilities. 7. Over the past several years, TSKB has been consistently providing significant amounts o f medium and long-term lending (Figure 6 - the large increase in 2001 i s partially due to retroactiverestatement o f TSKB's financials to include SYB which merged with TSKB inMarch 2002). Figure6: TSKB OutstandingLoanVolume, USDmillion 600 500 400 300 200 100 - I 1997 1998 1999 2000 2001 2002 I Source: TSKB 8. Other Services. Other TSKB services include: (i) investment banking services such as IPOs, valuations, M&As, privatization consultations, and research, (ii) treasury operations, and (iii)capitalmarket operations and portfolio management. Lending, however, is TSKB's core business product - in2002, net fee and commission income accounted for only around 20 percent o fnet interest income. 39 Table 2: Other Services by TSKB in 2002 lother Services (VolumelClient) Volume E. Sources of FundingandAssetLiabilityManagement 9. Funding. TSKB's main sources o f funding are foreign development and commercial bank loans, loans from international financial institutions (IFIs), and small-scale borrowing in international capital markets. As o f end-2002, the funds borrowed include borrowings from the European Investment Bank, the Japanese Bank for International Cooperation, Akbank, the World Bank, KfW, Dresdner Bank and other international and local banks and IFIs. Securities issued include a Japanese yen-denominated bond and a small amount o f promissory notes. Funding composition in2002 was as follows: Figure7: TSKB BalanceSheet-Compositionof Liabilities 4FundsraisedthroughRep's OMoneyMarketDeposits 0SecuritiesIssued Other Liabilities Equity Capital & Minority 1997 1998 1999 2000 2001 2002 Source: TSKB. Figuresfor 1997 and 1998 are not inflation-adjusted. 40 10. FWmaturity exposure. TSKB has been in constant compliance with the BDDK regulations regarding foreign exchange exposure, and generally maintains a prudentlybalanced asset/liability mix in terms o f maturity structure. During the last two years, its net FX position went down from US$14.2 million to US$4.2 million (on a balance sheet o f roughly US$1 billion). As for maturity structure, TSKB's mediumand long-term lendingi s funded primarily by medium and long-term borrowings from the international commercial and development banks and IFIs, providing for a proper maturity match. In addition, TSKB has strong overall risk management procedures inplace and holds a portfolio o f liquid assets as part o f its liquidity risk management strategy. F. Asset CompositionandCreditPolicies 11. Duringthe last few years, TSKB increased its share of loans in total assets from 45-48 percent to close to 60 percent, which i s much higher than the banking system's average 22-25 per cent in 2001-2002. Medium and long-term loans make up the bulk o f TSKB's lending. The asset composition o f TSKB i s provided below: Figure8: TSKB BalanceSheet-Compositionof Assets ~ 0% 10% W Loans 20% 30% 0Investment and Tradable Financial 40% Assets 50% 0DuefromBanks 60% 70% .Fixed Assets 80% 90% Other Assets i 100% 1997 1998 1999 2000 2001 2002 Source: TSKB. Figuresfor 1997 and 1998 are not inflation-adjusted. CreditPolicies 12. TSKB extends long, medium and short-term loans within the framework o f principles and limits determined by the Board o f Directors. The Board o f Directors approve the credit line and project-financing packages recommendedby the Credit Committee. The Credit Committee, formed by the President and the Executive Vice Presidents and attended by the Department Heads o f Loans, Financial Analysis, Economics and Research, Engineering and Operations discussesthe loan application on the basis o f the credit report prepared by TSKB's research team generally formed by an engineer, an economist and a financial analyst from the TSKB staff. 41 13. The credit report aims at estimating the cost and benefit o f the investment project under evaluation with respect to profitability, economic benefit and undertaker risk. Basically the investmentproject is evaluated under economic, technical and financial sub-topics, within a time perspective o f roughly five years. Technical and economic analysis is carried out by the specialized staff within these fields. The credit report i s therefore composed o f these three different analysis integrated and interpreted ina single text by the financial analyst. All decisions regarding lendingand collateral are givenon the basis o fthe credit report. 14. TSKB extends loans against collateral. The basic policy concerningcollateral is to obtain a mortgage o f first degree on the plant to be set up or to obtain a bank letter o f guarantee. When deemed necessary TSKB resorts to other types o f collateral such as mortgage onproperty outside the plant, bank letter o f guarantee and personal guarantee. In case joint financing with other financial institutions, a mortgage may be established jointly in favour o f the institutions concemed or a pool sharing agreement providing for proportional claim on the proceeds o f the existing mortgage may be concluded. Sometimes Treasury Bills or Govemment Bonds issuedby the Turkish Republic may also be deposited as collateral. Because o fbeing regarded as the most liquid type o f collateral these Bonds have a positive effect on the capital adequacy ratio requirement just like the bank letter o f guaranteeand the mortgage o f first degree. 15. One o f the main objectives of TSKB is to ensure the proper use o f its loans. With this objective inview: inthe case o f loans to be used for the importation o f goods, disbursements are made exclusively by TSKB; inexport and import financing, transactions have been concluded in a manner acceptable to TSKB and in the case o f local currency loans, disbursement will depend on the realization o f conditions laid down previously. Within this framework Loans, Operations, Treasury and Technical Services Departments co-operate to observe the proper implementation o f disbursementand collection. 16. The companies financed by TSKB and the sectors they belong to are followed up periodically. The purpose o f the follow-up i s to ensure that the investments are completed intime and conditions set forth are satisfied as well as to identify the problems arising during the implementation and operation stage so as to be able to render assistance to the companies in solving their problems. 17. As an independent evaluation, inthe credit contracts it is stated that the annual financial statements and accounting records o f the company should be audited by an auditing firm acceptable to TSKB inaccordance with the International Auditing Procedures and Principles and results should be delivered to TSKB duringthe lifetime o fthe loan. 18. It has been a common practice in TSKB to evaluate periodically (once in three or six months) the financial statements o f the companies in which there's TSKB involvement. Within this framework the credit limits once approved have been revised, raised or cancelled by the Credit Committee especially when the original approval date i s earlier than two years. G. CapitalAdequacy, Asset Quality and CapitalBase 19. TSKB maintains a policy o f requiringbank guarantees for part o f its loans to non-bank borrowers. Having bank risk versus company risk on its loan book reduces the capital requirement for TSKB, as exposure to OECD-zone banks is risk-weighted at only 20%, compared to 100% for non-bank borrowers, in calculating its capital adequacy ratio (CAR). At six-monthly intervals starting at end-2000, TSKB has kept its CAR in the range o f 19.3-34.09 42 percent. The CAR as o f September 30, 2003 and the projected year end-2003 CAR are both around 31percent. 20. Non-performing loans (NpLs) held by TSKB increased from virtually zero in 1999 to 5 percent in 2001 and 7 percent in 2002. This is a reflection o f the combination o f tougher loan loss provisioning standards following the 2000/01 financial crises, and an actual increase in delinquencies byborrowers affected by the crises. 21. The TSKB loan book (currently approximately $600 million on a total balance sheet o f around $1.1 billion), with the EFIL I1loan o f $300 million, i s expected to increase to nearly US$$900 million on an approximate asset base o f $1.4 billion. Besides, there are likely to be additional lines o f credit from IFIs including IBRD. TSKB's CAR as a result i s projected to decrease from the current 31 percent to approximately 20 to 25 percent, still comfortably above the minimumrequirement o f 8 percent. Nevertheless, during the project implementation period, the Bank will monitor TSKB's balance sheet and capital base growth to avoid over-exposure. 22. TSKB also has an additional constraint o f a single borrower exposure. It has existing banking or equity links/exposures with a number o f banks in the system. Thus the amount o f additional wholesale TSKB loan exposures on each such retail bank inlight o f EFIL I1will need to be monitored to avoid excessive single borrower exposure. Inpractical terms it will mean that TSKB will need to wholesale EFIL I1to a more diverse group o f PFIs. This actually will be a desirable outcome and i s consistent with the project objective o f broadening and deepening financial intermediation. H. EarningsandLiquidity 23. TSKB has been profitable for the last few years with the exception o f 2001. In2001, the bank incurred significant losses as a result o fthe T L devaluationinthat year resulting innegative net operating income and a net loss for the ear. The results have improved considerably in2002. 43 Figure9: TSKB IncomeStatement-Results as % of Total OperatingIncome -+-Fee Income& ~ Commission +Foreign Exchange Loss, Net Net Income -H-- Net Interest I Income +Net Operating Income I 1999 2000 2001 2002 Sozme: TSKB Table 3: TSKB-Return on AssetslReturnon Equity 1999 2000 2001 2002 ROA 4.43% 3.21% -5.63% 1.38% ROE 33.24% 21.86% -45.55YO 11.12% 24. The impact o f the crises i s also visible in the banks return-on-assets and return on equity ratios, which both turned negative in2001, but recovered in2002. This experience is inline with the experience of other Turkishbanks, which also incurred losses during 2001 as a result o f the crisis in that year and the associated extraordinary exchange rate and interest rate volatility, which imposed sizeable losses on almost all banks, both directly and indirectly through the concomitant deterioration inthe banks' loan books. 44 Appendix 6.2 Likely Profileof ParticipatingBanksand LeasingCompanies, Pre-qualificationand FinalEligibilityCriteria A. TypicalParticipatingBankProfile 1. There were 51 banks in the Turkish banking system at end-September, 2003. These include private commercial banks, state owned banks, foreign banks, and non-deposit taking investment & development banks. Out o f this universe, TSKB has active working wholesaling and other types o frelationship with 36 Turkish banks. Inorder to determine the extent o f credit exposure it should take on any one o f these banks, TSKB carries out on a semi-annual basis a risk assessment o f these banks by analyzing their financial information including capital adequacy, profitability, and liquidityratios. However, inthe interest o f efficient implementation o f EFIL 11, and following the successful approach used in the first EFIL, it was agreed that the number o f participating banks should be limited to about 4-6 banks. This would enable an amount o f approximately $30-50 million to be intermediated by each bank and allow the World Bank and TSKB to create the right incentives for the selected banks to focus their management time and effort on timely and efficient implementation o f the EFIL11. 2. A secondary objective o f EFIL I1is to continue a dialogue with the leading private sector commercial banks and encourage them to improve their financial intermediation skills and volume, by maintaining prudent and rigorous credit appraisal standards and expanding their operations towards increasingthe share o f credit to the private sector intheir balance sheets. 3. Inorder to achieve these objectives, the selected banks should have (i)a proven track record o f lending to exporters, and (ii) a certain `critical mass' in terms o f their balance sheets and, though not as critical, their branch networks. Finally, the participating banks have to demonstrate full and continuous compliance with the technical and prudential standards applicable to their activities, and a clear drive towards increasing lendingto the private sector as a share o ftheir total assets. 4. The selection o f the participating banks is therefore being undertaken in two stages: (i) pre-qualification, and (ii) eligibility and selection. The pre-qualification criteria are listed final below: 0 The banksshouldbe privately owned, domestically incorporatedcommercialbanks; 0 Minimum total asset size should be at least US$500 million equivalent, and the banks should have maintained this minimum asset size for each o f the last two years . This would establish that the pre-qualified banks have at least a minimum size of operations on a consistent basis for two years running; and 0 The pre-qualified banks (as determined by information compiled by TSKB) should have a minimum export loans/total loans ratio o f 10 percent for the last two years on average for which data i s available. This would establish that the pre-qualified banks have a proven export orientation in their lending operations and maintained this orientation consistently for the last two years. 45 B. Pre-qualified List 5. The pre-qualification process has ledto a list o f 14banks. Table 4: Banks satisfyingthe pre-qualification criteria ranked by (i)totalassets; and(ii)exportsectorloans/totalassets Annual average Annual Banks sxport loadtotal loans total assets 2002 2000 2003 Q1 2002 2001 percent Percent U S $ million US$ million US$million Akbank 13.56 22.73 15,081 14,672 15,597 Isbank 19.66 37.81 14,914 14,239 15,148 Garanti 20.67 26.66 12,236 11,738 14,786 Yapi Kredi 9.53 25.84 11,580 11,295 14,054 Kocbank 44.72 37.08 4,123 3,993 4,63 1 Finansbank 17.78 31.03 3,326 2,956 3,148 Disbank 34.45 27.80 2,365 2,337 2,456 Oyak Bank 35.47 32.32 2,172 2,111 2,769 Denizbank 31.34 20.33 1,843 2,023 1,809 Sekerbank 40.80 18.75 1,369 1,341 1,674 TEB 48.65 39.26 1,364 1,424 1,469 Anadolu Bank 30.76 10.16 777 686 857 Altematif Bank 39.42 22.11 756 749 1,008 Tekstilbank 39.06 24.50 680 649 1,132 * End-2001export indata isnot available Souire: Bankers Association of Turkey 6. Final selection of participating banks. The banks to be selected for participation will have to meet the final eligibility criteria mentioned below, be an acceptable credit risk to TSKB, andhave expressed interest inparticipationinthe credit line. All the capital based criteria would have to be certified bythe banks' extemal auditors as o fthe latest available half-year period. C. General Criteria 7. The participating bank shall remain in general compliance with all legal and regulatory requirements applicable to its operations, including but not limited to BDDK- promulgated prudential regulations regarding capital adequacy, large exposures, related lending, and foreign currency exposures, as (re)confimed by the bank's auditors in writing on a semi- annual basis. 46 D. Audit Criteria 8. The participating bank shall, at the time o f selection and for the duration o f its subsidiary loan agreement with TSKB, for each year-end beginningwith year-end 2003, present an audit reportwhich: 0 Covers two full years o f operations; 0 I s prepared by an internationally recognized external audit firm in accordance with IntemationalAuditing Standards and Intemational Financial Reporting Standards (IFRS); and 0 Contains an unqualified audit opinion. E. TypicalParticipatingLeasingCompanyProfile 9. There were 107 leasing companies in Turkey in mid-2002. These included 91 private self-standing companies, among them several state-owned and foreign-owned firms, 5 specialized finance houses, and 11investment & development banks allowed by law to engage in leasing transactions. 10. The total asset size o f the leasing industry was US$1.96 billion as o f end 2002, but increased to US$2.41 billionby end-June, 20033, o f which lease receivables made 75 percent. At the end o f first half o f 2003, business volume (new leases) o f the industry had reached US$1 billion, compared to US$1.29 billion for the entire year 2002, suggesting a strong pickup in interest from the real sector in leasing products. Total shareholders' equity on June 30, 2003 was US$300 million. The total assets of the ten largest companies range from US$50-250 million, and together they account for over 60 percent o f the overall industry's assets and 75 percent o f new business volume (during first half o f 2003), suggesting the presence o f a large number o f marginalplayers. 11. It was agreed between the Bank and TSKB that the number o f participating leasing companies should be limited to about 4-6 enable the EFIL I1 funds to be intermediated most effectively by the strongest industry players. This would allow an amount o f approximately US$15-25 million to be intermediatedby each leasing company and enable the World Bank and TSKB to create the right incentives in the selected companies to focus their management time andeffort ontimely andefficient implementationo fthe EFIL11. 12. A secondary objective o f EFIL I1is to establish and move forward a dialogue with the leading private sector leasing companies and build a consensus with them on the best way to improve the leasing environment and the prospects for further development o f the leasing industryinTurkey. 13. Inorder to achieve these objectives, the selected pre-qualified companies should have (i) a certain `critical mass' in terms o f their lease receivables, and (ii)proven ability to generate a new leasing volume. Finally, the leasing companies selected to participate have to demonstrate full and continuous compliancewith the laws andregulations applicable to their activities. The 23 percent increase inU S dollar terms inthe first 6 months of2003 was due mostly to appreciation ofthe TurkishLira. Innominal TL terms, the increase was around 9 percent. 47 14. The selection o f the participating leasing companies has therefore been planned in two stages: (i)pre-qualification, and (ii) eligibility and selection. The pre-qualification criteria final used are listedbelow: 0 The leasingcompanies should be privately owned; 0 Minimum leasereceivables should be at least US$50 million equivalent, and the leasing companies should have maintained this size on average for the last two years . This would establish that the pre-qualified leasing companies have at least a minimum size o f operations; and 0 The pre-qualified leasing companies should have a minimum new leasing volume o f US$30 million on average for the last two years. This would establish that the pre- qualified leasing companies have a proven track record o f active operations. F. Pre-qualified Short List 15. The pre-qualificationprocess has ledto a preliminary list o f 9 leasing companies. Table 5: Leasingcompanies satisfying the pre-qualification criteria ranked by (i)totalleasereceivables; and(ii)annualvolumeofleasing Annual Lease volume Receivables of leasing 2002 2002 US$ million U S $ million 196.7 185.1 158.3 160.1 142.6 133.5 Garanti Leasin 138.5 156.7 109.3 197.6 BNP-AKDresdnerLeasin 94.0 46.8 91.6 62.1 56.2 59.9 55.1 74.9 Source: Turkish Treasury / FIDER (Turkish Association o f LeasingCompanies) 16. Final selection of participating leasing companies. The leasing companies to be selected for participation will have to meet the final eligibility criteria mentioned below, be an acceptable credit risk to TSKB, and have expressed interest inparticipation inthe credit line. All the legal and regulatory criteria would have to be certified by the leasing companies' external auditors as o fthe latest available half-year period. 48 G. GeneralCriteria 17. The participating leasing company shall remain in general compliance with all legal and regulatory requirements applicable to its operations, as (re)confinned by the leasing company's external auditors inwriting on a semi-annual basis. H. OperatingCriteria 18. The participating leasing company should have beenprofitable for at least two out o f the last three years of its operations. I.AuditCriteria 19. The participating leasing company shall, at the time o f selection and for the duration of its subsidiary loan agreement with TSKB, for each year-end beginning with year-end 2003, present an audit reportwhich: 0 Covers two full years o f operations; 0 I s prepared by an internationally recognized external audit firm in accordance with International Auditing Standards and International FinancialReporting Standards (IFRS); and 0 Contains an unqualified audit opinion. 49 Annex 7: FinancialManagement,Audit andDisbursementArrangements A. Project FinancialManagement Summary of FinancialManagementArrangements 1. The task team has conducted an assessment o f the adequacy o fthe project financial management systemat TSKB. The current financial management arrangements for the project are satisfactory to the Bank. 2. Detailed financial management questionnaire is included inthe project files. A summary o fthe conclusions are as follows: 1Rating 1.ImplementingEntity Satisfactory 2. Fundsflow Satisfactory 3. Staffing Satisfactory 4.Accounting Policies andprocedures Satisfactory 5. Intemal Audit Satisfactory 6. Extemal Audit Satisfactory 7. Reportingand Monitoring Satisfactory 8. Information systems Satisfactory OVERALL FMRATING Satisfactory Country Issues 3. A Country Financial Accountability Assessment for Turkey was carried out in2001. The CFAA report identified some weaknesses inthe Turkish financial accountability, inboth the public and the private sector. Main findings inthe public sector accountability covered issues like failure to define and control the entirety o fpublic funds, incomplete audit coverage, weak forces o fpublic accountability, narrow accounting model and procurement risks. Main findings intheprivate sector accountingandauditingarethe existence o faregulatory approach where specialized agencies each devise and enforce their and different obligations without adequate coordination and where there i s no common general platform. 4. US$200 million o f EFIL I1i s envisaged to be disbursed through banks. The 1999Banks Law established the Banking Regulation and SupervisionAgency, and among its powers is the power to determine the accounting and auditing requirements applicable to the banks under its supervision. Banks must submit non-audited monthly prudentialretums to the BRSA, and publishaudited annual financial statements. Only auditors approved bythe BRSA may carry out such audits. All changes inauditor must also be approved, and a change can be imposedwhere there i s dissatisfaction with the performance o f the auditor. The external auditor i s requiredto report to the BRSA on banks' internal control and risk management systems, as well as being obliged to report direct to the BRSA with respect to certainissues which may threaten the going concem nature o f a bank. 50 5. Untilthe 1999bankinglaw reforms, the Council ofMinisters rather thanbanking supervisors, were responsible for promulgatingrequirements inareas such as loan loss provisioning, and these rules were relaxedtwice inresponse to the Asian and Russianfinancial crises (inFebruary 1998 and August 1999). Requirements with respect to the calculation o f capital adequacy on a consolidated basis, and to disclosures inthe areas o f large exposures, connected lending, foreign exchange exposures, interest rate risk exposures, and maturity risk exposures also fell short o fthe relevant EU, Base1Committee and IFRS norms. This served to undermine the quality and relevance o f informationprovided to regulators and to the market, and has ledto weakening the early-warning signals provided by financial statements and to understating the extent o fproblems which exist. Since December 1999,efforts were made to strengthen significantly the regulatory and institutional infrastructurefor banking regulation (including the creation o fthe BRSA), including upgrading o fthe relevant financial reporting obligations. InJune 2000, the Treasury issued an instruction which brought disclosure rules for bankscloser to InternationalAccounting Standards, andinJune 2001, the BRSA issued a new Regulationon Chartering and Operations o fBanks, which further enhances public disclosure requirements. 6. The Bank in 1999 has extended an "Export Finance IntermediationLoan" to Eximbank where Treasury acted as the guarantor. Eximbank acted as an APEX bank and extended credit lines to ParticipatingFinancial Institutions (PFI) for on lending to beneficiary enterprises. At the inception o f EFILthe PFIswere obliged under the terms o f SLAs to remainincompliance with "prudential" ratios which were stricter than those imposedon the banking system by the Turkish bank regulatory authorities (at the time the TurkishTreasury and the Central Bank). As conditionality for FSAL andlater PFPSAL the prudentialregulations for the Turkishbanking systemwere tightenedand inMay 2001, the SLAs were amended to replace the original "prudential" ratios with those set forth inthe (new) banking law andregulations issuedby BRSA. 7. The BRSAissued a new comprehensive regulation on accountingstandards for banks in July 2002, which brings these standards inline with IFRS.However, the BRSA regulation does not require full application o f IFRS 27 (consolidation o f subsidiaries), as banks only have to consolidate their financial subsidiaries, while for nonfinancial subsidiaries separate financial statement disclosure i s mandated. The statements o f such non-financial subsidiaries are not IFRS-based4, however, and thus their disclosure will not allow the user to consolidate these with the IFRS-based consolidated statements o fthe parent bankandits financial subsidiaries. Also, as the IFRS are subject to change, any such change will necessitate an adjustment o fthe BRSA regulation. 8. The BRSA also issues rules governing the external audit o fbank financial statements, and only auditors approved by the BRSA may carry out such audits. The "Regulation on Principles for Independent Auditing" and the "Regulation on Authorization o f the Auditing Institutions and Permanent or Temporary Withdrawal oftheir Authorities", bothpublishedinthe Official Gazette Nr.24657 on January 31,2002; these regulationsare broadly inline with ISA. 9. TSKB has been assessed for compliance with BRSA prudential regulations by the project team and found to be incompliance. The participating banks are not yet determined however 6 Only if all non-financialsubsidiariesof a bank are listed or publicly held, and only ifthe CMB requiresthe use of full IFRS for all listed or publicly held entities, will the financial statements for such non-financial subsidiaries be IFRS-basedand allow full consolidationwith the IFRS-basedfinancial statements of the parentbank and its financialsubsidiaries. 51 their compliance with BRSAprudentialregulations is a conditionalityfor initialandcontinued eligibility. 10. US$lOO million o f EFIL I1is envisaged to be disbursedthrough financial leasing companies inTurkey. Leasingcompanies inTurkey are subject to Financial Leasing Law enacted in 1985 and the Regulations Dealing with the Establishment and Activities o fFinancial Leasing Companies were last amended in 1992. Leasing companies are regulatedand supervised bythe Bankingand ForeignExchange Department o fthe Treasury. According to the leasing law, the leasing companies shouldbejoint stock companies with a minimumpaid incapital o fUS$2 million. Total leasetransactions o fthe companies could not exceed 30 times a leasingcompanies net worth (15 times for transactions with connected parties). There i s not a limit on single party exposure and there i s no active supervision by the Treasury. 11. Inadditionto the lack ofsupervision inthe leasing industryinTurkey, there is also not very reliable data dissemination to the markets. Quoted leasing companies are subject to the accounting principles publishedby Capital Markets Board. The changed regulations requiring the application o f IFRS 17, became applicable after July 1,2003. Therefore due to different accounting policies applied the financial statements o f leasing companies are far from reflecting the real financial positions o fthese entities. However due to these inconsistent application o f accounting principles, it is common practice for leasingcompanies to have financial statements prepared inaccordance with IFRS and audited inaccordance with ISA.Eightypercent ofthe transaction volume inthe leasing industryi s handledby 10 large leasing companies inthe sector, andwe havebeeninformedthat theywould all have IFRSfinancial statements available for the last three years. Therefore our criteria o f initial and continued eligibility will be based on calculations derivedfrom IFRS financial statements. 52 Risk Analysis 12. A summary o fthe risk assessmentfor the project is as follows Risk Comments Inherent Risk 1. Country FinancialManagement Risk High Basedon CFAA report 2. Project Financial Management Issues Moderate Overall Inherent Risk High Control Risk 1.Implementing Entity Moderate 2. Funds Flow Moderate 3. Staffing Moderate 4. Accounting Policies and Procedures Moderate 5. InternalAudit Moderate 6. External Audit Moderate 7.Reporting and Monitoring Moderate 8. Information Systems Moderate Overall Control Risk Moderate Risk Mitigation Strategy 13. Country financial management risk - the CFAA has identified major weaknesses in the Turkish financial accountability, inboth the public, private and the banking sector. These risks together with the developments inthe sector after the preparationo f CFAA has beenexplained in detail in the "Country Issues" section. The project teams assessment o f the banks` compliance with the BRSA prudential regulations showed that the bank is in compliance with the BRSA prudential regulations. 14. The accounting standards applicable to the banks differ with respect to consolidation from International Financial reporting Standards (IFRS). The financial intermediaries which will manage the credit lines to export companies will submit their IFRS based audited financial statements to the Bank in addition to their audited financial statements prepared in accordance with the BRSA accounting standards. TSKB will bear the credit risk for the loans it extends to the PFIsandthe PFIs will bear the credit risk onthe credits made available to export companies. Strengthsand Weaknesses 15. The significant strengths that provide the basis for reliance on the project financial management system include (a) the disbursements to the export companies will be made by submission o f invoices and TSKB will be responsible for the control o f these invoices inaddition to the PFIs; (b) funds will be disbursed through PFIs which will be selected for their financial strength and capacity to appraise and supervise sub-projects; and (c) experience o f TSKB and expected PFIs, several o fwhich have participatedinEFILI. 16. There are no significant weaknesses inthe project financial management system. 53 Implementing Entity 17. The loan is a credit line and the borrower and the implementingentity of the o f the loan will be TSKB. TSKB will then on-lend to PFIs for lending to exporters. Treasury will be the guarantor o fthe loan. 18. TSKB was established in 1950 with the support o f the World Bank and the cooperation o f the Government o f the Republic o f Turkey, Central Bank of Turkey and leading commercial banks o f Turkey. TSKB has been founded for the purpose o f (i) providing assistance to private sector enterprises inall sectors o f the economy primarilyinthe industrial sector (ii) encourage to and assist the participation o f private and foreign capital incorporations established and to be established inTurkey (iii) assist the development o fthe capital market inTurkey. to 19. TSKB's largest shareholder is the I s Bank Group by 55.3 %. Consolidated financial statements are prepared for Is Bankasi and therefore there i s not a consolidation requirement for TSKB. TSKB has internal regulations and manuals for internal control and risk management in compliance with the banking law. 20. A separate project implementation unit (PIU) has been established at TSKB under the supervision o f one o f its executive vice presidents to oversee the implementation o f EFIL 11.The PIUis staffed with experienced management and staff, and as the primary project counterpart for the Bank team will provide the overall administration o f all aspects o f the credit line andrequired reporting to the Bank. 21. The PFIs are not known at this stage. Signing subsidiary loan agreements with two PFIs, which have undergone the qualification process i s an effectiveness condition for the loan. Compliance with the prudential regulations set out by Banking Regulatory Supervisory Authority (BRSA) i s required for continuing eligibility o f TSKB and the PFIs. This will be monitored through (a) prudential regulation compliance certificate and (b) annual audit reports. This certification will be issued by the banks' external auditors. Leasing companies have not been financial intermediaries in World Bank projects in Turkey before. Eligibility indicators have been identified and agreed with TSKB for the leasing companies and TSKB will be responsible from monitoring the continuing compliance o f the leasing companies with the eligibility criteria. Funds Flow 22. There will be special account in the name o f TSKB for the project. Funds from the loan will be made available to PFIs following submission o f payment documents (invoices for the goods and works purchased by the export companies) to TSKB. This information will be given to TSKB inelectronic form and TSKB will be responsible from controlling these invoices. Staffing 23. TSKB has given the names o f personnel assigned to the project. The qualifications and experience o f the nominated staff are satisfactory to the Bank. However controlling the invoioes will result with and additional workload and TSKB will assign two more staff to the project who will be solely responsible from controlling the invoices. Accounting Policies and Procedures 54 24. The financial management capacity at TSKB i s satisfactory. The Bank has qualified personnel, adequate manuals and guidelines to conduct efficient financial management. The accounting and reporting systems at the bank are geared toward producing statements and information as required by Turkish law and regulations as well as International Accounting Standards. 25. Considering that the bank has adequate accounting and reporting systems the main transactions that i s the movements in the special account, credit lines made available to the PFIs will be inthe bank`s main accounting systems. The main accounting system will be supported by a sub-system (MIS) for project accounting and reporting purposes. The follow-up o f documentation submitted by the export companies to withdraw loan funds will be made in this system. The systemwill also be capable o fproducingthe FMRs. Internal Audit. 26. TSJSJ3 has internal auditing department staffed with qualified audit professionals who are capable o f producing basic audit tasks. Transactions under the loan will be subject to internal audit as a part o fbanks' credit portfolio audits. I nformation Systems. 27. The main transactions that is the movements o f the special account, credit lines made available to PFIs andwithdrawals from the credit lines will be inthe main accounting system o f TSKB. The main accounting system will be supplementedby a Management Information System (MIS). Supervision Plan 28. During project implementation, the Bank will supervise the project's financial management arrangements in two main ways: (i)review the project's quarterly financial management reports as well as the banks` and project's annual audited financial statements and auditor's management letter; and (ii)during the Bank's supervision missions, review the project's financial management and disbursement arrangements (including a review o f a sample of SOEs and movements on the Special Account) to ensure compliance with the Bank`s minimum requirements. As required, a Bank-accredited Financial Management Specialist will assist inthe supervision process. 55 B. Audit 29. Annual and six-monthly (limited review) audits o f TSKB i s undertaken on an International Financial Reporting Standards (IFRS) basis in accordance with Intemational Auditing Standards by a reputed international auditing firm. The current auditors o f TSKB are Deloitte and Touche's member firm inTurkey. The last three years' audit reports (in accordance with IFRS) are reviewed and all were unqualified. In order to ensure that the project accounts andthe special account would be audited inaccordance with the World Bank audit guidelines the mission discussed and agreed with TSKB that the auditors o f TSKB's annual financial statements will also carry the audit o f the project audit as the preparation o f project financial statements i s TSKB's responsibility. The audited project accounts will include; project balance sheet, sources and uses o f funds and the special account statement. The auditors terms of reference will also cover whether the SOEs submitted during the fiscal year, together with the procedures and internal controls involved in their preparation can be relied upon to support the related withdrawal applications. TSKB has been engaging the services o f international auditors for several years and therefore the engagement o f an auditor will not be a specific Board condition andwill not be financed out o fthe loan. 30. The PFIs will also submit annual audited accounts to TSKB. It is common practice for the expected PFIs to have their accounts prepared in accordance with International Financial Reporting Standards (IFRS) and audited in accordance with ISA. As the PFIs are not known at this stage the engagement o fauditors for PFIswill not be a specific board condition. C. DisbursementArrangements 31. The Disbursement Categories and Percentage o f Expenditures to be financed, and projected disbursements are shown inTable 6 below. The total loan i s expected to be disbursed over four years and nine months from the date o f effectiveness, expected to be inMarch 2004. ExpenditureCategory Amount of FinancingPercentage Loan Allocated ~~ Sub-LoansandLeases 300,000,000 100percent of amounts disbursedexcluding taxes Front EndFee 3,03 1,000 100percent Unallocated 69,000 TOTAL 303,100,000 32. The EFIL I1is expected to achieve full credit line utilization rate within this period as a result o f incorporating the following features in loan design: (i) utilization parameters are loan flexible - both short and medium term working capital loans by themselves or in combination with investmentloans will be available; (ii) use o f TSIU3, rather than the Government, as the the Borrower and Implementing Agency, creating positive incentives (onlending margin) for efficient loan utilization; (iii) pre-allocating an amount of subsidiary loans (and the commitment 56 fee burden) to participating banks and leasing companies upon subsidiary loan signing, and therefore creating downstream positive incentives for the PFIs in terms o f higher returns by quicker utilization, and the negative incentive o f commitment fee payments in the absence o f such utilization; (iv) the inflexibility o f previous credit lines in Turkey has been avoided (e.g., too many requirements in terms o f minimum sub-loan maturity, sub-borrower co-financing requirements, etc.) which performedmuchbetter whenrestructured to rectify such inflexibility. 33. Retroactive financing o f expenditures incurred between September 30, 2003 and the date o f Loan signing, will be allowed up to an amount o fUS$30 million. D. SpecialAccount 34. To facilitate timely project implementation, TSKB will establish, maintain and operate, a separate Special Account in US$ in itself under terms and conditions satisfactory to the World Bank. The Special Account would have an Authorized Allocation o f up to US$20 million representing the expected advance payments on contracts duringthe peak quarter o f expenditures ifmade exclusivelythroughthe Special Account. At the start ofthe project, the Special Account deposits would be limited to half o f the Authorized Allocation (US$lO million), and the remaining portion o f the Authorized Allocation would be disbursed upon TSKB's request when the aggregate amount o f withdrawals from the Loan Account plus the total amount o f all outstanding Special Commitments entered into by the World Bank shall be equal to or exceed the equivalent o f US$40 million. Replenishment applications would be submitted at least every three months, and would include reconciled bank statements as well as other appropriate supporting documents. The minimum application size for payments directly from the Loan Account for issuance o f Special Commitments and direct payments i s 10 percent o f the Special Account authorized allocation. 57 Annex 8: ProcurementArrangements 1. The procurement o f goods (including related services) and works will be carried out in accordance with the World Bank's Guidelines:Procurement under IBRD Loans and IDA Credits (issued in January 1995,RevisedJanuary andAugust 1996,September 1997 and January 1999). The procurement arrangements are described below. The project estimated cost andprocurement methods are summarized in Table 8.1 o f this Annex. The World Bank's review process i s also presented inTable 8.2. 2. Incase o f procurement under sub-loans and leases, the ParticipatingFinancial Intermediaries (PFIs) will be responsible for ensuring that the procurement rules for sub-loans and leases specified below are followed by the sub-borrowers. TSKB will be responsible for reviewing and monitoring the compliance with the procurement rules by the intermediary banks and leasing companies, and their sub-borrowers (beneficiary enterprises). A specialist assigned for the procurement arrangements within the TSKB PIU will be responsible for all procurement oversight for the management o f the project. Ifneeded, the assigned procurement staff will be trained through World Bank seminars to be conducted inTurkey in order to be familiar with the World Bank's procurement rules and practice. The Bank also encourage TSKB for the employment o f one specialist who has experience in the Bank's procurement procedures. The PIUwill keep the records and copies o f the documents o f the procurements handledthrough the intermediary banks and leasing companies. The World Bank will conduct regular post reviews o f the sub-projects not requiring a prior review. The PIU will be responsible for assembling the documentation related to specific procurement transactions from the PFIs and sub-borrowers in order to facilitate the Bank's reviews. 3. Private Sector Procurement Practice in Turkey. Inthe Country Procurement Assessment Report (CPAR) dated June 2001, it was determined that there are well established commercial practices for the procurement o f goods, works and services by the private sector enterprises, autonomous commercial enterprises and individuals. In case o f goods, the local practice i s to prepare the technical specifications and solicit quotations from the local and/or international market. Incase o f medium and large works, the technical specifications are usually prepared by consultant companies and bids are collected from qualified contractors. Minor works are generally tendered on a lump sum basis by collecting bids from a number o f local contractors. When equipment and machinery i s needed for expansion o f existing facilities, the purchasers usually prefer proprietary goods from a single source for the sake o f standardization and minimization o f the operation and maintenance cost. Therefore, the local private sector or commercial practices can be considered to be consistent with the World Bank's criteria with respect to economy and efficiency. The general rule in the sector i s to procure the least cost goods, works and services consistent with minimumquality requirements. 4. Procurement of Goods and Related Services. Based on the assessment above, procurement o f goods and related services (installation and maintenance) financed under the proposed project will be according to the World Bank Procurement Guidelines. For contracts below US$5.O million equivalent, established local private sector commercial practices will be followed inaccordance with paragraph 3.12 of the Procurement Guidelines. Care has to be taken o f other relevant factors such as time o f delivery, efficiency and reliability o f the goods and availability o f maintenance facilities and spare parts thereof, and in case o f non-consultant services, of the quality and competence o f the parties rendering them. Advertising in the local and international press will not be mandatory. However, International Competitive Bidding 58 (ICB) would be required for individual contracts o f US$ 5.0 million equivalent and above for goods and related services. All procurement o f goods and related services under contracts equal to or above US$ 5.0 million equivalent will be subject to prior review. Contracts placed by sub- borrowers on their subsidiary or affiliated companies will not be eligible for financing out o f the Loan. The procurement o fthe second handgoods are not eligible for financing out o fthe Loan. 5. Procurement of Works. Procurement o f works financed under the proposed project will be according to the World Bank Procurement Guidelines. For civil works estimated to cost less than US$1.O million equivalent per contract, established local private sector commercialpractices will be followed in accordance with paragraph 3.12 o f the Procurement Guidelines. For contracts above U S $ l.O million equivalent but less than US$5.0 million equivalent, National Competitive Bidding(NCB) procedures satisfactory to the World Bank would beused. For contracts US$5.0 million equivalent and above, International Competitive Bidding (ICB) would be required for individual contracts. All ICB contracts and the first two N C B contracts for works shall be subject to prior review by the World Bank. 6. Review Procedures The Bank will review the procurement arrangements proposedperformed by TSKB in every year, including contract packaging, applicable procedures, and the scheduling o fthe procurement processes, for its conformity with Bank Procurement Guidelines, the proposed implementation program and disbursement schedule. (a) Prior Review: The following procurement action and documentation would be subject to Prior Review by the Bank in accordance with the procedures set forth in paragraphs 2 and 3 of Appendix 1to the Procurement Guidelines. Goods and Works: For ICB and the first two NCB Contracts for each PFI; prior review o f all BiddingDocuments, BidEvaluation Reports, Recommendations o f Contract Award and draft Contract will be conducted. For Contracts awarded through Commercial Practices; prior review o f first two contracts will be conducted for each PFI. (b) Post Review: The procurement documents for all other contracts shall be subject to the Bank's post review in accordance with the procedures set forth inparagraph 4 o f Appendix 1to the Procurement Guidelines on a random basis, one in five contracts. Post review o f the procurement documents will normally be undertaken during the Bank supervision mission or as the Bank may request to review any particular contracts at any time. In such cases, the TSKB shall provide the Bank for its review the relevant documentation. The post review shall be conducted by the Bank's Procurement Specialist. The outcome o f the post review will be communicated bythe Bank at the earliest time. 59 Table 7: ProjectCosts by ProcurementArrangements (in US$ million)* ProcurementMethod Expenditure ICB NCB Commercial Total Cost Category Practice (Bank Financed) 1. Sub-loans and leases Goods 25.0 250.0 275.0 Works 15.0 5.0 5.0 25.0 Total 40.0 5.0 255.0 300 (300) Figures inparenthesis are the amounts to be financed by the World Bank loan. * While iti s expectedthat bothPFIsand sub-borrowerswill contributeto the financingof individual sub-projects, the precise amount of such financingto beprovidedcannot be determined ex ante, as there are no predeterminedPFI/sub-borrower cofinancingrequirements. Instead,PFImaximumexposure to individual sub-borrowerlimits, debt equity anddebt service coverageratio requirementsfor sub-borrowers, andmaximumsub-loan size will drive the amountof financingto be providedby these parties. Table8: Thresholdsfor ProcurementMethodsandPrior Review (in US$ million) Procurement Method Expenditure Category Thresholds ICB NCB Commercial Practice 1. Sub-loans and leases Goods 25.0 4.O Works 25.0 21.0 <1.0 Prior Review All Firsttwo Firsttwo contracts contracts contracts for for each each PFI PFI 60 Annex 9: Turkey's Export Growth, Export Loans and General FX Loan Availability Analysis 1. GDP Growth. GDP (in constant 1987 prices) has fluctuated widely, due to the global crisis o f 1997/1998, and the crises Turkey experienced during the 2000/2001 period. While economic recovery was significant last year, GDP in 2002 was just a bit above the 1998 level. The current global economic downturn i s limitingTurkey's export-led growth potential. Figure 10: GDP-Local Currency 1995 1996 1997 1998 1999 2000 2001 2002 1 I I +GDP (by Kind o f Activity) +GDP Growth Source: TurkishTreasury 2. Exports as percent of GDP. Even with the erratic GDP (in constant 1987 prices) performance during the last 4 years, exports as percent o f GDP have grown continuously since 1995, with the exception of 1999 as a result of the meltdown of the Russian economy - an important destination for Turkish exports. Nevertheless, among the top 30 exporters globally, Turkey ranks only 21" in terms of export share in GDP (see Table 8 below). 61 Figure11: Export/GDPDevelopment 125,000 45.0% 120,000 115,000 -5.- 35.0% 110,000 c a cl 105,000 k 25.0% 100,000 95,000 90,000 15.0% 1995 1996 1997 1998 1999 2000 2001 2002 I Source: Various TurkishAuthorities Note: The difference inthe level o f Turkish exports as percent o f GDP inthe graph above and the table below is due to the difference inthe starting base for constant price level calculation (1987 for the data in the graph, and 1995 for the data inthe table). Table 9: Exportsof goods and services (% of GDP, 2001) 1 Singapore 173.6 11 Sweden 46.5 21 2 HongKong 143.9 12 Denmark 45.6 22 Spain 29.9 3 Malaysia 116.3 13 Switzerland 45.5 23 Italy 28.3 4 Ireland 95.4 14 Canada 43.8 24 France 27.9 5 Belgium 84.4 15 South Korea 42.9 25 Mexico 27.6 6 Thailand 66.3 16 Saudi Arabia 41.9 26 UK 27.1 7 Netherlands 65.1 17 Indonesia 41.1 27 Australia 22.9 (*) 8 Austria 52.2 18 Russia 36.8 28 India 13.7 9 Taiwan 50.9 19 Germany 35.0 29 Brazil 13.4 I10 Norway 46.6 (*) 20 Chile 1 34.7 I 3 0 USA 11.2 (*) (*)2000 data Source: SIMA 62 3. Export Growth. Turkish exports grew from the US$26-28 billion range in the pre-crisis period to US$36 billion in2002, and continued to grow at a fast pace inthe first months o f 2003. Such a spurt was caused by a sharp depreciation o f the Turkish Lira, for a while increasing the competitiveness of Turkey's exports on the global market. However, the recent appreciation o f the Lira, coupled with an economic slowdown in Turkey's main export destination, Germany, and other trading partners signals a likelihood o f a slowdown o f the rate o f export growth inthe period ahead. Figure12: Turkey's ExportPerformance 40 36 .g -.-32 a n 28 24 0.0% 20 I 1997 1998 1999 2000 2001 2002 I , I 1aExports +Export growth rate , Source: Various TurkishAuthorities 4. Export Credit Costs. The cost o f Turk EXIM's Bank's short-term benchmark credits to exporters has gone down from the highs o f the crisis period, yet has not achieved the pre-1998 level, despite the low interest rate environment globally, and even edged upwards during the last few observed months. The cost o flocally obtainable mediumand long-term credit to exporters, if available at all, i s prohibitive. 63 Figure13: Cost ofEximbank'sShort-TermExportCredit - % Spreadover 6-monthUSDLIBOR - 5.00 * 4.00 - 1.00 - 1/98 9/98 5/99 1/00 9/00 5/01 1/02 9/02 5/03 I MontWYear Source: Turk Eximbank 5. Ex~ortand total lending;. In TL terms, banking system loans have grown over the last three years. However, due to the devaluation of the Lira, the US$ equivalent of the loan stock shrunk dramatically in 2001 and remained virtually unchanged in 2002. Medium and long-term loans (in US$ equivalent) have somewhat recovered in 2002 compared to 2000, but short-term export and longer-term export-guaranteed investment loans have not. Figure14: ExportFinance 30.00% 25.00% 20 00% 15.00% 10.00% 5.00% 0.00% 2000 2001 2002 ' +Export & export-guaranteed investment loans/ Total loans l +Export & export-guaranteed investment loans/ Total assets I 64 6. During the last three years, the banking system has reduced its direct lending exposure to the public sector. However, the other side o f the picture i s Treasury securities owned by the banks: they have increased continuously from 2000, almost doubling in US$ terms by 2002, and proving to be the favorite destination for the banks' free funds. Total securities owned by the banks, the majority o f which was Treasury paper, increased as percent o f total loans from 58 percent in2000 to 180percent in2002. Table 10: TurkishBankingSector Data2000 2002 - Loans,USDMillion Change Total, ofwhich -37.0% To private sector -37.3% To public sector -3 1.4% Short-term loans -41.6% Medium & long-term loans -27.4% Export & export guaranteed investment loans -25.9% Working capital loans -13.9% Memo: Total System Assets -24.1% Memo: Securities 49.8% Loansas % of total assets Securities as YOof loans M<loans as % oftotal loans Export loans as % oftotal loans Loans,TRL Trillion Change Change Total, of which 35.0% 11.6% To private sector 34.4% 13.8% To public sector 46.9% -3 1.3% Short-term loans 25.1% -5.5% Medium & long-term loans 55.6% 40.4% Export & export guaranteed investment loans 58.7% 2.9% Working capital loans 84.5% 322.5% Memo: Total System Assets 62.6% 25.5% Memo: Securities 221.1Yo 45.2% 65 Annex 10: SafeguardPolicy Issues 1. Environmental Assessment policies o f the Bank will apply to EFIL 11. Environmental issues o f sub-borrowers and their sub-projects will be addressed through the sub-loan environmental eligibility assessment. TSKB will be responsible for ensuring that sub-borrowers and sub-projects financed under the EFIL I1undergo environmental screening to ensure their conformance with Turkish environmental legislation and regulations and the World Bank's policies and procedures, as set forth in OP/BP 4.01. The credit officers already appointed by TSKB to staff the PIU will perform this function. The PIU Operations Manual detailing, inter alia, the World Bank's requirements in respect o f environmental assessment, will be prepared prior to loannegotiations. 2. All sub-loans to be financed under the EFIL I1 should be subjected by PFIs to an environmental review process incorporating the procedures described in section VI o f the project's Operations Manual. The PFIs should use these procedures inreviewing and appraising sub-borrowers/sub-projects, and to inform Beneficiary Enterprises o f environmental requirements for sub-loan appraisal, so that sub-projects can be implemented in an environmentally sound manner. 3. The procedures essentially consist o f Environmental Screening, Environmental Impact Assessment, and Environmental Mitigationwhere necessary. The Environmental Screening will be carried out by the PFIs at an early stage intheir sub-loan review procedures to determine the appropriate environmental risk category for the sub-borrowedsub-projects, and may require the contracting o f external expertise. Following screening, an Environmental Impact Assessment (EIA) in line with the environmental classification o f the sub-borrowedsub-project will be recommended. The sub-borrowers will be responsible for carrying out any environmental analysis and for confirming that the proposed sub-projects comply with national environmental guidelines, and for obtaining the necessary clearance from the appropriate licensing authorities. Once the analysis i s performed and recommendations incorporated into the sub-project, the PFI will appraise the proposed sub-loan package which would include, where appropriate, an environmental mitigation plan. The implementation of the mitigation planwill be monitored by the PFI. The overall review process will bemonitoredbythe Project Implementation Unit (PIU). 4. All sub-borrowedsub-projects will follow the environmental review process presented schematically below. STEP 1: The sub-borrower prepares an initial sub-project concept. Following informal discussion with the PFI, in which the PFI alerts the sub-borrower o f its environmental assessment requirements,the sub-borrower prepares Part A o f the environmental screening form and includes this with the initial sub-project concept. At this time, it is the responsibility of the sub-borrower to initiate discussions with the local environmental authorities (LEA) in order to fulfill any local and national environmental review requirements (such as investment incentive certificate and/or other official approval/permits). It will be the responsibility o f the sub-borrower to obtain the appropriate permits and licenses as required by national law in order to facilitate the clearance process with the local LEA. These requirements are considered separate, but parallel, to those presented here and satisfying them is the responsibility o f the sub-borrower. 66 STEP 2: The PFI screens the sub-project and informs the sub-borrower o fthe EIA category prior to appraisal and subsequent follow-up requirements for sub-loan processing. STEP 3: The sub-borrower, or its consultants, submits the environmental analysis (ifapplicable). The sub-borrower will obtain a positive EIA report, given by the relevant LEA, in conformity with applicable EnvironmentalRegulations for the activities listedinCategories I1and 111. STEP 4: The PFI reviews the environmental analysis that has been submitted and reports its findings to the sub-borrower. The PFI provides its clearance once the analysis is judged to be satisfactory. STEP 5: The sub-borrower incorporates the recommendations provided in the analysis into the sub-project design and implementationplan, including associated estimated costs. STEP 6: The sub-borrower finalizes the sub-loan application package, including the relevant environmental documentation, and submits it to the PFIfor its appraisal. STEP 7: The sub-loan becomes effective upon verification o f the LEA approval and clearance, which can be obtained at any step inthe sub-project preparationcycle. STEP 8: The sub-borrower submits the clearance letter o fthe LEA to the PFI. STEP 9: The PFImonitors the implementation o f the EIA mitigation plan and informs the PIU. 5. Prior and Post-Review-IBRD/PIU. Environmental evaluations andreview procedures will be subject to ad-hoc review by the PIU and IBRD supervision missions. The review o f evaluations will ensure that: the work was o f satisfactory quality, community participation took place when appropriate, the appropriate recommendations were made, all documentation was properly filed and recorded, and that the conditions o f approval by the local LEA were met. DuringEFILI1implementation, IBRDmissions will supervise the overall screening process and implementation o f environmental recommendations for selected sub-bon-owershub-projects. The IBRD supervision team will also review, ad-hoc, environmental documentation. Therefore, all this documentation shouldbe kept on file with the PFIs and forwarded to the PIU as needed. 67 Annex 11: Project Processing 3 10 68 Annex 12: Documentsinthe ProjectFile Documents inthe Project files include the following: Articles of Association of TSKB 2000 - 2002 annual reports and audited (KPMG) financial statements of TSKB Audited financial statements ofpotential participatingcommercial banks: * Garanti Bank ** Kocbank Yapi Kredi * Disbank * OyakBank * TEB Bank Audited financial statements ofpotential participatingleasing companies: * Garanti Leasing * Koc Leasing * Yapi Kredi Leasing * DisLeasing * TEB Leasing Law on the CentralBank of the Republic of Turkey Banks Act Law on Leasing and related regulations World Bank study: Non-Bank Financial Institutions and Capital Markets inTurkey EFILProject documents TurkishUndersecretariat ofForeignTrade and other sources: Foreigntrade statistics (6/2003) and other export performance indicators 69 c, m .m Ccl 0 .. 2w 42 Annex 14: Turkey at a Glance Turkey at a glance %m3 Europe8 Central Ttirkey Asla E46 476 2509 21030 160 1740 217 0.1 2 0 4 ti7 63 0 70 69 cig 33 25 '30 8 11 82 91 81 14 3 I01 102 1W 103 Q5 101 I$@ 2001 1 0 2 $44 1w9 145 2 1823 170 23 9 168 21.3 11@ 14 4 33 7 28.8 138 209 192 19.6 185 24 4 20 7 20.7 -15 -06 23 -0.8 18 2 0 36 3284 6 356 78.4 713.4 .Q ?r23 440 4%0 2001 2002 200296 -7 5 7 8 4.7 0 0 6 1 3.6 7 4 110 4 9 1912 1991 2001 ZOO2 I 22.7 153 128 130 25.1 3% 261 254 17.7 18% 158 18.0 P 52.2 547 81 1 616 76.3 1332 66.3 $.ha fjg6 129 14.2 140 15.0 17 3 31.3 30.5 1982.92 1992-02 2001 2002 Orowtit of rxparts amimporis I 14 4 0 ?6 Q 72 2161 3 2 5 7 10 7.2 3 3 8 0 82 4.2 3 1 4 2 f 0 0 4.3 2 2 4 2 26 fQ 3.4 4 5 54 5 0 4141 420 357 88 8 3 -248 I 5 7 Note 2002 data are preliininaryastimaks 'The diamondsshmQfour key indicatcrsin the counby (in troldi coniparfd with ikincome-yroupamrage If data are mis$ing the diamond v~ill be incomplete 71 PRICES ond COVERNMEHT FINANCE 1382 1932 Mol 2002 I Mo rO1 53 9 448 28.2 63.7 54 8 43.5 . 190 2Q3 .... 2.32 .1J -14 7 4 7 -10.7 2 0 9 -123 TRADE 2001 2wt2 5883 14.891 M 373 39'827 L0.w I 1.145 5603 10344 12066 1.571 2,%3 1876 1705 4.655 13440 28 #& 32673 8,843 22871 41.399 51.270 123 1 3 3 948 1211 3 . w 3903 9,316 8955 2.214 7,970 7 344 8M P .' 95 76 75 90 81 80 94 93 I. 105 BALANCEof PAYMENTS I> 1982 1*92 2001 2002 7,818 a343 Q403 54,6008 9,5@ 26,705 .15816 55" -1%n4 .3.m 4 587 4R? -1,48 -1670 50oo -4,549 2,2R 4,059 3803 3496 -%a -974 3,300 -1 540 1,123 2458 -16 314 1.328 -1m -1,464 12924 212 2027 15252 33 I92 s a w 1629 6.851 3 1228367 ##" EXTERXALOEBT end RESOURCE FLOWS 1982 1992 Mo'l 2002 131407 53ii7 A. 5x.? 89 G 15155 88B 28632 708 7 307 XI6 0 334 762 -$m '14 797 I46 3 W 2.187 3811 55 ??P 2.789 0 -1.194 4.G11 -1862 180 648 685 2.200 3 *fijo 5oc, 286 1537 1031 86 733 437 442 415 447 1,100 583 IR 4 m 292 272 289 428 #8 316 72