GOVERNMENT DEVELOPMENT BANK FOR PUERTO RICO
A ROADMAP FOR INSTITUTIONAL TRANSFORMATION December, 2016
CONTENTS Executive Summary ........................................................................................................................i Overall Conclusions ....................................................................................................................i Guiding Principles for an Economic Development Bank ................................................ iii Institutional Transformation ...................................................................................................... iii Changes in the Operational Structure .............................................................................. vii Recommendations for a Development Bank ...........................................................................x Introduction ............................................................................................................................... 1 Development Banks: The International Experience ................................................................ 5 Central Banks............................................................................................................................. 7 Development Banks ................................................................................................................. 9 Performance ........................................................................................................................ 12 Importance of the institutions in periods of fiscal constraints ........................................... 14 Development Banks............................................................................................................ 14 Institutional structures and conditions needed to run development banks .................. 15 Development banks ........................................................................................................... 15 Experience in the US ............................................................................................................... 16 State Banks ........................................................................................................................... 16 Federal Institutions ............................................................................................................... 19 Best practices of Development Banks ................................................................................. 22 Selection of States and Countries for Benchmarking ........................................................ 25 Florida ................................................................................................................................... 25 Nevada................................................................................................................................. 26 Hawaii ................................................................................................................................... 26 Chile ...................................................................................................................................... 26 United States for Comparative Purposes ......................................................................... 26 Governmental Organization of Fiscal Management Systems Under Selected States and Countries .......................................................................................................................... 26
Florida ................................................................................................................................... 27 Nevada................................................................................................................................. 28 Hawaii ................................................................................................................................... 29 Chile ...................................................................................................................................... 30 United States for Comparative Purposes ......................................................................... 30 Benchmarking Fiscal Management Practices.................................................................... 31 Best Practices and Recommendations ............................................................................... 33 Set Long-Term Goals for a Balanced Budget ................................................................. 33 Improve Financial Reporting and Transparency ............................................................ 33 Mandate Increased Independence between Fiscal Management Authority and Lending Decisions ............................................................................................................... 34 The External Environment of the GDB ...................................................................................... 38 Economic Growth ................................................................................................................... 40 Employment............................................................................................................................. 41 Gross Fixed Capital Investment ............................................................................................ 42 Government Expenditures ..................................................................................................... 43 General Fund Net Revenues ................................................................................................. 45 Debt .......................................................................................................................................... 46 The Internal Environment of the GDB....................................................................................... 47 Total Assets ............................................................................................................................... 47 Loan Receivables ................................................................................................................... 49 Net Loans Receivable, by Fund ........................................................................................ 50 Delinquency Rate of Loan Receivables .......................................................................... 50 Net Assets and Net Operating Income ............................................................................... 52 Managerial Practices during the Period ................................................................................. 53 Managerial Practices in Fiscal Year 2014 ............................................................................ 56 In light of the previous indicators, the following conclusions can be reached: ........ 56 The Future Economic Situation and the GDB ......................................................................... 57 The Economic Scenario – 2016 to 2030 ............................................................................... 57
External Environment from fiscal 2016 to fiscal 2020 ...................................................... 58 External Environment from fiscal 2021 to fiscal 2025 ...................................................... 58 External Environment from fiscal 2026 to fiscal 2030 ...................................................... 59 GDB and Municipalities ............................................................................................................. 61 GDB’s role in municipal financing ........................................................................................ 61 Municipal Responsibilities....................................................................................................... 65 Financing Options for Municipalities .................................................................................... 65 Borrowing.............................................................................................................................. 65 Levying Taxes ....................................................................................................................... 66 Public-Private Partnerships (PPP) ....................................................................................... 66 Intergovernmental Transfers .............................................................................................. 67 GDB’s Role in Economic Development ............................................................................... 67 Importance of Decentralization ........................................................................................... 69 Municipalities and GDB’s Loan Portfolio.............................................................................. 70 Economic Development Bank ................................................................................................. 72 EDB Assets & Loans ................................................................................................................. 72 Impaired Loans........................................................................................................................ 74 Overall Conclusions.................................................................................................................... 77 Guiding Principles for an Economic Development Bank .............................................. 80 Institutional Transformation .................................................................................................... 81 Changes in the Organizational Structure ........................................................................ 82 Changes in the Operational Structure ............................................................................. 84 Recommendations for a Development Bank ........................................................................ 88 Legal Background ...................................................................................................................... 92 Act 252 of May 13, 1942 ......................................................................................................... 92 Act 46 of May 13, 1943 ........................................................................................................... 93 Act 272 of May 15, 1945 ......................................................................................................... 93 Act. 17 of September 23, 1948 .............................................................................................. 94 Act 31 of 1957 .......................................................................................................................... 94
Act 13 of May 30 of 1960 ....................................................................................................... 96 Act 1 of September 11 of 1986 ............................................................................................. 96 Other Laws ............................................................................................................................... 97 GDB Components................................................................................................................. 100 Recent Acts and Executive Orders with impact on the GDB ........................................ 103
Executive Summary The objective of this report is to answer two questions: Should there be a Government Development Bank and, if the answer is yes, what should be its role? In order to answer these questions, the report considered the experiences with development banks in a number of jurisdictions, studied the available literature on development banks, evaluated both the GDB and the EDB and looked into the existing documentation on both, presented the economic and fiscal context, considered he legislative history of both GDB and EDB and identified best practices that could provide guidance to Puerto Rico. The report also looked into the needs of municipalities and their relationship to the GDB. The report concludes that there is a need for a development bank and proceeds to describe needed steps to make it viable.
Overall Conclusions The Island’s overall economic performance in recent decades, along with misguided management practices have led to poorly informed policymaking. This has limited the fiscal capacity of the Island and also its ability to generate new productive activity. The government has become dependent on debt and taxes in order to maintain spending levels in a context of a shrinking economy. Legal mandates have provided justification for government spending with little or no due diligence as to their need and feasibility. Concepts such as capital spending, infrastructure investments, long-term borrowing to finance current expenditures, and utilizing non-recurring revenue sources to cover recurring costs, have all become part of the traditional repertoire utilized by Commonwealth institutions to maintain the fiscal apparatus through several decades of lackluster economic growth. Nevertheless, increased government spending is not the only problem but rather, the quality of our public spending. This can be remedied by strong monitoring and performance-based evaluation mechanisms that are currently lacking in our institutional make-up. But it is also related to the absence of clearly espoused priorities in key areas. In an economic landscape characterized by serious scarcity of resources, having institutions that are able to prioritize public interventions in the economy is essential. The current fiscal condition, the Island government’s lack of credibility and the limited potential for short and medium term growth, make the development of effective financial policies imperative. Commitment to sound practices is no longer an option, but a mandate. Even if GDB is restored and best practices are followed to create a development bank, positive externalities in the economy will be limited if general fund
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expenditures continue to be financed with non-recurring revenue sources. The reliance on credit in previous decades for covering operational fiscal gaps has closed the door for debt issuance to promote economic development initiatives. The use of highly sophisticated financial instruments to finance current government expenditures rather than new productive capacity has halted the ability to stimulate economic development. Financing entities dealing with economic development must be closely related to other economic development agencies. Puerto Rico’s experience has been that of a highly fragmented system that has made political interference in decision-making a much more prevalent practice than is desirable. Autonomy in the process of deciding on politically sensitive decisions must be provided to development finance entities, requiring profound transformations in their governance structures. Yet, they must operate in close coordination with other entities related to economic development policy. The empirical evidence worldwide showed “that government ownership of banks has, if anything, been associated with faster long run growth. The evidence suggests that government ownership of banks during 1995–2007 has been robustly associated with higher economic growth.” 1 Moreover, during the global financial crisis of 2008-2010, most development banks played a countercyclical role by providing credit to private firms that were temporarily unable to access funding from private commercial banks or capital markets. The World Bank survey2 on development banks also notes that poor lending decisions, high levels of non-performing loans, political requirements and mandates, are characteristics of those DBs that in the past have failed. During the past decades the GDB has provided funding to finance deficits and special programs such as the Special Communities project. The GDB was used by other Commonwealth instrumentalities as a lender of last resort with few posibilities for repayment of loans. The information presented throughout this report evidences the need for an institution that is able to finance, promote and support the implementation of economic development initiatives. Even though past performance is not encouraging, the current state of affairs calls for an institution which is able to perform the functions that GDB performed initially, that is, to provide development banking services to an economy severely constrained financially, assuring that the following guiding principles are followed. 1
Andrianova, S., Demetriades, P. & Shortland, A. (2010), Is Government Ownership of BanksReally Harmful to Growth?, Berlin: German Institute for Economic Research, 2010.
2
Luna-Martínez, et al, 2012
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Guiding Principles for an Economic Development Bank
Political independence – this can be achieved by adequate representation of stakeholders in its Board, the manner in which members are selected and appointed, and the terms of their appointment.
Market neutrality- requires that the Bank does not destabilize private sector banks The proposed entity (see recommendations section) can introduce new financial products to demonstrate their financial feasibility to the private market, as the GDB once did by financing housing projects and the Caribe Hilton, among other projects.
Self-sustaining – although a World Bank survey found that 40% of development banks receive government transfers to partially fund their operations, it is essential that the proposed Bank be self-sustainable and non-reliant of government subsidies. (World Bank, 2013)
Best and brightest – institutional autonomy demands high banking standards, risk management, monitoring, highly trained personnel (with competence and experience). The Bank’s leadership should aim at attracting the “best and brightest” to its staff.
Structural focus – projects financed by the Bank should be chosen on the basis of their impact on the economy, avoiding highly visible but inconsequential projects in terms of their impact on economic development.
Policy innovation - via well-designed lending and underwriting practices the Bank can have a major influence on innovations both in its clients and in the policy making system. This focus will influence the choice of projects to be financed. .
Collaboration - GDB and its new institutional structure is part of a wider policy cluster, designed to stimulate economic growth and sustainable development. Thus, the Bank will not be an isolated institution, but rather part of a group of agencies and programs focused on economic development.
Institutional Transformation It is recommended that Puerto Rico maintain a centralized state development finance institution that is able to support economic development projects via different financing mechanisms. The main recommendation in this report is to call attention to the need to maintain a development bank as an instrument for economic development. Relegating such a role to private commercial banks, to a number of other state agencies, or to the limited amount of capital available in non-financial institutions, is to
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limit the possibility of generating the productive investment necessary for a prosperous and growing economy. The existing Economic Development Bank has, to some extent, been able to reach agreements with other agencies that provide loans and grants and has introduced financial rationality to the process. The current state of affairs demands a vigorous tool that could bootstrap innovation and sustainable economic development. The institutional transformations proposed in this report rescue the original conception of the GDB as a development bank and a clear separation of its role as a fiscal agent to the Commonwealth. An important task in this transformation is to find equilibrium between competing interests that are typical to development banks, that is, a well-conceived balance between large-scale projects and small business ventures, between “infrastructure3” projects with longer term returns and turnkey projects with immediate returns, between lower risk and high risk investments or financing public productive investments or private investments. These are all competing claims on resources that must be addressed via the design of strict rules and procedures that must be part of the bank’s charter. Development banks remain relevant in the world economy, and are much needed in developing countries and, in some instances, in developed economies. Economies such as the economy of Puerto Rico demand strong and innovative institutions that are able to provide direction to economic development initiatives. The coming years will require deep transformations in our society4 similar to those that took place in the 1950’s and 60’s. Such profound change demands an entity with the capacity to promote expansionary fiscal policy and promote the creation of new productive capacity. The success of reconstructing Puerto Rico’s economy requires a clear recognition of past mistakes (not unique to Puerto Rico), and introducing safeguards that minimize the potential recurrence of such errors. For instance, as the Volcker Alliance stated in its 2014 report on topics related to public finance: “While states may need to tap rainy day funds or seek other short-term solutions during economic downturns, the use of nonrecurring resources to cover recurring costs should be avoided. States shouldn’t balance general fund budgets with proceeds from debt or asset sales, extraordinary legal settlements, or other one-time fixes—such as transfers 3
During the pasts decades the concept of infrastructure has been coined to describe almost any government sponsored project, thus, usually includes projects with small effects on economic growth.
4
Some trends identified in recent literature, include de-globalization, metropolitan areas as development hubs, decentralized political scenarios, local relevance, environmental challenges, generational change, aging and smaller population, among other trends.
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or loans from funds dedicated to specific purposes. They should follow consistent policies for revenue and expense management so that future revenue cannot be shifted routinely into the current fiscal year (or expenses pushed out to the next one) to cover an unbalanced budget.” “Operating budgets should not be funded with the sale of bonds or other forms of debt that provide immediate cash but move the cost of debt service to future years. Even if states are prohibited from using borrowing to cover operating costs, there are ways to get around that prohibition, including shifting money from one fund to another. Governments shouldn’t directly or indirectly treat the proceeds of debt sales as revenue.” (Volcker Alliance, Truth and Integrity in State Budgeting, 2014) Delineating a course of action for the future of development banking in Puerto Rico, requires that the enabling law for such an institution provide a clear mandate that limits undue political influence in the entity. The legislative mandate should also incorporate a commitment to monitoring and evaluation, and sufficient transparency as to guarantee that mistakes such as the ones described above are minimized. Changes in the organizational structure and processes of the GDB are outlined below:
The proposed bank should be organized as a corporate entity separate from central government.
This
will
necessitate
creating
a
new
charter
to
guarantee
independence from political interventions and will entail changes to the bank’s governance
structure
(terms,
stakeholder
representation
and
manner
of
appointment of Board members)
It will merge GDB with EDB. This will facilitate obtaining initial capital for developing banking projects that currently are not undertaken under the EDB or the GDB. The new development bank will be named the Puerto Rico Development and Innovation Bank (PR-DIB). The name highlights the Bank’s mission to be a development oriented bank focused on innovation through its support of emerging technology firms in the various sectors. These two defining characteristics, and the fact that immediate returns are not necessarily the driver of Bank initiatives, differentiate the Bank from the rest of the financial system
The new bank must adapt its financial products to the new trend seen in the private banking sector towards providing private capital for startups and small businesses. Collaboration with private banks will permit leveraging the new Bank’s resources.
Merge Puerto Rico’s Public Private Partnership Authority with the new bank; this provides an additional tool to mobilize private capital for financing projects; will also
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guarantee the PPP authority’s independence, since it will operate under the aegis of the Bank’s independent Board.
To guarantee political independence, the new bank must be self-sustaining. Any initial allocation to fund its operations or, if needed, additional allocations from the Central Government, should be provided with no specific conditions, beyond the rules and regulations already in place and reporting requirements on the use of such funds.
Modify the existing GDB and EDB charters to segregate all financial advisor responsibilities out of the bank, except for a possible role as adviser to municipalities in development finance matters.
Previous GDB functions pertaining to fiscal agent and financial advisor to the Commonwealth, now being handled by AAFAF, should be transferred to a Financial Management Authority to be created. The Authority will share a similar governance structure to that of the new bank, which will guarantee political independence. This entity will exercise an oversight function over all Commonwealth entities.
Transfer the municipal budget and finance division from the Office of the Commissioner of Municipal Affairs (OCMA) to the new Financial Management Authority.
Maintain an Economic Analysis division within the PR-DIB able to provide in-depth sector analysis, needs assessments, financial and cost-benefit analysis and technical assistance to potential clients (feasibility studies, market research, social impacts, etc.).
Assure that the Statistics Institute provides greater transparency to the statistical information related to the government’s financial and operational condition, including PR-DIB operations.
Further analysis is required to determine if the limited public management functions that PR-OMB performs can be transferred to the new financial management authority. It is important to note that current budget functions should be kept within OMB due to its strong relation with public policy, which will be inevitably restricted by a proposed merger. Moreover, the treasury division within Hacienda and other public accounting offices could also be transferred to the proposed financial management agency. This will be somewhat similar to the examples outlined in the Report on Hawaii’s Department of Budget and Finance.
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Changes in the Operational Structure
The Bank must adopt significant risk management policies to securitize its role as development bank, and to safeguard it against losses. For example, the African Development Bank performs stress tests on its private sector portfolio (African Development Bank, 2011). According to the Bank for International Settlements, credit risk exposure continues to be the main source of bank problems worldwide, and thus, a holistic approach to monitoring, assessing and counteracting risks both on and off the balance sheet should be a high priority to ensure the bank’s sustainability (Bank for International Settlements, 2000).
The Bank should assess the viability of engaging in any sort of countercyclical policy program, and ascertain concrete and safe repayment sources so that the impact upon assets does not propagate across long time spans. The strength of the Bank should lie in ensuring long-term availability of credit to sustain capital improvements beyond any short-term fluctuations. Therefore, its participation in temporary expansionary measures should never endanger the Bank’s long-term viability.
The Bank should impose an overall credit limit for a particular client. Continued increases in lending to a particular client, absent significant quantitative and qualitative improvements in the client’s repayment sources and collateral, should be reduced to a minimum. A hard ceiling on the client’s profile would ensure fiscal responsibility and ensure coherence between lending and revenue growth.
Revenue sources other than bond issues should be given preference, since such financing may be costly. According to Brown (2016), “a general rule for government bonds is that they double the cost of projects, once interest is paid.”
Up to date systems and procedures - The bank should have an authoritative database of development projects proposed by central government, municipalities or other state entities, as well as private entities. Moreover, during the past years several reports have highlighted the need of the modern and reliable financial management infrastructure. This pertains not only to GDB, but also Hacienda and OMB. The operational structure of the GDB is an ideal place to start this process. Delving into operational details of the recommended structure is outside the scope of the study, however.
Potential Sources of Funds Perhaps the most difficult task for the creation of the new institution is the matter of providing it with working capital in its beginnings. Although beyond the scope of this report, a number of suggestions can be made concerning this matter:
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A proposal made in the report is for the Board’s composition to reflect stakeholder interest in the Bank. Parallel to having a stakeholder Board, a possibility is for them to invest in the entity either through acquisition of Bank issued notes or, if made possible by legislation, invest in equity in the Bank.
A second proposal would be to allocate future Law 20 and Law 22 fiscal income to the Bank. Thresholds would have to be established for such an allocation. One possibility is to use Fiscal 2016 fiscal income as the threshold and allocate a percentage of excess income over this figure to the Bank.
A third possibility is to pool Bank loans and sell them in the secondary market, although this possibility would still require an initial investment from other sources.
Other sources to consider will include: redirecting deposits from state agencies (include deposits from state-led insurance services and other welfare programs such as driver’s insurance, employment insurance programs, among others) borrow from multilateral financial institutions (i.e. Interamerican Development Bank) and other Federal and international grantors. The proposed bank could follow an innovative approach by developing financial instruments such as diaspora bonds. Diaspora bonds have provided massive resources to small and big countries alike, i.e. Lebanon and some European countries.
Strategically, the proposed bank could initially utilize financing approaches that rely on private funding via collaboration with commercial banks. The EDB’s strategic plan calls for such an arrangement that would permit the EDB to loan to higher risk clients, assuring that the routine banking services such as deposits, letters of credit and other services are done by the commercial bank. If adopted for the new bank, commercial banks would provide financing under a formula to be determined, that could be based on a percentage of profits or some other parameter. This approach will reduce capital requirements for the bank and also leverage resources of commercial banks.
The current capital structure of the EDB could provide some seed capital for the proposed entity. The arrangement mentioned above whereby commercial banks would in effect provide financing for the PR-DIB using an agreed upon formula, would strengthen the PR-DIB capacity to lend to emerging, high risk firms.
Although the Bank should strive to be self-sufficient, an initial investment by the Government will almost certainly be required. Even if the central government provides an initial transfer, by restricting the bank’s ability to borrow from capital markets, it minimizes the Commonwealth’s liability.
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What follows are recommendations on various aspects related to the creation and operation of development banks. The information provided in the tables was derived from extensive literature search, including World Bank publications concerning development banks and from Estudios TÊcnicos, Inc.’s data bases.
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Recommendations for a Development Bank Dimension Vision
Recommendations 1. A well-defined Vision is essential to identify the market niche or niches the Bank should focus on, and to avoid the risk of either competing with the private sector or engaging in unsustainable lending practices. 2. The Bank should expect to be profitable or, at a minimum, financially selfsustainable, and non-reliant on government subsidies or transfers to fund its operations.
Mandate
1. A precise definition and articulation of mandate is necessary. It should, among other things, reduce the opportunities for political interference, and have the commercial and financial sectors clearly understand its role. In Puerto Rico’s case, a clear delimitation of roles between the institution and FAFAA is particularly important. 2. The mandate should make clear that development banks are a form of government intervention in the financial system with the purpose of addressing financial market failures, complementing government resources and market funding. 3. It should make clear that the practice of creating affiliates or subsidiaries in order to bypass financing constraints is unacceptable and that, even understanding that development banks play a social role, underwriting standards must be strict. 4. Bank practices must be consistent with the long-term economic goals of society, and the government's view of its role in providing finance. 5. A broad mandate in terms of sectors is best, as it will provide the Bank with flexibility to finance a wide range of activities and sectors. However, such a mandate will require very effective management. 6. The Bank must operate in consonance with the rest of the economic and financial system, but deal with gaps and unserved needs by the latter.
Scope of activities
Structural requirements (Refers to the functional microeconomic environment needed)
1.
In terms of scope and specialization, it must evaluate the advantages and disadvantages of specialization and a broader scope of services. In general, most DBs provide a broad range of services. Multiple roles have the disadvantage of running the risk of being ineffective and unfocused.
2.
The issue of scope in terms of types of clients is also important. Will the Bank concentrate on SMEs or large enterprises? Experiences vary but most point to an emphasis on disadvantaged firms without disregarding large scale projects that are considered essential.
1.
A developed private commercial and financial sector.
2.
A regulatory environment that supports investment.
3.
A pool of highly trained and competent financial and economic professionals.
4.
Adequate financing sources.
5.
Sound fiscal discipline from the government.
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Recommendations for an Economic Development Bank Dimension
Corporate governance and management
Recommendations 1.
Independence from the government and de-politicization of the bank and of its role is key.
2.
Annual evaluation of corporate and governance problems, and of the methods for achieving objectives, recognizing that market profit might not necessarily be the relevant performance benchmark.
3.
Its mandates should be also reviewed on a regular basis to ensure they operate according to goals and changing economic conditions.
4.
Adopt and implement internationally accepted accounting principles, and independent and timely financial audits.
5.
Transparency in its activities and providing timely information is a critical condition. Data disclosure is important for accountability and is also a public good for the development community, including academics, practitioners, and evaluators.
6.
Put in place a comprehensive risk management process for all risks including risk-modeling techniques for interest rates, credit market, operational risks, long-term payment or returns. The risk assessment unit must report directly to the Board.
7.
The Board of Directors’ primary function should be to provide strategic guidance and oversee management of the institution. IT should be held accountable for performance against previously determined objectives. The Board’s performance should be evaluated annually. If government representatives are appointed, they should be in the minority.
8.
In addition to lending, the Bank should also provide services such as technical assistance, economic and financial information and research results on specific sectors or industries.
9.
Supervisory practices derived from the Basel principles for Banking Supervision (2012) should be put in place. Financial regulation and supervision could be supplemented by market-based measures, such as credit ratings, in this case of the intrinsic quality of the bank.
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Dimension 1.
Financial sustainability
2. "The commercial activities of the bank should be financially sustainable. Financial sustainability protects the government against losses, ensures that the bank makes better use of scarce resources, assists it in raising funding at a lower cost, safeguards its independence and through demonstrating that investment in developmental projects may be profitable, attracts private investment." (J. Thorne, 2006, pp. 26 27)
3.
4.
5. 6.
7.
8.
1.
2. Performance assessment
3.
4.
Recommendations In general, there are two traditional ways in which state banks obtain funds, some of which the GDB has used: (1) direct origination, that is, its ability to autonomously originate debt or equity; (2) indirect origination, through which it create incentives to stimulate other financial intermediaries to originate loans, guarantees, provision of long-term funds, related to government targeted investment projects, companies, or industrial sectors. (E. Torres and Z. Zeidรกn (2016). The Bank could also borrow from private financial institutions. The Bank could act as a depository agency and provider of banking services for all agencies as a means of generating liquidity. This has obvious limits as recent experience in Puerto Rico has shown. After its initial funding, the Bank should strive to be a self-supporting entity that pays for its operations from service fees and interest earnings on loans and investments Explore the possibility, like the Bank of North Dakota reviewed in the Report, of the bank borrowing at the Federal Reserve's discount window. This will, of course, require that certain Fed requirements be met. The Bank should have broad but well-defined and regulated statutory authority to issue tax-exempt and taxable revenue bonds. As part of the financial system the Bank ought to limit itself to funding of those activities in which it has a "comparative advantage" (Better understanding of high-risk markets and in-depth knowledge of the clients of these markets), and mobilize whenever possible private-sector cofunding of its projects through diverse mechanisms or instruments. That way private sector banks might be more willing to expand into funding of high-risk projects and sectors. The bank should consider equity investing in order to overcome the problems of limited collateral and limited cash-flow during the early development of firms considered to have growth potential or that serve a particular need in the economy. An example could be a firm developing an enabling technology that will generate major positive spillovers. Assuring the financial sustainability of a development bank is complex, particularly if subsidies to the institution are to be avoided. Higher bank interest rates could support financial sustainability but could, at the same time limit its role in stimulating investment. The contribution of the bank should be measured through social aspects, such as the value of the service to clients, cost, number of clients, and also financial metrics, such as the traditional standard ratios that are typically used in the banking sector. A critical component of performance evaluation is the need to assure that corrective measures are implemented when needed. All loans, grants, and other activities should be subject of and impact analysis to determine the effect of the activity on economic development. This is useful in determining priorities. Good evaluation practices require input from various parties, which can include staff, senior management, clients, and external organizations. There is no single best standard, type, or system of evaluation; rather, there is a wide spectrum of evaluation methodologies that employ different degrees of rigor depending on the objective, purpose, and subject of evaluation.
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Introduction The concept of a bank is usually equated to a private institution whose sole purpose is to maximize profit, increase deposits and provide financing services. Yet, the concept of a development bank, a very different institution, permeates economic literature as an essential institution with multiple policy functions5. Multilateral institutions such as the World Bank, for instance, provides financing but also dictates policy conditions through their lending. There are several other financial institutions that have one or more characteristics that reflect a public orientation in their daily activities, including coops, community banks and others.6 Government led financial institutions continue to flourish around the world. These institutions include general 7 development banks, infrastructure banks, agricultural development banks, rural financing agencies, export credit guarantees, SME oriented development banks and even green banks, the most recent development in the UK8. In Puerto Rico, the concept of a government bank is even broader. It resembles that of a non-Anglo-Saxon tradition where the state leads economic activity via certain public institutions and financing mechanisms. This concept is usually confused with monetary policy institutions (such as central banks9) at a national or supra-national level, however, this group of institutions has a greater role in regulation, policy prescriptions and overall financing instruments in the economy10. The GDB started as a bank that not only financed infrastructure projects, but also some projects considered necessary for modernizing the economy. Over the years, private actors started developing major infrastructure projects with GDB financing. However, the definition of infrastructure became more lax and the GDB financed hotels and even shopping centers. Thus, the GDB became one of the main tools used by the state to stimulate investment in certain sectors. The Bank and its programs such as the TDF, were part of the package offered by the government when new investments were promoted. This change in the final recipients of state financing was partially determined
5
For instance, one of the mayor lenders in the world is the World Bank.
6
In the U.S. there is a limited number of public banking institutions or development banks at a state level.
7
Refers to entities with a broader legal mandate, such as “to promote economic development and support the financial needs of a nation�
8
United Kingdom Green Investment Bank
9
Typically, central banks establish policy prescriptions to stabilize the internal and external value currency and create sound monetary policy.
10
The duties and responsibilities of a central bank, must not be equated with those of a public bank or a public lending institution.
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by the need felt by the Government to complement the traditional incentives offered through PRIDCO for manufacturing activities.. Over the past decades the GDB has provided the government of Puerto Rico with a safety net, particularly, during times of slower economic growth. More recently, the bank has “endured” a global financial crisis, a local recession and severe fiscal constraints. Due to the Bank’s close links with the central government, the institution has not been able to act independently from political decisions and thus, has lost the credibility it once enjoyed. Being a central government institution that provided relatively low cost capital, other state entities utilized the bank to finance “operational” expenses, rather than productive investments. It is this same relation between government and the Bank that requires coordination. The bank supported the central government with technical advice and acting as fiscal agent on issues related to public debt and state financing (now handled by the AAFAF) with economic development issues assuming secondary importance. This conception does not operate in a historical vacuum. The dirigisme dogma of the post-war era or the central role of the state in economic activity caused an increase in the use of development banks as a policy tool throughout the industrialized and nonindustrialized world. Puerto Rico’s experience resembles that of this last group of countries, as the GDB, as mentioned, was conceived as an instrument to support the industrialization of Puerto Rico, including complementary activities. The GDB financed the construction of the Caribe Hilton, the first modern hotel in Puerto Rico, promoted by the economic development agency as a necessary infrastructure for attracting investment.
More recently, with the 2008 financial crisis and its subsequent credit
crunch, development banks have become more relevant across the world. The rationale for the existence of the GDB and other public financial institutions in Puerto Rico goes beyond the present fiscal crisis and the need to move beyond the current default scenario. There is a bigger question that precedes the current crisis and needs to be answered taking into account a wider set of social and economic variables; Does Puerto Rico need a public financial institution that is able to operate under market conditions? Should the GDB exist? If so, in what form, for what purpose? This report will examine these questions and tries to provide evidence to support the notion that given the Island’s stage of development, a development bank is imperative for long-term sustainable growth. That is, rather than weakening the GDB, one should seek initiatives on how to strengthen the institution, and establish strong mechanisms to guarantee a credible entity within Puerto Rico’s current economic policy portfolio. To dissolve the GDB without a substitute entity is to cross out one of the few economic development
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tools that can support the economy in recessionary periods and promote sustainable development. Moreover, as many other state and local governments around the world, the local economy has been under strong pressure due to decreased tax revenues, a result of the slow economic growth of the past decades and a severe contraction since 2006. The GDB’s current situation and the fiscal stresses of today are inevitably the sum of past practices that deferred current costs to a future generation. These practices are not unique to the Bank or attributed entirely to it, but rather were dependent to a great extent on decisions of other Commonwealth agencies and actors. Thus, the future of the GDB is contingent on the institutional transformation of the entities that have had direct influence on the Island’s economic development, directly or indirectly. In the following sections, this report will provide recommendations on aimed at strengthening the GDB, or a successor entity, in its role as a development bank, how to insulate the institution from undue political interference, promote the development of a self-sustainable organization and how to adopt innovative governance arrangements.
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UNDERSTANDING THE BASICS: THE CONCEPT O F DEVELOPMENT BANKS
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Development Banks: The International Experience After the Second World War, in response to the post-war economic realities and needs, the establishment of government-owned financial institutions took an impulse, in particular that of development banks and development-related institutions, both at the national and regional levels. State financial institutions 11 (SFI) comprise commercial banks, postal banks, insurance companies, credit guarantee funds, and development banks (DBs).12 Central banks are not considered SFIs given their objectives and functions. Between 1946 and 2011 88.0% of the DBs currently in existence were established.13 The Government Development Bank of Puerto Rico precedes by about a decade the growth in state financial institutions (SFIs) in Latin America and the developing world, during the Post-Second World War period. The creation of the GDB and the Puerto Rico Industrial Development Corporation, were highly influenced by the institutional experience of the U.S. with the Reconstruction Finance Corporation (RFC)14. The RFC was organized by Herbert Hoover in 1932 to bail out the banking system and its long term debt, mainly railroad bonds. Hoover, did not attempt to expand the use of the facilities of the RFC and failed to restrain the approaching depression, nor save the banking system. That endeavor came with the advent of Roosevelt’s New Deal. His conception was that the RFC could be used as a primary lending institution. That is, to issue credit at a low cost to develop infrastructure, machine-tool-design machinery, manufacturing, and agriculture. In 1948, the Puerto Rico Industrial Development Corporation (PRIDCO) used the lending facilities of the RFC to provide financial assistance to the industries it promoted (Bolivar 2011, p.96). The RFC was dissolved in 1956. A large number of studies were completed that established the analytical bases for development banking. Among the intellectual promoters of the idea, Alexander Gerschenkron is most often mentioned.
Among his most common citations is that
related to the subject of when the state should play a key role in the banking sector:
11
These SFIs generally encompassed two categories: the Development Financial Institutions (DFIs), that perform financial activities but are not depositary entities and, the National Development Banks (NDBs) that are depositary entities. [This classification (Scott 2007) is generally the conventionally adopted.]
12
José de Luna Martínez and Carlos L. Vicente (2012). Global Survey of Development Banks. The World Bank, Financial and Private Sector Development, Policy Research WP 5969 (February), p. 2. At: http://elibrary.worldbank.org/doi/abs/10.1596/1813-9450-5969.
13
José de Luna Martínez and Carlos L. Vicente (2012), p. 11.
14
The material on the Reconstruction Finance Corporation (RFC) is sourced from: Freeman, R., Reconstruction Finance Corporation: How Roosevelt’s RFC Revived Economic Growth, 1933-45, EIR Economics, March 17, 2006.
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Supply of capital for the needs of industrialization required the compulsory machinery of the government, which, through its taxation policies, succeeded in directing incomes from consumption to investment… The amount of waste that accompanied the process was formidable. But, when all is said and done, the great success … is undeniable… the policies pursued by the Russian government in the [eighteen-] nineties resembled closely those of the banks in Central Europe. (Gerschenkron 1962) The financial crisis and the Great Recession of 2008 shed new light on the discussion of the role of development banks. In spite of the wave of privatizations of state-owned financial institutions (SFIs) that has taken place over the past 30 years, SFIs still constitute an important part in the financial system. On average, they account for 25% of total assets in banking systems around the world. In the European Union, for example, SFIs represent 30% of the total financial system .In the so-called BRIC countries alone – Brazil, Russia, India, and China – the market share of SFIs is substantial.. During the global financial crisis of 2008-2010, most DBs played a countercyclical role by providing credit to private firms that were temporarily unable to access funding from private commercial banks or capital markets 15 . At the same time, the financial crisis has restarted new debates on their role and efficiency, as the role of the state in the economy has been increasingly debated. The role of central banks has also become a focal point of interest to governments and those outside government structures in recent years. That interest has been stimulated as a result of the financial crises experienced globally, as to how they have performed their assigned tasks in handling the crises, and as a consequence of the increased attention given to the approaches to economic policy and the role they have in fulfilling it.16 Although central banks do contribute to economic development their role, compared to DBs is reduced. The purpose of this chapter is threefold: One, to provide a background on the nature, characteristics, types, and role of development banks and central banks, in particular of the former; (2) their importance and the institutional frameworks that exist or are needed for their functioning, and; (3) a benchmarking exercise with other jurisdictions
15
José de Luna-Martínez & Carlos Leonardo Vicente Global Survey of Development Banks, the World Bank, February, 2012 .
16
Fabian Amtenbrink (2004). The Three Pillars of Central Bank Governance – Towards a Model Central Bank Law or Code of Good Governance. University of Groningen, The Netherlands. P. 1. At: https://www.imf.org/external/np/leg/sem/2004/cdmfl/eng/amtenb.pdf.
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that served to identify best practices. At the end some conclusions are derived that will serve for policy recommendations.
Central Banks A central bank is a banker's bank. It is normally part of or connected to the government of a country and manages the country's financial system. Nearly every country in the world has a central bank. Central banks from emerging markets have a wider range of functions than those in developed countries. The Federal Reserve Bank, or Fed, is the central bank for the U.S. Its main functions are:17 1. Typically, its primary function is to control a nation’s money supply (monetary policy) and acting as a lender of last resort to the banking sector and the government, and it issues currency. 2. In the case of currency management many countries outsource the retail management of currency circulation, retaining only the wholesale functions associated with the distribution of new notes, and also the printing of notes. 3. Although almost all central banks act as the government’s bankers, they do so with varying degrees of responsibility. Some do provide extensive account management services, others a minimum. 4. Central banks affect economic growth by controlling the liquidity in the financial system, and through the setting of targets on different interest rates. They set interest rates to target low inflation and maintain economic growth. As well as low inflation, a Central Bank will consider other macroeconomic objectives such as economic growth and unemployment. This objective, though, is not always in agreement, as there are trade-offs concerns “between the allocative and dynamic efficiency of financial intermediation, and cutting interest rates with the concern about prospective inflation pressures.”18 5. Use other monetary instruments to achieve macroeconomic targets. For example, in a liquidity trap, lower interest rates may be insufficient to boost spending and economic growth. In this situation, the Central Bank may resort to more unconventional monetary policies such as quantitative easing. This involves creat-
17
David Archer (2009), Roles and Objectives of Modern Central Banks, in Issues in the Governance of Central Banks, Bank for International Settlements, Central Bank Governance Group, (May 18), ch. 2. Geneva. At: http://www.bis.org/publ/othp04.htm.
18
David Archer (2009), p. 20.
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ing money and using this money to buy bonds; the aim of quantitative easing is to reduce interest rates and boost bank lending.19 6. When the central government expenditures exceeds government revenues and the government is unable to reduce its expenditure, it borrows from the central bank. This is called monetization of budget deficit or deficit financing. . 7. Governments keep their cash balances in the current account with the central bank. Similarly, central banks may make payments on behalf of the governments. 8. Central banks have also assumed an economic development function, both directly and through the banking system, by subsidizing the financing of economic sectors targeted by the government, or giving preferential treatment in the direct provision of banking services, especially of capital and trade financing to enterprises in targeted sectors.20 But, in general, in terms of their objectives, much greater emphasis is given to monetary policy objectives and those related to financial stability. 9. With respect to debt management, not all central banks have this function. In those cases in which they are involved, it is a partial involvement or a shared responsibility requiring a great degree of consultation with other entities.21 Although central banks have had a strong policy interest in public debt management, the widespread adoption of the practice of governments borrowing entirely on open markets, at market rates, has established a separation of government funding and central bank liquidity management. Many countries have established specialized debt management offices, either attached to the ministry (department) of finance or as independent agencies. Few central banks act as the government’s debt manager.22 Commercial banks provide banking services to businesses, institutions and individuals and use central banks as the depository of their cash and, in many countries as clearing house.. Usually a country's commercial banks have accounts at the central bank and occasionally borrow from it to offset any temporary shortages of cash.
19
Economics (2016), Quantitative Easing Definition. At: http://www.economicshelp.org/blog/1047/economics/quantitative-easing/
20
David Archer (2009), p. 20.
21
David Archer (2009), p. 29.
22
David Archer (2009), p. 45.
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Central banks serve the country's banking system, providing money transfers between banks and governmental institutions both domestically and in cases of transactions with foreign entities. They manage the monetary policy of their respective countries through their operations, that establish interest rates. They typically regulate commercial banking activities.
Development Banks The history of national development banks goes back to the beginning of the Industrial Revolution in Europe, in the form of Industrial or Credit Banks established to support industrialization.23 In the United States it started in the late 19th century in a somewhat different way, at the State level through private “Merchant Banks” or “Industrial Banks”. 24 After the Second World War a new generation of development banks appeared. The most important ones were those in Brazil, Germany, Japan and South Korea. There is no precise definition of a development bank.25 Fundamentally, a development bank is a term-lending institution focusing on long-term financing to projects that foster development. It is essentially a multi-purpose financial institution with a broad development outlook. Development banks may be publicly or privately-owned and operated, although governments frequently make substantial initial contributions to the capital of those that operate as private banks. A development bank may be defined as a financial institution concerned with providing types of financial assistance (medium as well as long-term) to business units, in the form of loans, underwriting, investment and guarantee operations, and promotional activities — economic development in general, and industrial development, in particular. They are financial intermediaries that specialize in providing long-term credit—usually subsidized—to promote industrialization or infrastructure projects.26
23
According to Sergio Lazzarini et.al., “despite their size and importance there are few studies examining their behavior in detail.” Sergio Lazzarini, et.al. (2014), What Do State-Owned development Banks Do? Evidence from BNDES, 2002 – 2009, p, 4. At: http://www.hbs.edu/faculty/Publication%20Files/What%20Do%20Development%20Banks%20Do%20Aug%208%20201 4%20FINAL_6f822fc1-73b1-4a78-8b5c-5d041739b6a2.docx.
24
The first national development bank in the U.S. was the War Finance Corporation, created by the Federal government in 1918 to give financial support to industries related to the war effort. It was liquidated in 1925. In 1932 it was recreated under the Roosevelt administration as the Reconstruction Finance Corporation, targeting investments in infrastructure, agricultural loans, and export financing. Both institutions were financed through the issue of bonds. In 1956 it was dissolved.
25
United Nations (2005). Rethinking the Role of National Development Banks. Department of Economic and Social Affairs, New York. Pp. 5 – 6. At: http://www.un.org/esa/ffd/msc/ndb/NDBs-DOCUMENT-REV-E-020606.pdf
26
Beatríz Armendáriz de Aghion (1999), “Development banking,” in Journal of Development Economics 58 (1999), p. 83. At: http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.177.4329&rep=rep1&type=pdf.
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Their funding usually comes from various sources: savings, domestic bond issues or bank loans, issuing debt against income generating assets, offering credit-enhanced securities to domestic investors, from multilateral financial organizations (such as the Inter-American Development Bank and the World Bank), or syndicated loans. Syndicated loans have become a significant source of financing for emerging economies. The international market (i.e. for deals with one foreign lender) accounts for a third of all international financing, including bond, commercial paper and equity issues in today’s development banking sector.27 There are different types, and like private banking institutions they can specialize or concentrate in one particular sector or activity: agriculture and rural development, industrial, housing, enhancing foreign trade (Like the U.S. ExImbank), entrepreneurship development, and contribute to the growth of capital markets by investing in equity shares and debentures of companies. There are also, at the regional level, financial institutions that provide financing for national development, known as a multilateral development bank (MDB). Examples of these are the World Bank, or regional banks, such as the Inter-American Development Bank, or the Caribbean Development Bank (CDB), which is a sub-regional MDB.28 29 The regional bank is formed by a group of countries, consisting of both donor and borrowing nations. It also offers advice regarding development projects. A majority are State-owned but there are different models. Some have their resources drawn from a special account in the Central Bank or Ministry of Finance, some have mixed national, foreign and multilateral ownership; some are private entities, a result of privatization since the 1980s, in view of their poor results. In developed economies there is also a wide variety of ownership, a mix of public and private banks. Some are second-tier banks (Prohibited from using public deposits for lending to the private sector), providing financial services to foreign trade companies and small businesses. In the U.S. there exists the Ex-Imbank, an entity of the federal government.30
27
U.N. (2005), p. 21.
28
See Stephany Griffith-Jones, D. Griffith-Jones and D. Hertova (2008), Enhancing the Role of Regional Development Banks, UNCTAD, G-24 Discussion Paper Series (July 2008). At: http://unctad.org/en/Docs/gdsmdpg2420081_en.pdf.
29
In 1986 the State Department of Puerto Rico started preliminary negotiations with the CDB for the possible incorporation of Puerto Rico to the Bank. In 1987, following these negotiations, the GDB requested from La Fortaleza the establishment of the public policy with respect to P.R.’s incorporation to the CDB. Since the GDB was not authorized by law to invest in obligations of the CDB, it was also needed to proceed through legislation. The initiative had the support of the U.S. State Department. The proposal was not followed through. Memorandum of William Lockwood Benet to Amadeo I. D. Francis, Assistant Secretary of State (October 24, 1989).
30
U.N. (2005), p. 8.
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Development Banks have diversified their operations to include such areas as advisory, consultancy, and training services, working capital and bridge financing, privatization design and implantation.31 The main characteristics of development banks include: 1. It is a specialized financial institution. 2. It provides medium and long-term finance to business units. 3. Unlike commercial banks, it does not accept deposits from the public. 4. It is not just a term-lending institution. It is a multi-purpose financial institution. 5. It is essentially a development-oriented bank. Its primary object is to promote economic development by promoting investment and entrepreneurial activity in a developing economy. It encourages new and small entrepreneurs and seeks balanced regional growth. 6. It provides financial assistance not only to the private sector but also to the public sector undertakings. 7. It aims at promoting the saving and investment habit in the community. 8. It does not compete with the normal channels of finance, i.e., finance already made available by the banks and other conventional financial institutions. Its major role is of a gap-filler, to fill up the deficiencies of the existing financial facilities. 9. Its motive is to serve the public interest rather than making profits. It works in the general interest of the nation. One key characteristic is that much of their lending is done to private firms. They are financial institutions dedicated to fund new and emerging businesses and economic development projects by providing equity capital and/or loans. Development banks provide capital to companies and organizations when raising money for ventures is difficult, particularly in countries where investment capital tends to be scarce. National development banks provide an important alternative to companies and projects that find it difficult to raise funds. These financial institutions thus solve capital market imperfections that would otherwise undermine the development of a new entity or innovation. 31
Ernani Torres and Rodrigo Zeidan (2016), “The life-cycle of national development banks: The experience of Brazil’s BNDES,� The Quarterly Review of Economics and Finance 62 (2016), p. 97. At: http://www.sciencedirect.com/science/article/pii/S1062976916300539.
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Supporters of development banks 32 typically view them in the context of Industrial policy, a concept not universally accepted. Those favoring a proactive industrial policy that targets specific sectors tend t look at development banks as playing a more active role in development. Financing of “basic industries”33, seen as necessary for industrial development is a typical activity that includes energy and transportation projects. Nevertheless, there is another group of authors who argue that rent-seeking behavior permeates the structure of development banks. Particularly, companies request subsidized loans or cheap credit for projects that would be normally funded using private sources of capital34. This assertion would depend on specific bank’s lending and underwriting practices.35. During the past several years, the emerging models of development banking that are arising are: (1) the banking model policy that calls for providing direct financing through government-supported development banks, with government capital; (2) the universal banking model where a development bank provides long-term financing plus advisory services through investment and commercial banks, and; (3) the “standard” development
bank
approach
that
provides
development
finance
through
independent development banks, whose capital is internally sourced with little or no support from the government.36 Performance The literature on the performance of development banks is substantial. Although there is no consensus on their overall benefits, evidence from various researchers suggests that “past performance of development banks, has generally been considered poor and the value of state ownership questioned. There are few institutions that achieve the optimum balance of effectively addressing a policy objective while being financially sustainable.”37 In their work focused on development bank performance, Levy et.al. (2005) found that: 32
Well-known figures include Harvard Professor Dani Rodrik and the institutional economist A. Amsden.
33
Development banks lend money for the construction of new buildings and public projects, as well as to companies that are seeking outside sources to fund a new venture or business initiative.
34
S. Lazzarini, A. Musacchio, R. Bandeira-de-Mello, R. Marcon, What Do Development Banks Do? Evidence from Brazil, 2002-2009; Harvard Business School, 2011.
35
Id. Authors developed an empirical analysis of the effects of the Brazilian Development Bank on private firms. This subject is usually charged with politicized views from both the left and right groups.
36
Association of Development Financing Institutions in Asia and the Pacific (2016). Development Banking Primer, pp. 3 - 4. At: http://www.adfiap.org/wp-content/uploads/2009/10/Development-Banking-Primer.pdf.
37
Eva Gutierrez, H. Rudolph, T. Homa and E. Blanco (2011). Development Banks: Role and Mechanisms to Increase their Efficiency, IBRD (January). At: http://elibrary.worldbank.org/doi/abs/10.1596/1813-9450-5729
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(a) state-owned banks located in developing countries are characterized by lower profitability than comparable privately owned banks; (b) there is no evidence that the presence of state-owned banks promotes economic growth or financial development; and (c) the evidence that state-owned banks lead to higher growth and financial development is not as strong as previously thought. The paper concludes that we still do not know enough to pass a final judgment on the role of state-owned banks and hence more research is needed.38 A similar finding with respect to public sector banks is mentioned by G. Caprio et.al. (2004), when in their review of various studies on the subject they concluded that “with rare exceptions, public sector banks have performed poorly by conventional financial measures, such as returns on equity or assets, and a greater number of nonperforming loans.”39 These and other patterns, according to the authors “account for the negative relationship between economic growth and state ownership of banks.”
40
They
recommend that “development banks should be managed more soundly, and restrict their activities to sectors in which the social returns from extending credit exceed the private returns.”41 The above criticism, seems to put aside one characteristic of development banks, that is, they are institutions that, given their objectives, assume greater risks than commercial banks. Also that development banks are needed to help fund sectors or activities where important externalities exist, implying that social returns are higher than market returns; this is, for example, the case with environmental externalities or those arising from improved educational services in key areas.42 This criticism goes to the issue of the concept of profit, which is different in the context of a development bank from that of a commercial bank, the key difference being that a development bank is created as economic development instrument, while a commercial bank is created to take advantage of business opportunities.43
38
Eduardo Levy, Alejandro Micco and Ugo Panizza (2005), State-Owned Banks: Do They Promote or Depress Financial Development and Economic Growth? Center for International Development, Harvard University. At: http://www.cid.harvard.edu/Economia/Mexico06%20Files/Levy%20Yeyati%20Paper041706.pdf
39
Gerard Caprio, J. Fletcher, M. Pormeleano, and R. Litan (2004), The Future of State-Owned Financial Institutions, Brookings Institution (September 1), p. 2. At: https://www.brookings.edu/research/the-future-of-state-ownedfinancial-institutions/.
40
Gerard Caprio, J. Fletcher, M. Pormeleano, and R. Litan (2004), p. 2.
41
Ibid. (2004), p. 10.
42
Op. cit. Stephany Griffith-Jones (2015).
43
Association of Development Financing Institutions in Asia and the Pacific (2016), Development Banking Primer, p. 4.
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Still, there are certain aspects that have characterized development banks in terms of costs. For instance, the main costs are related to the opportunity costs of the government of funds used in subsidizing long-term credit, either through direct or indirect mechanisms, plus the direct costs associated with the operation of the bank. Also, other relevant costs are those related to general banking risks, augmented by the very nature of development banks,, crowding out effects (if credits are cheaper than the market), and the evidence that government control over the banks leads to significant political pressures.44
Importance of the institutions in periods of fiscal constraints 45 Development Banks Development banks (DB) are important for two key reasons. First, by mobilizing broader financial resources, the leverage that public contributions through paid-in capital can have, is significant. DB lending can be funded in the private markets, and such DB lending can be co-financed by private lending and investing.46 Secondly, development banks provide counter- cyclical finance as private finance declines, as during the global financial crisis of 2008 - 2010. This happened not just in developing and emerging economies, but also in several developed ones, as more traditional financing sources, such as public expenditure and private bank lending had fewer resources available. Even if domestic banks and other financial intermediation vehicles could fill the gap, development banks can draw private capital into large long-term projects perceived by the market as high-risk. Furthermore, where the national development banks have relatively significant size, their counter-cyclical impact has been relatively larger. Governments recognized the need for a countercyclical source of finance that would continue to provide finance to firms during recessionary times. Several of them turned to national development banks – government-owned banks that are tasked with addressing market failures in the financial system, not without risks. Being supported by the government, they are able to provide countercyclical funding, assisting firms at exactly the time that private banks are forced to curtail their lending.
44
E. Torres and R. Zeidan (2016), p. 100.
45
Stephany Griffith-Jones (2015), “The positive role of good development banks,� Third International Conference on Financing for Development (May 20, 2015). At: http://www.un.org/esa/ffd/ffd3/blog/positive-role-developmentbanks.html.
46
Ibid. (2015).
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By facilitating financing for healthy and growing companies, in particular through longterm engagements, partnering institutions also reduce the perception of political risk and facilitate future syndications with private commercial banks.
Institutional structures and conditions needed to run development banks Development banks Macroeconomic stability is a prerequisite for the development of the financial system, as instability increases the risks associated with finance, especially long-term finance. This negatively affects both the price and the availability of such finance. Traditionally underserved market segments are even less likely to obtain funding in a volatile macroeconomic environment. Stability is also crucial for development banks, particularly if they are exposed to currency risk. Development banks are less likely to raise sufficient funds on the capital market or leverage co-finance from the private sector during periods of macroeconomic instability. Critical elements of macroeconomic stability include the following:47
Sound fiscal discipline
Balanced economic growth
Balance of payments stability
Price stability and limited external and internal price distortions
The absence of financial repression
Development banks have also proved unable to succeed without a reasonably functional microeconomic environment with proper regulation. Critical structural requirements include the following:48
Precise definition of the mandate of the development bank, that should, among other things, reduce the opportunities for political interference
Efficient resource allocation in the economy
A regulatory environment that supports investment
47
Janine Thorne (2012). A framework for successful development banks. Development Bank of Southern Africa, development Planning Division, WP 25. Pp. 7 – 9. At: http://www.dbsa.org/EN/AboutUs/Publications/Documents/DPD%20No25.%20A%20framework%20for%20successful%20development%20banks.pdf. This is in the case of independent economies. For Puerto Rico, even when some of the above criteria is relevant, one should add that conditions and the regulatory federal framework do have an impact.
48
J. Thorne (2012), pp. 8 – 9.
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Sufficient industrial capacity
Appropriate and well-maintained infrastructure
A developed private financial sector
Adequate competition and market discipline
Sufficient skills in the economy, including management skills
Reasonable levels of technological development
To the above we should add adequate financing sources.
Experience in the US The experience in the states of a state-owned bank has been very limited. In 2012 there were several bills and resolutions pending in 15 states to study establishing a state bank or investment trust, but none prospered.49 So far, there is only one state-owned bank, in North Dakota, the Bank of North Dakota, founded by the North Dakota Legislative Assembly, but there is another financial institution sponsored by the state, the California Infrastructure and Economic Development Bank, which is more of an infrastructure bank. The latter seems to be somewhat closer to P.R.’s experience.50 State Banks The Bank of North Dakota51
It was established in 1919 to provide financing to farmers but has grown to offer other small business loans and student loans. The main objective is for the bank to serve as an economic development tool. It is overseen by the governor, the attorney general, and the agriculture commissioner, while the legislature sets its budget. Some typical functions include:
Partner with smaller, local banks throughout the state on various loan programs. In a typical transaction, a smaller bank would originate a loan, and BND could guarantee part of it or buy down the interest rate. The effect is that a business loan that might otherwise not have been made – or that might have only happened at a high interest rate -- can be offered at a reasonable price.
49
National Conference of State Legislatures (2013). State-Owned Financial Institutions 2012 Legislation. At: http://www.ncsl.org/research/financial-services-and-commerce/state-owned-financial-institutions-2012-legis.aspx
50
P. Lemov (2012). “The Case for a State-Owned Bank.” Governing (April 12, http://www.governing.com/columns/public-finance/col-case-state-owned-bank-north-dakota.html.
51
Bank of North Dakota (BND), https://bnd.nd.gov/.
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2012).
At:
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It also does business in the state's secondary mortgage market, acting as a buyer and servicer of residential loans originated by other banks.
The Bank does offer savings and checking accounts to consumers, but that line of business makes up a small portion of the bank's portfolio. It also provides financing to improve medical facilities, remodeling or construction of new schools, and build new road and water infrastructure.
It serves as the depository agency and provider of banking services for all North Dakota agencies, and is the state’s Automated Clearing House. It originates ACH payments, process payroll files, accounts payable files and move money electronically. The North Dakota Legislature will appropriate funds from BND when needed through the budget process or state law.
Over 70.0% of the Bank’s earnings go to the state’s general fund.
It lacks federal oversight, its loans are not insured by the FDIC, and its staff members are considered state government employees.
The main difference with other development banks is that it takes deposits from individuals and state tax revenues, and in turn, makes commercial loans. Thus, it is perceived as a competitor to private or commercial banks, but it can purchase all or part of a bank’s loan after it has been issued and do other financing arrangements. In 2015 it had a net income of $131.0 million, with $7.4 billion in assets, from $4.0 billion in 2010. The loan portfolio amounted to $4.3 billion, and had $2.5 billion in public deposits. Their total home loan portfolio was $694.0 million.52 The bank has likely benefited more from successful lending, lower costs, and its tax-exempt status. The California Infrastructure and Economic Development Bank (IBank)
The California Infrastructure and Economic Development Bank (IBank) was created in 1994 to finance public infrastructure and private development.53
It is a self-supporting governmental entity that pays for its operations from service fees and interest earnings on loans and investments, and does not makes commercial loans and taking deposits. Is located within the Governor's Office of Business and Economic Development, and is governed by a five-member Board of Directors. The Governor appoints an Executive Director to manage the Bank. It has broad statutory authority to issue tax-exempt and taxable revenue bonds,
52
BND (2016). Financial Statements December 31, 2015 and 2014. At: https://bnd.nd.gov/annual-report/
53
California Infrastructure and Economic development Bank (IBank), http://www.ibank.ca.gov/ibank/About-Us.
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provide loans to state and local governments for public infrastructure and economic expansion projects and loan guarantees to help small businesses.
Its Bond Financing Program provides tax-exempt and taxable conduit revenue financing through low interest rates, long-term financing and flexible terms.54 The types of bond financing offered are tax-exempt financing to eligible nonprofit benefit corporations for the acquisition of facilities and capital assets, industrial development bonds, exempt facility bonds for projects that are governmentowned or consist of private improvements within publicly-owned facilities, and bond financings for various State entities and programs.
In the case of infrastructure, it finances a wide range of projects, excluding housing. The Infrastructure State Revolving Fund (ISRF) Program, a direct loan program, was originally funded with seed money from the State’s General Fund in the late 1990’s and early 2000’s. ISRF loans are currently funded with the proceeds of taxexempt ISRF revenue bonds.
It also provides loans to small business through its Small Business Loan Guarantee Program. The funds can be used for a variety of needs, including start-up costs and new construction.
It does not receive deposits from the state. California deposits its tax revenues in large commercial banks, as there has been strong opposition from the private banking sector to allow it.
Since its creation it has financed nearly $37.0 billion in infrastructure and economic expansion, and provided $500.0 million in low-cost loans for infrastructure to State and local governments. Has issued more than $36.0 billion in bond financings. The U.S. Virgin Islands Economic Development Bank55
It was created in 2014 through the merger of the Government Development Bank and the Small Business development Agency. It is a semi-autonomous government organization comprising five entities with the purpose of unifying and maximizing economic development of the Territory, and is part of the Economic Development Authority. The institution provides financial and technical assistance to local businesses through various loan programs which channels access to capital for small and medium-sized
54
As a conduit issuer, the Bank issues bonds on behalf of a borrower and then lends those proceeds to that borrower. The borrower provides security to the bondholder and agrees to repay the bonds.
55
VIEDA, http://www.usvieda.org/about-vieda/divisions/economic-development-bank.
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business. The loans can be used to start or expand a business, working capital, acquire inventory, equipment, materials and supplies. It offers tax incentives, a reduction of up to 90.0% of personal and corporate income taxes and up to 100% exemption on excise, property and gross receipt taxes. It is funded through the USVI’s State Small Business Credit Initiative Program. According to its most recent financial report (For 2014), its loan portfolio amounts to $4.9 million, with a delinquency rate of 54.5%.56 Federal Institutions The Federal Financing Bank
Outside the Eximbank, whose main purpose is to provide financing to the exports of goods and services of US companies, there is the Federal Financing Bank (FFB).57 It is a US government corporation created by Congress in 1973, under the supervision of the Secretary of the Treasury. The FFB was established to centralize and reduce the cost of federal borrowing, as well as federally assisted borrowing from the public. Also, to deal with federal budget management issues, this occurred when off-budget financing flooded the government securities market. Essentially multiple offers of a variety of government-backed securities were competing with Treasury securities. Its main functions and characteristics are:
The Federal Financing Bank (FFB) is a government corporation that functions under the general supervision of the Secretary of the Treasury. Part of the Department of the Treasury, the Federal Financing Bank (FFB) seeks to reduce the cost of federal borrowing.
Created during a period of competition between government-backed and Treasury securities, the FFB maintains the authority to purchase any financial obligation issued, sold or guaranteed by a federal agency to ensure that these obligations are financed appropriately. The Bank borrows from Treasury and lends to Federal agencies and to private borrowers that have Federal guarantees.
It was established to be the vehicle through which Federal agencies finance programs involving the placement of credit market instruments, including agency securities, guaranteed obligations, participation agreements, and the sale of assets.
56
VIEDA, 2014 Annual Report, pp. 36 – 37. At: http://www.usvieda.org/about-vieda/annual-reports.
57
AllGov. (2016), http://www.allgov.com/departments/department-of-the-treasury/federal-financingbank?agencyid=7260; Federal Financing Bank (2016), https://www.treasury.gov/ffb/.
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The FFB was established to centralize and reduce the cost of federal borrowing as well as federally-assisted borrowing from the public. Much of the FFB’s work is off budget, which has led some to nickname the institution a “ghost bank.” The Bank has a broad authority to purchase obligations issued, sold, or guaranteed by Federal agencies. The FFB has helped finance a wide array of government operations, from agricultural to military programs.
To lower the borrowing costs of agency-issued and agency-guaranteed securities, the Federal Financing Bank was established as a central financing authority for marketable federal securities (exempting those the Treasury borrowed on its own). At its inception, the FFB was given the authority to borrow up to $15 billion through the issuance of its own debt and unlimited authority to borrow from the Treasury.
All Bank assets are, or have a commitment to be, full faith and credit obligations of the U.S. government.
The FFB issues agency-backed securities in three ways:
Agency Debt: Agencies with authority from Congress to borrow to finance their activities sell their own debt securities in the same manner that the Treasury offers bonds, notes and bills to finance the government’s deficit.
Certificates of Beneficial Ownership: Federal agencies that make direct loans pool a number of loans together and then sell certificates representing a share in that loan pool. These certificates of beneficial ownership (CBOs) can be sold in larger units than individual loans and are guaranteed by the selling agency. By selling CBOs, the lending agencies can refinance their loan portfolios, in effect generating new capital for further loans.
Guaranteed Securities: To allow nonfederal enterprises to tap the government securities market as a source of financing, some agencies fully guarantee the repayment of interest and principal on securities issued by these enterprises. This approach evolved as the size of projects proposed for guaranteed financing grew larger and as banks and other lending institutions became more hesitant to make long-term large commercial loans for these ventures.
The FFB has a board of directors consisting of the Treasury Department’s secretary, deputy secretary, undersecretary for domestic finance, general counsel and the fiscal assistant secretary. The staff of the bank is organized into three sections: loan administration; loan accounting; and computer support.
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Today the FFB has statutory authority to purchase any obligation issued, sold, or guaranteed by a federal agency to ensure that fully guaranteed obligations are financed efficiently. Although it was originally thought that the FFB would finance its activities through issuance of its debt, treasury officials managing the FFB found it cheaper to borrow directly from the Treasury. The bank borrows at the Treasury’s current rates and lends to agencies and agency-guaranteed borrowers at the Treasury rate plus one-eighth of a percentage point. Because this rate is around one half of a percentage point below what borrowers would have to pay if they offered their securities in the market, they save millions of dollars by borrowing them from the FFB. Since the FFB’s inception, it has bought almost all debt issues and certificates of beneficial ownership offered by federal agencies. It has become a major source of financing for the securities of guaranteed borrowers that otherwise would be sold in the government securities market. TABLE 1
In fiscal year 2015 its loan portfolio amounted to $74.0 billion, with a net income of $352.1 million.58 EximBank
It is a wholly owned bank by the Federal government for the purpose of providing financial assistance to exports of goods and services of U.S. companies. Established in 1934, is the official export credit agency of the U.S. government. It operates as a government corporation, the bank finances and insures foreign purchases of United
58
Federal Financing Bank (2015). Financial Statements FY 2015 and 2014 (November 15, 2015), pp. 4 – 5.; 11. At: https://www.treasury.gov/ffb/financial-statements/
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States goods for customers unable or unwilling to accept credit risk, finance working capital for business exporting, and a foreign buyer’s purchase.59 In 1992, a cooperative program between Fomexport (the export promotion program as it was known then under the previous Economic Development Administration), and the Economic Development Bank and the Eximbank was established to support the export of services by local companies.
Best practices of Development Banks60 There are multiple examples of state-owned development banks that have been successful, including the Development Bank of South Africa, the Brazilian National Bank for Economic and Social Development (BNDES) or NAFIN (Nacional Finaciera) in México.61 An overview of those that have been effective shows that a governmentowned DB can be efficient if certain conditions are met: 1. Develop a strategic vision that includes avoiding competing with the private sector and engaging in unsustainable lending practices 2. Implement sound governance and focus on results measurement and monitoring, instead of measuring results through annual lending volumes 3. Transparency of loan policies 4. Improve risk management systems that will increase loan recovery rate compared to commercial banks, implement risk management units and allow them to report directly to the Board 5. Crowd in the private sector, increase efforts to involve the private sector in longterm financing 6. Consider alternative financing instruments, such as syndication programs to leverage commercial banks, and risk sharing agreements or facilities 7. Build an inclusive financial sector 59
Eximbank, http://www.exim.gov/.
60
Emmanuel Moulin (2007), Best Practices of Development Banks, Citibank (May 2007), at: https://www.unece.org/fileadmin/DAM/ceci/ppt_presentations/2007/fid/Emmanuel%20Moulin.pdf; Anne Maria Cronin (2012), Sustainable Banking – International Best Practices from the Perspective of International Development Financial Institutions, European Bank for Reconstruction and Development, at: http://www.unepfi.org/fileadmin/regional_activities/ceetf/3.%20Anne%20Maria%20Cronin.pdf; José de Luna Martínez and Carlos L. Vicente (2012).
61
United Nations (2005). Rethinking the Role of National Development Banks, pp. 35 – 36.
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8. Use the full range of instruments available for infrastructure financing 9. Innovate, in order to provide risk mitigation mechanisms 10. Use capital wisely, for instance, using guarantees to attract private investors, risk sharing agreements with commercial banks, partial credit guarantees 11. Adopt best practices of the private sector for internal management 12. Contribute to Public Goods and sound environmental standards 13. Avoid the intervention of politics in the institution 14. Environmental risk should also be considered at a portfolio level, and the bank should avoid overexposure to particular industries sensitive to environmental pressures 15. Not ignoring the negative consequences of the investment, in particular of infrastructure projects 16. There is an international consensus that DBs owned or controlled by the government should have the regulation and supervisory standards similar to that of private financial institutions62
62
The majority of DBs are in fact regulated and supervised by the same institution that supervises private commercial banks in their countries, such as the central bank or the bank supervisory agency, and they are required to comply with the same standards of prudential supervision (minimum capital, minimum capital adequacy requirements, loan classification and provisioning, etc.) of private commercial banks or any other private financial institution. JosĂŠ de Luna MartĂnez and Carlos L. Vicente (2012), pp. 21 – 22.
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BENCHMARKING: COMPARATIVE ANALYSIS OF BEST PRACTICES IN FISCAL MANAGEMENT AMONG SELECTED JURISDICTIONS
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Selection of States and Countries for Benchmarking In total, three U.S. states were selected for benchmarking and comparison to Puerto Rico’s economic indicators: Florida, Nevada and Hawaii. All three of these states feature structural characteristics somewhat similar to Puerto Rico. Tourism spending is an important part of total spending in the economy, much like in Puerto Rico. This includes closely related categories of aggregate spending such as the cruise industry in Hawaii and the casino industry in Nevada. In addition, all selected states have a relatively high Hispanic population, although none of these states has an economy that is as exportintensive as Puerto Rico’s. The table below summarizes some of the comparable demographic and economic indicators within the three selected states and Chile. Chile was selected as a model of fiscal management for a relatively small nation. Summary of Demographic and Economic Indicators in Selected States and Countries Hispanic Population
Exports
Total Population
Total GDP
(% Total Pop)
(% of GDP)
(Millions)
(US$ Billions )
Florida
23%
10%
20
$911
Nevada
27%
7%
3
$144
Hawaii
10%
1%
2
$82
Chile
>95%
30%
18
$240
Puerto Rico
99%
76%
4
$104
State/Territory
Sources: 2014 and 2015 American Community Survey (ACS) Estimates, United Nations Statistics Division, Office of the United States Trade Representative, World Bank Data, U.S. Bureau of Economic Analysis, CIA World Factbook
In addition, the fiscal management practices of the U.S. as a whole were reviewed. The following sections provide an analysis of the factors behind each of the comparable states and countries that were selected. Florida The State is known for excellent fiscal management and its fiscal condition is ranked highly by the Rating Agencies. As one of the U.S. most populous and diverse states, Florida has a dynamic economy that is closely linked to that of Puerto Rico with over one million residents from the Island.
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Nevada Nevada’s population is 27 percent Hispanic according to the 2014 American Community Survey. This is one of the highest percentages in the U.S. and even larger than Florida’s significant Hispanic population percentage (23 percent). Nevada has a population of around 3 million, which is comparable to Puerto Rico’s population. Rating Agencies give Nevada a very high ranking in terms of its fiscal management, which requires a balanced budget by law. Hawaii As an island with a small resident population, Hawaii has an economy that is comparable to Puerto Rico among the U.S. states. The state is judged to have a creditworthiness that qualifies for high-investment grade. Hawaii also has a large minority population, including a relatively large Hispanic population of about 10 percent. Chile Chile is a model for sound-fiscal management within Latin America. The country has consistently been one of the best performing countries in the Region. This was primarily driven by a set of economic reforms applied to Chile beginning in the 1980s that significantly reformed the economy and fiscal management practices. Since then, Chile has actively taken steps to further improve its fiscal management practices, including the recent creation of a centralized and integrated financial management system known as Sistema de Información para la Gestión Financiera del Estado (SIGFE). Chile is the only Latin American country that has a credit worthiness judged as “high-investment grade” by all major bond credit rating agencies. United States for Comparative Purposes Due to the multiple regional economies within the U.S. it is useful to look at the fiscal condition of the United States as a whole. The Commonwealth of Puerto Rico is closely linked to that of the United States due to significant resident and trade flows. Thus, the monetary and fiscal policy of the United States has strong effects in the economy of the Island. There is a large amount of data available to analyze the country’s overall fiscal condition, including publicly available Comprehensive Annual Financial Reports (CAFRs) statements through 2015. In spite of a moderate fiscal deficit relative to GDP, it is still an investment grade country.
Governmental Organization of Fiscal Management Systems under Selected States and Countries Effective organization of fiscal management and economic development authorities on a governmental level can lead to better economic outcomes and long-run fiscal
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health. The analysis performed indicates that while there are some common features within these states that have successful management, such as oversight from a state Governor’s office, there is no “one-size-fits-all” approach as each fiscal management division is organized differently with different levels of authority. Most of the entities chosen do not have the authority to provide credit for governmental purposes. In addition, although some states that were selected do issue bonds for the purpose of economic development, government run economic development banks at the state level are not the norm. Florida Florida’s fiscal management is the responsibility of the Bureau of Financial Management Services, which reports to the Department of Management Services (DMS) within the Florida State government. The DMS was created in 1993 after the Departments of Administration and General Services merged, and has several different functions. The head of the DMS is the Agency Secretary that is appointed by the Governor with State Senate confirmation. It has no direct lending authority. State bond financing is done by the Division of Bond Finance, which is a part of the Florida State Board of Administration (SBA). The SBA “was created by the Florida Constitution and is governed by a threemember Board of Trustees (Trustees)” including the Governor. These Trustees “delegate authority to the Executive Director/Chief Investment Officer to carry out the strategic direction in the day-to-day financial investments and operations of the agency.”63 Similar to many other states, Florida’s constitution mandates a balanced budget 64 . Moreover, Florida also has several software systems in use, which aid in fiscal management, including the Florida Accounting Information Resource (FLAIR) and the Florida Financial Management Information System (FFMIS), the latter of which is comprised of several large software subsystems that operate payroll, purchasing, budgeting and accounting. These systems provide “on-time” information of fiscal accounts. The official economic development agency for the State of Florida is Enterprise Florida. It is a public-private partnership that provides tax incentives to companies that create employment in the state within targeted industries, among other activities. Funding is allowed by the State legislature with recommendation of the Governor. Of note is the Florida Development Finance Corporation (FDFC), which is a state authorized issuer of industrial revenue bonds. According to the FDFC, it “offers tax-exempt, low-interest 63
http://www.sbafla.com/fsb/
64
The Volcker Alliance, Truth and Integrity in State Budgeting (2015). “In 49 states, “balanced budgets” are required by constitution or by statute; Vermont, the sole exception, follows the practice of its peers.1 In truth, however, there is no common definition of a balanced budget, and many states resort to short-term budget sleight of hand to make it appear that spending does not exceed revenue.”
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bond financing to qualified, financially sound, manufacturing and 501(c)(3) non-profit organizations.”65 Through this program, bond financing is an important component of the overall economic development operations of Enterprise Florida. The bureau that serves as a regulatory agency for the depositing of public funds within Florida is Bureau of Collateral Management (BCM) in the Florida Treasury. The bureau states that “BCM specializes in the administration of assets such as cash, certificates of deposit, letters of credit, and marketable securities that are deposited with or pledged to BCM for safekeeping.”66 Depositors must file an application with the BCM to become a qualified public depository (QPD). Thus, any QPD that has been vetted by the Bureau of Collateral Management can accept public funds. Nevada Nevada handles its fiscal management through the Fiscal Management Division of the State Budget Office. Chapter 353 of the Nevada Revised Statutes establishes this authority. Similar to Florida, this is handled under the oversight of the Governor’s office. The Nevada Executive Budget System (NEBS) is used to build the Governor’s Executive Budget. NEBS is a computer application and its use is mandatory for all budget accounts in the Governor’s Executive Budget. As in Florida, the investment in technologyrelated tools to provide “on-time” information on fiscal positions is evident. Nevada’s bond financing is handled by the Debt Management division of the Nevada State Treasurer, which is separate from the State Budget Office and assists the State legislature in making decisions regarding the State bond programs. Of note is Nevada’s conservative fiscal practices under this department, which according to Nevada’s government documents “…require strict adherence to a balanced budget under the State Constitution –similar to Florida– (i.e. no deficit spending). As soon as it becomes apparent Nevada’s budget is becoming unbalanced, such as when revenues fall short of projections, adjustments must be made to keep the state operating in the black.”67 In addition, the Nevada State Constitution “limits the aggregate principal amount of the State’s general obligation debt to 2 percent of the total reported assessed valuation of the State.”68 The largest economic development agency in Nevada is Diversify Nevada, also known as the Nevada Governor’s Office of Economic Development. Similar to Enterprise Flori65
https://www.enterpriseflorida.com/small-business/florida-development-finance-corporation/
66
http://www.myfloridacfo.com/division/treasury/collateralmanagement/
67
http://budget.nv.gov/Fiscal-Management/
68
https://nevadatreasurer.gov/Documents/debt/DC_Report.pdf
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da, Diversify Nevada assists in economic development through many avenues, tax incentives for small businesses and entrepreneurial training. In addition, the Nevada Department of Business & Industry issues tax-exempt Industrial Development Revenue Bonds (IDRBs) to assist in economic development. The Department states that “[IDRB] proceeds are utilized by private manufacturing companies interested in locating a facility in Nevada or expanding an existing Nevada-based business.”69 According to the Nevada State constitution, “The State, a local government or an agency of either, if specifically authorized by statute or a state agency if approved by the State Board of Finance, may deposit public money in any insured state or national bank, in any insured credit union or in any insured savings and loan association.”70 The Nevada State Treasurer manages the collateral pool for public deposits. Hawaii Similar to Nevada, Hawaii’s fiscal management is also handled by its budgetary department, the Hawaii Department of Budget and Finance. According to the Department, “The Administration is responsible for planning, directing and coordinating the development of the State’s plans and strategies relative to cash management, investments and bond financing.” It conducts reviews of the finances and operations of each department of the State to “ensure appropriate and effective expenditure of public funds.”71 Unlike the fiscal management authority of Florida, this department does have lending authority as established in Hawaii’s Revised Statutes, which includes general obligation and special assessment bonds. The State Constitution does mandate a balanced budget similar to Florida and Nevada. However, Hawaii’s State Government has not always adhered to it in recent years.72 Hawaii’s state government promotes economic development primarily through the Business Development & Support Division (BDSD) of the State’s Department of Business, Economic Development & Tourism (DBEDT). The BDSD states that “The Business Development & Support Division (BDSD) of DBEDT promotes industry development and economic diversification by supporting existing and emerging industries in Hawaii and by
69
http://business.nv.gov/Business/Access_to_Capital/IDRB/IDRB_Program_Overview/
70
https://www.leg.state.nv.us/NRs/NRS-356.html#NRS356Sec005
71
http://budget.hawaii.gov/finance/
72
http://www.hawaiinewsnow.com/story/13001282/hawaiis-state-budget-deficit-violates-constitution
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attracting new investment and businesses to the state.”73 Their activities include microloans to selected businesses, as well as grants and other business incentives. Similar to Nevada, Hawaii’s Revised Statutes stipulate that public funds can be deposited with any financial institution authorized to do business in the State of Hawaii.74 Similar to Florida and Nevada, Hawaii also has analogous collateralization requirements for public funds. According to the State of Hawaii Department of Accounting and General Services Audit Report for 2014, much more public cash is deposited with local depositories than with the State’s fiscal agents.75 Chile Although Chile has been a top economic performer within Latin America for decades, the country continues to modernize and reform its fiscal management practices. The primary fiscal management authority in Chile is Sistema de Información para la Gestión Financiera del Estado (SIGFE). According to SIGFE, it is “a government program to develop and implement a single information system…to improve and support the transparency of public sector financial management on three levels: strategic, sectorial and institutional.”76 This agency was formed recently through a joint effort of Chile’s Budget Office Dirección de Presupuestos (DIPRES) and its Comptroller/Accounting office Contraloría General de la República (CGR). According to the World Bank, Chile has a strong track record of fiscal prudence. The World Bank’s Country Financial Accountability Assessment of Chile also states that “current fiscal policy…provides for a structural budget surplus of 1 percent of GDP. Necessary adjustments to achieve this target are made to budget expenditures during the year.”77 United States for Comparative Purposes For the U.S. as a whole, fiscal management is handled by the Bureau of the Fiscal Service. According to the U.S. Treasury, it was recently established in 2012 “with the consolidation of two Treasury Department Bureaus: the Bureau of the Public Debt (BPD) and the Financial Management Service (FMS).” 78 BPD financed government operations, accounted for the resulting public debt, and provided financial and administrative ser73
http://invest.hawaii.gov/about-bdsd/
74
http://law.justia.com/codes/hawaii/2013/title-5/chapter-38/section-38-3
75
http://ags.hawaii.gov/wp-content/uploads/2012/09/MoneySecuritiesAuditReport-FY2014.pdf
76
Translated from Spanish official documents
77
https://openknowledge.worldbank.org/bitstream/handle/10986/8302/326301CL1rev0pdf.pdf
78
https://www.fiscal.treasury.gov/fsabout/fs_about.htm
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vices to federal agencies. FMS supplied central payments and collections and deposit services for the federal government and prepared the financial statements of the federal government. This division is part of the Treasury and hence, does have lending and borrowing authority. The Bureau of the Fiscal Service also provides central payment services to federal program agencies, government-wide accounting and reporting services, and financial management and IT services to a wide range of federal government clients. In this sense the scope of the U.S.’s fiscal management services is very broad.
Benchmarking Fiscal Management Practices The Mercatus Center of George Mason University, an American non-profit free-marketoriented research, education and outreach think-tank, publishes annually-updated rankings of all 50 U.S. states and Puerto Rico in terms of their general fiscal condition. It has become an established reference and authoritative source for fiscal management rankings. These are summarized by an overall ranking of 1 through 51, as well as rankings for individual criteria that help determine a state’s overall fiscal solvency. A description of all the concepts used in the Mercatus Center annual analysis to arrive at rankings is shown below. Definitions of Terms Used in Mercatus Center State Fiscal Condition Rankings Terms
Definition
Cash Solvency
Measures whether a state has enough cash to cover its short-term bills, which include accounts payable, vouchers, warrants, and short-term debt.
Budget Solvency
Measures whether a state can cover its fiscal year spending using current revenues. Did it run a shortfall during the year?
Long-Run Solvency
Measures whether a state has a hedge against large longterm liabilities. Are enough assets available to cushion the state from potential shocks or long-term fiscal risks?
Service-Level Solvency
Measures how high taxes, revenues, and spending are when compared to state personal income. Do states have enough “fiscal slack”? If spending commitments demand more revenues, are states in a good position to increase taxes without harming the economy? Is spending high or low relative to the tax base?
Trust Fund Solvency
Measures how much debt a state have. How large are unfunded pension liabilities, OPEB liabilities and state debt compared to the state personal income?
Source: Mercatus Center of George Mason University.
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The table below summarizes the most recent rankings among 50 states and the Commonwealth of Puerto Rico based on these criteria. Summary of Mercatus Center State Fiscal Condition Rankings
State/Territory
Cash
Budget
Long-Run
Solvency
Solvency
Solvency
ServiceLevel Solvency
Trust Fund
Overall
Solvency
Ranking
Florida
3
7
31
3
12
6
Nevada
16
20
25
2
44
13
Hawaii
23
43
42
43
43
45
Puerto Rico
51
51
51
51
51
51
Source: Mercatus Center of George Mason University, 2015 Rankings
Below is a color-coded table to indicate different degrees of government bond creditworthiness as judged by the major credit rating agencies:
Dark gray indicates the highest possible rating of creditworthiness: “AAA”.
Medium gray indicates high quality investment-grade bonds.
Light gray represents a rating that is below investment-grade and thus speculative (non-investment grade bonds are rated Ba1 or below by Moody’s and BB+ or below by Fitch and S&P). Bond Credit Ratings State/Territory or Country
Fitch
Moody’s
S&P
Florida
AAA
Aa1
AAA
Nevada Hawaii
AA+ AA
Aa2 Aa2
AA AA
USA
AAA
Aaa
AA+
A+ D
Aa3 Caa3
AAD
Chile Puerto Rico
Sources: Moody’s Investors Service, Standard & Poor's Financial Services, Fitch Ratings
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Best Practices and Recommendations Set Long-Term Goals for a Balanced Budget According to the National Conference of State Legislatures, all the states except Vermont have a legal requirement of a balanced budget79. Some are constitutional, some are statutory, and some have been derived by judicial decision from constitutional provisions about state indebtedness that do not, on their face, call for a balanced budget. Thus, even if all of the states analyzed have some sort of legal requirement for a balanced budget, they vary in how strict their adherence is to those limitations. For example, Nevada and Florida are known for conservative fiscal practices that are reflected in their low state debt to personal income ratios of around 3 percent according to the Mercatus Center (the national average is 6 percent). Hawaii’s state debt to personal income ratio is a larger 12 percent. Nonetheless, agencies such as the IMF recommend “a limit on debt expansion” as part of prudent fiscal management of public debt.80 Improve Financial Reporting and Transparency According to the World Bank “transparency - openness about policy intentions, formulating and implementation - is a key element of good governance.”81 One important aspect of transparency is the timely publication of government financial reports such as the Comprehensive Annual Financial Report (CAFR). CAFR’s are available for FY-2015 in all states and countries that were analyzed, except for Puerto Rico. The newest audited CAFR’s for Puerto Rico are for FY-2014, and the unaudited working draft version of this report was not published until February 2016. This delayed reporting negatively affects transparency and the ability of the government and other authorities to effectively manage Puerto Rico’s public debt. Florida and Nevada both have their own modern internal and proprietary financial reporting systems that are used for internal controls. Chile emphasizes the use of modern tools in financial reporting according to the World Bank. According to The GDB’s own
79
Also referenced in the Volcker Report (2015)
80
http://www.imf.org/external/np/mae/pdebt/2000/eng/
81
https://openknowledge.worldbank.org/bitstream/handle/10986/8302/326301CL1rev0pdf.pdf
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Financial Information and Operating Data Report, “The Commonwealth’s accounting, payroll and fiscal oversight information systems have deficiencies due to obsolescence and lack of compatibility that have adversely affected the Commonwealth’s ability to supervise and control expenditures.”82 Thus, improving IT and software systems within Puerto Rico’s fiscal entities to aid in financial reporting and transparency would be beneficial for Puerto Rico’s creditworthiness as well as potential investors. Mandate Increased Independence between Fiscal Management Authority and Lending Decisions It is important to note that the following conclusions make reference to central banks. The authors understand the fundamental differences of such institutions with those in Puerto Rico, yet, they serve to highlight the high degree of independence which is required when financial management, fiscal oversight and lending capabilities are handled by the same entity. The Government Development Bank (GDB) of Puerto Rico has been both the fiscal agent and the principal lending authority for Puerto Rico. The GDB’s Financial Information and Operating Data Report states that “[The] GDB has historically served as the principal source of short-term liquidity for the Commonwealth and its instrumentalities and as the principal depositary of public funds.”83 These responsibilities can potentially lead to over-extension of credit, as well as conflicts of interest. Mandating independence between fiscal management and lending functions is essential. According to a policy research working paper at the World Bank, “fiscal authorities…are often subjected to political pressures arising from election cycles that lead them to take myopic policy choices.”84 Several sources contend that eliminating both real and apparent conflicts of interest between public fiscal agents and debt managements is a worthwhile goal. According to a Stanford Institute for Economic Policy Research brief, “Wherever the central bank is responsible for debt management policy,
82
http://www.bgfpr.com/documents/CommonwealthReport11-06-15.pdf
83I
bid
84
http://treasury.worldbank.org/bdm/pdf/3_CoordinatingPDMwithFiscalandMonetaryPolicies_Togo.pdf
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conflicting objectives may emerge.”85 The IMF also warns against potential conflicts of interest, stating in its Guidelines for Public Debt Management that “where the level of financial development allows, there should be a separation of debt management and monetary policy objectives and accountabilities. Clarity in the roles and objectives for debt management and monetary policy minimizes potential conflicts.”86 The World Bank’s review of Chile’s public finances concluded that “The abundant trust in government in Chile today can be attributed, in part, to…the incontestable review by a competent, independent authority - the Contraloría General de la República de Chile (CGR).” 87 The CGR is Chile’s main accounting authority and provides oversight in public funds and reporting. The IMF’s Guidelines for Public Debt Management cites other countries such as Belgium, France, Ireland and Portugal, which have decentralized debt management and increased oversight within the last few decades. The World Bank also states that separating debt management from the management of fiscal policies can improve policy credibility, and that “credible policies are known to produce superior overall outcomes compared to less credible policies. For example, a credible monetary policy will be successful in taming inflationary expectations and reduce future uncertainty, which will in turn reduce the risk premium on longer dated domestic currency debt.”88 According to Stanford’s brief, “the separation of debt management from monetary policy will help the central bank to focus exclusively on price stability, which will provide transparency in its operations and thereby enhance its credibility,”89 making the fiscal agents more efficient and municipal bonds more attractive to potential investors. Thus, separating these two functions would also make fiscal management more effective overall and lower credit risk.
85
http://www-siepr.stanford.edu/papers/briefs/policybrief_jun05.pdf
86
http://treasury.worldbank.org/bdm/pdf/3_CoordinatingPDMwithFiscalandMonetaryPolicies_Togo.pdf
87
https://openknowledge.worldbank.org/bitstream/handle/10986/8302/326301CL1rev0pdf.pdf
88
http://treasury.worldbank.org/bdm/pdf/3_CoordinatingPDMwithFiscalandMonetaryPolicies_Togo.pdf
89I
bid
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In all states that were examined, there is a comptroller or accounting division that works with the state budget office independently of lending authorities. An increased emphasis on independent review of Puerto Rico’s public accounts would help improve overall fiscal management in the Commonwealth, and more should be done to strengthen independent oversight on Puerto Rico’s fiscal management, however there should still be efficient coordination and communication between fiscal agents and regulatory agencies. Stanford’s brief states that “monetary policy and public-debt management clearly have to be complementary. The industrial countries generally have separated the objectives and accountabilities of debt and monetary management, but ensure that the activities are coordinated.”90 The IMF also shares this sentiment, stating that although they recommend independent oversight into fiscal management, “debt management, fiscal and monetary authorities should share information on the government's current and future liquidity needs” and “debt managers should convey to fiscal authorities their views on the costs and risks associated with government financing requirements and debt levels.”91 This could encompass elimination of barriers of communication between fiscal management and regulatory bodies, as well as investment in IT and software development to help bring Puerto Rico’s technological infrastructure more in line with Chile and the U.S. states with successful fiscal management.
90I
bid
91http://www.imf.org/external/np/mae/pdebt/2000/eng/
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THE ECONOMY OF PUERTO RICO AND THE GDB: WHAT THE NUMBERS SAY
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The External Environment of the GDB92 The
Government
Development
Bank
(GDB)
is
a
complex
conglomerate
of
administrative, investment and depository component units that perform seven (7) main functions: 1. Fiscal Agent (now mostly handled by AAFAF) 2. Paying Agent 3. Financial Advisor 4. Interim Financier 5. Depository/Trustee of Commonwealth funds, public entities and municipalities 6. Investor 7. Guarantor of public and private enterprise loans Due to the breadth and diversity of its functions, the Bank developed a multifaceted array of funds, special accounts, subsidiaries, investments and deals with other affiliated corporations in coordination with the legislative and executive branches of the central government. The following diagram summarizes the main structure of the Bank per the 2014 Financial Statement:
92
The representation of the GDB along the following section, follows the bank’s duties and responsibilities as outlined in all legislation prior to Act 21-2016. Such assumption is necessary to guarantee a coherent analysis of GDB’s financial structure between 1998- 2014.
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F IGURE 1
Source: Government Development Bank (2016). Financial Statement 2014, p. 5.
This section provides an overview of both the external and internal environments that shaped the operations, financial condition and management of the Bank from fiscal 1998 onwards. However, due to dimension of the Bank’s complexity, the analysis was limited to the management of its enterprise funds (also called proprietary funds or business funds). 93 The external environment was developed on the basis of several indicators chosen as representative of the financial situation of the main clients of the GDB business-type transactions – Commonwealth agencies, municipalities and private sector projects. The internal environment analyzes the principal indicators of the bank’s financial situation and its loan portfolio, based upon the Government Development Bank Financial Statements from fiscal 1998 onwards. A subsection on significant
93
The analysis in this section only refers to the Enterprise Funds (business type-activities), except where otherwise specified. All information presented is based on the GDB’s financial statements of 1998- 2014.
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practices by the Bank that influenced its financial situation, as detailed in its financial statement notes, is also included.
Economic Growth From 1998 to 2006, Puerto Rico’s Gross National Product (GNP) had an average growth rate of 2.1%; from this point onwards, economic growth entered into a steep contraction that has continued until the present. Average GNP growth for the fiscal 2007 – fiscal 2015 period was -1.7%. This decade-long contraction shaped the Bank’s lending policies, the health of its loan portfolio and the sustainability of its different funds throughout the period. F IGURE 2
The Puerto Rico Fiscal Agency and Financial Advisory Authority (FAFAA) Economic Activity Index, which is a coincident index with respect to Puerto Rico’s economy, also registered a decline of 1.4% in fiscal 2016, indicating further GNP contraction is expected in fiscal 2016, for which final estimates are nota available as of November, 2016.
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F IGURE 3
Employment From fiscal 1998 to fiscal 2006, nonfarm wage-earning employment in Puerto Rico increased at an average rate of 0.7%. Since 2007, however, employment experienced a sharp annual decline of 1.6% on average from fiscal 2007 to fiscal 2015. In fiscal 2016, a 1% decline was experienced, highlighting the weakness in the jobs market. F IGURE 4
From fiscal 2010 onwards, the decline in public employment has outpaced declines in the private sector. This trend is expected to continue as the government implements more austerity measures in the coming years.
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F IGURE 5
Gross Fixed Capital Investment For the fiscal 1998-2015 period, gross fixed capital investment has declined. However, public construction investment was positive throughout fiscal years 2003 to 2006, 2008, 2011 and 2012, while in almost all of those years private construction fell. From fiscal 2013 to fiscal 2015, public investment decreased at a much faster rate than private investment, owing to a lack of access to credit markets, among other factors. F IGURE 6
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F IGURE 7
Government Expenditures Government expenditures increased at an average rate of 1.8% from fiscal 1998 to fiscal 2015. If we exclude the steep decline of fiscal 201594, the average increases to 2.8%. This significant increase in expenditures of government agencies and instrumentalities before 2015 (excluding PREPA and PRASA) likely placed upward pressures upon debt emissions, as expenditures maintained a fiscal imbalance with respect to revenues throughout the period.
94
This is partially attributed to the effects of Act 66-2014
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F IGURE 8
F IGURE 9
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General Fund Net Revenues With respect to the fiscal 1998-2015 period, General Fund Net Revenues (GFNR) stood close to their highest point in fiscal 2015. The average growth in GFNR stood at 2.7%. F IGURE 10
F IGURE 11
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Debt Puerto Rico’s Gross Public Debt tripled in amount from fiscal 1998 to fiscal 2015. Compared with growth in GFNR, the average growth for the period was more than 4.4 percentage points higher. In some years, revenues declined by more than 7%, while public debt increased in double digits. F IGURE 12
F IGURE 13
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The Internal Environment of the GDB This section highlights a series of indicators related to the GDB’s operations over time, and relates them to the external environment described in the previous section. This will provide an overview of the Bank’s fiscal situation given the aforementioned economic challenges. However, it must be noted significant managerial concerns also impacted the Bank’s functioning to a large extent.
Total Assets Total Assets of the GDB doubled from fiscal 1998 to fiscal 2012, mostly driven by increases in loan receivables; as a share of total assets, net loan receivables increased from 36.7% in fiscal 1998 to 52.8% in fiscal 2012. In fiscal years 2013 and 2014, net loan receivables represented 66.7% and 61.0% of the Bank’s total assets (of Enterprise Funds), respectively. F IGURE 14
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F IGURE 15
Virtually all assets in the Enterprise Funds are allocated to two (2) main funds: The GDB Operating Fund and the Housing Finance Authority. In fiscal 2014, these funds held 97.3% of the Bank’s enterprise fund assets. The share of assets held by the Housing Finance Authority increased from 12.6% in fiscal 1998 to 18.2% in fiscal 2005, and then declined to 7.5% in fiscal 2014. Other funds became less relevant in the period for historical and management reasons. T ABLE 2
Distribution of Total Assets of the GDB Enterprise Funds, by Fund Fiscal Years -- 1998, 2005 and 2014 Proprietary Fund
Fiscal Year 1998
2005
2014
81.9%
77.8%
89.8%
Capital Fund
3.0%
0.6%
0.002%
Development Fund
0.3%
0.3%
0.1%
12.6%
18.2%
7.5%
Public Finance Corporation
1.3%
0.0%
0.0%
Tourism Fund
0.8%
3.1%
2.5%
0.02%
0.02%
0.02%
GDB Operating Fund
Housing Finance Authority
Other (Nonmajor)
Source: Gov ernment Dev elopment Bank (2016). Financial St at ement s (Various Years) -- Balance Sheet of Ent erprise Funds.
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Loan Receivables The GDB issues loans to three (3) main client types: Commonwealth Agencies, Municipalities and certain Private Sector firms. Of these, the largest client types are Commonwealth agencies, followed by municipalities. Over time, municipalities’ share of net loans receivable has increased significantly, from 9.5% in fiscal 2000 to 34.7% in fiscal 2014. F IGURE 16
F IGURE 17
The percentage of loans issued to the private sector peaked in fiscal 2002 at 13.1%, and fluctuated between approximately 6% and 9% from fiscal 2005 onwards.
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F IGURE 18
Net Loans Receivable, by Fund Over time, the two main funds – the GDB Operating Fund and the Housing Finance Authority – have also represented the majority of loan receivables. As can be seen in following figure, these two funds were the main lending funds prior to 2004.
F IGURE 19
Delinquency Rate of Loan Receivables The percentage of loans with accounts 90 or more days due averaged 21.4% for the fiscal 2006-2012 period, significantly higher than the average delinquency rate in commercial banks’ loan/lease portfolio during the same period (8.3%). In fiscal 2014,
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lack of access to credit markets, coupled with a deterioration in the ability to pay in the central government, resulted in approximately 73.7% of gross public sector loans being declared as non-accrual, of which almost the totality belonged to Commonwealth agencies.95 F IGURE 20
The percentage of non-accrual loans from the private sector increased significantly from fiscal 2009 onwards. The average percentage of non-accrual loans for the fiscal 2000-2008 period was 18.6%. In contrast, the average percentage of non-accrual loans for the fiscal 2009-2014 period was of 41.9%. This is consistent with the weakening of the economy during the period. F IGURE 21
95
Source: Government Development Bank (2016). Financial Statement 2014, p. 62.
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Net Assets and Net Operating Income GDB net assets almost doubled from fiscal 1998 to fiscal 2013, consistent with the increases in lending seen in previous sections. In fiscal 2014, an unrestricted loss of $766.7 million in the GDB Operating Fund’s net assets basically wiped out the total net assets of the bank, producing a negative balance in net assets of $186.3 million that year. Additionally, a $2.7 billion incurred expense to provide an allowance for nonaccrual Commonwealth loans pushed net operating income towards a deficit of more than $2 billion. F IGURE 22
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F IGURE 23
Managerial Practices during the Period The following tables list some key managerial practices during the 1998-2014 period that had a significant impact upon the GDB’s loan portfolio and net position. Most of the items deal with the different mechanisms by which both the Commonwealth and the GDB intended to restructure, refinance and repay debt from public corporations and municipalities, including: oversight agreements, modifications to borrowing and credit approval limitations, collateralization practices, receipt of properties in lieu of payments, and other.
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T ABLE 3 Significant Managerial Practices Which Impacted the GDB Loan Portfolio Fiscal Years -- 1997 - 2013 Item
Source
1997 Financial Statement - Note 4 Legislative Appropriations and Other Central Government 2000 Financial Statement - Note 4 Revenues funded a certain public sector loans on irregular (Clarification Regarding intervals Irregularity of Assistances)
Page
** 2000 (p. 14)
Extended financing of PRASA Bonds in expectance of credit rating improvement or better interest rate conditions
1997 Financial Statement - Note 4
**
The Public Finance Corporation bought a temporary right to collect real property taxes for $140 million to the Commonwealth
1998 Financial Statement -- Note 4
14
Emission of significant amounts of "Commonwealth Appropriation Bonds", which are bonds payable from the 2001 Financial Statement -- Note payment of certain promissory notes issued by the 10 Commonwealth and other entities, including the Bank and its component units.
45
Emission of Debt with no designated source of repayment.
2002 Financial Statement
31
Act 164 of December 17, 2001 -- Internal Restructuring of Debt with Agencies (approximately $2.4 billion)
2002 Financial Statement
70
Financial Statements (1998 - 2013)
1998* (p. 15) 2000* (p. 14) 2001 (pp. 32-33) 2002 (p. 58) 2003 (pp. 59-60) 2004 (pp. 65-66) 2005 (p. 60) 2006 (p. 60) 2007 (p. 51) 2008 (p. 35) 2009 (pp. 37-39) 2010 (pp. 35-37) 2011 (pp. 36-37) 2012 (pp. 35-36) 2013 (p. 37-38)
No allowance for loan losses from public sector entities, based upon the traditional receipt of a "pooled" supply of resources from legislative appropriations and/or other Commonwealth resources, including future bond emissions, to pay the GDB and Commonwealth obligations.
Source: Government Development Bank (2016). Financial St at ement (Various Years) -- Not es t o Financial St at ement s. *The statements for 1998 and 2000 are combined statements of both their current and past year. **The currently available copy of the 1997 Financial Statement had no page numbers; hence, only the note number is given.
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T ABLE 4 Significant Managerial Practices Which Impacted the GDB Loan Portfolio Fiscal Years -- 1997 - 2013 Item
Source
Page
Tax Debt Bonds were not able to recoup enough tax lien receivables and established reserves to be paid, and legal action was undertaken against its issuer (the PFC).
2003 Financial Statement
78
Significant fund transfers to special trust funds or other investment funds outside of the Bank and its component units
2003 Financial Statement
82
Establishment of FIA, the Imperative Interest Fund and other corporations to manage and refinance outstanding Commonwealth and Instrumentalities' debt
2006 - 2009 Financial Statements
2006 (p. 70) 2007 (p. 51) 2008 (p. 35) 2009 (p. 38)
Act 80 of 2007 -- leverage with municipalities increased, as a portion of the municipal sales tax was established to be deposited in special accounts for the purpose of granting loans to municipalities.
2009 Financial Statement
39
Restructuring agreements with a municipality, as well as receipt of several properties in lieu of loan payments.
2009 Financial Statement
Act 4 of 2009 -- Increased the limit on borrowing collateralized upon Legislative Appropriations without approval from Legislature, from $100 million to $200 million in June 4.
2010 Financial Statement
Entrance into additional fiscal oversight agreements with several public corporations.
2010 Financial Statement
Act 24 of 2014 -- Imposed further limits on borrowing by public corporations, agencies and instrumentalities; increased the amount of debt backed by the Commonwealth's full faith and credit; and granted the GDB additional oversight capabilities on other agencies and instrumentalities, including the capability to order the transfer of these entities' accounts into the Bank.
51
37
2013 Financial Statement
48
48
Source: Government Development Bank (2016). Financial St at ement (Various Years) -- Not es t o Financial St at ement s. *The statements for 1997-1998, and 1999-2000 are combined statements of both years. **The currently available copy of the 1997 Financial Statements had no page numbers; hence, only the note number is given.
The practices noted above were made with consent from the Board of Directors, named by the Governor of Puerto Rico and confirmed by the Senate. The conflicts of interest arising from the main debtor (Commonwealth of Puerto Rico) choosing the management of the bank enabled the approval of many unsound fiscal practices. While the GDB was originally envisioned as an interim lender, in practice it helped subsidize significant long-term financial problems in the Commonwealth and its instrumentalities, exemplified by the loan to the PRHTA in 2009. As seen in the previous
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tables, multiple examples exist of risky and suboptimal managerial decisions taken by the Bank, that resulted in additional debt emissions or restructuring agreements.
Managerial Practices in Fiscal Year 2014 Both, operating expenses and the net position of the GDB, reached negative levels in fiscal 2014. This was a result of breaking the long-standing practice of not considering the public sector portfolio as impaired, and thus creating a large allowance for loan losses and impairment provisions based upon the cash receivable from the impaired debt.96 As a result of the financial difficulties, the Governor issued several executive orders declaring the Commonwealth in a state of fiscal emergency and halting the payment of the GDB’s debt obligations. In addition, significant efforts were made to achieve a restructuring agreement with creditors.97 In light of the previous indicators, the following conclusions can be reached: 1) The bank’s long-standing practice of not creating an allowance for loan losses from the public entities and agencies was inconsistent with the actual financial situation of the Bank and its debtors. In fiscal 2001 and 2010, restructuring agreements with public agencies had to be made in order to safeguard the GDB’s portfolio; an average of 20.8% of loans delinquent 90 days or more from fiscal 1998 to fiscal 2012, the acceptance of properties in lieu of payment in several occasions, the consistent use of legislative appropriations to assist public entities in repaying their debts, and the creation of affiliated/subordinated entities to help refinance Commonwealth debt from entities/instrumentalities imply that the actual risk from accepting Public entities’ loans was much higher than stated. In fiscal 2014, the inclusion of an allowance for loan losses from the Highways and Transportation Authority and other entities led to a net operating loss of over $2.6 billion, and an almost $800 million decrease in unrestricted assets basically wiped out the Bank’s net position.
96
Source: Government Development Bank (2016). Financial Statement 2014, pp. 10-12.
97
Ibid, pp. 16-20.
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2) The lack of an independent governance structure in the bank enabled significant business practices that adversely affected the GDB’s portfolio. Lending, using other debt emissions as collateral, became a frequent practice, and several additional contributions to other government funds were approved by the Bank. 3) Only a small percentage of loans making up total loan receivables was used for development projects. The majority of loan receivables were from public agencies and municipalities, and only an average of 8.9% of loans were held by the private sector. In terms of Funds, the majority of loan receivables was in the GDB operating fund and the PR Housing Finance Authority; the remaining funds held less than 5% of the Bank’s total assets throughout the period.
The Future Economic Situation and the GDB This section reviews possible scenarios for the economic situation in Puerto Rico based upon the key indicators discussed and their implications on future GDB performance.
The Economic Scenario – 2016 to 2030 The following table presents a baseline forecast of key external environment economic indicators of the GDB: T ABLE 5
External Environment of the GDB -- Main Indicators Baseline Scenario -- 2016 - 2030 Variable
Period Averages 2016-2020
2021-2025
2026-2030
GNP Growth
-1.8%
1.1%
1.9%
Growth in Gov ernment Consumption Expenditures
-2.9%
0.3%
1.6%
Total
-3.8%
0.5%
2.4%
Public Construction
-6.7%
2.6%
1.8%
Priv ate Construction
-4.4%
1.2%
2.5%
-1.1%
0.1%
0.6%
I nv estment Growth:
Employment Growth
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External Environment from fiscal 2016 to fiscal 2020 During this period, most indicators are expected to contract, and additional downside risks deriving from public sector restructuring will continue to worsen the GDB’s external environment. The following key factors are expected to predominate: 1) A significant restructuring of all Commonwealth and instrumentality debt is expected to take place, with its effects likely extending further into the decade; 2) Investment in construction will continue to contract, owing to stagnation of the housing market and significant cutbacks in public spending and investment; and 3) Employment is expected to decline, stimulating out-migration of working age. The number of businesses is expected to continue declining. As a result of this negative external environment, the GDB’s net position and operations are expected to worsen if the current institutional structure is maintained. First, the debt restructuring process will likely include GDB debt, as it is under jurisdiction of the Fiscal Oversight Board. This implies changes in debt agreements and/or the Bank’s loan portfolio. Secondly, significant spending cutbacks will likely worsen Commonwealth agencies’ financial position, which will have negative effects upon the public sector loan portfolio. Although not involved in the restructuring agreements, municipal obligations will be affected both directly and indirectly: the worsening economic situation will place downside risks upon municipal tax revenues, the public sector is expected to reduce or eliminate important municipal transfers altogether, and municipal access to credit markets will be non-existing or severely limited. External Environment from fiscal 2021 to fiscal 2025 This scenario assumes the prevalence of the economic scenario described for the previous period. It also assumes that the economy will stabilize into a new equilibrium based on a smaller population and economy, and key structural reforms will be enacted to improve economic performance. This results in the following changes: 1) Private and public construction investment are expected to increase slightly throughout the period, as access to credit markets is regained and a moderate improvement plan is enacted to address key areas of the economy. A ROADMAP FOR INSTITUTIONAL TRANSFORMATION
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2) The economy is expected to grow modestly throughout the period. Private sector investment will remain cautious and the slowdown in population will continue eroding the housing market’s potential growth. 3) Employment will remain stagnant – after the significant reductions in employment during the previous year, the economy is expected to enter a new equilibrium in the labor market. Both total and nonfarm employment are expected to be smaller, in response to the cautious behavior of the private sector. 4) Government expenditures are expected to stabilize – balanced-budget practices, coupled with reductions in the scope and size of the government’s services, will limit government spending further into the decade. External Environment from fiscal 2026 to fiscal 2030 During the previous stabilization period, policymakers are expected to have enacted key structural reforms to lay the foundation for future growth. Assuming the previous stabilization period, this would result in the following trends for fiscals 2026 to 2030: 1) A high-growth period will likely ensue, as the results of previous period reforms are felt and confidence in the public sector is regained; 2) Employment is expected to increase by an accumulated 5% during this period; 3) Investment will recover slightly, led by increases in private sector construction of non-housing related projects; and 4) Government expenditures are expected to increase partly as a result of further structural reforms, fueled by expected increases in tax revenues, among other improvements.
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GDB AND MUNICIPALITIES
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GDB and Municipalities In countries with limited capital markets, access to capital is achieved through a central government development bank or, in some cases, a housing bank (Rodden, Eskeland, & Litvack, 2003). This can be both positive and negative, depending on the implementation and the politics that govern the banking institution. In the case of Puerto Rico, it’s the Government Development Bank (GDB) that is charged with aiding the municipalities as their fiscal agent. The GDB has ample power to oversee municipal finances, and even determine which municipalities are financially stable enough to issue debt. This places the GDB in a unique position to serve, not only as the municipalities’ fiscal agent, but also allows it to serve as a driver for economic development at the municipal level. Many municipalities, particularly smaller ones, need a banking entity to be able to access the necessary financing to aid in their development. Many of these smaller municipalities would likely be unable to access private banking funding due to their low income and small population and precarious fiscal situation. Given the current economic and fiscal climate, it is likely that intergovernmental transfers decline in the coming years, and this would make access to financial markets that more critical. This could limit the municipality’s ability not only to invest in economic development projects, but also to provide important services to its residents. Throughout this chapter the GDB’s current responsibilities are laid out, including the impact it can have on municipal governance and the loans to municipalities so that they can satisfy their residents’ needs.. GDB’s role in municipal financing
The GDB’s responsibilities regarding municipalities were laid out in a series of laws beginning in 1945. This section aims to provide a brief overview of the GDB’s role in municipal financing. The following laws that detail the GDB’s responsibilities regarding municipal financing and are presented in chronological order:
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Act 272 of May 15, 1945 – This law sets up the Development Bank of Puerto Rico and allows it to act as the fiscal agent of the Insular Government for the purpose of registering, authenticating or countersigning, the bonds, notes or other evidences of indebtedness of the Insular Government, its agencies and municipalities and of the Treasurer of Puerto Rico. The Bank is authorized to act as paying agent or co-paying agent, with or on behalf of the Treasurer of Puerto Rico for the payment of interest and principal of bonds, notes or other evidences of indebtedness issued by the Insular Government and its agencies, and by the Treasurer of Puerto Rico and by or on behalf of the municipalities of Puerto Rico, no agency of the Insular Government nor municipality thereof, shall select any other Bank, Trust Company, individual, partnership or corporation to act as such paying agent.
Act. 17, 1948 – In 1948 the Bank’s Charter was created, it defines the Bank’s duties and powers. It also designates a dual role for the Bank, as both Financial Advisor & Fiscal Agent for the ELA, its municipalities and public corporations in connection with issuance of bonds and notes, and to make loans and advances to these entities. The charter provides for perpetual existence of the bank and limits amendments to the charter or any act of PR that could impair any outstanding obligations or commitments of the Bank.
Act No. 29 of June 30, 1972 – Creates the Puerto Rico Municipal Finance Agency, a public corporation of the Commonwealth of Puerto Rico. Its purpose is to allow the municipalities of Puerto Rico to access the capital markets so that they might finance more effectively their public improvement programs. The Agency is authorized to issue bonds for the following purposes: 1. Purchasing bonds and notes of Puerto Rico municipalities secured by ad valorem taxation, without limitation of rate or amount, on all taxable property within each such municipality and issued in accordance with applicable law; 2. Making payments into the respective Bond Service Accounts;
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3. Operating Funds or Reserve Accounts of any trust indenture under which bonds of the Agency are issued; 4. Funding bond anticipation notes theretofore issued by the Agency to provide funds to purchase general obligation municipal bonds and notes; and 5. Refunding any outstanding bonds of the Agency.
Act No. 44 of 1988 – The Puerto Rico Infrastructure Financing Authority is created in order to provide financial, administrative, consulting, technical, advisory, and other types of assistance to other public corporations, governmental instrumentalities, political subdivisions and municipalities (collectively, “Benefited Entities”) authorized to develop infrastructure facilities and to establish alternate means for financing infrastructure facilities.
Act No. 64 of July 3, 1996 – Incorporates into a single statute the provisions of Act No. 7 of October 28, 1954, and several other laws relating to municipal finance and municipal taxes and made certain changes to such provisions to, among other things, expedite and streamline the procedures for the issuance of municipal obligations, including general obligation municipal bonds and notes. The GDB must approve any proposed issue of municipal general obligation debt. It is required to verify that the municipality has the legal margin available and the payment capacity to incur such additional general obligation debt. The Puerto Rico Legislature has fixed a limitation for the issuance of general obligation municipal bonds and notes for the payment of which the good faith, credit and taxing power of each municipality may be pledged. The principal amount outstanding of any such bonds and notes may not exceed 10% of the aggregate assessed valuation of the taxable property within such municipality (the "Legal Margin," and the amount by which such municipality's Legal Margin
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exceeds a municipality's outstanding general obligation debt, the "Available Legal Margin").
Act 18 of 2014 – Creates the Municipal Administration Fund, and authorizes municipalities to designate the funds deposited in this special fund to guarantee the repayment of any loan, bond, or note. The act also states that the municipal sales tax is to be 1% while the state sales tax is 6%.
Act 19 of 2014 – Creates the Municipal Finance Corporation, an independent corporation, COFIM has the same powers, rights and faculties as the GDB under its Charter. It is authorized to issue bonds and use other financing mechanisms to pay or refinance, directly or indirectly, in whole or in part, the debts of the municipalities of the Commonwealth payable or backed by the municipal sales and use tax. COFIM receives, from the first revenues of the municipal sales and use tax collected, the greater of: (i) an amount computed by applying a 0.3% fixed tax rate to the total revenues collected, or (ii) a fixed amount that increases annually, known as the Annual Fixed Income. These revenues, which are deposited in COFIM’s Redemption Fund, are used to pay and secure the debt issued by COFIM.
Act 24 of 2014 – Prohibits the GDB from making loans to public entities payable from future increases in rates, taxes or other charges, except for emergency loans. Act intended to provide the GDB with fiscal discipline. Increases to $2 Billion amount of Bank obligations backed with full faith and credit of the Commonwealth. Grants Bank oversight over certain public funds deposited at private financial institutions and require public funds be deposited at the Bank (except for Legislative Branch, Judicial Branch, UPR, Government Pension Plans, Municipalities) OMB may assume, on behalf of the Commonwealth Government,, the repayment from budget appropriations of certain obligations owed by government agencies or public corporations to the Bank.
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Municipal Responsibilities To better understand the importance of financing for municipalities, one must first understand their role and responsibilities. In economic terms, local governments should provide goods and services to a specific area, so long as residents are willing to pay for these services. Among these important services are: 1. garbage collection, 2. security, 3. public transportation (including road maintenance), 4. health, and 5. education services, among others. Many of the outlined services can be better provided at a local level, since local governments can offer more efficient and agile services given that the decision making process is carried out at a level closer to that of the citizen. This is what’s known as the “subsidiarity principle� as detailed in (Barnett, 1997). This is due to differences in costs, accessibility, and preferences at local levels. Municipalities are limited in the services they can offer by the revenues they generate. Unlike central governments, municipalities cannot freely increase taxes so as to generate new revenue. The free movement of labor and capital will mean that any substantial increase in taxes could lead to businesses and residents moving to a nearby municipality with lower taxes.. Financing Options for Municipalities Local governments have several means to finance economic development projects, among these are levying taxes, intergovernmental transfers, borrowing, public-private partnerships, or a combination of these. This section presents the benefits and drawbacks of each of these financing methods. Borrowing For a large project, borrowing is a reasonable source since costs can be distributed over several years. Another benefit of long term financing is that the municipality avoids significant variations in costs from one year to another simplifying tax planning.
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Long term borrowing should be restricted to financing capital expenditures and economic development initiatives. Long term debt does have disadvantages, the main one being that it limits the municipality’s ability to deal with unforeseen events, such as natural disasters. This is because debt service is usually fixed at a given amount for the loan’s term. Investment in infrastructure, education, transportation, and public safety should be fostered. What should be avoided at all costs is borrowing to cover fiscal deficits. Levying Taxes Levying new taxes, or increasing taxes, is rarely an option to finance new development projects as the municipalities have certain constraints when increasing taxes. As presented in previous sections, if a municipality were to increase a tax, given the free movement of labor and capital, residents and companies could simply move to another municipality. It should also be pointed out that in many cases levying taxes can’t always generate the required capital for an economic development project, that require a substantial initial investment. Because of this, levying taxes is only a viable option for small projects and even so, there are limits to the type and duration of new taxes earmarked for specific projects. The current economic climate in Puerto Rico limits the municipalities’ ability to increase revenues through the Sales and Use Tax, construction fees and franchise taxes. As economic activity continues to contract, municipalities will be limited in terms of financing possibilities. Public-Private Partnerships (PPP) In cases were municipalities do not wish or are unable to incur in new debt, PublicPrivate Partnerships (PPP) are an option. In certain PPP’s the private sector covers the up-front costs in exchange for a long term lease to operate the service (Tassonyi, 1997). Because of this, many municipalities around the world have turned to PPPs. This helps the municipalities deal with many of the up-front costs associated with large projects,
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thus allowing municipalities to initiate economic development and infrastructure projects without increasing their debt burden. The downside of a PPP is that the cost of the project is often passed on directly to the user of the services generated. An example of this is a toll on a new private highway. Developing countries have encountered difficulties with PPPs because of the risk for both the public and private sectors (Annez, 2006). These are due to factors that include a lack of transparency by the local government, revenue streams that do not match the expectations of the private partner and, in many cases, the need for public funding not planned for. Intergovernmental Transfers Intergovernmental transfers should be avoided as they could promote dependency on the central government. Transfers can be conditional, meaning they can only be used for a specific purpose, or unconditional and can be used for any purpose the municipality sees fit. Transfers tend to create fiscal problems at the municipal level as transfers distort local decision making, “these systems of grants, although serving legitimate purposes, can, under certain circumstances, be a source of serious fiscal mischief” (Oates, 2008). Because of the current fiscal crisis it’s also likely that the Commonwealth will be unable to maintain, let alone increase, intergovernmental transfers. Therefore, this is not a viable option for Puerto Rico’s municipalities. GDB’s Role in Economic Development Options for municipal financing are limited, particularly for small municipalities, this means the GDB has assumed a much more important role. The financing provided by the GDB in the coming years will be critical in allowing the municipalities to invest in infrastructure and economic development. This will help boost economic activity not only at a local level, but could provide benefits to the Commonwealth as a whole if municipalities stimulate such activities. Given the current economic conditions, the GDB’s importance regarding its duties as lender for the municipalities will become ever more important. The municipalities are
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facing a decrease in revenues as intergovernmental transfers are reduced. Economic activity is expected to continue to contract until at least 2020. Because of this, municipalities will have a need for a public bank that will help finance their economic development and infrastructure initiatives. This is especially true for small municipalities, since access to private financing will become even more difficult for them. Smaller municipalities also tend to rely more on intergovernmental transfers, this is the case not only in Puerto Rico (Estudios TÊcnicos, Inc, 2016), but internationally as well (Slack, 2007). Financing budget deficits offers no long term benefits and could lead to debt increasing to unsustainable levels for some municipalities, and is to be avoided. At an international level many countries limit or even outright deny the municipalities access to credit (Rodden, Eskeland, & Litvack, 2003). This is where the GDB’s role as financial advisor to the municipalities will be critical. The GDB must aid the municipalities in the coming years as they see their access to credit limited, intergovernmental transfers decline, and tax revenue decreased by a contraction in economic activity. Over the coming decades it is expected that further urbanization will place additional pressure on municipal governments (United Nations, 2014). This presents a challenge for them since they will need to maintain cities economically viable by offering an adequate level of services while keeping taxes sufficiently low to attract new business activity. Once access to credit markets is available, the GDB should consider lowering the cost of borrowing by pooling municipal debt. This is currently done through COFIM. By pooling the debt of several municipalities the financing authority for the municipalities can have greater flexibility when negotiating terms and costs. This also lowers the administrative costs associated with debt issuance. The financing authority could also have greater access to credit markets and benefit from a higher credit rating (United Nations, 2009). Yet, this strategy must be accompanied by a decentralization process, that would allow the municipalities to provide better services to residents, and more efficiently.
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Importance of Decentralization The process of decentralization cannot be interpreted as increasing municipal responsibilities without transfer of funding, limiting the local government’s ability to provide the services delegated to it. This trend has been observed worldwide as in many cases the transfer of power from central to local governments (decentralization), hasn’t been accompanied by an increase in local revenues, so expenditure growth has outpaced revenue growth (United Nations, 2009). Local governments rely on intergovernmental transfers or are forced to borrow because of insufficient income from the various taxes that they levy. In many cases this happens for reasons beyond their control, such as incentives legislation that limits the taxing power of municipalities. By transferring responsibilities from central to local governments without additional revenue sources the local government’s ability to adequately offer services is limited. The need for more control of fiscal issues by municipalities has been laid out on an international level, “Unless local governments can alter the tax rates, they will not achieve local autonomy or accountability”98. The benefits of decentralization in Puerto Rico have been laid out in a recent report (Comisión de Descentralización y Regiones Autónomas, 2013). Given that municipalities have closer contact with residents and their needs, they can better direct funds to deal with such needs and do so more efficiently. Decentralization can also lead to greater public participation in the municipal government. Municipalities must become more accountable and transparent and include residents in decision processes of how funds are raised and spent. One way to increase accountability while improving financial management is to use a performance based budgeting approach, and use benchmarks. This will allow the public to view how their funds are being spent based on the community’s goals. This will also allow the GDB to view how efficiently funds are being spent and better aid the municipalities in improving their financial management.
98
UN HABITAT, “Guide to Municipal Finance”, 2009, P.23.
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Municipalities and GDB’s Loan Portfolio The GDB’s net loan receivables from municipalities has increased substantially in the past decade, from $498.2 million in 2006, to $2,214.9 million in 2014. The GDB’s net loan receivables are 344.5% higher in 2014 than in 2006. This highlights the GDB’s importance in financing municipal operations. As the economic downturn, that began in 2006 has deepened, the GDB’s role as fiscal agent and lender for the municipalities has become ever more important. The rate of growth began to slow down in 2013 and 2014 as the GDB’s fiscal situation worsened. This has left municipalities with limited access to financing. The sharp increase in loans to municipalities is also worrying, as it could point to municipalities increasing their dependence on borrowing. In the future, the proposed PR-DIB must ensure that all loans to municipalities are for initiatives that generate the wherewithal to pay back the loan. F IGURE 24- N ET LOANS RECEIVABLE TO MUNICIPALITIES (M ILLIONS ) $2,214.9 $2,212.5 $2,145.0 $1,792.1 $1,466.8 $1,175.0 $1,003.3 $743.3 $498.2
2005
2006
$602.4
2007
2008
2009
2010
2011
2012
2013
2014
Source: GDB Financial Statements for FY 2005-2014
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ECONOMIC DEVELOPMENT BANK (EDB)
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Economic Development Bank The Puerto Rico Economic Development Bank (EDB) was created by Act 22 of 1985. The purpose of this new institution was to promote the development of the private sector in Puerto Rico’s economy. The EDB was to offer any person, institution, and credit union, whether for profit or non-profit, with direct loans, and/or loan guarantees. The EDB places a priority on small and medium size enterprises. What qualifies as small and medium enterprises is defined by the Board of Directors of the EDB. In 2006, the EDB’s Board of Directors created the Economic Development Bank Capital Investment unit (EDBGCI). It shares the same board of directors as the EDB and the EDBCI’s operation consists mainly of supporting the EDB in the development of the Puerto Rico private sector. The EDBCI invests in equity and other forms of capital start-up in local enterprises. The EDB transferred $27.4 million in initial capital to the EDBCI, another $30 million was assigned afterwards.
EDB Assets & Loans In fiscal year (FY) 2014 the EDB had $1,092.2 million in total assets, 20.9% less than the $1,379.0 million it reported for FY 2011. As a percent of total assets, loans represented 28.5% in 2014, almost double the 15.2% reported for 2012. This is due to both an increase in loans and a decrease in total assets. F IGURE 25 Total Assets (millions) $1,579.1 $1,379.0
$1,295.2 $1,090.2
2011 2012 2013 Source: EDB Financial Statements for FY 2013-2014
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F IGURE 26
Loans as Percent of Total Assets 28.5% 21.1% 15.2%
2012 2013 Source: EDB Financial Statements for FY 2013-2014
2014
Nearly half of the EDB’s loans in FY 2014 were to firms in the Services sector, with a further 24.4% loaned to companies in the Commercial sector. Loans to companies in the manufacturing sector represented 11.8%, only slightly more than loans to the Agricultural and Tourism sectors. F IGURE 27 Distribution of Loans Receivable by Sector in FY 2014 Tourism, 8.8%
Agricultural, 9.3%
Manufacturing , 11.8% Commercial, 24.4%
Services, 45.7%
Source: EDB Financial Statements for FY 2014
The EDB’s net assets and net operating income have remained relatively stagnant in the past three years reported (2012-2014). In 2014, net assets reached $166.0 million,
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5.4% higher than the $157.5 million reported in 2012. Meanwhile, net operating income totaled $108.1 million in 2014, this was 1.6% lower than in 2012. F IGURE 28 Net Assets and Net Operating Income $160,082,377
$157,513,363 $109,902,986
2012
Net Assets
$107,332,197
2013 Net Operating Income
$165,997,214
$108,093,576
2014
Source: EDB Financial Statements for FY 2013-2014
Impaired Loans Loan receivables delinquent 90 days or more have increased from 9.4% in 2012 to 14.9% in 2014, a substantial increase. As loans increased so has the delinquency (90 days or more). The value of loans in delinquency by 90 days has more than doubled in just two years. Between 2013 and 2014 Commercial delinquencies of over 90 days increased by 62.6%, and 67.3% for those in the service sector. The largest increase was observed in manufacturing, an 88.5% increase in delinquencies 90 days or more was reported. The EDB classifies these loans as impaired loans and consider improbable that the debtor will be able to pay according to the contractual terms of the loan agreement.
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F IGURE 29
Loans Due 90 days or More as Percent of Gross Loan Receivables
14.9%
11.8% 9.4%
2012 2013 Source: EDB Financial Statements for FY 2013-2014
2014
T ABLE 6 Loan Receivable Delinquency by Industrial Sector (90 days or more) Sector
2013
2014
% Change
Agricultural
$ 11,449,673
$ 11,960,600
4%
Commercial
$ 8,998,038
$ 14,628,796
62.6%
Services
$ 8,131,575
$ 13,604,360
67.3%
Manufacturing
$ 3,905,057
$ 7,362,744
88.5%
Tourism
$ 3,939,800
$ 3,874,054
-1.7%
Total
$ 36,424,143
$ 51,430,554
41.2%
Source: EDB Financial Statements for FY 2014
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CONCLUSIONS
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Overall Conclusions The Island’s overall economic performance in recent decades, along with misplaced management practices have led to poorly informed policymaking. This has limited the fiscal capacity of the Island and also its ability to generate new productive activity. The Island as a whole has become dependent on debt and taxes in order to maintain government spending. Legal mandates have done little to limit the state’s borrowing activity; somehow our institutional creativity has been transformed into complex legal and accounting schemes that provided justification for government spending. Many justifications have been offered through the years by Commonwealth institutions to issue debt. Increased government spending is the key problem and the quality, measured in terms of cost-effectiveness, of our public spending is highly questionable. This can be remedied by strong monitoring and performance-based mechanisms, that are currently lacking in our institutional structure. But it is also related to the absence of clearly espoused priorities in key areas. In an economic landscape characterized by serious scarcity of resources, having clear priorities is indispensable for public interventions in the economy. The current fiscal condition, the Island’s credibility and the potential for future sustainable growth, make the development of effective financial policies imperative. Commitment to sound practices is no longer an option, but a mandate. Even if the EDB and the GDB are converted into a true development bank, positive externalities in the economy will be limited if general fund expenditures continue to be financed with nonrecurring revenue sources. The reliance on credit in previous decades for covering operational fiscal gaps has closed the door for debt issuance that promotes economic development. The use of highly sophisticated financial instruments to finance current government expenditures rather than new productive capacity has halted the ability to stimulate economic development. Financing entities dealing with economic development must be closely related to other economic development agencies and agreed upon strategies. Puerto Rico’s experience has been that of a highly fragmented system. This has made political interference in decision-making a much more prevalent practice than is desirable and
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has made it almost impossible to integrate development objectives with lending practices. Lack of autonomy from politically sensitive decisions must be provided to crucial state entities, requiring profound transformations in their governance structures.. The empirical evidence worldwide shows “that government ownership of banks has, if anything, been associated with faster long run growth. …the evidence suggests that government ownership of banks during 1995–2007 has been robustly associated with higher economic growth.”99 Moreover, during the global financial crisis of 2008-2010, most Development Banks played a countercyclical role by providing credit to private firms that were temporarily unable to access funding from private commercial banks or capital markets. The World Bank survey100 on development banks also notes that poor lending decisions, high level of non-performing loans, political requirements and mandates, are characteristics of those DBs that in the past have failed. During the past decades the GDB has provided funding to finance deficits and special programs such as the Special Communities project. The GDB was used by other Commonwealth instrumentalities as a lender of last resort with few posibilities for repayment of loans. The information presented throughout this report evidences the need for an institution that is able to finance, promote and facilitate economic development interventions in the economy. Even though past performance is not encouraging, the current state of affairs calls for an institution which is able to perform the functions that GDB performed initially. That is, to provide development banking services to an economy that has endured a decade-long economic contraction and in which private financing sources are limited.
99
Andrianova, S., Demetriades, P. & Shortland, A. (2010), Is Government Ownership of BanksReally Harmful to Growth?, Berlin: German Institute for Economic Research, 2010.
100
Luna-Martínez, et al, 2012
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RECOMMENDATIONS
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Guiding Principles for an Economic Development Bank
Political independence – this can be achieved by adequate representation of stakeholders in its Board, the manner in which members are selected and appointed and the terms of their appointment...
Market neutrality- requires that the Bank does not destabilize private sector banks. The proposed can introduce new financial products to demonstrate their financial feasibility to the private market, as the GDB once did by financing housing projects and the Caribe Hilton, among other projects.
Self-sustaining – although a World Bank survey found that 40% of development banks receive government transfers to partially fund their operations, it is essential that the proposed Bank be self-sustainable and non-reliant of government subsidies. (World Bank, 2013)
Best and brightest – institutional autonomy demands high banking standards, risk management, monitoring, highly trained personnel (with competence and experience). The Bank’s leadership should aim at attracting the “best and brightest” to its staff.
Structural focus – projects financed by the Bank should be chosen on the basis of their impact on the economy, avoiding highly visible but inconsequential projects in terms of their impact on economic development.
Policy innovation - via well-designed lending and underwriting practices the Bank can have a major influence on innovations both in its clients and in the policy making system. This focus will influence the choice of projects to be financed. .
Collaboration - GDB and its new institutional structure is part of a wider policy cluster, designed to stimulate economic growth and sustainable development. Thus, the Bank will not be an isolated institution, but rather part of a group of agencies and programs focused on economic development.
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Institutional Transformation Based on the above research and the socioeconomic scenarios outlined, it is recommended that Puerto Rico maintain a state institution that is able to support economic development projects via different financing mechanisms. A most important recommendation is the need to maintain a development bank as a tool for economic development. Relegating such a role to private commercial banks, to other state agencies, or to the limited amount of investment capital available in non-financial institutions, is to limit the possibility of generating the investment necessary for a prosperous and growing economy. The current state of affairs demands a vigorous tool that could bootstrap innovation and sustainable economic development. The institutional transformations proposed in this report rescue the original conception of the GDB as a development bank. An important task in this transformation is to find an equilibrium between competing interests that are typical to development banks, that is, a well-conceived balance between large-scale projects and small business ventures, between “infrastructure101” projects with longer term returns and turnkey projects with immediate returns, between lower risk and high risk investments or financing public productive investments or private investments. These are all competing claims on scarce resources that must be addressed via the design of strict rules and procedures that must be part of the bank’s charter. Development banks remain relevant in the world economy, and are much needed in developing countries and in some developed economies. Economies such as the economy of Puerto Rico demand strong and innovative institutions that are able to direct economic development. The coming years will demand deep transformations in our society102 similar to those that took place in the 1950’s and 60’s. Nonetheless, such profound changes demand an entity with the capacity to promote policies aimed at creating new productive capacity.
101
During the pasts decades the concept of infrastructure has been coined to describe almost any government sponsored project, thus, usually includes projects with small effects on economic growth.
102
De-globalization, metropolitan revolutions, decentralized political scenarios, local relevance, environmental challenges, generational change, aging and smaller population, among other trends.
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These transformations must demand a clear recognition of past mistakes (not unique to Puerto Rico), and provide the safeguards that minimize the potential recurrence of such errors. Sometimes these changes seem like small institutional transformations, but their effects are profound in the economy. For instance, As the Volcker Alliance stated in their 2014 report: “While states may need to tap rainy day funds or seek other short-term solutions during economic downturns, the use of nonrecurring resources to cover recurring costs should be avoided. States shouldn’t balance general fund budgets with proceeds from debt or asset sales, extraordinary legal settlements, or other one-time fixes—such as transfers or loans from funds dedicated to specific purposes. They should follow consistent policies for revenue and expense management so that future revenue cannot be shifted routinely into the current fiscal year (or expenses pushed out to the next one) to cover an unbalanced budget.” “Operating budgets should not be funded with the sale of bonds or other forms of debt that provide immediate cash but move the cost of debt service to future years. Even if states are prohibited from using borrowing to cover operating costs, there are ways to get around that prohibition, including shifting money from one fund to another. Governments shouldn’t directly or indirectly treat the proceeds of debt sales as revenue.” (Volcker Alliance, Truth and Integrity in State Budgeting, 2014) Delineating a course of action for the future of development banking in Puerto Rico, requires the enabling law of such an institution to provide a clear mandate that limits the undue political influence that could hamper the institution in achieving its objectives. The legislative mandate should also provide a commitment to monitoring and evaluation, and sufficient transparency as to guarantee that mistakes such as the ones described above are minimized. Changes in the Organizational Structure
The new bank should be organized as a corporate entity separate from central government, with limited political intervention. It’s necessary to draft a new
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charter that guarantees independence from political appointments; this entails changes
to the
bank’s
governance
structure
(terms, and
stakeholder
representation, responsibility for making appointments)
Merge GDB with EDB. This will facilitate obtaining initial capital for developing banking projects that currently are not undertaken under the EDB or the GDB. The new development bank will be named the Puerto Rico Development and Innovation Bank (PR-DIB). The name highlights the Bank’s mission to be a development oriented bank focused on innovation through its support of emerging technology firms in the various sectors. These two defining characteristics, and the fact that immediate returns are not necessarily the driver of Bank initiatives, differentiate the Bank from the rest of the financial system
The new Bank must adapt its financial products to the new trend seen in the private banking sector towards providing private capital for startups and small businesses. Coordinate lending activity with private banks in order to leverage on their resources and specialized knowledge
Merge Puerto Rico’s Public Private Partnership Authority with PR-DIB; this provides an additional tool to mobilize private capital into EDB/GDB sponsored projects and will also guarantee the PPP authority’s independence a sit will operate under the aegis of the Bank’s independent Board.
To guarantee political independence, PR-DIB must be self sustaining. Any initial allocation to fund its operations or, if needed, additional allocations from the Central Government, should be provided with no specific conditions, beyond the rules and regulations already in place and reporting requirements on the use of such funds.
Modify GDB and EDB charters to segregate all financial advisor responsibilities out of the bank.
Previous GDB functions pertaining to fiscal agent and financial advisor to the Commonwealth, now handled by AAFAF, should be transferred to a Financial Management Authority.
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Create the Puerto Rico Financial Management Authority; the Authority will share a similar governance structure to that of the new GDB, which will guarantee political independence. This entity will guarantee adequate oversight over all Commonwealth entities, including GDB. This could also limit potential conflict of interests that have existed in the GDB’s governance body.
Transfer the municipal budget and finance division from the Office of the Commissioner of Municipal Affairs (OCMA) to the new Financial Management Authority.
Maintain an Economic Analysis division within the PR-DIB that is able to provide in-depth sector analysis, needs assessments, financial and cost-benefit analysis and technical assistance to potential clients (feasibility studies, market research, social impacts, etc.).
Further analysis is required to determine if the limited public management functions that PR-OMB performs can be transferred to the new financial management authority. It is important to note that current budget functions should be kept within OMB due to its strong relation with public policy, which will be inevitably restricted by the proposed integration with Hacienda. Moreover, the treasury division within Hacienda and other public accounting offices could also be transferred to the proposed financial management agency. This will be somewhat similar to the examples outlined above on Hawaii’s Department of Budget and Finance.
Changes in the Operational Structure
The Bank must adopt significant risk management policies to securitize its role as development bank, and to safeguard it against losses in its main portfolios from sovereign and non-sovereign debt. For example, the African Development Bank performs stress tests on both its sovereign and private sector portfolio (African Development Bank, 2011). According to the Bank for International Settlements, credit risk exposure continues to be the main source of bank problems worldwide, and thus, a holistic approach to monitoring, assessing and counteracting risks
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both on and off the balance sheet should be of high priority to ensure the bank’s sustainability (Bank for International Settlements, 2000).
The Bank should assess the viability of engaging in any sort of countercyclical policy program, and ascertain concrete and safe repayment sources.. The strength of the Bank should lie in ensuring long-term availability of credit to sustain capital improvements beyond any short-term fluctuations. Therefore, its participation in temporary expansionary measures should never endanger the Bank’s long-term viability.
The Bank should impose an overall credit limit for a particular client. Continued increases in lending to a particular client, absent significant quantitative and qualitative improvements in the client’s repayment sources and collateral, should be reduced to a minimum. A hard ceiling on the client’s profile would ensure fiscal responsibility and ensure coherence between lending and revenue growth.
Revenue sources other than bond issues should be given preferences. According to Brown (2016), “a general rule for government bonds is that they double the cost of projects, once interest is paid.” In addition, by maintaining government funding sources within government instead of depending on private lending, the bank can limit the eventual cost to its clients..
Up to date systems and procedures - The bank should have an authoritative database of development projects enacted by central government agencies, municipalities or other state entities. Moreover, during the past years several reports have highlighted the need of the modern and reliable financial management infrastructure. This pertains not only to GDB, but also Hacienda and OMB. The operational structure of the GDB is an ideal place to start this process.
Potential Sources of Funds
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Perhaps the most difficult task for the creation of the new institution is the matter of providing it with working capital in its beginnings. Although beyond the scope of this report, a number of suggestions can be made concerning this matter:
A proposal made in the report is for the Board’s composition to reflect stakeholder interest in the Bank. Parallel to having a stakeholder Board, a possibility is for them to invest in the entity either through acquisition of Bank issued notes or, if made possible by legislation, invest in equity in the Bank.
A second proposal would be to allocate future Law 20 and Law 22 fiscal income to the Bank. Thresholds would have to be established for such an allocation. One possibility is to use Fiscal 2016 fiscal income as the threshold and allocate a percentage of excess income over this figure to the Bank.
A third possibility is to pool Bank loans and sell them in the secondary market, although this possibility would still require an initial investment from other sources.
Other sources to consider will include: redirecting deposits from state agencies (include deposits from state-led insurance services and other welfare programs such as driver’s insurance, employment insurance programs, among others) borrow from multilateral financial institutions (i.e. Interamerican Development Bank) and other Federal and international grantors. The proposed bank could follow an innovative approach by developing financial instruments such as diaspora bonds. Diaspora bonds have provided massive resources to small and big countries alike, i.e. Lebanon and some European countries.
Strategically, the proposed bank could initially utilize financing approaches that rely on private funding via collaboration with commercial banks. The EDB’s strategic plan calls for such an arrangement that would permit the EDB to loan to higher risk clients, assuring that the routine banking services such as deposits, letters of credit and other services are done by the commercial bank. If adopted for the new bank, commercial banks would provide financing under a formula to be determined, that could be based on a percentage of profits or some other parameter. This approach will reduce capital requirements for the bank and also leverage resources of commercial banks.
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The current capital structure of the EDB could provide some seed capital for the proposed entity. The arrangement mentioned above whereby commercial banks would in effect provide financing for the PR-DIB using an agreed upon formula, would strengthen the PR-DIB capacity to lend to emerging, high risk firms.
Although the Bank should strive to be self-sufficient, an initial investment by the Government will almost certainly be required. Even if the central government provides an initial transfer, by restricting the bank’s ability to borrow from capital markets, it minimizes the Commonwealth’s liability.
What follows are recommendations on various aspects related to the creation and operation of development banks. The information provided in the tables was derived from extensive literature search, including World Bank publications concerning development banks and from Estudios Técnicos, Inc.’s data bases.
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Recommendations for a Development Bank Dimension Vision
Recommendations 1. A well defined Vision is essential to identify the market niche or niches the Bank should focus on, and to avoid the risk of either competing with the private sector or engaging in unsustainable lending practices. 2. The Bank should expect to be profitable or, at a minimum, financially selfsustainable, and non-reliant on government subsidies or transfers to fund its operations.
Mandate
1. A precise definition and articulation of mandate is necessary. It should, among other things, reduce the opportunities for political interference, and have the commercial and financial sectors clearly understand its role. In Puerto Rico’s case, a clear delimitation of roles between the institution and FAFAA is particularly important. 2. The mandate should make clear that development banks are a form of government intervention in the financial system with the purpose of addressing financial market failures, complementing government resources and market funding. 3. It should make clear that the practice of creating affiliates or subsidiaries in order to bypass financing constraints is unacceptable and that, even understanding that development banks play a social role, underwriting standards must be strict. 4. Bank practices must be consistent with the long-term economic goals of society, and the government's view of its role in providing finance. 5. A broad mandate in terms of sectors is best, as it will provide the Bank with flexibility to finance a wide range of activities and sectors. However, such a mandate will require very effective management. 6. The Bank must operate in consonance with the rest of the economic and financial system, but deal with gaps and unserved needs by the latter.
Scope of activities
Structural requirements (Refers to the functional microeconomic environment needed)
1.
In terms of scope and specialization, it must evaluate the advantages and disadvantages of specialization and a broader scope of services. In general, most DBs provide a broad range of services. Multiple roles have the disadvantage of running the risk of being ineffective and unfocused.
2.
The issue of scope in terms of types of clients is also important. Will the Bank concentrate on SMEs or large enterprises? Experiences vary but most point to an emphasis on disadvantaged firms without disregarding large scale projects that are considered essential.
1.
A developed private commercial and financial sector.
2.
A regulatory environment that supports investment.
3.
A pool of highly trained and competent financial and economic professionals.
4.
Adequate financing sources.
5.
Sound fiscal discipline from the government.
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Recommendations for an Economic Development Bank Dimension
Corporate governance and management
Recommendations 1.
Independence from the government and de-politicization of the bank and of its role is key.
2.
Annual evaluation of corporate and governance problems, and of the methods for achieving objectives, recognizing that market profit might not necessarily be the relevant performance benchmark.
3.
Its mandates should be also reviewed on a regular basis to ensure they operate according to goals and changing economic conditions.
4.
Adopt and implement internationally accepted accounting principles, and independent and timely financial audits.
5.
Transparency in its activities and providing timely information is a critical condition. Data disclosure is important for accountability and is also a public good for the development community, including academics, practitioners, and evaluators.
6.
Put in place a comprehensive risk management process for all risks including risk-modeling techniques for interest rates, credit market, operational risks, long-term payment or returns. The risk assessment unit must report directly to the Board.
7.
The Board of Directors’ primary function should be to provide strategic guidance and oversee management of the institution. IT should be held accountable for performance against previously determined objectives. The Board’s performance should be evaluated annually. If government representatives are appointed, they should be in the minority.
8.
In addition to lending, the Bank should also provide services such as technical assistance, economic and financial information and research results on specific sectors or industries.
9.
Supervisory practices derived from the Basel principles for Banking Supervision (2012) should be put in place. Financial regulation and supervision could be supplemented by market-based measures, such as credit ratings, in this case of the intrinsic quality of the bank.
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Dimension 1.
Financial sustainability
2. "The commercial activities of the bank should be financially sustainable. Financial sustainability protects the government against losses, ensures that the bank makes better use of scarce resources, assists it in raising funding at a lower cost, safeguards its independence and through demonstrating that investment in developmental projects may be profitable, attracts private investment." (J. Thorne, 2006, pp. 26 - 27)
3.
4.
5. 6.
7.
8.
1.
2. Performance assessment
3.
4.
Recommendations In general, there are two traditional ways in which state banks obtain funds, some of which the GDB has used: (1) direct origination, that is, its ability to autonomously originate debt or equity; (2) indirect origination, through which it create incentives to stimulate other financial intermediaries to originate loans, guarantees, provision of long-term funds, related to government targeted investment projects, companies, or industrial sectors. (E. Torres and Z. Zeidรกn (2016). The Bank could also borrow from private financial institutions. The Bank could act as a depository agency and provider of banking services for all agencies as a means of generating liquidity. This has obvious limits as recent experience in Puerto Rico has shown. After its initial funding, the Bank should strive to be a self-supporting entity that pays for its operations from service fees and interest earnings on loans and investments Explore the possibility, like the Bank of North Dakota reviewed in the Report, of the bank borrowing at the Federal Reserve's discount window. This will, of course, require that certain Fed requirements be met. The Bank should have broad but well-defined and regulated statutory authority to issue tax-exempt and taxable revenue bonds. As part of the financial system the Bank ought to limit itself to funding of those activities in which it has a "comparative advantage" (Better understanding of high-risk markets and in-depth knowledge of the clients of these markets), and mobilize whenever possible privatesector co-funding of its projects through diverse mechanisms or instruments. That way private sector banks might be more willing to expand into funding of high-risk projects and sectors. The bank should consider equity investing in order to overcome the problems of limited collateral and limited cash-flow during the early development of firms considered to have growth potential or that serve a particular need in the economy. An example could be a firm developing an enabling technology that will generate major positive spillovers. Assuring the financial sustainability of a development bank is complex, particularly if subsidies to the institution are to be avoided. Higher bank interest rates could support financial sustainability but could, at the same time limit its role in stimulating investment. The contribution of the bank should be measured through social aspects, such as the value of the service to clients, cost, number of clients, and also financial metrics, such as the traditional standard ratios that are typically used in the banking sector. A critical component of performance evaluation is the need to assure that corrective measures are implemented when needed. All loans, grants, and other activities should be subject of and impact analysis to determine the effect of the activity on economic development. This is useful in determining priorities. Good evaluation practices require input from various parties, which can include staff, senior management, clients, and external organizations. There is no single best standard, type, or system of evaluation; rather, there is a wide spectrum of evaluation methodologies that employ different degrees of rigor depending on the objective, purpose, and subject of evaluation.
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APPENDIX: GDB’S LEGAL FRAMEWORK
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Legal Background This chapter summarizes the main statutorily changes to the GDB overtime. It provides insight into the main institutional transformations of the GDB and other Commonwealth entities.
Act 252 of May 13, 1942 This Act created a Development Bank of Puerto Rico, under the Governorship of Rexford Tugwell, a member of the Roosevelt’s Administration “Brain Trust”.
The Act
states that the purpose of the Development Bank of Puerto Rico shall be to attain, or to help in the realization of the complete development of the human and economic resources of Puerto Rico by engaging in general banking business. The Development Bank of Puerto Rico would be a nonprofit instrumentality of the Insular Government. The Governor would establish its functions, that could include, the power and authority to accept government and private deposits, to lend money and to issue bonds, as well as promissory notes, to lend money for industrial and commercial purposes and for agricultural purposes and to regulate the terms and conditions for accepting deposits, loaning money, and making loans for acquisition, possession, ownership, use, and disposal of various kinds of property, and all other internal and external affairs of the bank, but it cannot accept deposits, borrow or lend money, or in any other way engage in general banking business unless and until it is authorized to do by the Legislature of Puerto Rico. In making loans or otherwise extending credit, preference and priority would be given, when all other factors are equal, to the Puerto Rico Development Company (PRIDCO), and to enterprises recommended by said company, so that it may support the industrial and commercial development of the Island. It further states that: ”The debts or obligations of said corporate entity shall not be debts or obligations of The People of Puerto Rico or of any of its municipalities or other political subdivisions; and neither The People of Puerto Rico nor any of its municipalities and other political subdivisions shall be responsible for the same."
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Act 46 of May 13, 1943 The Bank cannot accept deposits, borrow or lend money, or in any other way engage in general banking business, unless and until it is authorized to do so by the Legislature of Puerto Rico. The Bank is authorized to accept deposits, borrow or lend money, and engage in general banking business, subject to the limitations imposed by said Act and by its charter.
Act 272 of May 15, 1945 Permits the Development Bank of Puerto Rico to act as fiscal agent of the Insular Government for the purpose of registering, authenticating or countersigning, the bonds, notes or other evidences of indebtedness of the Insular Government, its agencies and municipalities and of the Treasurer of Puerto Rico. Authorized to act as paying agent or co-paying agent, with or on behalf of the Treasurer of Puerto Rico for the payment of interest and principal of bonds, notes or other evidences of indebtedness issued by the Insular Government and its agencies, and by the Treasurer of Puerto Rico and by or on behalf of the municipalities of Puerto Rico. No agency of the Insular Government nor municipality thereof, shall select any other Bank, Trust Company, individual, partnership or corporation to act as such paying agent. Bank will be the Financial Advisory and Reporting Agency to the Governor of Puerto Rico and to the Treasurer of Puerto Rico. Allows the sale or exchange by the Insular Government or by the Treasurer of Puerto Rico of any bonds, notes or other evidences of indebtedness. Appointed and authorized to act as agent for the payment of interest and principal of bonds, notes or other evidences of indebtedness issued by any public service enterprise or authority owned or controlled by the Insular Government heretofore created or hereinafter created, including but without limiting thereto,
Puerto Rico Water Resources Authority,
Puerto Rico Transportation Authority, Development Company of Puerto Rico,
Puerto Rico Agricultural Development Company,
Puerto Rico Aqueduct and Sewerage Service,
Puerto Rico Land Authority,
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Puerto Rico Communications Authority
No such unit shall select any other Bank, Trust Company, individual or partnership or corporation to act as such paying agent, for such purposes, unless the Bank shall, by resolution of its Board of Directors, determine not to act as such paying agent, for such unit, in such instance.
Act. 17 of September 23, 1948 Provides the Bank’s Charter for the Government Development Bank for Puerto Ricodefines the Bank’s duties and powers. GDB Dual Role: Financial Advisor & Fiscal Agent for the Government, its municipalities and public corporations in connection with issuance of bonds and notes, and to make loans and advances to these entities. The charter provides for perpetual existence and states that no amendment to the charter or any act of PR shall impair any outstanding obligations or commitments of the Bank. The Bank is given tax exemption in PR.
Act 31 of 1957 Amends Sections 2 of Act 17 of 1948, Purposes and Business Object of the Bank: States, in summary, the powers of the Bank as follows:
(A) To act as fiscal agent and as paying agent and as a financial advisory and reporting agency of the Commonwealth Government and of the agencies, instrumentalities, commissions, authorities, municipalities and political subdivisions of Puerto Rico, including the Treasury.
(B) To act as depositary or trustee of funds for the Commonwealth Government or for the United States and for any agency, etc. or municipality, to give security for the repayment of any such funds and to pay interest thereon, and to act as depositary of funds for any bank or trust company doing business in the Commonwealth of Puerto Rico.
(C) To lend money, with or without security, to the Commonwealth its agencies and municipalities.
(D) To lend money, with or without security, to any person, firm, corporation or other organization where such moneys are to be used to further
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the governmental purpose of developing the economy of Puerto Rico, particularly with respect to its industrialization, such loans to be represented by the promissory notes, bonds, debentures or other obligations or evidences of debt of such borrowers;
(E) To invest its funds in direct obligations of the United States or obligations guaranteed as to both principal and interest by the United States, or obligations of Puerto Rico or guaranteed as to both principal and interest by Puerto Rico, or obligations of any agency, instrumentality, commission, authority, municipality or political subdivision thereof, or obligations insured or guaranteed under housing laws of the United States, or in obligations issued by the Federal Land Banks or in obligations issued by the Federal Intermediate Credit Banks.
(F) To discount, at a uniform rate or rates of interest to be fixed from time to time by the Board of Directors of the Bank, for banks or trust companies organized under or subject to the Banking Law, negotiable drafts, notes, bills of exchange and acceptance, bearing the endorsement of the bank or trust company for which discounted...
(G) To lend money, at a uniform rate or rates of interest to be fixed from time to time by the Board of Directors of the Bank, to any bank or trust company organized under or subject to the Banking Law, for a period not exceeding ninety days, on the promissory note of such bank or trust company, secured by notes, drafts, bills of exchange or acceptance eligible for discount by the Bank....
(H) To lend securities, on a fully secured basis, to any bank or trust company organized under or subject to the Banking Law.
(I) To borrow money and contract debts for its corporate purposes upon such terms and conditions as the Bank may from time to time determine, with or without security, to dispose of its obligations evidencing such borrowing, to make, execute and deliver trust indentures and other agreements with respect to any such borrowing, contracting of debt, issuance of bonds, notes, debentures or other obligations, and by the authority of the Government of Puerto Rico which is hereby granted, to issue its bonds,
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notes, debentures or other obligations in such form, secured in such manner, and subject to such terms of redemption with or without premium, and to sell the same at public or private sale for such price or prices, all as may be determined by its Board of Directors. ď‚—
(J) To exercise all such incidental powers as may be necessary or convenient for the purpose of carrying on the foregoing business and objects. The power granted in paragraphs (C),(D), and (E) above shall not include the power to lend moneys on short term or to invest in short term securities other than marketable securities, where the borrower or obligor has facilities available to it in banks organized under or subject to the Banking Law.
Act 13 of May 30 of 1960 Amends Section 2(D) of Charter, Bank may sell evidence of debt of borrowers etc. (Securitization) and establishes a 20% deposits reserve. “Section 2 (D)-The Bank may hold, negotiate or in any other manner dispose of such promissory notes, bonds, debentures, convertible debentures, warrants, equipment trust certificates, securities received through the organization of the issuer thereof, or other obligations or evidences of debt of such borrowers, or the securities obtained through the exercise of the rights and/or privileges contained therein.
Act 1 of September 11 of 1986 Amends the GDB Charter- To lend money, in or outside Puerto Rico with or without collateral, to any person, firm, corporation or other organization or legal or political entity where such moneys are to be used to further the governmental purpose of developing the economy of Puerto Rico, particularly with respect to its industrialization, such loans to be represented by the promissory notes, bonds, debentures, convertible debentures, warrants, equipment trust certificates, securities received through the organization of the issuer thereof or other obligations or evidences of debt of such borrowers; To invest its funds in direct obligations of the United States or obligations guaranteed as to both principal and interest by the United States, or obligations of any agency, instrumentality, commission, authority or other political subdivisions of the United States; or obligations of Puerto Rico, or guaranteed as to both principal and interest, by Puerto Rico; or obliga-
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tions of any agency, instrumentality, commission, authority, municipality or other political subdivisions of Puerto Rico; or obligations of international banking institutions recognized by the United States and to which the United States have contributed capital. The Bank also may invest its funds in bank acceptances or other obligations or certificates of deposit endorsed or issued, as the case may be, by banks organized or authorized to do business under the laws of the Commonwealth of Puerto Rico, the United States, or any State of the Union.
Other Laws
Act 69 of September 17 of1992-Amends the GDB Charter-Allows the GDB to lend up to 18% of its total capital outside of PR and the USA when deemed beneficial to the creation or retention of employment or establishment of new industries in PR.
Act 75 of September 7 of 1993-Amends the GDB Charter-Allows investments in common or preferred stock issues by private nationally recognized corporations; Also in acceptances or bank obligations or certificates of deposit, issued or endorsed by banks of PR or USA Corporations.
Act 215 of August 9 of 1998- Amends the GDB Charter-Allows additional types of investments, specifically, “To acquire, hold and dispose of stocks, warrants, participations (with or without preference) in partnerships and joint ventures, as well as debentures, convertible debentures and other securities issued by any corporate entity, organized under the laws of the Commonwealth of Puerto Rico or authorized to do business in Puerto Rico, or any partnership or joint venture organized under the laws of the Commonwealth of Puerto Rico, of the United States, or of any other country in the world engaged in projects which promote the economic development of Puerto Rico; and to exercise any and all powers or rights in connection therewith, as well as to guarantee, through guarantees or letters of credit, loans and other obligations incurred by public and private entities. The Act also authorizes the Bank to enter into repurchase agreements.
Act 236 of August 13 of 1998- Amends the GDB Charter- The Board of Directors of the Bank shall be the Board of Directors of each and every one of such subsidiary corporations, with the exception of the subsidiary to be known under the name
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of Puerto Rico Tourism Development Fund, which shall have a Board of Directors composed of the President of the Government Development Bank for Puerto Rico, the Executive Director of the Puerto Rico Tourism Company and the Secretary of the Treasury.
Act 418 of October 10 of 2000- Amends the GDB Charter – Allows the Bank to carry out any transaction involving the trading of currency of foreign countries through the transfer of funds in bank accounts, and participate in the trading of Latin American currency."
Act 93 of August 4 of 2001- Amends the GDB Charter- Increases funding for Tourism Development Fund.
Act 164 of December 17 of 2001- states that public corps must refinance their debt with the GDB. Transfers $2.5 Billion public corporation’s debts to GDB.
Act 125 of August 8 of 2002- Amends the GDB Charter-Authorizes transfer of 10% or $10,000,000 annually, whichever is greater, of GDB net earnings to PR General Funds.
Act 173 of December 16 of 2009- Amends the GDB Charter- To clarify certain accounting requirements of reimbursements of the Tourism Development Fund.
Act 24 of February 13 of 2014- Requires that all Commonwealth agencies and instrumentalities and public corporations negotiate and issue agreements, debts instruments or financial contracts to restructure or refinance theirs debts with the GDB. New agreements would become effective on July 1st, 2016. The Commonwealth’s full faith and credit for 2 Billion GDB debts, specified by the GDB and Treasury. Prohibits GDB from issuing debt for instrumentalities of the Commonwealth Government (not GDB subsidiaries) which payment requires increases in taxes or future bonds; emergency loans are allowed up to 10% two year average gross income, up to 50,000,000. Allows GDB to require any agency or instrumentality of the Commonwealth to deposit and maintain the totality of its funds in deposits, certificates or other instruments issued by the GDB. (Except if prohibited by Bond contracts of the instrumentality) Exempts the Judicial and Legislative Branch, UPR, Comptroller, FEI, Municipalities and Retirements Systems. Notwithstanding the foregoing, GDB may loan to any instrumentality at risk of default on its principal or interest debt payments.
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Act 97 of July 1 of 2015-Prohibits GDB from lending to Public Entities if a public entity is in default with GDB, or principal outstanding exceeds 5% of GDB total loan portfolio; Use of proceeds of new loans must be for capital expenditures or working capital needs (less than 1 yr. maturity); Established ratios of capital to assets, loan to deposits and others.
Act 21 of April 6 of 2016- Emergency Moratorium Act and Financial Rehabilitation of PR- "Declares a State of Emergency and Moratorium on Debt Payments and Litigation; amends GDB Article 11. Appointment of and powers of a receiver; Article 12.- Priority of expenses and unsecured claims in a receivership; Article 13.Provisions relating to contracts entered into before appointment of receiver; Article 14.- Power to organize and operate a bridge bank; CHAPTER 6.- Creates the PUERTO RICO FISCAL AGENCY AND FINANCIAL ADVISORY AUTHORITY -The Authority is created for the purpose of acting as fiscal agent, financial advisor and reporting agent of the Commonwealth and its public corporations, instrumentalities, commissions, authorities, municipalities and political subdivisions and to assist such entities in confronting the grave fiscal and economic emergency that the Commonwealth is currently experiencing. All fiscal agency, financial advisory, and reporting functions of the Bank are transferred to the Authority, including all powers and responsibilities under the Act No. 272 of May 15, 1945, amended. The Authority shall oversee all matters related to the restructuring or adjustment of any covered obligation, or otherwise coordinate and implement liability management transactions for any covered obligation.
Act 40 of May 5 of 2016- Amends Organic Act of GDB and Emergency Moratorium and Financial Rehabilitation Act- Establishes rules over deposits of depositary institutions; Amends Art. 11 (H) Powers of Syndic; Art. 12(A)(4); non guarantee debt payment priority.
Act 69 of July 14 of 2016- Requires investment of certain funds in tax revenue anticipation notes (TRANS). Suspends monthly transfers by the Treasury to Special Fund for Amortization of General Obligations Debt.
Act 74 of July 20 of 2016- GDB Debt Consolidation and Conversion -The
GDB
is
authorized to consolidate $4,366,000,000 investments in debt of ELA Gov. entities; Authorizes the GDB to restructure the consolidated debt into a new, 35 yr., 5% A ROADMAP FOR INSTITUTIONAL TRANSFORMATION
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debt; Prohibits ELA agencies from taking additional debt based on the laws which authorized the restructured loans.
Act 84 of July 22 of 2016- Municipal Administration Fund Act (FAM); Assigns a percentage of the IVU to FAM; substitutes GDB for AFFAF; eliminates GDB's obligation to advance funds in relation to Municipal Finance Corp.; the accounts will be under custody of institutions designated by the FAM.
GDB Components The GDB Board has created a number of associated components through the years:
Puerto Rico Development Fund 1977- The Puerto Rico Development Fund was created to expand the financing sources available for the development of the private sector of the economy of Puerto Rico and to complement the Bank’s lending program in this area. The Puerto Rico Development Fund has the legal power to invest in capital stock and guarantee long-term loans for private businesses that are unable to obtain credit form private banking institutions.
Government Development Bank for PR Capital Fund 1977- The Bank established the Puerto Rico Development Fund, a subsidiary empowered to invest in capital stock and guarantee long-term loans for private businesses unable to obtain credit from private banking institutions.
The Puerto Rico Industrial, Tourist, Educational, Medical and Environmental Control Facilities Financing Authority (AFICA) 1977- a public corporation affiliated to the Government Development Bank to provide private entities access to the capital markets in order to finance industrial projects, mainly related to pollution control. Subsequent amendments to AFICA bylaws and changes to its Charter Law have been made to include manufacturing, tourism, medical, educational, and certain qualified commercial projects. The GDB affiliate agency provides an alternate method to finance capital investment in Puerto Rico for public and private sector projects which help boost the island’s economic development. AFICA provides financing for these projects, usually at a lower cost than those of-
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fered by the private sector, and acts as a conduit in financing projects through tax-free bond issues. While AFICA benefits investors, by offering tax-free income, it also helps borrowers as they obtain financing at usually lower interest rates than those offered by the private sector. Since its creation, AFICA has participated in over 238 transactions
facilitating
over $6 billion in financing transactions.
Puerto Rico Public Finance Corporation 1984- The Puerto Rico Public Finance Corporation was created by resolution of the GDB Board of Directors to provide central government agencies an alternate mechanism to fulfill their financing needs. The Resolution that created PFC provides that, in the event the entity is dissolved or ceases to exist without the designation of a successor agency, any funds or assets not needed to fulfill the debt service of its bonds or any other obligation shall be transferred to the Puerto Rico Secretary of the Treasury and deposited in the General Fund.
Puerto Rico Infrastructure Financing Authority- PRIFA 1988- was created in to provide financial, administrative, consulting, technical, advisory, and other types of assistance to other public corporations, governmental instrumentalities, political subdivisions and municipalities (collectively, “Benefited Entities”) authorized to develop infrastructure facilities and to establish alternate means for financing infrastructure facilities. The Authority is authorized to issue bonds and provide loans, grants and other financial assistance for the construction, acquisition, repair, maintenance and reconstruction of infrastructure projects by Benefited Entities. The Authority’s enabling act also established the Puerto Rico Infrastructure Fund, funded with annual fixed amounts from the first proceeds of federal excise taxes imposed on rum and other articles produced in Puerto Rico and sold in the United States which are transferred to Puerto Rico pursuant to the United States Internal Revenue Code of 1986, as amended. Currently, this amount is $117 million, until fiscal year 2052.
PR Tourism Development Fund 1993- The Puerto Rico Tourism Development Fund was created to facilitate private-sector financings to Puerto Rico’s hotel industry. TDF provides guarantees financings and may provide di-
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rect loans. As of March 31, 2014, TDF has facilitated the financing and development of 29 projects (5,468 hotel rooms and 9 golf courses), with a total investment in excess of $2.5 billion, of which the financing component totaled $1.2 billion in guarantees and $335 million in direct loans.
Children’s Trust Fund-July 30, 1999- Puerto Rico created the Children’s Trust Fund, with the monies from the settlement of claims against tobacco companies and it is funding over 90 programs for Puerto Rican families. The Children’s Trust is governed by a board of directors. The GDB is in charge of providing all of the Trust Fund’s staff while serving as its disbursement agent and financial advisor.
PR Housing Finance Authority- Act 103 of August 11, 2001-The Puerto Rico Housing Finance Corporation and the Puerto Rico Housing Bank and Finance Agency merged under, as amended. The name of the entity was changed to Puerto Rico Housing Finance Authority (PRHFA) and its corporate structure remained as that of a subsidiary of the Government Development Bank. PRHFA’s principal mission is to promote the development of low-income housing and provide financing, subsidies and incentives so that people may acquire or lease a dignified home.
Special Communities Perpetual Trust- Act No. 271 of November 21, 2002An irrevocable and permanent Public Trust Fund was created, to be known as the "Special Communities Perpetual Trust", a nonprofit public corporate body was constituted irrevocably and in perpetuity with independent legal capacity, in order to effectively provide financial resources to Special Communities and foster their development. The Special Communities Perpetual Trust is attached to the Government Development Bank.
Government Economic Development Bank “GEDB”- Act 22 of 1985 -creates an instrumentality with the purpose of fostering the economy of PR, promoting the private sector small and medium businesses, especially in manufacturing, commerce, agriculture, tourism and services. Authorized to issue up to $100,000,000 in bonds.
Act 67 of 1994-Transfers the GEDB to the GDB.
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Act 88 of 1998-Provides for syndication of GEDB- Nullity of Transfer to favor one creditor over another.
Act 124 of 1998-Transfers the Agricultural and Commercial Credit and Commercial Corporation to the GEDB.
Act 214 of 2004-Authorizes the Economic Development Bank of PR to create the Science, Technology and Investigations Trust of PR.
Recent Acts and Executive Orders with impact on the GDB
H.R. 5278-Act of July 1, 2016 (PROMESA); -The Puerto Rico Oversight, Management, and Economic Stability Act.
OE-2015-022-Working Group for Fiscal and Economic Recovery of Puerto Rico (Debt Restructuring).
OE-2015-046-Revenue Streams from Available Resources, “CLAWBACK”.
OE-2016-10-GDB Bank reserves 20% requirement are suspended.
OE-2016-14-Default on GDB Debt; Default AFI; Other measures to protect Essential Services.
OE-2016-18- Moratorium on Payment of ACT Debt, June 18, 2016
OE-2016-30- State of Emergency Declaration- Moratorium on Debt Payments by ELA, June 30, 2016.
OE-2016-3- Emergency Status, Suspends Payments, Suspends Income Transfers.
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REFERENCES
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Rodden, J., Eskeland, G., & Litvack, J. (2003). Fiscal Decentralization and the Challenges of Hard Budget Constraints. Cambridge, Massachusetts: Massachusetts Institute of Technology (MIT) Press. Slack, E. (2007). Grants to Large Cities and Metropolitan Areas. In R. Boadway, & A. Shah, Intergovernmental Fiscal Transfers, Principles and Practice (pp. 453-481). Washington, DC: The International Bank for Reconstruction and Development/The World Bank. Tassonyi. (1997). Financing Municipal Infrastructure in Canada’s City-Regions. In P. Hobson, & F. St-Hilaire, Urban Governance and Finance: A Question of Who Does What. Montreal: Institute for Research on Public Policy. United Nations. (2009). Guide to Municipal Finance. Nairobi: UN-Habitat. United Nations. (2014). World Urbanization Prospects: The 2014 Revision. Department of Economic and Social Affairs, Population Division. New York: United Nations.
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