Can DFIs add value? -FIRA’s Experience –

Can DFIs add value?Can DFIs add value? -FIRA’s Experience –-FIRA’s Experience –

September 22, 2004September 22, 2004

The World Bank

Presentation prepared by:

Francisco Meré

1. Introduction

2. New business model

3. FIRA: A Value-Creating FDI

4. Future directions

Agenda

FIRA is a second-tier trust fund created by the Mexican government within the central bank 50 years ago

$27,748 $35,185

• Designed to promote agricultural development through the provision of short and long term funding to the banking system to finance agriculture

• At the time, capital, debt and interbank lending markets were highly underdeveloped

• Due to banks´ underserving to agriculture, a mandatory lending regulatory requirement was in place until late 80´s

• FIRA´s loan portfolio was heavily subsidized from onset

• Original assumption was that enhanced funding would encourage an increase in credit to farming

• Loans concentrated in primary (commodities) activity

• Later incursion in credit guarantee schemes with no premium charged

Banking liberalization, NAFTA and tequila crisis posed new challenges to FIRA, while ag sector still underserved

• FIRA´s products were not attractive to banks and therefore its lending fell 70%

between 1994 and 1998

• Traditional commodities agriculture was challenged by trade liberalization, thus

risk perception about the sector was increased

• Less than 10% of banking system loans go to agriculture

• Large percentage of rural population without access to banking system

• Debt markets have developed, thus enhanced funding is not an answer

% of population living in such municipalities

0

10

20

30

40

50

Mexico South &Southeast

Center Center * Center-west

NorthwestNortheast

Dec-95 Jun-01

Municipalities without bank branches (%)

0

20

40

60

80

100

Mexico South &Southeast

Center Center *Center-west

NorthwestNortheast

Dec-95 Jun-01

Source: Mexico´s CNBV, INEGI

1. Introduction




Agenda

Ag. development

Ag + rural financial market development.

Primary activity

Value chain (food system) and off-farm activities

We have a new market-oriented approach: from development banking to banking development

focu

ssc

op

e

Product driven Client driven

app

roac

h

Uncapped non-focused subsidies

Value added approach and focused “smart” subsidies

inst

rum

ent

EVOLUTION

38,575

36,23128,844

31,88323,791

19,60817,777

20,132

24,663

24,325

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

1995 1996 1997 1998 1999 2000 2001 2002 2003 Programa2004

With our new approach, FIRA has achieved higher private sector engagement (double digit growth for five consecutive years)

Commercial banking

Lending in millions (Million Mx Ps.)

-5,093.6

5,195.9

3,399.2

1,175.7208.4

-1,718.5

-6,000

-3,000

0

3,000

6,000

1998 1999 2000 2001 2002 2003

Change in credit stock by commercial banks using FIRA´s funds (million Mx.

Ps.)

Banrural closure

Descuentos otorgados por la Banca Comercial a productores PD1

(Millones de pesos de 2003)

8,120.76,293.5

6,524.0

6,814.6

5,163.5

4,871.4

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

1998 1999 2000 2001 2002 2003

5,368.6

1,816.2

6,298.3

3,288.6

Lending to low income producers

August 2003-2004 (million Mx. Ps.)

Commercial bank lending to low income farmers (million Mx. PS.)

Low-income Mid-income

81%

17%

Source:FIRA

We have gradually moved away from subsidy-based operation to value-added activities

From 2001 to 2003, interest rate subsidies have declined 19 percent in absolute terms

From 1998 to July 2004, the spread between FIRA’s lending rate and interbank lending rate has been reduced in 530 points

Spread

5.0% 4.7%

2.9%

7.2%

2.9%

2.0% 1.9%

0%

1%

2%

3%

4%

5%

6%

7%

8%

1998 1999 2000 2001 2002 2003 Jul-04

Interest rate subsidies Thounsand pesos, August 2004

Concept 2001 2002 2003

Subsidies 884,657 895,380 581,532

Portfolio 16,442,449 18,774,682 21,195,087

% 5.4 4.8 2.7

While keeping our risk-bearing portfolio under control and reducing our expected loss

FIRA´s risk sharing (% of total loan portfolio)

33.0

35.9

32.8

27.2

-

10

20

30

2000 2001 2002 2003

3.42

4.65

0.0

0.8

1.5

2.3

3.0

3.8

4.5

5.3

99-02 00-03

Expected loss in guaranteed portfolio (%)

Source: FIRA

1. Introduction




Agenda

Our strategy is based on four pilars

Value proposal

(Know your market)

(know your client)

Financial innovation

Adequate governance

Professional management

FIRA´s new activity is aimed at solving market failures/imperfections with a market approach and a clear

vision of financial market development

F I R AF I R AF I R AF I R A

Value creationValue creationValue creationValue creation

Asymmetric Asymmetric information information solutionssolutions

Asymmetric Asymmetric information information solutionssolutions

Market makingMarket makingMarket makingMarket makingTransaction costsTransaction costsreductionreduction

Transaction costsTransaction costsreductionreduction



Asymetric Asymetric information information solutionssolutions


Market Market makingmaking


Cost transactionCost transactionreductionreduction


Financial market outreach to low income rural entrepreneurs is being fostered with “smart subsidies” rather than interest rate subsidies

Ou

trea

ch s

ub

sid

ies

Transaction costs subsidy

• Covers screening and transaction costs associated with first time small borrowers

• Reduces discrimination by size of borrower

• Declining with 3-year-life

• Portable by borrower among different FIs

• Creates information (public good)

Infrastructure Development

subsidy

• Partially covers the cost of creating new human infrastructure to enter marginal markets

• Covenant by bank to net increases in lending to those marginal markets

• Allocated on a per annum basis and subject to auditing

Transaction costs subsidy has led to an increasing outreach









Associated

Year credit Subsidies Beneficiaries

1998 296.3 22.3 495,666

1999 376.9 23.1 604,460

2000 467.8 24.3 704,169

2001 367.1 17.7 319,263

2002 399.2 19.6 348,073

2003 478.4 18.1 343,855

2004 * 433.4 14.7 286,811

TCS 1998 – 2004(usd millions)

* As of August 2004

Source: FIRA

New borrowers 164,290 106,207

Continuing subsidized borrowers

179,565 86,687

2003 August 2004

Financial constrain catch 22: low income borrowers are perceived high risk; their size limits their access to risk management instruments

• FIRA has become the leading broker for interest rate derivatives for ag and rural sector (swaps)

• US$660 million book with 80% having a maturity greater than 3 years

• Roughly 22% of total loan portfolio is hedged

• FIRA charges for the service

• Position is 100% hedged with international (investment grade) counterparties

• Value-added activity:

1. Develops/expands market and access2. Information generation 3. Lowers transaction costs for all agents









FIRA offers very competitive rates by bundling the fixed interest rate credit demand in batches

C.F. Bundling = More Volume = Attractive Interest Rates

C.F. Bundling = More Volume = Attractive Interest Rates

Informativeweekly rate

proposal

Informativeweekly rate

proposal

Farmer’srequestsFarmer’srequests

Cash flowgrouping

Cash flowgrouping

Interest rate swap closingInterest rate swap closing

Fixed interest rate credit disbursementFixed interest rate

credit disbursement









Outstanding book value in Mx. Ps.(end of month)

0

500,000,000

1,000,000,000

1,500,000,000

2,000,000,000

2,500,000,000

3,000,000,000

3,500,000,000

4,000,000,000

4,500,000,000

5,000,000,000

5,500,000,000

6,000,000,000

6,500,000,000

7,000,000,000

7,500,000,000

8,000,000,000

Ju

n-0

0

Ag

o-0

0

Oct-0

0

Dic

-0

0

Fe

b-0

1

Ab

r-0

1

Ju

n-0

1

Ag

o-0

1

Oct-0

1

Dic

-0

1

Fe

b-0

2

Ab

r-0

2

Ju

n-0

2

Ag

o-0

2

Oct-0

2

Dic

-0

2

Fe

b-0

3

Ab

r-0

3

Ju

n-0

3

Ag

o-0

3

Oct-0

3

Dic

-0

3

Fe

b-0

4

Ab

r-0

4

Ju

n-0

4

Ag

o-0

4

Demand for the product has soared

Source: FIRA

SPV

INVESTOR

1. Supply agmt.

2. Loan

Transfer of rights

Debt issueFunding and partial enhancement

1. Senior tranche

2. Junior tranche with sinking fund









• Value chain integration through better supply chain mgmt.

• Reduction of transaction costs and risk via portfolio approach

• No subsidies; fee-based structuring service

• First loss enhancement by industry, market making enhancement by FIRA at a premium

• Transactions account for 5% of loan portfolio and growing

• Gradual decline in FIRA´s level of enhancement

An innovative approach to investment banking creates value for food system and develops financial markets

PRODUCER

AGRIBUSINESS

PROCESSOR

•Alliance with world-class partners

•Warehousing sector development

•Creation of risk assessment capabilities in financial sector

•Broad acceptance of structure

•Low VaR linked to price of underlying commodity

•Commodities such as sugar, corn, wheat, sorghum, shrimp and live cattle

•Portfolio has accounted for 10% of total loans

Other Investors (Rabobank,

Deutsche bank)ServicerRepo of CD

Portfolio sale

Credit derivative

Structuring of ABS for commodity inventory financing has been key for financial innovation as well as for market and institutional development

Mexican Banks









OTC hedge

1. Introduction




Agenda

Traditional second-tier lending is of little use in more developed markets

• Second-tier lending without interest rate subsidies is only attractive to weaker FIs, then the concern shifts to an adverse selection problem

• A more active approach to solving information, risk management and transaction costs problems is needed

• Interest rate subsidies have proved not only distorting but ineffective by FIRA´s independent third party evaluations

• Transaction costs and infrastructure development/roll-out subsidies are transparent and measurable

As a consequence of industry concentration, we’ll be more active on FI development

• Six banks account for:

1. 83% of FIRA´s loans

2. 73% of banks´ loan portfolio

3. 66% of total assets

4. 70% of all bank branches

• We are now doing business with two newly created banks and 14 non-banking FI

• FIRA´s commitment is to be a non-dominant source of funding to those FIs

We see ourselves evolving to be a leader in financial innovation and market development

• Consolidate structured finance function through the creation of extended maturity, multi-crop revolving facilities, and going public with those structures

• Exit existing derivatives activity (transfer to market) and engage in more sophisticated markets (weather derivatives, etc)

• Public entity with private behavior

Can DFIs add value? -FIRA’s Experience –

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