International Experience with
Specialized Municipal Finance
Institutions
and
Lessons for the Philippines
Most countries of the developed
and developing world have some
sort of specialized institution to
facilitate borrowing by local
governments.
Examples from advanced economies
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USA
Canada
Norway
Sweden
Netherlands
Italy
Denmark
Finland
Japan
Etc.
17 State Bond Banks
6 Provincial Municipal Finance Corps
Kommunal Bankan
Kommuninvest
Bank of Netherlands Municipalities
Crediop
KommuneKredit
Municipality Finance plc
Finance Corp. for Muni Enterprises
Examples from developing economies
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Columbia
Parana State
Tamil Nadu
Tunisia
• Sri Lanka
• Jordan
• Etc.
Findeter
Paranacidade
Tamil Nadu Urban Dev authority
Caisse des Prets et de Soutien des
Collectivity Local
Local Government Loans Fund
Banque de Development des Villes et
des Villages
In advanced economies LGs have
options but bond floatation favored
• Brings in institutional investors, insurance funds,
etc, and often provides lower interest rates, longer
maturities and larger debt size than bank loans;
• Can lead to structured products including
securitizations to fill special needs.
But:
• Documentation and due diligence required is
expensive since all investors need information on
risks and likely performance of issue. High fixed
cost of issuing a bond means that only large bonds
have cost advantage over bank loans.
• Small and medium sized local governments cannot
avail of bonds --- even in advanced economies
Specialized financial intermediaries for
local government in developed
economies fill a market niche
Function:
To help small and medium sized local
governments take advantage of the more
favorable terms of bonds by pooling
borrowing needs and sharing risks;
Municipal finance institutions in
advanced economies
Operations:
• Aggregate the borrowing needs of member LGs on
periodic basis;
• Float a large bond in their own name and distribute
proceeds through sub-loans to LGs;
• Minimize interest rate and maturity risk by closely
matching amount, tenor and timing of its borrowings
with those of its sub-loans to LGs
MFIs in Advanced Economies
Enhancement of security to bond investors:
• Over-collateralization through maintenance of reserve
fund, e.g. equal to peak future year debt service amount;
• Pledge of full faith and credit from borrowing LGs;
sometimes joint and several obligations.
• Other guarantees or security from LGs e.g. intercept,
pledge of property tax receipts, etc.
• Due diligence is on structure of issue and on the MFI not
individual LGs;
Nordic Countries
Local Government Driven
• Local Government Associations were instrumental
in establishing first MFIs in Nordic countries;
• Operate similar to credit union
• Member deposits and the joint-and-several
obligation of members provide security to investors
in MFI bonds.
• Some require member LGs to pass eligibility test to
join
US State Revolving Funds for
Water and Sanitation
• Federal and State level subsidies for water and
sanitation are channeled to state revolving fund
rather than applied to specific projects;
• Several States use these subsidies to create
dedicated reserve fund to collateralize pooled bond
floatation to support needs of local governments in
state. This creates leverage.
• Pooled SRF bonds of NY State are AAA rated even
when many participating local governments have
lower ratings or not rated at all.
Municipal funds in developing
countries are very different
• Set up as simple pass-through revolving funds for
Multilateral Bank lending;
• Help create a credit culture among local
governments
• Help establish track record of repayment
• Help encourage fiscal discipline among LGs
But…
• Neither the national government nor IFIs can satisfy
all investment needs of local governments;
• Foreign borrowing from IFIs and government funds
are not leveraged. (IFIs should play a small but
catalytic role.)
Questions for many countries
• How to bring in domestic private capital and reduce
the dependence of local government on national
budgets;
• How to foster competition among multiple lending
sources for LGU business so that margins will be
lowered and interest rates and tenors improved.
• How can MDFs evolve to play the market niche role
played by such institutions in developed economies?
• How to use domestic subsidies and IFI funds to gain
leverage in raising private domestic funds;
Three examples of enhancing access
to domestic private capital
Columbia, and Czech Republic
• Second tier institutions that rediscount private bank
loans to Local Governments;
• Extend tenor of private bank loans and “introduce”
private banks to LG market
Tamil Nadu State Municipal Fund in India
• Private management;
• Successful domestic bond floatation
Lessons from International Experience
• Organization: Corporate structures with Boards of
Directors and independent management;
• Security: Collateral from borrowing LGs in form of
intercept, reserve fund or other assets;
• Competition: Multiple sources and types of lenders
to help extended tenor and lower i rates;
• Special Privileges: Private bank lending should not
be discouraged by giving government lending
institutions special advantages;
• I rates: Market determined to spur competition
Establishing a lending Institution is not
sufficient in LDCs
• Maintenance of stable macro environment;
• Domestic capital market regulation;
• Solid legal framework, including strong LG code,
regulation of banking and securities; regulation of
LG borrowing;
• Local government reform: budget, taxation,
planning, project analysis, transparent procurement,
use of private sector;
• Clear, accurate, consistent, timely, information on
LGs
Philippines
• Decentralization supported by strong Local
Government Code –1991;
• Well defined system of transfers of centrally
collected taxes to LGs;
• Well defined own-source revenue base for LGs ( but
very poorly used)
Philippines MDF Experience
• MDF established in 1984 as revolving fund for ODA
to local governments. MDF is department of DOF;
• NG allows intercept of its flows to borrowing local
government as security;
• MDF Staff review project feasibility and the paying
capacity of LG borrowers;
• Good lending record: essentially zero arrears; OED
found loans to be productive.
Other lending to LGs in the Philippines
Government Owned Financial Institutions
(GFIs) have significantly picked up lending to
LGs in past 5 years;
Private lending to LGUs in Philippines
• No private bank lending to LGs’; local banks
express need for protection from political risk;
• 8 bonds issued in recent years supported by private
bond guarantee, demonstrating some market
appetite; high cost of issuing bond compared to
bank loans limits demand.
Issues
• Only GFIs and MDF allowed to access intercept;
• Only GFIs allowed to be LG depositories;
• Government has matching grant program BUT only
projects supported by MDF loans eligible;
• All LG loans made by National Government institutions,
using National Government flows as security;
• As dept of government, MDF hamstrung:
– “Freezes” that prevent hiring needed staff
– Budget rules hinder new lending
– All decisions made by public officials
• MDF role now being duplicated by GFIs
» Risks are too concentrated, there is limited
choice by LGs
Next Steps for Philippines
• Encourage gradual entry of private bank lending to
better off LGUs by leveling playing field with GFIs;
better off LGUs should “graduate” to private sector.
• Convert MDF into market friendly institution that
begins to facilitate LG access to domestic private
capital markets, and leverages IFI and public funds.
Key steps required to encourage
private bank lending
• Allow a limited number of accredited private banks
to be depository banks of LGUs and obtain recourse
to IRA intercept;
• Re-examine matching grant program; allow an
LGU to obtain a loan for a project eligible for a
matching grant from any source (including a private
bank) and still receive grant.
Bond market access for all but
largest LGs will depend on
An intermediary that pools needs and risks
of multiple LGUs and floats bonds on their
behalf, or formation of an LGU credit union
style institution
Significant access to private capital will
require simultaneous and continuous
efforts to build capacity of LGUs
• Financial reforms including budgeting, planning,
accounting, collections, and resource mobilization
• Improved project management and monitoring
• Better public information and consultation with
community groups
LGUs should have a choice.
• A healthy LG finance system in Philippines needs :
– Private bank lending for better off LGUs;
– Direct bond market access; and
– Market oriented specialized financial intermediaries for
smaller LGs
• Competition among sources and institutions is
essential
• DOF needs to move simultaneously on several fronts
Key Recommendations
• Allow a few accredited private banks to become
depository banks for LGUs;
• Corporatize MDF; decide among market friendly
options that will leverage IFI funds and tap domestic
markets;
• Expand capacity building for LGUs
• Reform Loan-grant-equity mix to have sustainable
matching grants that apply to eligible projects no
matter where LGU borrows.