Documentof The World Bank FOROFFICIALUSEONLY ReportNo: 36238-TR PROJECTAPPRAISAL DOCUMENT ON A PROPOSEDLOAN INTHEAMOUNTOFEuro50MILLIONTOHALKBANKASI AND A PROPOSEDLOANINTHE AMOUNT OFEuro 100MILLIONTO TURKIYE SINAI KALKINMABANKASI(TSKB) WITH THE GUARANTEE OF THE REPUBLIC OF TURKEY FOR AN ACCESS TO FINANCEFOR SMALLAND MEDIUMENTERPRISESPROJECT May 12,2006 PrivateandFinancial Sector DevelopmentUnit ECCUG Europeand CentralAsia Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosedwithout World Bank authorization. CURRENCY EQUIVALENTS (ExchangeRate EffectiveMarch31st, 2006) Currency Unit = New Turkish Lira(TRY) TRY 1.345 = US$1 US$1.441 = SDR1 FISCAL YEAR January 1 - December31 ABBREVIATIONS AND ACRONYMS BAT Banks Association of Turkey IFRS International Financial Reporting BEEPS Business Environment and Standards EnterprisePerformance Survey ISA International StandardsofAuditing BRSA BankingRegulationand ISDS Integrated SafeguardsData Sheet Supervision Agency MoEF MinistryofEnvironment andForests CAS Country Assistance Strategy NPL Non-Performing Loan CBT Central Bank ofTurkey OECD Organization for Economic ECA Europe andCentral Asia Cooperation and Development EFIL Export Finance Intermediation PA PrivatizationAdministration Loan PDO Project Development Objectives EL4 Environmental Impact PFI Participating Financial Intermediary Assessment PFPSAL Programmatic FinancialandPublic EIB EuropeanInvestmentBank Sector Adjustment Loan EMU EuropeanMonetaryUnion PIU Project ImplementationUnit EU EuropeanUnion SDIF Savings Deposit InsuranceFund EUR Euros SIS State Institute o f Statistics inTurkey FDI ForeignDirect Investment SME Small andMediumEnterprises FI Financial Intermediaries SOE State OwnedEnterprises FIDER TurkishLeasingAssociation SPO State PlanningOrganization FIL Financial Intermediary Loan TKB Turkish Development Bank FSL FixedSpreadLoan TRY New TurkishLira ICA Investment Climate Assessment TSKB Turkish Sinai KalkinmaBankasi ICB International Competitive Bidding Vice President: Shigeo Katsu Country ManagerlDirector: Andrew Vorkink Sector Director: Fernando Montes-Negret Sector Manager: Gerard0 Corrochano Task Team Leader: MarialisaMotta TURKEY Access to Financefor SmallandMediumEnterprises CONTENTS Page STRATEGIC CONTEXT AND RATIONALE ......................................................................... 1 Country and sector issues............................................................................................................ 1 Rationale for Bankinvolvement................................................................................................. 9 Higher level objectives to which the project contributes............................................................ 9 PROJECTDESCRIPTION ....................................................................................................... 10 Lendinginstrument................................................................................................................... 10 Project development objective andkeyindicators.................................................................... 10 Project components................................................................................................................... 11 Lessons learned andreflected inthe project design.................................................................. 13 Alternatives considered andreasonsfor rejection.................................................................... 14 IMPLEMENTATION ................................................................................................................ 14 Institutionalandimplementation arrangements........................................................................ 14 Monitoring and evaluation ofoutcomeslresults........................................................................ 15 Sustainability............................................................................................................................. * . * 15 Critical risks andpossible controversial aspects....................................................................... 16 Loadcredit conditions andcovenants....................................................................................... . . 17 APPRAISAL SUMMARY ......................................................................................................... 17 Economic and financial analyses.............................................................................................. 17 Technical................................................................................................................................... 17 Fiduciary................................................................................................................................... 18 Social......................................................................................................................................... 18 Environment.............................................................................................................................. 18 Safeguard policies..................................................................................................................... 19 Policy Exceptions andReadiness.............................................................................................. 19 Annex 1: Country and Sector or ProgramBackground ......................................................... 20 Annex 2: MajorRelatedProjectsFinancedby the Bankandlor other Agencies .................29 Annex 3: Result FrameworkandMonitoringIndicators ....................................................... 30 Annex 4: DetailedProjectDescription ...................................................................................... 35 Annex 5: ProjectCosts............................................................................................................... 45 Annex 6: ImplementationArrangements ................................................................................. 46 Annex 7: FinancialManagementandDisbursementArrangements ..................................... 63 Annex 8: ProcurementArrangements ...................................................................................... 72 Annex 9: EconomicandFinancialAnalysis ............................................................................. 75 Annex 10: SafeguardPolicyIssues ............................................................................................ 76 Annex 11:ProjectPreparationand Supervision ..................................................................... 78 Annex 12: Documentsinthe ProjectFile ................................................................................. 79 Annex 13: StatementofLoansand Credits .............................................................................. 80 Annex 14: Countryat a Glance ................................................................................................. 83 Annex 15: Maps(IBRD 33501) .................................................................................................. 85 TURKEY ACCESS TO FINANCE FORSMALL AND MEDIUMENTERPRISES PROJECT APPRAISAL DOCUMENT EUROPEAND CENTRAL ASIA ECSPF Date: May 11,2006 Team Leader: MarialisaMotta Country Director: Andrew N.Vorkink Sectors: Micro- and SME finance (70%); Sector ManagerlDirector: FernandoMontes- General finance sector (15%); General Negret industryandtrade sector (15%) Themes: Small andmediumenterprise support (PI Project ID: PO82822 Environmental screeningcategory: Financial Intermediary Assessment LendingInstrument: Financial Intermediary Loan ProjectFinancingData [XILoan [ ] Credit [ ] Grant [ 3 Guarantee [ ] Other: For LoanslCreditslOthers: RECONSTRUCTIONAND DEVELOPMENT Total: 0.00 150.00 150.00 Borrower: Turkiye Sinai Kalkinma Bankasi (TSKB) andHalk Bankasi (Halkbank); Guarantor: Republicof Turkey ResponsibleAgency: Turkiye Sinai KalkinmaBankasi (TSKB) and Turkiye Halk Bankasi(Halkbank) Turkey lAnnual 1 30.00 50.00 1 50.00 I 20.00 I 0.00 1 0.00 I 0.00I 0.00 I 0.00 'Cumulative] 30,OO II80.00 I130.00 I150.00 1 0.00 I 0.00 I 0.00 1 0.00 I 0.00 I Project implementation period: Start July 30,2006 End: August 20,2010 1 Expectedeffectiveness date: July 30,2006 (for Halkbank) andNovember 1,2006 (for TSKB) Does the project depart from the CAS incontent or other significant respects? Re$ PAD A.3 [ ]Yes [XINO Does the project require any exceptions from Bankpolicies? Re$ PAD D.7 [ ]Yes [XINO Have thesebeen approved byBankmanagement? [ ]Yes [ IN0 I s approval for any policy exception sought from the Board? [ ]Yes [ IN0 Does the project include any critical risks rated "substantial" or "high"? Re$ PAD C.5 [ ]Yes [XINO Does the project meet the Regional criteria for readinessfor implementation? Re$ PAD D.7 [XIYes [ ]No Project development objective Re$ PAD B.2, TechnicalAnnex 3 Theproject's maindevelopment objective is to increaseTurkishSMEs' access to medium and long-term finance. Project description [one-sentence summary of each component] Re$ PAL)B.3.a, Technical Annex 4 Theproject will finance two credit lines targeting SMEs. The first componentis aEuro 100 million equivalent wholesale credit line to TSKB to be intermediatedthrough retailbanks to SMEsinTurkey. The secondcomponent is a Euro 50 million equivalent credit lineto be intermediated through Halkbank as a retailbank directly to SMEs inregions inTurkey where credit is less developed. Which safeguardpolicies are triggered, ifany? Re$ PAD D.6, TechnicalAnnex 10 Environmental Assessment (OPIBPIGP 4.01). The project hasbeen assignedcategory "FI". Significant, non-standard conditions, if any, for: Re$ PAD C.7 Boardpresentation: For bothHalkbank and TSD: submission o fthe Operational Manuals for the SME project to the WB and approval ofthe Manuals by the Bank's boards. Loanlcredit effectiveness: For TSKB: signingof at least two subsidiary loan agreementswith two PFIs satisfactory to the WB. Satisfactory legal opinions on the Loanand GuaranteeAgreements for bothTSKB and Halkbank and satisfactory legal opinions on the two subsidiary loan agreements between T S D andthe PFIshavebeenreceived. Covenants applicable to project implementation: TSKB and Halkbankto maintain satisfactory financialmanagement systems for the project, includingrecords and accounts, andpreparefinancial statementssatisfactory to the WB. Annual project accounts andanIFRSaudit ofTSKB's andHalkbank's financial statementsto be providedwithin six monthso f each year-end duringthe implementationperiod(audits to be carried out byindependent external auditors inaccordancewith International Auditing Standards and International FinancialReportingStandards, underterms o freferencesatisfactory to the wB)* TSKB and Halkbank to maintainaPIUwith satisfactory staffing andother resourcesas required for effective project implementation. TSKB andHalkbankto monitor project performance inaccordancewith the agreed performance monitoringindicators. Compliance by Halkbank and TSKB (including PFIs) to applicable prudential regulations set out by BRSA. TSKB andHalkbankto submit to the World Bank for orior reviewthe first two sub-loans, STRATEGIC CONTEXTAND RATIONALE Country and sector issues To stay on a path of steady growth and ensure compliancewith EUaccession requirements, Turkey needs to maintain macroeconomic stability and broaden structural reforms to improve the business environment. Turkey's economic stability has significantly improved since the 2001 financial crisis, as indicated by a marked reduction in inflation, strong growth, and improvements in public finance (refer to Annex 1 for fbrther details about Turkey's economic background). These macroeconomic changes have been coupled with a variety of structural reforms, including reforms in the financial sector. As it embarks on the path toward EUaccessionand strives for steady economic growth and increasedemployment, Turkey needs to further improve its macroeconomic stability and continue structural reforms to improve the business environment and the growth o f the private sector, particularly small and medium enterprises (SMEs). While acknowledging the importance of macroeconomic factors for sustainable growth and employment, this project proposal specifically focuses on improving Turkey's business environment byincreasing access to finance for SMEs. Turkish SMEs could be a powerful engine for sustaining Turkey's growth, creating employment, maintaining social stability, and integrating the Turkish productive sector with the EUand the global economy. However, their value added, productivity and exports are very limited. Many small firms also prefer to remain informal. Turkish SMEs (roughly defined here as firms with fewer than 250 employees') constitute 61 percent o ftotal employment but contribute only 26.5 percent to the economy's value added, significantly less than SMEs in comparator countries (see Table 1).2 Figures from the Turkish Foreign Investor Association indicate that Turkish SMEs' contributions to investment and exports are about 7 percent and 8 percent respectively, versus 36 percent and 20 percent in South Korea, for e~ample.~ Anecdotal evidence confirms that the productivityo f Turkish SMEs (e.g., inthe food processing, textile and retail industries) is lower than the productivity of SMEs insimilar income comparator countries. Finally, informality i s very high inTurkey (51 percent o f total employment in 2004).4 This has significant impacts on the Government's fiscal revenues, on competition, and on the overall productivity of the Turkish private sector. Measures to alleviate constraints on SME growth, coupled with measures to improve the country's overall business environment would help improve the productivity and growth of the Turkishreal sector, reduce informality, and increase employment. `For an overview o f definitions o f SMEs inTurkey, see The TurkishState Planning Organization (SPO), 2004 SME Strategy and Action Plan, page 26. The Regulation on theDefinition, Qual~cationand Classification of Small and Medium Sized Enterprises, November 2005, Ministryo f Industryand Trade defines SMEs as enterprises with less than 250 employees andnet sales less o f than 25 million TRY. The TurkishStatePlanning Organization (SPO), 2004, reports that Turkish SMEs constitute 99.8 percent o f total enterprises and 76.7 percent o ftotal employment (SMEStrategy and Action Plan, page 8). Differences indata depend on different definitions o f SMEs and o f formal employment, and onthe different years o fthe analysis. YASED (International InvestorsAssociation o fTurkey), 2003. Mimeo. Turkey: Labor Market Study (2006), The World Bank. 1 Table 1:SMEs' employment andGDP share: Cross country comparison SMEsector-share of SME sector- Country formal employment contributionto GDP Turkey 61 27 Bulgaria 50 39 Romania 37 34 Poland 63 49 SlovakRepublic 57 37 Italy 80 59 Source: Ayyagari, Beck & Demirguc-Kunt,2003. Note: SMEsare definedas firms with fewer than 250 employees. One of the key reasons for SMEs' limited value added and productivity is insufficient access to credit. Credit to firms remains at a low level, although it has been increasing in the past three years. Inaddition, the credit to firms remains concentratedwith large firms rather than SMEs, but similarly the trend o f the past few years has been more growth in SME credit than in large firm credit. Turkish Government agencies, banks and chambers o f commerce confirm that Turkish SMEs receive a disproportionately small share o fbank lending-estimates vary between 3.5 and 20 percent depending on the definition o f SMEs' (versus 47 percent in South Korea, for example). The low level o f development o f credit to SMEs i s due to four main factors. First, the overall level of credit to the private sector remains small; although it has been growing rapidly in the past three years (see Figure 1). With credit to the private sector reaching 24 percent o f Gross Domestic Product (GDP) in November 2005, Turkey's financial sector ranks below those o f most EUmembers and candidate countries, among which the average credit to the private sector to GDP ratio is 2-8 times higher than in Turkey. The low credit level is mainly due to Turkish banksholdingunusually large portions oftheir assets inGovernment securities, andcredit to the public sector amounted to 37 percent o f total bank assets inDecember 2005 (see Figure 1 for a comparison o f credit to the public and private sectors). Second, following the recent macroeconomic stabilization, banks have been aggressively growing their consumer credit portfolios (consumer loans and credit cards-see Table 2), which have yielded higher spreads than commercial credit. Third, credit to firms has traditionally concentrated on large firms. At the end o f 2004, more than 50 percent o f the total commercial credit in Turkey was directed to just 418 large firms. However, as mentioned above, the trend during the past few years hasbeen towards less concentration with the large firms. Fourth, access to credit to SMEs i s constrained bythe Turkish financial informationinfrastructure. Informationon SMEs collectedbythe Public Credit Bureau is not sufficient to help financial institutions assess SMEs' credit worthiness, while the country's private credit bureau i s not yet providing information on SMEs. Financial institutions' difficulties in evaluating SMEs are compounded by shortcomings in the collateral regime, which make it difficult for SMEs to borrow by pledging movable assets. The improvement incredit to SMEs inthe past few years i s largely a result of more conducive fiscal Some banks define SMEs according to their volume o f sales as well as overall borrowing inthe banking sector. Moreover, it i s difficult to estimate the share of SME lending because some SME owners may be receiving consumer loans for their businesses. 2 and monetary policies resulting in less Government borrowing, lower inflation, and lower real interest rates. Figure 1:Credit to private andpublic sectors Table 2: Growthrate ofprivate sector loans, 2003-2005 (real) Credit billionUS$, 2003 real 2004 real 2005 real Nov. 2005 growth growth growth Consumer loans 31.7 74% 86% 60% Housingloans 9.1 63% 147% 255% Credit cards 12.1 44% 78% 15% Other 10.5 155% 82% 57% Non-consumer loans 53.9 23% 26% 29% Total 85.6 33% 41% 39% Source. Central Bank ofthe Republic of Turkey and staff calculations. % g G 2 2 z 6 z % z Z % g z 2 8 8 3 - - - - - - - - - - - - - - - - - 9 9 S 5 S F J S S S S S S S S S S S Source: Central Bank of Turkey Low access to credit is coupledwith unfavorable credit conditions-high interest rates and short loan maturities. Nominal interest rates are among the highest inthe region (see Figure 2), reflecting inpart inflation andinpart highrisk associated with SME lending. Inaddition, lending to SMEs in Turkey is very short term, with the average loan maturity at 1.2 years being the lowest among all countries inthe ECAregion (see Figure 3). Figure 2: Average nominal interest rates paid on loans by SMEs (<250 employees) 25 + 20 15 az 10 5 0 3 Figure 3: Average loan maturity for SMEs (<250 employees) T-------- " ~ _ _ ^ ", __.-"- -7I Source:BEEPS,200.5. Banks are increasingly shifting their focus towards SMEs, which they view as the market segment with the best growth potential. Several banks and leasing companies interviewed duringproject preparation confirmed that SMEs are a strategic market niche inwhich they plan to expand their portfolios. Recent development of credit scoring models and mass marketing of standardized credit products have contributed to the growthof lending to smaller firms. Figure 4 shows that the number of credits given to firms has grown rapidly since 2002. A s discussed above, overall credit to firms has been growing, but at the same time the average loan size has been decreasing implyingthat the credit to the S M E segment is growing faster than loans to the large corporations. The data confirms that banks and leasing companies view the SMEs as an important strategic segment. Figure 4: Number of firm credits Figure 5: Average loan size 400,ocKI 600 350,Mx) p250,000 - 500 300,000 ,e /o 2 p. 400 N L :200,ooo 0 B 2 2 300 z d 150,MX) J 5 200 1 0 0 , ~ 9 50,ooO 100 0 2002 2003 October 2004 0 2002 2003 October2004 Source: Central Bank of Turkey. Source: Central Bank ofTurkey. Leasing, another key source of credit for SMEs, is also underdeveloped in Turkey, but growing quickly. Many leasing companies offer small size leases with short term maturity, targeting mainly SMEs. Although Turkey's leasing sector i s very small, it has been growing quickly since 2001 (refer to Annex 1 for further background details about Turkey's leasing sector). With the average lease from the fifteen largest leasing companies ranging between 4 US$52,000 and US$162,000,6 the Turkish leasing industry is an important source o f finance for SMEs. For some companies, leases below US$50,000 account for the majority o f contracts. Based on interviews with selected leasing companies, leases are offered with maturities ranging from 6 to 36 months, and the shorter maturities are more c ~ m m o nWith the exception o f one . ~ company that provides mainly leases in local currency, leases in foreign currency (mainly US$ and Euros) account for 75 to 97 percent of new leasing volumes of the interviewedcompanies, For the leasing companies in aggregate, 76 percent o f their leasing receivables are in foreign currency.* The local currency portfolio is expectedto increase due to reductions inNew Turkish Lira (TRY) interest rates. The country's major leasing companies also project further growth, particularlyinthe SME segment, wheremost oftheir businessis concentrated. While lending to SMEs is increasing, SMEs still have minimal access to medium term credit in foreign currency and inTRY. As indicatedinFigure3, loans to SMEs inTurkeyare mostly short term. Banks report an average maturity o f less than one year for local currency loans and less than two years for foreign exchange loans (in US$ and Euros). Maximum maturities are 2 years for local currency loans and up to 5 years (inlimitedvolumes) for loans in US$ or Euros. Leasing companies also extend mainly short term leases. Supplier and trade credits are prevalent inTurkey as an alternative to bank lending and leasing. While these fimding mechanisms help SMEs manage their short term cash flows, they do not provide an effective substitute for bank loans with longer maturities. Banks' and leasingcompanies' ability to extendmediumterm creditis constrainedby their own lack of access to medium and long term funding. Most Turkish banks hold short term deposits and liabilities, and thus cannot offer long term loans without taking significant maturity mismatch risks. The banks take liquidity risk as only 9 percent o f bank liabilities had more than one year maturity in September2005, while 30 percent o f loans hadmore than one year maturity (see Table 3). Similarly, banks take interest rate risk as only 3 percent o f banks' liabilities had a repricing maturity o f 1 year or more, compared to 25 percent o f loans. The associated interest rate risk hinders banks' ability to provide further medium term financing to SMEs. Leasing companies face similar constraints, resulting in financial leasing receivables being at most a few years. Thus, despite lower inflation and improved economic conditions, medium term loans to SMEs are still very scarce. Mediumterm financing inTRY is even more limited. As shown in Table 4, 31 percent o f loans are currently in foreign currency, makingit very difficult for banks to lendto non-exporting SMEs, whose earnings are mainly inTRY. Inseveral interviews during project preparation, both banks and leasing companies showed a strong interest in access to mediumterm financing inbothforeign andlocalcurrency. 'Based FIDER. on interviews with Deniz Leasing, Dis Leasing, Seker Leasing, TEB Leasing, Alternatif Leasing, Finans Leasing, and Garanti Leasing, June 2005. 'According to 200441 data on the TurkishTreasury's website. The data reflect only leasing companies and not banks that provide leasing. 5 Table 3: Maturity distribution and interest rate Table 4: Share of foreign currency repricing assets, loans, and liabilities, 2002-2005 Interest rate Maturity distribution repricing 2002 2003 2004 2005 Dec Dec Dec Sep Assets 43 38 36 32 02 03 04 05 Sep 05 Loans 59 45 35 28 Loans(percent of loans) c 6 months 50 47 50 52 63 Liabilities 57 50 47 41 6-12 Months 14 17 16 18 12 Source: BRSA and staff calculations. 1 Yearandover 35 35 34 30 25 Liabilities (percent ofliabilities) e 6months 82 76 72 85 93 6-12 Months 5 7 6 7 4 1Yearandover 12 14 8 9 3 Source:Banks Association of Turkey and staffcalculations. The new TRY currency swap market is not a complete solution to increase access to medium term local currency. The recently developed currency swap market (started in early 2005) provides an opportunity for some banks to lock inmedium term TRY interest rates. Fixed coupon bonds worth several billion TRY have been issued by international issuers, and the swap market has developed intandem. However, the swap market is only attractive to a small segment of the Turkish banking system and is not yet widely used. It is costly, requires management's time, and is not attractive to banks that do not find themselves inthe wholesale market. While the scarcity of credit for SMEs affects the whole country, it is particularly acute in the East and Center. Credit in Turkey is concentrated in the country's main urban centers: Istanbul, Izmir and Ankara. In2004, firms outside these cities received only one-third as much credit as firms in Istanbul, while contributing three times as much as Istanbul's firms to the country's GDP (see Table 5). A study by the World Bankg shows that financial depth and outreach indicators vary widely across Turkish regions. A s shown in Table 6, credit depth inthe East and South East is one-sixth o f credit depth in the Marmara region. Similarly, the East and South East regions have the fewest bank branches per 100,000 people (3.9 and 3.6 respectively), less than one third the number o fbranches inthe Marmara and Aegean regions. Table 5: Regional distribution of credit and GDP Share of Credit (percentage) Share of GDP (percentage) Istanbul 62.0 21.3 Ankara 9.8 7.6 Izmir 5.3 7.3 Other............................ 22.9 63.8 Total " . ...................................... 100.0 100.0 ...........,..,.....,.,,., ~ ~ "."................................... " Sources: State InstituteofStatistics, CreditBureauat the CentralBank of Turkey. Note: Creditdataare from 2004. GDP dataare from 2001, but the proportionstendto be stable over time. World Bank (June 2005), "Financial Sector Depth and Outreach across Turkey." 6 Table 6: Regionalindicators o fbankingservices Marmara Aegean Mediterranean Central Black East Anatolia Sea Anatolia East Anatolia Financial depth, 2003 Percent CreditlGDP 55 23 20 30 21 14 9 DepositlGDP 128 62 52 136 46 29 36 Bankingoutreach, 2003 Number Number ofbranches per 100,000 people 13.7 10.3 6.7 8.6 6.7 3.6 3.9 Branches per 1,000 sq km 33.1 10.3 6.5 5.4 4.9 3.1 1.7 Percent Distribution of Deposits, 2004 51.4 10.6 7.5 22.8 4.5 1.6 1.6 ~istributionof Credits,2004 58.1 10.4 7.8 13.9 5.7 2.6 1.6 Source: Banks Association of Turkey. State-owned banks, particularly Halkbank, serve firms in less developedregions more than privatebanks do. Public bankshavemore branches and extend more credit inthe Southeastand East Anatolia regions than do private banks. About 14percent o f state-owned bank branches are located in the South East and East Anatolia regions, compared to 8 percent o f all banks. While only 3 percent o f the total portfolio o f Turkish banks reaches the South East and East Anatolia regions, public banks dedicate 6 percent o f their portfolio to these areas, and Halkbank alone allocates 10 percent o f its total credit to these regions (see Table 7). Halkbank also has the most branches in the regions where credit i s less developed. Private banks and leasing companies interviewedduringproject preparation indicatedthat they planto grow mainly inmore advanced areas (i.e,, the Marmara, Aegean andMediterraneanregions). These banks consider the East side of the country a potentially interesting market for the longer term, Halkbank, on the other hand, has short term plansto grow its portfolio inthe East and South East, to take fill advantage o f its branches andits knowledge o fits clients inthese regions. 7 Table 7: The role of state banks inthe East and South East regions, 2003 Marmara Aegean Mediterranean Anatolia Central Black south East Sea Anatolia East Anatolia Regional d i s ~ i b u t i ~ ~ -banks ~ l l %Credit 59% 11% 7% 14% 6% 2% 1Yo %Deposit 51% 11% 7% 24% 5% 2% 2% %Branches 40% 15% 10% 17% 9% 4% 4% Regional distr~butio~-state-owned banks %Credit 28% 15% 11% 21% 19% 3% 3% %Deposit 31% 12% 8% 38% 7% 2% 3% %Branches 25% 16% 10% 20% 15% 6% 8% Regional distribution-~alkbank %Credit 30% 16% 13% 16% 15% 5% 5% %Deposit 32% 15% 9% 33% 7% 2% 3% %Branches 29% 19% 11% 18% 14% 5% 5% Source:Banks Association o f Turkey. The Government of Turkey is committed to increasing access to credit for SMEs throughout the country. SME development is one ofthe pillars ofthe Government's policies to improve the productivity of the private sector and enhance the country's competitiveness." It is at the forefront of the Turkish Government's SME Strategy to ensure sustainable economic growth and social stability." It is also a significant element of the EU Program for Turkey's accession.l2Both the Government's strategic documents and the EU accession paper indicate that insufficient access to long term finance is a critical constraint on SME development in Turkey.I3 Since the 2001 crisis, the Government has taken measures to promote the stability and soundness of Turkey's financial sector, and it is now committed to improvingaccess to credit for the private sector. The Government's plans include increasing SMEs' access to finance, providingseed capital for new enterprises, improving assessment of SMEs' financial structures, strengthening guarantee schemes for SMEs and improvingstate aid for SME investment^.'^ The Government also has specific regional development plans for increasing growth in the more remote areas of the country (the East and South East) to prevent wider regional disparities. Consistent with its overall strategic framework o n S M E development, the Treasury has welcomed the proposed World Bank financed project to increase access to finance for Turkish SMEs." loRepublic o fTurkey, 2003: Preliminary ~ationalDevelopmentPlan (2004-20061, pages 101-108 `*Commission SPO, 2004: SME StrategyandAction Plan o fthe EuropeanCommunities, 2005: Regular Report on Turkey'sProgress towardsAccession. l3The Government's strategy to increase SMEproductivity and growth inTurkey also includes reforms to improve the overall business environment, development of technological and innovationcapacity at the firm level, and education and training to promote entrepreneurship. l4SPO, 2004: SMEStrategyand Action Plan, pages 64-68. l5See comments on the DecemberAide Memoire receivedby the Treasury inFebruary 2005 (including feedback from TKB, TSKB, the Central Bank, KGF, Halkbank, The Union o f Chambers Commodity Exchanges inTurkey, KOSGEB and Yapi ve Kredi Bankasi) and the Aide Memoire o f the World Bank team's June missionto Turkey. 8 2. Rationalefor Bank involvement The World Bank is uniquely positioned to provide access to mediumto long term credit in both local and foreign currency to Turkish banks, which could in turn on-lend to SMEs. This would address existing market failures currently facing SMEs when borrowingfrom the local financial market. The rationale for World Bank involvement stems from its access to long term funds at favorable terms and from its in-depthworld wide experience in credit line financing. This additional option fbrther strengthensthe rationale for WorldBank involvement in the proposed project, which will meet banks', leasing companies' and SMEs' need for medium term loans inTRY. The proposed operation will allow the World Bank to reduce existingmarket failures that are currently preventing local banks from providing long term finance to SMEs in foreign and local currency. It is expectedthat, inthe mediumterm, the World Bank project will contribute to the development of the local financial market by helping Turkish financial institutions to raise long term funds and to realize the feasibility o f increasing their lending to SMEs. The proposed World Bank credit line will complement existing credit facilities provided by international organizations. Credit lines currently providedby international organizations total about US$2.9billion (see h e x 2). Most o f these lines primarily target medium-to-large exporting firms, with an average loan size per firm of about 2-3 million and maximum loan amounts of about 10-20 million. A few institutions, including KFW, TOBB16 and KOSGEB (through Halkbank), target very small firms, with maximum loans per firm of about 100,000. The proposed project will help fill the existing gap by targeting underserved small and medium firms (including non-exporting firms) with average and maximum loan sizes o f 700,000 (approximately) and 2.5 million, respectively. The 2.5 million cap ensures that firms with adequate access to finance do not crowd out those in need. According to a recent survey of manufacturing firms in T~rkey,'~ only 1.7 percent o f firms got their last loan in excess o f 2.5 million, and for those who borrowed inlocal currency, only 7 percent exceeded2.5 million 3. Higher level objectives to which the project contributes The project's main objective is to increase SMEs' access to credit, in turn contributing to improvements in their growth. By providing SMEs with access to credit, the project will help increase their sales and productivity, in turn helping reduce the gap between SMEs and large firms. The project will also provide credit to regions with low credit activities (i.e., the East and South East; see the project description), ensuring that these areas are not left behind and that the credit andproductivity gaps betweenmore and less advancedregions do not widen. The project is consistent with the World Bank Turkey Country Assistance Strategy (CAS), the overall World Bank program supporting reform of the Turkish financial sector and improvement of the real sector. Several ongoing and upcoming World Bank operations will complement the proposed project, ensuring broad impact on private sector development. The project is included as a FY06 deliverable-in the CAS and i s a key element o f the World The Unionof Chambers CommodityExchangesinTurkey. InvestmentClimate Assessment survey conductedjointly by the WorldBank andTOBB (TheUnionof Chambers CommodityExchangesinTurkey). 9 Bank's program aimed at improving Turkey's financial sector and business environment. More specifically, the project is designed to help Turkey achieve the objective of the third CAS pillar (improving the business climate) with a specific focus on removing finance constraints affecting SMEs. complementary World Bank financial sector initiatives currently under development include: (a) the Programmatic Financial and Public Sector Adjustment Loan (PFPSAL 111), focused on improvingthe corporate insolvency regime and strengtheningbanking supervision, privatization and restructuring strategies for state-owned banks; and (b) two ongoing credit lines targeting export companies (EFIL I1 and EFIL 111). Complementary World Bank initiatives currently under development to improve the overall business environment and private sector productivity include: (a) the forthcoming Investment Climate Assessment and (b) the planned Employment Generation Development Policy Loan, an operation aimed at increasing employment and growth that will include initiatives covering the following four areas: investment climate reforms, labor market reforms, reforms to improve the financial sector (follow up to PFPSAL 111), and reforms to improve productivity at the firm level (including innovation, technology absorption and skills development). PROJECTDESCRIPTION Lendinginstrument The proposed lending instrument is a Financial Intermediary Loan (FIL), using IBRD funds, with TSKB and Halkbankas financialintermediaries and implementationagencies. The World Bank will enter into two separate legal agreements with TSKB and Halkbank. The FIL will be a Fixed Spread Loan (FSL) in Euro with an embedded conversion option for swapping into TRY. Both TSKB and Halkbank indicated their intention to convert part o f the loan amount into TRY during project implementation. TSKB will act as wholesaler, lendingto other financial intermediaries, while Halkbank will act as retailer, lending directly to SMEs. Each of the loans will be backed by a Government guarantee. Section 3 below provides a more detailed description o fthe proposeddual currency lendinginstrument. Projectdevelopmentobjective and keyindicators The project's main developmentobjective is to increaseTurkish SMEs' access to medium term finance. Key proposed indicators to measureproject outcomes include (see Annex 3 for a complete list): (a) Numberof SMEs and SME portfolios financed underthe project; (b) Share of medium term-financing (more than 12 months) inthe total SME loan portfolio financed under the project; (c) Non-performing loanratios for the project; (d) Share ofcredit line disbursedinlocalcurrency under the project; and (e) Numberofprovinces with active SME clients financed under the project. To assess project implementation progress, the World Bank will also monitor on a quarterly basis the amount o f credit disbursed over the originallyplanned disbursement. In addition to the indicators included above and in Annex 3, the project will monitor basic indicators providing an overview o f (a) the profile o f SMEs financed under the project (e.g., 10 amount o f sales, number o f workers, economic sector) and (b) the lending technologies used by PFIs and Halkbank (e.g., number of PFIs using credit scoring models or the information provided by the credit bureau to grant loans to SMEs); and (c) overall increase in access to finance for the SME sector inTurkey. These indicators will be monitored for analytical purposes only and serve as useful inputs to define policies and projects aimed at further improving access to credit for SMEs inTurkey. Project components The projectwill finance two credit lines targeting SMEs. The total project amount will be 150 million. The project will include two components: (i) wholesale credit line of 100 a million to be intermediated by TSKB, which in turn will intermediate through retail banks and leasing companies, and (ii)retail credit line o f 50 million to be intermediated by Halkbank. a SMEs will be the final beneficiaries of both credit lines. For the purpose of this project, SMEs will be defined as firms employing fewer than 250 people and having annual sales of less than US$20 million." TSKB will on-lend the World Bank funds to private banks and leasing companies, which intum will lendto SMEs. Halkbank will provide credit directly to SMEs. To ensure covering underserved regions, Halkbank will lend funds under the proposed credit line only to SMEs located inthe North, East, South East andthe center o fthe country. TSKB and the PFIs that receive credit by TSKB will target the rest of the country. (See Appendix 4.A for a detailed description of the geographical areas covered by the two banks.) The Treasury, Halkbank and TSKB have agreed with the World Bank team on the proposed geographical division. Both credit lines will finance medium term working capital (e.g., raw materials) and investment loans (e&, vehicles, machinery or equipment, or civil works) and leases. There will be no sector restrictions. However, a cap o f about 30 percent o f the total lendingamount will be applied to the tourism sector. SMEs operating in the tourism sector include "hotels, motels, resorts, pensions, holiday villages and camping sites." Concerns have been raised that demand from this sector is high, and the cap will ensure sectoral diversification of the program. The compliance of TSISB and Halkbankwith the 30 percent cap requirement for the tourism industry will be monitored during project supervision on the basis of a specific financial management report. Under the first project component, the World Bank will providea 100 millioncredit line to TSKB, which will be the borrower and implementingagency for this component. The Turkish Government will issue a guarantee to the World Bank. TSKB is a private development bank. It was one o f the financial intermediaries inthe World Bank's EFIL Iproject and i s the borrower and implementingagency for the EFIL I1and I11projects (see a detailed description o f TSKB in Section C and Annex Cl). TSKB will on-lend the World Bank funds to private banks and leasing companies (Project Financial Intermediaries, PFIs), which will be selected pursuant to criteria agreed between the borrower and the World Bank (see Appendix 2B). The PFIs will inturn make working capital and investment sub-loans and leases to private l8See footnote 1. For the EuropeanCommission's definition of SMEs, see: Commissionofthe EuropeanCommunities, 2004: Working PaperSEC (2005) 170, page 6. 11 SMEs. The on-lendingbanks and leasing companies will assume the credit risk of the sub loans. As the Apex institution, TSKB will assume the creditrisk ofthe loanthat it intermediates. Under the second component, the World Bank will provide a 50 million credit line to Halkbank, which will be the borrower and implementing agency for this second component. The Turkish Government will issue a guarantee to the World Bank. As mentioned above, to ensure coverage o f underserved regions (the North, East, South East and part o f the Center) the project includes a second credit line targeting these areas, which will be intermediated by Halkbank. Halkbank was selected after evaluations o f all potential candidates among public banks in Turkey and discussions with the two most promising candidates. Halkbank has a unique advantage in offering credit to the Easternregions o f the country due to its strong branch presence in the targeted region (see Section 1) combined with its focus on the SME segment and its plans to further grow its SME portfolio. Additional criteria for selecting Halkbank were its financial soundness, the recent good performance o f its credit portfolio, and the size of its current credit portfolio in the targeted region, creating confidence that the bank will be able to disburse the loans in a sound manner (see Appendix 6A).I9As with TSKB for Component 1, Halkbankwill assume the credit risk for Component 2. The World Bank's loan to TSKB and Halkbank will start as a Euro Fixed Spread Loan (FSL) with the option to convert into TRY. The loans to both banks will start in Euros, Withdrawals can be converted into TRY at any time during the life o f the loans, resulting in a local currency obligation for the converted portion of the loans. To re-denominate part o f the loan obligation inTRY, the World Bank Treasury executes, with a market counterpart, a Euro- TRY swap. The WorldBankpasses to the borrower the terms o fthe swap it obtains inits market transaction. Ifthe maturity o f the conversion i s shorter than the maturity of the loan, then at the maturity of the conversion, the borrower will have the option to roll over the conversion (ifthe swap market still exists at that time), or to revert the remaining obligation to Euros. If the borrower chooses to roll over the conversion, it will not be exposed to currency risk, but there will be interest rate risk because the loan will be converted at market interest rates at that time. Our survey of the market indicates that, at this point intime, it is possible to execute Euro-TRY swaps for up to 10 years. For conversion o f disbursedamounts to TRY, a minimum amount of 3 millionequivalent will be required inorder for the World Bank Treasury to enter into a swap with the market counterpart to effect the transaction. The conversion date (which is the start of the conversion period) will always fall on the interest payment date next following the execution date of the conversion request. The FSL Conversion Guidelines will apply when requesting, accepting and effecting conversions on Fixed-Spread Loans. The guidelines are posted on the World BankTreasury's pageat the web address: http://treasury. worldbank.orglSenrices/Financial+ProductslCu~ent~ProductslFixed+Spread+Loan~(FSL).html. Additional information on the structure of the loan will be included inthe Operational Manuals ofTSKB and Halkbank. Annex 4 includes a detailed description of the project components. The Annex provides (a) the exact geographic regions served by Halkbank and TSKB's PFIs under this operation, (b) the terms and conditions o f the World Bank loans to TSKB and Halkbank, (c) the eligibility criteria The World Bankteam's summary evaluations ofother banks that were considered as alternatives to Halkbank are available on request. 12 for the PFIs that will receive funds from TSKB, and (d) the eligibility criteria for the SMEs that will receive funds from the PFIs andHalkbank. Lessons learned and reflected in the project design The project reflects lessons learned from recent analytical work on SME development. Specific support to SMEs isjustified by the fact that SMEs face market failures that need to be addressed to avoid increasing the gap between SMEs and larger firms. SMEs: (a) are more affected by regulation and transaction burdens than larger firms (business environment constraints), (b) have little access to credit @name constraints) and (c) have limited access to information, advisory services, technology and innovation (knowledge constraints)." On the basis of these lessons, the project proposesto reduce access to finance constraints byproviding a credit line specifically targeting SMEs. The Government is undertaking complementary initiatives to reduce business environment and knowledge constraints (partly in collaboration with the World Bad-see Section 3 on World Bank complementary operations), ensuringthat all constraints facing SMEs will be addressed. The project also reflects lessons learned from recent analytical work on credit line financing and existing World Bank credit lines in Turkey and other countries. The project will benefit from lessons learned from credit line financing throughout the world (e.g., India, China, andBosnia) as well as from the Turkey EFILI, and I11projects. One concise statement I1 of lessons learned from credit lines that the World Bank has provided to its client countries throughout the world i s the following: "While past experience with financing o f credit lines has been mixed, recent evaluations indicate that the problems have stemmed mainly from weak borrower accountability and management capacity, lack o f clearly defined and transparent indicators for monitoring of the financial performance of the concerned financial intermediaries as well as poor monitoring of the overall project impact, inadequate demand from ultimate beneficiaries and lack of bankable sub-projects, and inflexibilities inproject design that make it difficult to adjust design to reflect changing ground realities" (SME India Project, based on, among other papers, Yaron, J., 2003). Existing World Bank credit lines in Turkey have not experienced these problems. However, these lessons have been taken as a reference and incorporated in the design of the proposed operation as follows: (a) both TSKB and Halkbank have been assigned clear responsibilities for project implementation, (b) the management capacity of both banks has been evaluated, and both banks have excellent capacity and are fully able to implement the operation (see Annex 6), (c) the team has defined clear project indicators (see section B.2), and (d) both PFIs and SMEs have expressed strong demand for medium term creditz1.The World Bank team has specifically asked TSKB to meet and discuss its experience with Halkbank, to facilitate transfening lessons learned to the other institution involved in the project. Lessons learned fiom the Turkey EFILprojects, two o fwhich (EFIL I1andEFIL 111)are intermediated by TSKT3, include sound knowledge of criteria for selection and evaluation o f PFIs, credit evaluation, implementation procedures, and environmental requirements. These are particularly relevant because they have been internalized both by the World Bank team and by 2o For an overview of constraints facingSMEs, see IFC, 2004. "SME Strategy". 21 With respect to demand, during project pre-appraisal, the World Bank team estimatedthat the total financing needsunder the proposed credit line wouldbe significantly above US$300million-the estimate is based on interviews with Halkbank and with six PFIsthat would borrow from TSD. 13 TSKB. EFIL Iand I1have successfully disbursed the allocated funds in a few years and have resulted in reduction of the average loan size, thus reaching more and smaller borrowers. Participating borrowers have increased both employment and exports during the life of the project. Alternatives considered and reasonsfor rejection The proposed design was chosen based on the Government's and the banks' proposals and on a World Bank's internal assessment of the best possible solutions to increase access to finance for SMEs. The proposed design stems from several discussions that the World Bank team hadwith the TurkishTreasury, the State Planning Organization, TSKB, Halkbank andother public banks, as well as commercial banksand leasing companies. Alternatives considered at various stages of project preparation included (a) a broader operation, financing initiatives to remove business environment and knowledge constraints for SMEs, (b) the addition of a specific technical assistancecomponent to improve Turkey's financial information infrastructure, and (c) the inclusion of a second public bank (in addition to Halkbank) as an intermediary for the proposed operation. During a pre- identificationmission, the World Bank team suggestedto the Turkish Government the possibility o f designing a broad SME operation, including initiatives to remove business environment and knowledge constraints that SMEs are currently facing. The Treasury andthe SPO clarified to the World Bank team that the Govemment had specific ongoing initiatives aimed at reducing business environment and knowledge constraints and suggested that the World Bank focus on access to finance only. Following the Government's suggestion, the World Bank team proposed financing an operation includingboth a credit line and a specific technical assistancecomponent to improve Turkey's financial information infrastructure. (See the Project Concept Document.) Duringthe pre-appraisalmission, the Treasury andthe SPO askedthat the project finance only a credit line. They suggested including the initiatives originally proposed under the financial information infrastructure component in a separate development policy loan operation on employment and sustainable growth that the World Bank is currently preparing. The Treasury clarified that the Govemment does not need to borrow from the World Bank to implement the initiatives proposed under the proposed financial infrastructure component because most institutions involved with these initiatives (e.g., the Central Bank, BRSA, the private credit bureau and The Union of Chambers Commodity Exchanges inTurkey) have sufficient resources to implement the improvements suggested by the World Bank. Finally, the Government suggested that the World Bank team evaluate other Turkish public banks as possible intermediaries o f the proposed credit line. After conducting an evaluation o f other public banks, the World Bankteam decided not to include a thirdinstitution(or replace Halkbankwith another public bank). More information on the team's evaluation process is available to the Board membersonrequest. IMPLEMENTATION Institutional and implementation arrangements The implementation agencies for the proposed project will be TSKB (Component 1) and Halkbank (Component 2). Each bank will establish a Project Implementation Unit (PIU), 14 which will be fully funded and staffed by each bank and will operate under the overall supervision o f an Executive Vice President. The PIUs will include experienced managementand staff, including representatives o f the financial analysis, financial control, credit, administrative, and operational departments. TSKB's PIU has already been established and comprises the team implementing EFIL I1and EFIL 111. Halkbank has also established its PIU. The managers and staff that have beenproposedfor the PIU are well knownto the World Bank team, and the same team proposed for staffing the PIU i s currently working on the PFPSAL I11operation. Annex 6 provides a summary evaluation ofbothTSKB and Halkbank, including an analysis o f the banks' financial soundness, their implementation capacity (which is also assessed inAnnexes 7 and 8) and specific considerations on the banks' ability to meet the World Bank requirements included inOP 8.30 onFinancialIntermediation. Monitoring and evaluation of outcomeslresults The World Bank will evaluate progress on the proposed indicators through regular reporting by TSKB and Halkbank and through supervision missions. TSKB and Halkbank have agreed to submit yearly reports including output and outcome indicators (see Annex 3) and semi-annual financial management reports to the World Bank. The financial monitoring reports (FMRs) will be included in the Operational Manuals, The data will come from internal TSI(B andHalkbankreports, as well as (for Component 1) reports provided bythe PFIs. The PIUs have sufficient capacity to ensure provisionofthe monitoringdata. Sustainability Project sustainability will be ensured by Government commitment to increase access to finance to SMEs, Turkish banks' increasing focus on the SMEs segment, and TSKB's and Halkbank's increasing capacity to intermediate international credit lines for SMEs. First, the project's sustainability will be supported by the Government's plans to foster SME development (see SPO SME Strategy, 2004). As discussed inprevious sections, the Government has taken several steps toward improving SMEs access to finance (as well as overall business environment conditions). This will help ensure that increasing access to finance for SMEs will remain at the center of the Government's agenda. Second, during the past few years, Turkish banks have been significantly shifting their credit portfolios towards smaller firms. This trend is likely to continue, as confirmedby interviews with PFIs duringthe pre-appraisal mission. While the World Bank can play an important catalytic role at this stage by providing banks with mediumterm financing that is currently very scarce, it is expectedthat, inthe future, banks will be able to secure this funding directly. This will lead to full sustainability o f the operation. Should the market develop more slowly than expected, the World Bank could provide a second credit line to ensure that banks continue to have access to medium term funds that they can in turnon-lend to SMEs. 15 Criticalrisks and possible controversial aspects Risk RiskRating MitigatingMeasures Generic Risk (ToProject Development Objective) Macroeconomicrisk M Reformsto reducethe country's macroeconomicrisks are underway. The mediumterm financing inlocal currency providedthroughthe proposedprojectwill mitigatethe impact ofpotentialmacroeconomicrisks on SMEs andon the involved participatingfinancial intermediaries(PFIs). 4 Governmentcommitmentto reformsin M Many financial reformsand reformsto improveoverall the financial sector or to overall conditionsfor SMEdevelopment are already underway. reformssupporting SMEdevelopment Ongoingandupcomingtechnical andfinancial support from (e.g., business environmentreforms) is the World Bankinbothareas (e.g., PFPSAL111, new not sustained, or Governmentpriorities development policy loanoperationon employmentand change growth) will helpthe Government maintainitsreform focus __.................................................. andefforts. " " - - " " ... _ ._ ............"..........", ................................... ~ ," " Project-SpecificRisks (To ComponentResult) ................................ For",.."....._....Components Both" .............." -- ..........". _. e Markedly improved financing M 1-1 The local currency financingprovidesan interestingoption for conditions for Turkish bankscould TSKB and Halkbankthat is not readily availableinthe market. renderthe credit line un-competitive, The team is working to ensurethat fiduciary and safeguard consideringthe needto complywith requirementsofthe credit lines are streamlinedandplacea fiduciary and safeguardrequirements minimum burdenon theparticipatingbanks, basedon under the proposedWorld Bank experience from the EFIL projects. Component 1 Lower than expecteddemandof PFIs N The World Bankteamhasdirectly assessedPFIs' needs for for mediumterm credit for SMEs funds. The World Bankteam's mainmitigation measure against possiblelow demand hasbeenestablishingatotal credit line that is only afraction (i.e., about 50percent) ofthe total amount that PFIsstatedtheycould disburseduring the life ofthe project. A second operationcould bepreparedincase PFIs' demandturns out to be as strongas predictedduring .............................................................. ......................... " ........................ .... .... ....... I 1"" " " " "11I FoJ.ect-.preparationl " "" Component2 4 Higher credit riskandlowerthan N The World Bank teamhas directly assessed Halkbank's needs expecteddemand for mediumterm for fundsbasedon its currentportfolio, aggregatecredit growth credit for SMEs locatedinthetargeted to firms, andHalkbank's growth plansinthe targetedregions regionswhere credit is less developed (see Annex 6A). The World Bankteam's main mitigation measureagainst possible low demandhasbeenestablishinga total credit line that is only about50percent ofthe total amountthat Halkbankstatedit coulddisburseduring the life of the project andonly about 25 percent of its currentportfolio extendedon commercialterms inthe region. A second operationcould bepreparedincase Halkbank's demandturns e Implementationdelaysdue........................the fact .......................................................................................... out to be as strong as predictedduring projectpreparation. " "" ...... .........."....".... ........................................................................................................................................................................................................................................................... " to M In-depthevaluationofHalkbank's financial, procurementand that someimplementationarrangements environmentalcapacityduring projectpreparation(see (e.g., environmentalsafeguards) are Annexes 6A, 7,8 and 10). beingintroducedfor the first time at Halkbank. MeetingsbetweenHalkbank andTSKB to facilitate exchange of experience betweenthe two institutions, particularly on requirements to ensure that Halkbankmeetsenvironmental .......... .............................................. safeguards. _........................... "......... ...... ............................................................................................................................................................ ........................................................................................... " " 4 Governmentinfluenceon Halkbank N Halkbankis intheprocesso fbeingprivatizedand is lendingdecisions. increasinglyoperatingon a commercialbasis. As the privatization processmoves forward, the Government's influenceoverthe operationofthe bank through its governance is expectedto be continually reduced. Overallriskrating N 16 RiskRating: H(HighRisk),S (SubstantialRisk),M(Modest Risk),N(Negligible or LowRisk) Loadcredit conditionsand covenants Board Conditions: For both Halkbank and TSKB: submission o f the Operational Manuals for the SME project to the World Bank andapproval o fthe manuals by the banks' boards. Effectiveness Conditions: For TSKB: signing o f at least two subsidiary loan agreements with two PFIs satisfactory to the World Bank. e Satisfactory legal opinions on the Loan and Guarantee Agreements for both TSKB and Halkbank as well as satisfactory legal opinions on the two subsidiary loan agreements between TSKB andthe PFIs havebeen received. General Covenants: TSKB and Halkbank to maintain satisfactory financial management systems for the project, including records and accounts, and prepare financial statements satisfactory to the World Bank. Annual project accounts and an IFRS audit o f TSKB's and Halkbank's financial statements to be provided within six months of each year-end during the implementation period (audits to be carried out by independent external auditors in accordance with International Auditing Standards and International Financial Reporting Standards, under terms o freference satisfactory to the World Bank). TSKB and Halkbank to maintain a PIU with satisfactory staffing and other resources as requiredfor effective project implementation. TSICB and Halkbank to monitor project performance in accordance with the agreed performance monitoringindicators. Compliance by Halkbank and TSKB (including PFIs) to applicable prudential regulations set out by BRSA. TSKB andHalkbank to submit to the World Bank for prior review the first two sub-loans. APPRAISAL SUMMARY Economic andfinancialanalyses NA Technical 17 NA Fiduciary The project financial management systems at TSKB and Halkbank have been assessed by the task team. The current financial managementarrangementsfor the project are satisfactory at both banks. All o fthe subcategorieso f financial management are rated satisfactory for bothbanks. To assess the continued soundness o f TSKB and Halkbank, their compliance with domestic prudential regulations will be monitored through (a) prudential regulationcompliance certificate and (b) annual audit reports. TSKB and Halkbank will each maintain records and will ensure appropriate accounting for the funds provided. FMRswill be prepared semi-annually andwill be submitted to the World Bank no later than45 days after the end o fthe period. The formats o f the FMRs have been agreedwith bothTSKB andHalkbank. Procurement will be carried out in accordance with the World Bank's "Guidelines: Procurement under IBRD Loans and IDA Local private sector commercial practices will be followed for procurement o f goods and works worth less than 2.5 million.23 Procurement capacity at TSKB and Halkbank has been assessed, and the procurement risk at TSKB is rated low, and at Halkbank it is rated average. The procurement arrangement at each bank will be reviewedannually. Social NA-During the Project Concept Review Meeting, it was agreedthat the project does not have any potentially negative social implications. By increasing access to fmance and growth of SMEs, it i s expectedthat the operation will have apositive impact on employment. Environment The project has been assigned Category "FI" in accordance with World Bank safeguard policy OPiBPlGP 4.01 (Environmental Assessment). TSKB and Halkbank have each prepared Environmental Assessment Framework documents acceptable to the World Bank. The fi-ameworks define environmental assessment procedures to be used in sub-project evaluation. These Framework documents have been posted on the banks' websites and will be included as separate chapters in the banks' respective Operations Manuals. Both banks have decided to include the possibility of financing sub-projects that may, by Turkishenvironmental regulations, require an Environmental Impact Assessment (EM) report. The environmental procedures defined by both banks are consistent with Government of Turkey Environmental Assessment requirements, World Bank Environmental Assessment policies, and procedures utilized in previous Financial Intermediary operations in Turkey. A detailed environmental assessment is included inAnnex 10. 22DatedMay 2004 23Inaccordancewithparagraph3.12 ofthe WorldBankprocurementguidelines. 18 Safeguard policies Environmental Assessment Policies will apply to the proposed project. TSKl3, Halkbank and sub-borrowers (PFIs and SMEs) will have to comply with these policies. (See description in section D5 above.) No other policy is expectedto be triggered by the project-see table below. The possibility of other policies being triggered by specific sub-loans made to SMEs will be assessedwhen conducting the loans' environmental assessments. Safeguard Policies Triggered by the Project Yes N o ~ Environmental Assessment (OPIBPIGP 4.01) [XI [I Natural Habitats (OPIBP 4.04) [I [XI Pest Management (OP 4.09) [I [XI CulturalProperty(OPN 11.03, beingrevisedas OP 4.11) E l [XI InvoluntaryResettlement (OPIBP 4.12) [I [XI Indigenous Peoples (OD 4.20, beingrevisedas OP 4.10) [I [XI Forests(OPIBP 4.36) [I [XI Safety o fDams (OPIBP 4.37) E l EX1 Projects inDisputedAreas (OPIBPIGP7.60)* [I [XI Projects on International Waterways (OPIBPIGP 7.50) [I [XI Policy Exceptions and Readiness The project complies with all applicable World Bank policies. There i s no specific policy exception. Theproject is ready for implementation. Specific conditions that have beenmet andthat are sufficient to start withproject implementation include: P Fiduciary (financial management and procurement) arrangements are in place-see Annexes 7 and 8. > Bothborrowers have establishedProject Implementation Units-see Annex 6. P Outcome and output indicators and monitoring and evaluation procedures have been agreed uponwith the counterparts and are inplace (see Annex 3). * By supporiingtheproposedproject,the Bank does not intend toprejudice thefinal determination of theparties' claimson the disputed areas 19 Annex 1: Country and Sector or ProgramBackground TURKEY:Access to Financefor SMEs 1. Country background Economic performance in Turkey has improved significantly in recent years, but the current account deficit and non-FDI capital inflows create vulnerabilities. AAer contracting following the financial crisis in 2001, the economy grew on average 7.5 percent in the period 2002 to 2005 (Figure 5). Interest rates on Government securities fell below 20 percent by March 2005 and to less than 15 percent in early 2006 - substantially lower than the rates during the immediate post-crisis period (Figure 6). Monetary and fiscal policies have produced financial and economic stabilization and disinflation by successfully maintaining investor confidence and market access. Inflationhas fallen from 69 percent in2001 to 7.7 percent in2005 and i s targeted to decline to 5 percent this year under the Central Bank o f Turkey's inflation targetingprogram. Stability o f interest and exchange rates is an important underpinning for the development of credit and thus for the success o f this operation (see section on critical risks and possible controversial aspects above). The current levels o f TRY interest rates are based on ample international investor appetite for emerging market debt and the market view that Turkey remains committed to the economic and structural reforms in the IMF program and the EU accession process. Turkey's current account deficit, which i s in excess o f 6 percent o f GDP, continues to be fundedlargely with strong n0n-FD1~~capital inflows, exacerbating vulnerabilities arising from changes in international liquidity or investor sentiment, although the floating exchange rate regime provides some cushion against TRY liquidity problems, because the Central Bank can let the currency depreciate andi s thus more free to provide liquidity. Figure 5: Turkey's GDP growth, 1988-2005 Figure6: Inflationand interest rates, 1988-2005 10 1 120 ,I 8 1 -Interest - - rate Inflation 6 .- 4 2 2 2 -2 -4 -5 -8 J ,...... . . . . . . . . ... , - - N N N F . m m 0 0 0 0 0 0 0 0 8 8 8 3 3 3 ~ N N N N N 3 3 3 3 R 8 3 8 R S g 2 2 8 E i g g 2 g p zc g- E 0 0 0 0 0 Source: Central Bank o f Turkey and staff estimate. Source: Bloomberg, CBT, and staff calculations. Note: Inflationmeasureschangein consumer price index, and interest rates reflect bond equivalent yield o f 3 month t-bills. 24The distinctionbetween FDIandnon-FDI flows is basedonwhether the investment represents a lasting interest. Increased FDImitigates the riskfromthe current account deficit. Although FDIinto Turkey (net) increased from less than 1percent o f GDP in2004 to 2.6 percent o f GDP in2005, portfolio and other investments into Turkey increased from 6.8 to 8.4 percent o fGDP. 20 Structural reforms and trade integration will help solidify economic improvements. Trade integration increased significantly, with exports growing on average by 25 percent25since 2003 to US$73 billion in 2005. Initial structural reforms include liberalization o f key industries, reforms inthe financial sector, and increased autonomy for institutions such as the Central Bank and the banking sector supervisory agency. The three-year IMF stand-by credit facility for 2005-08 as well as existing and planned World Bank development policy loans support important reforms and help reassure investors o f the Government's commitment to continued reform. Inthe area o f fiscal policy, the Government needs to continue structural reforms in the social security system, tax administration, and tax simplification. Furthermore, it needs to complete the restructuring o f the banking sector-some priorities include addressing shortcomings o f state-owned banks, further strengthening bank supervision, as well as efforts to improve the financial information infi-astructure, including the credit information systems, auditing and accounting systems and collateral regimes. Increasing employment and improving the country's business environment by increasing firms' technology, information and efficient services are equally challenging tasks awaiting Turkey as it embarks on the path toward EU accession and strives for steady economic growth and improvedwelfare. 2. The Turkish real sector The industrial and service sectors have been the key drivers of growth in the past few years, while agriculture has been shrinking. Services make up 63 percent o f the country's GDP, followed by the industrial sector with 27 percent (see Table 9). In addition to manufacturing, which grew on average 4.5 percent over the past ten years, service sectors such as wholesale and retail trade and transportation and communications have beenimportant drivers o f growth. Hotels and restaurants, which remains a small share o f the economy, i s becoming increasingly important, pointing to the significant potential o f the tourism industry. The largest manufacturing sub-sectors are apparel and textiles (which combined account to 25 percent of total exports) and motor vehicles and the communication apparatus industry (e.g., telecorn equipment), followed by manufacturing ofbasic metals such as gold, steel and silver (see Table 10). ''Compoundedannual growthrate. 21 Table 9. GDP by sector, Turkey: 2005 distribution and growth rates. 2005 value, 2005 distribution, Growth, percent il bill. US$ percent 1996-05 2003-05 Farming 33.9 9.8 1.5 3.8 Forestry 1.3 0.4 -1.2 3.3 Fishing 1.5 0.4 2.2 5.1 AgricultureTotal 36.8 10.7 1.4 3.8 MiningandQuarrying 5.2 1.5 0.5 7.6 Manufacturing 75.5 21.9 4.5 8.1 Electricity Gas Water 11.5 3.3 5.2 6.8 Industrial Total 92.2 26.7 4.4 7.9 ConstructionIndustry 15.7 4.5 0.6 12.8 Wholesale Retail 61.1 17.7 5.6 10.6 Serviceso fHoteland Restaurant 13.0 3.8 4.7 6.7 Commerce Total 74.1 21.5 5.5 10.1 Transportation and Communications 52.8 15.3 4.7 7.8 Financial Institutions 16.0 4.6 -0.4 0.4 Ownership o fDwellings 16.7 4.8 1.7 1.7 Professionsand Services 12.5 3.6 3.8 7.7 (Less) Relative Banking Services 9.3 2.7 -1.2 1.4 Sectors Total 307.5 89.1 3.9 7.7 Government Services 35.6 10.3 1.5 1.o Non-profitprivate services 2.2 0.6 0.7 0.0 Total 345.3 100.0 3.8 7.4 Source: SIS. I1Compoundedannualgrowthrates. Table 10. Manufacturing industry: export by sector. Turkey, 2005 Value, bill. US$ Distribution Growth I1 Percent 2005 2005 1996-05 2003-05 Agriculture andForestry 3.3 4.5 4.9 25.1 Foodproducts andbeverages 4.3 5.8 6.3 26.7 Wearing apparel 9.9 13.5 8.3 10.3 Textiles 8.7 11.9 9.6 13.0 Motor vehicles andtrailers 10.2 13.9 29.8 36.9 Manufacture o fbasic metals 6.9 9.4 13.3 33.0 Communicationand apparatus 3.1 4.3 29.1 27.2 Manufacture o fmachineryandequipment 4.9 6.6 21.7 24.7 Chemicals andchemicalproducts 2.8 3.8 9.5 20.8 Other 26.8 36.6 17.2 28.6 Total 73.3 100.0 13.6 24.5 Source: SIS. I1CompoundannualgrowthratesinnominalUS$ values. Several features of the Turkish economy indicate that the real sector has potential to further increase its investment, productivity and growth levels and that SMEs have an importantrole to play. These features include: 22 (a) High unemployment despite significant growth. Despite significant growth and trade integration, Turkey's employment rate remains low.26"In the period 1981-2003, the Turkish working-age population grew by 21million, butonly 5 millionjobs were created. As aresult, the employment rate (the percentage o fthe adult population that is employed) was 43 percent in2005 (Figure 8), one ofthe lowest inthe world. Most countries, with the exception ofthe Middle East, have employment rates above 50 percent" (Verghis M., 2004). Inthe past few years, Turkey has also experienced high unemployment rates-well above 8 percent since 2002 and at 10.3 percent in2005 (Figure 7). Increasing employment is one o f Turkey's most important challenges, and SMEs have a key role to play, since they already employ more than 60 percent of the labor force in the country and have the potential to hrther increase their labor force ifthey improvetheir growth. (b) High informality.By some estimates, the informal sector inTurkey produces 31 percent o f GNI, morethaninmost comparator countries, andabsorbs as much as 51percent ofthe labor force.27 High informality has a significant impact on the Government's fiscal revenues, competition levels, and the overall productivity o f the Turkish private sector. Improving benefits for SMEs-including access to finance-would improve the incentives for informal firms to register andbecomepart o fthe formal sector. (c) The dual structure of the Turkish economy, which comprises a few modern and dynamic firms together with several laggards. While some Turkish sectors are highly modern and productive (labor productivity o f the apparel and automotive industries are estimated at more than 80 percent of US levels, for example2*)others (such as the electricity, retail and dairy sectors) have strikingly low productivity, hampered by lack o f competition and presence o f traditional players which are often SMEs-see Figure 9, Increasing access to finance will give SMEs the opportunity to grow, in turn reducing productivity gaps within and among sectors. (d) Low but recovering FDI (see Figure lo). Inadditionto macroeconomic instability, various factors have limited FDI in Turkey, including investment climate conditions and specific legal and institutional issues. Some of these constraints have beenmitigated, andFDIis now growing. In 2005, FDI amounted to 2.6 percent o f GDP, inpart driven by the Government speeding up privatization efforts. On the one hand, FDI can play an important role in increasing productivity and growth o f local firms-including SMEs-by increasing competition, and generating spill-over effects through development o f supply chains involving local firms. On the other hand, a vibrant local SME sector is an essential stimulus to attract FDI. As cheap labor becomes less relevant to attracting FDI, availability o f dynamic local SMEs with a highly skilledlabor force become more important for influencing the location decisions o f multinational companies. Thus, supporting development o f local SMEs will also contribute to increasing FDIand overall economic growth and employment levels. 26For a detaileddiscussionofthe Turkishlabormarket, World Bank(2006), "Turkey: LaborMarket Study", ''OECD,Economic Survey of Turkey (Paris, 2004). 28Productivityis definedas outputper worker (McKinsey). 23 Figure7:Unemploymentrate, Turkey. Figure8: Employment rate, Turkey 47 46 45 4- E 44 43 42 2000 2001 2002 2003 2004 200s 41 2000 2001 2002 2003 2004 2005 SourceTurkstar. Source: Turkstat. Figure9: Laborproductivity by sector = Figure 10: Foreign direct investmentlGDP Autopa- Apparrl 5 ! steel +- i = i - TcleconWircline 7 Tel-Wuelas Cement Dary :- csrdentialcommcnon -1 Retailbanking Elechlciiy generation Confectionery retad tad Ekcmcity transin anddisu 0 20 40 60 80 IW 120 .ActualLaborProductivity 2001 2002 2003 2004 2005 Note: McKinsey GlobalInstitute (2004). Source: Central Bank of Turkey. 3. The Turkishbankingsector2' Low concentrationand increasingforeign ownershipare distinctivefeatures of the Turkish bankingsector. In2005, the Turkishbankingsector hadUS$295 billioninassets (more than a quarter larger than that o f Mexico, but only about half the size o f the Brazilian bankingsector). Untilrecently, the Turkish banking sector was almost entirely domestically owned, and most banks are affiliated with large industrial groups, Since late 2004, however, there has been a strong interest in Turkish banks among international investors-in particular European banks. The three largest Turkish banks held 45 percent o f banking assets in September 2005, substantially lower than in the Czech Republic (70 percent), Estonia (98 percent) and Hungary (54 percent).30Finally, state-owned banks play an important role, accounting for 34 percent of 29This section borrows fromthe backgroundpaper "Financial sector depthand outreachacross Turkey" preparedby Soledad Martinez Peria (DECRG). 30As reported inthe Financial Structure Database o fthe World Bank. 24 the assets in the system (see Table 11) compared to, for instance, those in Mexico (23 percent) andPoland(20.5 percent). Table 11:The structure o fthe Turkishbankingsector Billion YTL Share o fsystemipercent September 2005 Assets Deposits Loans Capital Assets Deposits Loans Capital Statebanks 122.5 87.0 33.1 15.8 33.6 37.7 24.2 36.6 Private Turkish banks with foreign strategic interest 74.0 46.6 32.9 5.2 20.3 20.2 24.1 11.9 OtherTurkish private banks 141.0 85.1 58.6 17.0 38.7 36.9 43.0 39.2 Foreignbanks 20.4 12.2 10.2 2.9 5.6 5.3 7.5 6.7 Otherbanks /l 6.3 0.1 1.7 2.4 1.7 0.0 1.2 5.6 Total 364.3 231.0 136.4 43.3 100.0 100.0 100.0 100.0 Source: BanksAssociationof Turkey. /lIncludesbanksundertheSDIF,investmentanddevelopmentbanks. As a result of the 2001 crisis, the financial sector started a process of consolidation and strengtheningo f financial sector supervision. The number o ftotal banks contracted from 62 in 1999 to 4731in 2006, largely due to activities to deal with troubled banks. The SDIF took over the administration of 21 banks during 1997-2003, of which 20 have been merged, sold to domestic and foreign investors, or closed. The authorities initiated a program to strengthen private banks and restructure state-owned banks, while also strengthening the regulatory and supervisory framework. As a result, financial risks inthe bankingsector have been reduced and the performance of both private banks and state-ownedbanks has also improved. For example, the share o f non-performing loans (NPLs) decreased to 4.8 percent by the end o f 2005 from almost 11.5 percent at the end of 2003. At the same time, return on assets increased to 2.8 percent from 0.5 percent, and banks are well capitalized with a capital adequacy ratio of 23.3 percent. 4. The Turkish leasing sector Compared to other countries in Europe, the leasing industry is underdeveloped in Turkey. As shown inFigure 11, with 0.9 percent of leases to GDP, Turkey ranks below most European countries (with the exception of Austria, Finland, and the Netherlands), including Estonia, the Czech Republic, Slovenia, Poland and Romania. In fact, for Estonia and Slovenia, the lease to GDP ratio i s 5 and 10 times larger, respectively, than that o f Turkey. The leasing industry in Turkey has developed as a vehicle for investment financing inthe form of financial leases only, while operational leases havenot beenintroduced. 31Inaddition, there are four participationbanks. 25 Figure 11: LeasingassetsinEurope, 2003 Figure 12: Leasingvolume inTurkey, 1998-2005 10 9 8 8 7 126 2 5 ; 4 2 3 2 1 0 1998 1999 2000 2001 2m 2003 m 2om* Developed Europe EmergingEurope Source: Leaseurope and WDI. * Estimate Source:TurlushAssociation o fLeasing Companies. Although Turkey's leasingsector is very small, it has been growing strongly since 2001. As of 2004, Turkey's leasing sector had US$3.6 billion in assets (about 1.6 percent o f banking sector assets), up from US$0.7 billion in 2001.32 There are almost 100 leasing companies registered in Turkey, but the fifteen largest leasing companies accounted for 86 percent o f new lease volume and 83 percent o f contracts in2004. The largest leasing companies are subsidiaries of banks, marketingtheir services through the branch networks o f their parent companies.33As shown in Figure 12, the leasing industry shows strong growth, reaching U$2.9 billion in new leases in 2004 from US$0.7 billion in 2001, reflecting in part the strong GDP and in part the improved conditions for financial intermediation with improved financial stability and lower inflation. The leasing industry finances approximately 7 percent o f total fixed capital investments. The manufacturingsector accounted for 48 percent o f new leases, while services received 43 percent. Textiles (13 percent) and construction (16 percent) were the main sub- sectorsinthe manufacturing and service sectors, re~pectively.~~ 5. Financialdepth Trends in financial sector depth indicators are mixed. As shown in Figure 13, the share of liquid liabilities to GDP grew almost uninterrupted since the mid-1980s, with some reversals duringthe 1994 and2001 crises. Stock market capitalization also grew considerably duringthis period, although both the 1994 crisis and, in particular, the 2001 crisis brought about large declines. However, the evolution of the private sector credit to GDP ratio has been rather disappointing. During the late 1980s and early 1990s, credit depth did not increase. After the 1994 crisis, domestic credit depth improved until the 2001 crisis, after which it went down to pre-1994 levels. Not surprisingly, the ratio o f private credit to GDP for Turkey (24 percent) i s below most other EU accession countries, such as the Czech Republic (30 percent), Poland (28 32 Basedon data from the TurkishLeasing Association (FIDER) 33 Deposit-taking banks are not allowed to directly engage inleasing activities. As result, most banks have established leasing companies. 34 Leasing volume generally fluctuates with GDP growth. 35 Based on 0443-0541 data from FIDER. 26 percent), and Hungary (38 percent).36Nevertheless, Turkey fares favorably interms o f the ratio of stock marketcapitalization to GDP. Figure 13: Financial sector depthindicators for Turkey, 1987-2005 70 1 m F 2 8 Z 8 2 Z 8 8 6 % % 8 Z 8 3 8 3 m E E E E e E 2 2 2 2 E E s s s g a s - - Mz inclFXdepositslGDP -Credit to non-financialprivatesectoriGDP -Stock market capitalizationiGDP Source: CentralBankofTurkey, Istanbul Stock Exchange. Credit to the private sector is growing from a small base, reflecting the improved macroeconomicenvironment and shiftingprofit opportunities.Lendingto the private sector has been depressed since the late 1990sin part by heavy Government demand for funds (which crowded out lending to the private sector) and the zero weight risk assigned to Government securities for computing the banks' capital adequacy ratio. As shown Figure 14, lending to the public sector, which includes lending to state-owned enterprises, has been growing much faster than loans to firms or consumers. Lending has been complicated by the volatile financial environment, with a highinflation rate and erratic interest rates. However, because of reductions ininterest rates and inflation, banks have started to change part of their Government securities holdings into loans to the private sector, resulting in gains in lending to private firms and consumers. Banks are growing their loan portfolios aggressively into areas with higher spreads, especially consumer credit (consumer loans and credit card receivables, and recently mortgage loans), which have been growing faster than corporate commercial loans (see Table 12). Finally, lendingto firms may be affected by some aspects of the business and institutional environment, such as the legal rights o f borrowers and creditors, where Turkey fares worse than comparator countries. For example, boththe cost to create collateral as a percentageo f per capita income and the cost of enforcing contracts as a percentage o f debt values are higher than in some EU accessioncountries, such as the Czech Republic, Poland, and Ukraine. 36Data from the World Bank Financial Structure Database. 27 Figure 14: Credit to privateandpublic sectors(in Table 12: Growthrate of privatesector loans, real terns) 2003-2005 Credit ~ ~~ billionUS$, 2003 real 2004 real 2005 real Claims on Public Sector Nov.2005 growth growth growtht'l \ Consumer loans 31.7 74% 86% 52% I I f Housingloans 8.7 63% 147% 240% Creditcards 12.1 44% 78% 12% Other 10.9 155% 82% 45% .: Non-consumei'loans 53.9 23% 26% 29% Total 85.6 33% 41% 36% .-E Source: Central Bank of theRepublicof Turkqvand siafjcnlculations. e 3 25 */IDoesnot BawlonNovember2005 data. include credit to other financial institutions. 0 Source: Central Bank of Turkey 28 Annex 2: Major Related Projects Financed by the Bank andlor other Agencies TURKEY: Access to Finance for SMEs Table 13: Relatedprojects Targeted Name of ProjectKOan Organization sector Total amount Export Finance Intermediation Loan I1 World Bank Exporters $303M Export Finance Intermediation Loan I11 World Bank Exporters $300M Renewable Energy Loan World Bank Energyfm $202 M Industrial PollutionPrevention Loan EIB SMEs 70M TERRA Earthquake Loan2A EIB Finns 75M TERRA Earthquake Loan2B EIB Firms 75M SME Global LoanI1 EIB SMEs 50M IndustryGlobal LoanI1 EIB SMEs 125M Industry GlobalLoanI11 EIB SMEs 200M SME Global Loan IV E13 SMEs 250M SME Global LoanV EIB SMEs 250M Autoproductor andEnergy Project EIB Finns 40M TSI(B APEX Loan EIB SME f150M AFD Credit line Agence Franqaise de Dkveloppement SMEs 50M AFD Credit line Agence Franqaise de Dkveloppement SMEs 20M JSIC SME Credit JBIC SMEs JPY27BN CEB Credit Council of Europe Development Bank SMEs 200M Islamic Development Bank Islamic Development Bank SMEs $50M KfWIndustrialPollutionPreventionLoan Kreditanstalt fur Wiederaufbau SMEs 9,7M KfWCredit Kreditanstalt fur Wiederaufbau SMEs 21,3M Spanish SME SME credit Line SMEs -US$2,857M 30M Total Source: Turkish Trensuty. 29 May 18,2006 Annex 3: Result Framework and MonitoringIndicators PDO Project Outcome Indicators Use of Project Outcome Information Improve TurkishSMEs' access Number o f SMEs and SME portfolio financed by YR2-3: determine ifproject to mediumterm finance. TSKB's PFIs andHalkbank under the project. design or strategy needs to be changed (see specific elements that couldbemodifiedbelow). Intermediate Outcomes Intermediate Outcome Indicators Use of Intermediate Outcome Monitoring Outcome 1:Loans' Maturity Share o f mediumterm financing (more than 12 YR2-3: determine ifloan Provide mediumterm loans to months) intotal S M E loanportfolio financed maturities needto be revised. SMEs fmanced under the under the project byHalkbank and TSKB. project. Outcome 2: Local currency lending Provide local currency loans to Share o f credit line disbursedinlocal currency. YE-3: determine ifthe structure SMEs fmanced under the o f the local currency option needs project. Share o f mediumterm financing (more than 12 to be revised. months) disbursedinlocal currency. Outcome 3: Geographical coverage Number o fprovinces with active S M E clients YR2-3: determine ifthe Provide loansto SMEs located financed under the project- throughout the geographical targeted areasneed inthe east andthe center of the country and inHulkbunk Regions (see Annex 2). to be changed. country under the project. Number o f loans financedby the project in Hulkbank Regions. Disbursed amount financed by the project in Halkbank Regions. Outcome 4: Quality o fthe portfolio under the proposed For both Halkbank andTSKB, percentage of non- YR2-3: determine ifcriteria to project perfonning SME loans3' extended under the select PFIs and SMEs needto be project is below 5% o fthe total project portfolio. changed. 37Non-performing loans are defined as category 111,IV and V loans according to the BRSA definition. 30 - E U 0 zf ep 0 U # Z X X X X X X X X X X # # * x x x x x x x x7 xxx xxx xxx x E iD 0 0 P4 m- 3 3 h *& U I I 1 I I 0 Y 3 0 0 0 " ' 3 0 0 0 " ' 28 zmg 0 VI 0 v -mooN 0 m N 3 0 0 0 Q 8 0 U N N 0 =3 8 0 N 00" May 18,2006 Annex 4: DetailedProject Description TURKEY:Access to Finance for SMEs The appendicesbelow describe indetail: Appendix 4A. Geographicaldivision ' Appendix 4B. Terms andconditions that apply to TSKB 4B.1. Loanterms and conditions betweenthe World Bank and TSKB 4B.2. Eligibility criteria for the PFIs that will be financed by TSKB 4B.3. Terms andconditions o f subsidiaryloansbetween TSKB andPFIs 4B.4. Eligibilitycriteria for SMEs 4B.5. Terms andconditions betweenPFIs and SMEs. Appendix 4C. Terms andconditions that apply to Halkbank 4C.1. Loanterms andconditions between the World Bank and Halkbank 4C.2, Eligibility criteria for SMEs 4C.3. Terms andconditions between Halkbankand SMEs. 35 May 18,2006 Appendix4A: Geographicaldivision Halkbank's lending underthe proposed credit line will berestricted to the following regions ~Halk~ank Regions): South East Anatolia, all provinces: Adiyaman, Batman, Diyarbakir, Gaziantep, Kilis, Mardin, Siirt, Sanliurfa, and Sirnak. East Anatolia, all provinces: Agri, Ardahan, Bingol, Bitlis, Elazig, Erzincan, Erzurum, Hakkari, Igdir, Kars, Malatya, Mug, Tunceli, andVan. Central Anatolia, selectedprovinces: Sivas, Kayseri andYozgat. Black Sea, selected provinces: Corum, Amasya, Samsun, Ordu, Giresun,Rize, Trabzon, Bayburt, Artvin, Giimiishane andTokat. Mediterranean, selected provinces: Kahraman Maras, Hatay and Osmaniye. HalkbankRegions will not include Adana. TSKB's lending under the proposedcredit line will be restricted to the regions and cities not includedinthe list above. These geographical areas will be definedas TSKBRegions. The following criterionmustbeusedto identifythe locationofa sub-loan: e The proceeds o f the loan must be applied by the sub-borrower in the eligible region. Ifa loanis for an investmentor aproject, the locationofthe investment or project determines the region. If proceeds are used for working capital, the locationinwhich the materials and other inputsare useddetermines the region. 36 May 18,2006 Appendix 4B: SummaryofTerms andConditionsfor TSKB 4B.1. Loanterms and conditionsbetweenthe World Bankand TSKB TSKBwill draw the loan's credit line hndsinEuros andbeableto convert all or portionso fthe outstanding amount into TRY. The loanwill be a FixedSpreadLoan (FSL), with levelrepayments, a five year graceperiodanda 15 year total repayment term. The front-end fee will bepaidfrom the loanproceeds. IfcurrencyconversionintoTRYisrequested: a e The lending rate for a EUR FSL is currently EUR LIBOR + 0.52% less any applicable waiver. To effect the conversion, the World Bank enters into a swap with a market counterpart, and the pricing will be based directly on the terms achieved on the swap between the World Bank and the market counterpart plus a transaction fee o f0.02% annually. e The pricing o f the converted portion o f the loan will be based on a market transaction that the World Bankundertakeswith a swap counterpart andwould be the TRY equivalent of the EUR LIBOR + fixed spread for the maturity o f the conversion. Borrowers may refer to internationally recognized swap screen quotes for indicative rates. However, it should be noted that the actual pricing would be basedon the swap transaction undertaken by the World Bank with the swap counterpart. TSKB will paythe World Bank a front-end fee o f 1percent, less any waiver, and an annual commitment fee of 0.85%, less any waiver, on undisbursedbalances for the first four years, and 0.75%, less any waiver, thereafter; the commitment fee will be payable with effect from 60 days after loan signing. TSKB will on-lend the funds to PFIs using subsidiary loan agreements that will define the loan conditions. All subsidiary loan agreements are subject to prior review andacceptancebythe World Bank, TSKB must maintain, for the duration of the project implementation period, a Project Implementation Unit (PIU) staffed with qualified personnel and capable o f satisfactorily implementingall aspectso fthe project. For the duration o fthe project implementation period, beginningwith year-end 2006, TSKB must annually submit an audit report, that: (i)s prepared in accordance with i International Auditing Standards and International Financial Reporting Standards; and (ii) an unqualified audit opinion, except as the World Bank shall otherwise has agree. TSKB will be subject to monitoringofthe outcome and output indicators inAnnex 3 "Results Framework and Monitoring" on a yearly basis. 37 May 18,2006 TSKB will be subject to monitoring of the indicators in the Financial Management Reports in the Operational Manuals on a semi-annual basis, and must submit semi- annual financial managementprogressreports to the World Bank. 0 TSKB will make its best effort possible to utilize all payments made by PFIs under Subsidiary Loan Agreements to finance additional development projects to further the development o f SMEs. 4B.2. Eligibility Criteria for PFIsthat will be financedby TSKB TSKB will on-lend to participating banksandleasingcompanies (PFIs). PFIs will be selected on the basis o fthe following criteria: Forbothbanks andleasing companies Before final selection of the PFIs, TSKB will send the World Bank the financials o f the proposed intermediaries together with a request to include the PFIs inthe project. The World Bank will review and clear TSEI=_B's assessment by conveying "no objection" for each PFI's participation for the requested amount. The no objection will bebased on the criteria includedinthis section. TSKB will send the financials of the proposed intermediaries to the World Bank every year to ensure that the selected PFIs continue to meet the required criteria throughout the life o f the project. However, "No objection" isnot requiredfor the continuedparticipationo fthe PFIs. Banks and leasing companies must annually provide IFRS financial statements audited inaccordance with International Standardsof Auditing (ISA). Additional conditions for the banks The following criterion applies only at the time the banks enter into the project: Total assetsmust exceedUS$300millionequivalent at the end o f2005. The following criterion applies throughout the period in which the banks participate in the project: 0 The banks must be and remain in compliance with applicable laws and regulations issued by the Turkish authorities, including the prudential and regulatory norms set forth and enforced by the Banking Supervisory and RegulatoryAuthority o f Turkey (BRSA), as certified by independentexternal auditors on an annual basis. Incase the initial eligibility of the banks falls to such a date that their year-end audits have been already completed and do not cover this requirement, then the banks would be required to submit a management letter in a format acceptable to the World Bank confirming their compliance with applicable laws and regulations issued by the TurkishAuthority. 38 May 18,2006 Additional conditions for the leasingcompanies The following criteria apply at the time the leasingcompanies enter into the project: e Total lease receivables during the last two years (for which data are available) must exceeda minimumo fUS$30millionequivalent on average. e New lease volume during the last two years (for which data are available) must exceeda minimumofUS$20millionequivalent on average. The following criterion applies throughout the period during which leasing companies participate inthe project: e Leasing companies must be in general compliance with legal and regulatory requirements applicable to the leasing industry, including but not limited to such regulations as those imposed by the leasing industry regulator and as certified by the leasing companies' external auditors on an annual basis. Incase the initial eligibility of the leasing companies falls to such a date that their year-end audits have been already completed and do not cover this requirement, then the leasing companies would be requiredto submit a managementletter ina format acceptableto the World Bankconfirmingtheir compliance with applicable laws andregulations issuedbythe TurkishAuthority. 4B.3. Terms and Conditionsof Subsidiary LoansbetweenTSKB and PFIs PFIs must start and remain incompliance with the eligibility criteria for PFIs, except for criteria that apply only at the time banks and leasing companies enter the project (see specifications insection above). The loan denomination may be inEuros or TRY The funds available to PFIs will depend uponthe availability of funds to TSKB from the World Bank. The cost of subsidiary loans will include, at a minimum, the cost of World Bank funds to TSKB plus anon-lendingmarginreflecting(a) TSKB's administrative costs; and(b) a credit riskmargin. PFIs will be responsible for ensuring that sub-borrowers comply with the World Bank's procurement rules for the procurement o f goods and works under sub-loans and leases, applicable Turkish environmental legislation and regulations, and the World Bank policy on environmental assessment. PFIs will provide TSKB with a set o f documentation for all sub-loans and leases, in order to enable TSKB to maintain all project records andmake them available for ex- post reviewby the World Bank or by external auditors as necessary. SMEs will be required to keep copies o f invoices for all expenses financed with working capital and investment loans received under the proposedproject. SMEs will 39 May 18,2006 be required to send to their respective PFIs copies of invoices for expenses financed with investment loans. Invoices for expenses financed with working capital loans may be kept bythe SMEs. 4B.4. EligibilityCriteriafor SMEs For the purpose of this project, SMEs are defined as firms with less thanUS$20 million insales andfewer than250 employees. Allprivatesmallandmediumenterprises (private ownership more than 50 percent), irrespective of their sector, will be eligible for participation as sub-borrowers on a commercial basis. The maximumlending amount for the tourism sector should not exceed 30 percent o f the total amount lent to TSKB by the World Bank (i.e., 30 million). SMEs operating in the tourism sector are defined as: hotels, motels, resorts, pensions, holidayvillages and camping sites. 4B.5. Terms and Conditionsof SubsidiaryLoansbetweenPFIsandSMEs SMEs must meet the eligibility criteria identified inthe section above. e Sub-loans and leases must be given inthe eligible region-see Annex 4B.1. e Sub-loans and leases may be made for bothworking capital and investment purposes. Sub-loans and leases can be denominated inany currency, e Sub-loans and leases will be evaluated in accordance with the PFI's normal project andcredit evaluationguidelines. The following minimumrequirements will apply: + Sub-borrowers may have a maximum debu'equity ratio of 80:20 after receipt o f the sub-loadlease. + For all loans exceeding 750,000 (or the equivalent in other currencies), sub- borrowers must submit a cash flow statement following a format agreed upon with TSKB. + For all loans, sub-borrowers, after receipt of the sub-loadlease, should be projected to generate enough cash during the pay-back period of the sub- loadlease to maintain a minimumdebt service coverage ratio of at least 1:1. Except as the Bank shall otherwise agree, the aggregate amount o f outstanding Sub- loans and the aggregate amount of outstanding Lease Financing to any one S M E from all PFIs shall not exceed the equivalent o f2,500,000. For the first two sub-loans or leases, irrespective o f size, prior review by the World Bankwill be required. All sub-loans and leases not subject to prior review can be subject to ex-post review by TSKB or the World Bank in order to verify compliance with the subsidiary and sub-loan and lease agreement terms. 40 May 18,2006 0 The relevant authorities must certify that the SMEs (sub-borrowers) and sub-projects meet environmental laws and standards in force in Turkey. The World Bank policy on environmental assessment will also be complied with. 0 Goods andworks on the World Bank's negative list will not be eligible for financing. 0 Sub-borrowers must comply with the World Bank's procurement procedures for the procurement o f goods and works to be financed under project sub-loans (see Annex 8). 41 May 18,2006 Appendix 4C: Summaryof Terms andConditionsfor Halkbank 4C.l ConditionsbetweenHalkbankandtheWorldBank e Halkbank will draw the loan's credit line funds inEuros and will be able to convert all or portions o f the outstanding EUR obligation into TRY. The loan will be a Fixed Spread Loan (FSL) with level repayments, a five year grace period, and a 15 year total repayment term. The front-end fee will bepaid from the loanproceeds. IfcurrencyconversionintoTRYisrequested: a + The lending rate for a EUR FSL i s currently EUR LIBOR + 0.52% less any applicable waiver. To effect the conversion, the World Bank enters into a swap with a market counterpart, and the pricing will be based directly on the terms achieved on the swap between the World Bank and the market counterpart plus a transaction fee of 0.02% annually. + The pricing of the converted portion o f the loan will be based on a market transaction that the World Bankundertakes with a swap counterpart and would be the TRY equivalent o f the EUR LIBOR + fixed spread for the maturity o f the conversion. Borrowers may refer to internationally recognized swap screen quotes for indicative rates. However, it should be noted that the actual pricing would be based on the swap transaction undertaken by the World Bank with the swap counterpart. Halkbank will pay the World Bank a front-end fee o f 1percent, less any waiver, and an annual commitment fee o f 0.85%, less any waiver, on undisbursed balances for the first four years, and 0.75%, less any waiver, thereafter; the commitment fee will be payable with effect from 60 days after loan signing. Halkbank must create and maintain, for the duration o f the project implementation period, a Project Implementation Unit (PIU) staffed with qualified personnel and capable o f satisfactorily implementing all aspects o fthe project. For the duration o f the project implementation period, beginning with year-end2006, Halkbank must annually submit an audit report that (i)s prepared inaccordancewith i International Auditing Standards and International Financial Reporting Standards; and (ii) has an unqualified audit opinion, except as the World Bank shall otherwise agree. Halkbank will be subject to monitoring o f the outcome and output indicators in Annex 3 "Results Framework andMonitoring" on a yearly basis. 42 May 18,2006 Halkbank willbe subject to monitoringofthe indicators inthe FinancialManagement Reports in the Operational Manuals on a semi-annual basis, and must submit semi- annual financial managementprogressreports to the World Bank. Halkbank will maintain a set o f documentation for all sub-loans at headquarters and make them.available for ex-post review by the World Bank or by external auditors as necessary. SMEs will be required to keep copies of invoices for all expenses financed with working capital and investment loans received under the proposed project. SMEs will be required to send to Halkbank headquarters copies o f invoices for expenses financed with investment loans. Invoices for expenses financed with working capital loans may bekept bythe SMEs. Halkbank will make its best effort possible to utilize all payments made by SMEs under the Sub-loans to finance additional development projects to further the development o f SMEs. 4C.2 EligibilityCriteriafor SMEs For the purpose o f this project, SMEs are defined as firms with less than US$20 million insales andfewer than250 employees. Allprivatesmallandmediumenterprises(private ownership more than 50 percent), irrespective o f their sector, will be eligible for participation as sub-borrowers on a commercial basis. The maximum lending amount for the tourism sector should not exceed 30 percent o f the total amount lent to Halkbankby the World Bank @e., 15 million). SMEs operating inthe tourism sector are defined as: hotels, motels, resorts, pensions, holidayvillages and camping sites. 4C.3 TermsandConditionsbetweenHalkbankandthe Sub-BorrowerSMEs a SMEs must meet the eligibility criteria identifiedinthe section above. a Sub-loansmustbe giveninthe eligibleregions-see Annex 4B. 1. a Sub-loansmaybemade for bothworking capital andinvestment purposes. a Sub-loans canbe denominatedinanycurrency. a Investment loans under the operation will be assessed using Halkbank's investment loan evaluation framework, and working capital loans will be assessed using Halkbank's working capital loan assessment framework, including its credit scoring system.40The two systems are slated to be merged, and Halkbank will inform IBRD 40 At appraisal, the World Bank team conducted a detailed review of Halkbank's evaluation system, which it deemedadvanced and sound. The system includes a detailed assessmentofboththe SME's andthe owner's financial statements (including cash flow statements), collection and evaluation of all information available at the local credit bureaus, and an evaluation o fthe SME's soundness on the basis of several 43 May 18,2006 o f any changes to the system. Inaddition to the information already required to the sub-borrowers by Halkbank (including cash flow statements for all loans), minimum requirements for loans extendedunder the proposedproject include: + Sub-borrowers may have a maximumdebtlequityratio o f 80:20 after receipt o fthe sub-loan. + Sub-borrowers, after receipt o fthe sub-loan, should beprojectedto generate enough cashduringthe pay-back periodo fthe sub-loanto maintain aminimum debt service coverage ratio o fat least 1:1. The credit assessment files will be kept at the PIUor with the SME loan department, both located at Halkbank headquarters. Information on the share o f public ownership inthe SME as well as on the geographical location where the hnds will be applied (see conditions above) will also be maintained for each SME at Halkbank headquarters. Sub-loan pricing and maturity will be determined by Halkbankbased on the needs o f the particular sub-borrower and sub-project being financed, with the proviso that the lendinginterest rate must, at a minimum, cover the cost of World Bank funds, credit risk and operational costs. Except as the Bank shall otherwise agree, the aggregate amount of outstanding Sub- loans to any one SME shall not exceed the equivalent of2,500,000. For the first two sub-loans, irrespective o f size, prior review by the World Bank will berequired. All sub-loans not subject to prior review can be subject to ex-post review by the World Bank inorder to verify compliance with sub-loan agreement terms. The relevant authorities must certify that the sub-borrowers and sub-projects meet environmental laws and standards in force in Turkey. The World Bank policy on environmental assessment will also be compliedwith. Goods andworks on the World Bank's negative list will not be eligible for financing. Sub-borrowers must comply with the World Bank's procurement procedures for the procurement ofgoods andworks to be financed underproject sub-loans (see Annex 8. financial ratios and a credit scoring system. Further documentation on Halkbank's credit assessmentis available uponrequest. 44 May 18,2006 Annex 5: Project Costs TURKEY: Access to Finance for SMEs Project Cost By Component andlor Local Foreign Total Activity (In Euros) (Euros) (Euros) Halkbank TSKB Credit line 49,875,000 99,750,000 149,625,000 Front endfee la 125,000 250,000 375,000 Unallocated -- -- -- Premia for interest rate caps and -- -- -- collars Total Baseline Cost 50,000,000 100,000,000 150,000,000 Physical Contingencies -- -- -- PriceContingencies -- -- -- Total Project Costs 50,000,000 100,000,000 150,000,000 Interest during construction Front-end Fee Total Financing Required 50,000,000 100,000,000 150,000,000 /a The borrowers will pay the front end fee fromthe loanproceeds. 45 May 18,2006 Annex 6: ImplementationArrangements TURKEY:Access to Financefor SMEs The implementationagenciesfor the proposedprojectwill be TSKB (Component 1) and Halkbank (Component2). Appendices 6A and 6B provide summary evaluations of TSKB andHalkbank respectively, includingan analysis o fthe banks' financial soundness and specific considerations on the banks' ability to meet the World Bank requirements included in OP 8.30 on Financial Intermediaries. Annexes 7, 8 and 10 provide a more detailed analysis o f Halkbank's and TSKB's financial management, procurement and environmental procedures. Below is a brief summary of TSKB's and Halkbank's overall implementation capacity. TSKB has proventhrough previous operations that it is very capable of intermediating credit lines from international development banks, including the IBRD. The bank already has a Project Implementation Unit in place, with significant experience in selection and supervision of PFIs, overall monitoring and evaluation o f project implementation, and compliance with required fiduciary responsibilities. The PIU's experience and success have been clearly demonstrated by EFIL I1record-time disbursement. The PIU will be supervised by the bank's Executive Vice President o f Technical Services, who will act as Program Manager. The PIU staff will comprise the Executive Vice President o f Technical Services, the Head o fthe Financial Analysis andEngineeringDepartments, the Head o f the Economic Department, the Head of the Head Office Operations Department, the Head o f the Corporate Marketing Department, and the Head o f the Financial Control Department. Theproposedproject will not require hiringo f any additional staff, Halkbank has adequate staffing to carry out the proposed project and for supervising sub-project implementation. The bank's core business is provision of credit to SMEs. Halkbank's staff i s fully adequate to ensure satisfactory implementation o f the proposed project, including supervision of sub-projects, overall monitoring and evaluation o f project implementation and compliance with required fiduciary responsibilities. Halkbank has also specific experience implementingWorld Bank projects, including the Second Small and Medium Scale IndustryProject (L3067) and the Agro IndustryProject (L3077). A first evaluation of Halkbank's capacity to carry out environmental assessment of sub-projects is included in Annex 10. The Project Implementation Unit will be supervised by one of Halkbank's Executive Vice Presidents. A First Vice President will act as Program Manager. The PIU staff will comprise four Financial Specialists, an Environmental Specialist and a Procurement Expert. Halkbank's Credit Department will carry out the loan evaluations. The proposed project will not require hiring o f additional staff, although one person may need to receive some training to ensure compliance with World Bank environmental policies andTurkish laws. 46 May 18,2006 Appendix 6A: Tiirkiye SinaiKalhnmaBankasi(TSKB) Assessrnent4l 6A.1 Overview ofTSKB TSKB is the largest privateinvestment anddevelopment bank inTurkey and accounts for 1.5 percent o f bank loans in Turkey (see Table 6A.1 for key indicators on the bank). TSKB often takes credit riskwith banks, andassessingthe creditworthiness ofbanksis at the core o f TSKBs business. It was one of the PFIs in the EFILIproject and currently is the borrower o f the EFIL I1and EFIL 111Loans. As such, it is well known to the World Bank team through a regular exchange of views on the implementation of the EFILs, and through reviews of TSKB's audited reports and other financial reporting requiredunder the projects. TSKB maintains an overall sound financial and operational structure, and i s fit to undertake the financial liability of the Loan's Component 1 and operational commitments to act as the PIUfor the project. Table 6A.1:TSKB key indicators Million Share of Svsteml December 2005 US$ Perceni11 Assets 2,460 0.8 Deposits 0 0.0 Loans 12 1,302 1.o Securities 823 0.7 Branches (number) 1 0.0 Source: Banks Association of Turkeyand stfl~cfllculations. I1 Sharesofsystemreflect September 2005 data. 12 Includes leasing assets worth US$ 177million. TSKB's main business i s to extend mediumand long term loans. About three quarters o f its loans are in foreign currency. Trade credit and financial leases are also important products for the bank. Finally, TSKB provides a wide range o f investment banking services, including public offerings, private equity f h d management, mutual fimd management, and investment advisory services. These services, however, represent a small part o f the bank's activities, with net fees and commission amounting to just 6 percent o f net interest income in 2005. As an investment and development bank, TSKB does not accept retail deposits, and it has only three locations42includingrecently opened branches in Izmir and Ankara. Table 6A.2 includes the bank's summary balance sheet and income statement. 41Unless otherwise noted, data inthis section reflect 2005 and are based on audited financial statements. 42TSKBhas anoff-shore branch inBahrain. 47 May 18,2006 Table 6A.2: Summary balance sheet and income statement for TSKB and the banking system TSKB TurkishBankingSystem Million US$, December 2005 (September2005for system) YTL FX Total YTL FX Total ASSETS CASHAND BALANCES WITH THECBT 0 0 0 4,080 3,436 7,515 TRADING SECURITIES(Net) 0 0 0 6,423 7,389 13,812 Of whichpublic sectorsecurities 0 0 0 6,279 7,357 13,636 BANKS AND OTHERFINANCIAL INSTITUTIONS 30 63 94 4,883 11,873 16,757 Of whichforeign banks 0 28 28 1,678 10,528 12,207 INVESTMENT SECURITIESAVAILABLE FOR SALE (Net) 594 229 823 35,909 18,621 54,531 LOANSI1 226 1,036 1,302 69,946 31,331 101,277 Short term 3 32 750 39,534 13,000 52,534 Mediumandlongterm 249 1,011 1,260 29,866 18,310 48,176 Loans under follow-up 26 7 33 5,301 160 5,461 Specificprovisions(-) 26 7 33 4,755 139 4,894 INVESTMENT SECURITIESHELDTO MATURITY (Net) 0 0 0 29,078 8,012 37,089 Of whichpublic sector securities 0 0 0 25,993 6,768 32,761 RESERVEDEPOSITS 0 19 19 3,795 6,760 10,555 PROPERTYAND EQUIPMENT(Net) 28 0 28 6,841 12 6,853 OTHERASSETS 170 25 195 18,307 3,722 22,029 TOTAL ASSETS 1,088 1,372 2,460 179,261 91,156 270,417 LIABILITIES DEPOSITS 0 0 0 104,137 67,358 171,495 Of whichsavings deposits 0 0 0 58,201 0 58,201 Of whichpublic sector deposits 0 0 0 6,317 0 6,3 17 Of whichforeign currency deposits 0 0 0 0 63,991 63,99 1 INTERBANK MONEY MARKET 290 62 352 9,573 3,118 12,691 FUNDSBORROWED 21 1,554 1,576 2,574 26,096 28,670 Of whichforeign banks 8 1,401 1,409 1,861 24,904 26,765 FUNDS 0 0 0 3,939 5 3,944 PROVISIONS 32 5 38 5,004 309 5,3 12 OTHERLIABILITIES 6 79 85 9,874 3,227 13,101 SHAREHOLDERS'EQUITY 409 1 410 34,840 365 35,205 TOTAL LIABILITIES 759 1,701 2,460 169,941 100,477 270,417 INCOME STATEMENT INTERESTINCOME 181 30,910 Of which interest on loans 61 14,979 Of which interest on securities 109 14,009 INTERESTEXPENSE 80 17,245 NET INTERESTINCOME 100 13,665 NET FEESAND COMMISSIONS INCOME 6 3,562 NETTRADING INCOME 7 1,654 OTHEROPERATINGINCOME 21 1,944 TOTAL OPERATINGINCOME 135 20,865 PROVISIONFORLOAN LOSSESOR OTHERRECEIVABLES(-) 7 4,153 OTHEROPERATINGEXPENSES(-) 37 10,471 NETOPERATINGINCOME 91 6,241 PROFITiLOSSESFROMASSOCIATESAND SUBSIDIARIES 1 290 NET MONETORYPOSITIONGAINiLOSS 0 0 INCOMEBEFORETAXES 93 6,53 1 PROVISIONFORTAXES ON INCOME -19 -2,503 NET OPERATING INCOMEEXPENSEAFTER TAXES 74 4,029 EXTRAORDINARYINCOMEiEXPENSEAFTER TAXES 0 0 NET PROFITiLOSSES 74 4,028 Source: BAT and st~~calculations. Note: Incomestatementdataare annualized. /IForTSKB,leasereceivablesareincludedunderloans. 48 May 18,2006 TSKB is ownedbyTurkey's largestprivate bank, Isbank, ithas a minority stakefrom the state controlled bank, Vakif Bank, and 41 percent of its stock i s held by non-strategic investors and is traded on the Istanbul Stock Exchange (see Figure 6A.1). As of December 2005, TSKB had a staff o f 286, with an average lengtho f service inthe bank of 10 years, and an average age o f 36 years. TSKB has transactions with its owners and relatedparties amounting to US$85 millioninloans andUS$23 innon-cash loans. Figure6A.1:Ownership ofTSKB Isbank (Turkey's largest Vakifoank (Large stateowned privatebank), 50% deposit taking bank), 8% Stock Exchange,42% Source: TSKBwebsite. 6A.2 Suitability ofTSKB as Counterpartfor Component 1 TSKB is the proposed borrower and Project Implementation Unit (PIU) for Component 1. With more than halfof its credit portfolio reflecting credit risk to other banks or loans covered by a bank guarantee, TSKB has good experience assessing bank credit risk, which will be a main responsibility under Component 1. Furthermore, TSKB has extensive experience with intermediation o f funds from international organizations, including the European Investment Bank, Japan Bank for International Cooperation, Kreditun~taZtfiir Wiederauflau, Council o f European Development Bank, IFC, and Agence Franpise de Dkveloppement. TSKB enjoys a special status, which allows it to receive Government guaranteeson its borrowings. 6A.3 FinancialSoundness and RiskExposures TSKB is a profitable and solvent bank with a sound liquidity position and moderate marketrisk exposures. Ithas a largecredit portfolio mostly inforeign currency, exposing the bank to indirect exchange rate risk and shocks to the real sector. The risks are mitigated by extensive use o f bank guarantees, collateral taking, and lending to firms with foreign currency earnings. Onbalance, TSKB is viewed as a sound bank. TSKB is rated by both Fitch Ratings and Moody's and receives ratings in line with the largest and best rated banks in the country-see Tables 6A.3 and 6A.4. Strong capitalization, improved asset quality and profitability, stable funding, and the bank's niche position as the keypositives are cited in the ratings, together with the key risks are 49 M a y 18,2006 related to low fee and commission income and the volatile economic environment in Turkey. Table 6A.3: Ratings byFitchRatings TSKB Akbank Isbank GarantiBank LongTermRating BB- BB- BB- BB- Short TermRating B B B B LocalCurrency LongTermRating BB- BB+ BB- BB- LocalCurrency Short TermRating B B B B Source: Fitch Ratings. Note: Ratings as ofDecember 9,2005. Table 6A.4: Ratings by Moodys Ratings TSKB Akbank Isbank Garanti Bank FinancialStrengthRating D+ D+ D D+ ForeignCurrency LongTermRating B1 B1 B1 B1 Source: Moody s Ratings. Note: Ratings as ofDecember 14,2005. Solvency. TSKB has increased its capital, which now amounts to US410 millionor 13.9 percent of assets, in line with the Turkish banking system. (See Table 6A.5.) On a risk weighted basis, the capital adequacy ratio of 36.8 is very high, reflecting the frequent use of bank guarantees, which lead to a 20 percent risk weighting of loans. The bank is, indeed, well capitalized. Table 6A.5: Solvency Banking System TSKB Percent 2005 2005 2004 Tier llrisk weightedassets 24.1 34.9 40.5 Capital adequacyratio 23.3 36.8 42.8 Capitalitotal assets 11.9 16.7 15.8 Source: Banh Association of Turkey and staff cahlations. Note: The banking systemreflects September data, andTSKB reflects Decemberdata. Credit risk and loanportfolio performance. TSKB's loan portfolio is large and amounts to US$1,302 million (including USD 173 million in lease receivables), or 53 percent of its assets. It has a low risk profile, as illustrated by the low risk weights applied under the regulatory rules (see Figure 6A.2) with only 36 percent of loans receiving a 100 percent risk weight. The majority o f its loans (52 percent) are to banks or with a bank guarantee, which allows the 20 percent risk weight. An additional 11 percent of its loans are risk weighted at 50 percent, reflecting the increasingly popular use ofmortgage collateral. 50 May 18,2006 Figure6A.2: Riskweightingofloans, December 2005 nt riskweight, (1%) Source: Banks Association of Turkeyand staff calculations. The bank's gross NpLratio, at 2.3 percent, is below those o f the Turkishbanking system (see Table 6A.6) and has been reduced by more than half since 2003. The reduction in N p L s reflects mostly collections on existing NPLs, while write offs were about a third o f collections. Gross additions to NPLs in 2004 and 2005 and were just US$2.2 million or less than a quarter of a percent of net loans. Thus, the performance o f TSKB's loan portfolio is very good. TSKB provisions its NPLs 100 percent, which i s a conservative provisioningpolicy. Table 6A.6: Credit risk Banking Svstern TSKB - _ 1 Percent 2005 2005 2004 Gross NPLslgross loans I1 4.6 2.3 3.7 Gross NPLs (incl. substandard)igross loans 1'1 5.1 2.5 4.1 Gross NPLsicapital 15.2 9.6 15.0 LoanprovisionslNPLs (incl. substandard) 89.6 100.0 100.0 Loanprovisionsicapital 15.2 9.6 16.4 Source: Bank Association of Turkey and sta~calculations. Note: The banking systemreflects September data, and TSKB reflect December data. il Includingfinancial leasereceivables. TSKB's outstanding loans are about three quarters in foreign currency. In case o f a depreciation o f the Turkish Lira, this creates credit risk for the bank as the value o f the loan in Lira terms increases. This risk is mitigated for borrowers that are naturally hedged, for instancebybeingpricetakers inexport markets. However, even exporters are not perfectly hedged, collateral value will typically depreciate, and this indirect exposure to exchange rate shocks therefore remains a concern. On balance, TSKBs loan portfolio has a moderatecredit risk profile. Profitability. TSI(B's profitability is in line with the Turkish banking system (see Table 6A.7) as well as with international standards, with ROA o f 3.6 percent and ROE o f 21.4 percent. The low operating expenses reflect in part that the bank does not engage in costly retailoperations and inpart that the bank is efficiently run. 51 May 18,2006 Table 6A.7: Profitability Banking System TSKB Percent 2005 2005 2004 Realreturn on average assets 1.6 3.6 2.3 Real returnon average equity 11.6 21.4 13.3 Net interest income lessprovisionslaverage assets 3.8 4.5 3.9 Net interest income lessprovisionslgross income 45.6 69.4 51.5 Other operating expenseslgrossincome 50.2 27.3 21.1 Net trading incomelgross income 7.9 4.8 1.4 Source: Banks Association of Turkeyand staff calculations. Note: The banking systemreflects September data, andTSKB reflect December data, Liquidity. Because TSKB does not take deposits, its liability side is very stable and well protected from liquidity shocks, as confirmed by the very high liquid assetslshort term liabilities ratio in Table 6A.8. As shown in Table 6A.2, liabilities are almost entirely borrowings, while interbank money market liabilities are small. This leaves TSKB very resilientto liquidityshocks. Table 6A.8: Liquidity Banking System TSKB Percent 2005 2005 2004 Liquidassetsltotal assets 39.1 38.1 31.1 Liquidassetslshort termliabilities 280 2,484 2,503 Source: Banks Association of Turkeyand sta~caIcu~ations. Note: The banking systemreflects September data, and TSKB reflect December data. Market risk expusures. TSKB's direct market risk exposures are very moderate because it does not collect deposits and has a long term funding base and therefore is able to extend medium andlong loanswithout the maturity mismatches that banksnormally have to carry. Moreover, since its balance sheet i s dominated by foreign currency (see Table 6A.9), the bank is not very exposedto fluctuations inlocal currency interest rates. TSKB has manageableshort net foreign position amounting to 2.2 percent o f its capital as o f the endof2005. Table 6A.9: Exchange rate risk Banking System TSKB Percent 2005 2005 2004 Net foreign exchange positiononbslcapital -5.8 -17.6 -5.4 Net foreign exchange position on and off bslcapital -1.5 -2.2 -5.5 Foreign currency denominated loansltotal loans 30.9 76.4 91.2 Foreign currency denominated assetsltotal assets 33.7 55.8 68.8 Foreign currency denominated liabilitiesltotal liabilities 37.2 69.1 74.8 Source: BanksAssociation of Turkeyand staff calcuI~tions. Note: The banking systemreflects September data, and TSKB reflect December data. 52 May 18,2006 6A.4 Operational Policy8.30 (OP 8.30) Considerations OP 8.30 applies to TSKB for the proposedoperation. Insummary, the conditions are viewed as beingmet for TSKB as an APEX institution. Regardingthe specific issues underOP 8.30: (a) Adequate profitabili~,capital, and portfolio quality, as confirmed by financial statementsprepared and audited in accordance with accounting and auditingprinciples acceptable to the Bank TSKB is a well capitalized, profitable bank with a sound loan portfolio. The bank prepares financial statements in accordance with Turkish regulations, as well as in accordancewith IFRS andthe statementsare viewed as adequate. (b) Acceptable levels of loan collections Gross NPL levels are below those o f the Turkish banking sector as a whole, and collections on NPLs are strong, while new NpLs are a small fraction o f the bank's loan book. Thus, the performance o f TSKB's loan portfolio i s very good-see also section on credit risk and loanportfolio performance above. (c) Appropriate capacity, including staffing, for carrying out sub-project appraisal (including environmental assessment) andfor supervising sub-project implementation The World Bank has extensive and recent experience working with TSKB, and it has proved its ability to fulfill the requirements of the World Bank. Under this operation, TSKB will be lendingto banks, which i s a common activity for TSKB. (See also Section 6A.4 on this.) (d) Capacity to mobilize domestic resources TSKB is not allowed to collect deposits, and borrows limited amounts in the domestic interbank money market through rep0 operations (US$352 million). Most o f its borrowings are fi-om foreign banks (US$1,409 million). Rather than an inability to mobilize domestic resources, the predominance o f foreign bank liabilities reflects TSKB's ability to attract them at more favorable terms, (e) Adequate managerial autonomy and commercially oriented governance TSKB i s a publicly traded privatelyowned and profitablebank that makes decisions on a commercial basis. flAppropriate prudentialpolicies, administrative structure, and businessprocedures TSKB i s subject to bank regulations and follows a prudent approach to risk management. IFC recently extended a US$50 million subordinated loan to TSKB confirming that institution's trust inTSKB's procedures. A separate assessment o f financial management i s beingconducted and i s attachedinAnnex 7. 53 May 18,2006 Appendix 6B: HalkbankAssessment43 6B.1 OverviewofHalkbank Halkbank is a large deposit-taking state bank primarily serving SME customers throughout Turkey. It is the gfhlargest bank inTurkey by assets andhasthe fourth largest branchnetwork44(see Table 6B.1 for keyindicators). The bank currently has the Turkish Government as its sole shareholder, but the bank is slated for privatization, and the Privatization Administration has hired a financial advisor (investment bank) to bring Halkbankto the market. Inpreparation for privatization, the bankhas been operationally restructured through the closing o f branches and substantial reduction of staff, while expanding its loan portfolio to increase profitability in line with its strategy. Inorder to ensure successfkl privatization and maximize the value to the Government as the bank's shares are sold, strategic and operational decisions are increasingly made on a commercial basis. Substantial financial and operational restructuring over the past few years have contributed to the bank now being financially sound as well as profitable. Untilrecently, the bank had ajoint board o f directors with another major state bank, Ziraat Bank, but in preparation for the privatization, Halkbank now has its own board. The board approves policies, strategies, and principles for the bank. In line with industrypractice, the bank has a risk management unit reporting directly to the board. An organizational chart for the bank i s included inFigure6B.1at the endof this Appendix. Table 6B.1:Halkbank key indicators December 2005 Billion Share of System/ percent Assets 20.2 6.8 Deposits 15.6 8.6 Loans 4.6 4.1 Securities 12.7 11.9 Branches (number) 584 9.4 Source: BRSA and sta~calculat~~ns. 6B.2 SuitabilityofHalkbankas Counterpartfor Component2 Halkbank hasbeen selected as counterpart for Component 2, which will provide credit to SMEs inunderserved areas inthe East and Center o fthe country. One o fHalkbank's key strategic objectives is to grow its SME business. Halk's vision reads, "Becoming the leading SME bank of the country.. .." Infact, Halkbank's portfolio i s already dominated by commercial credit (with a significant share of SMEs), while the bank extends very little consumer credit (14 percent o f loans). 43Unless otherwise noted, data in this section reflect 2005 and are from the Banking Regulation and SupervisionAgency. 44ByDecember 2005, Halkbank hadreduced its numberofbranches to 584 inpart as a result ofbranch consolidation after the merger with Pamukbank. 54 May 18,2006 Halkbank has a relatively strong presence in the East and Center o f the Country where credit i s less developed. While the Turkish banking system only has 7.6 percent of its loan portfolio in the targeted regionp5 (as defined in Appendix 4 4 , Halkbank has 26 percent o f its loanportfolio (or US$693 million) inthis area.46Details on the loans inthe two relevant parts ofthe country areprovidedinTable 6B.2. Table 6B.2: Halkbank loanportfolio byregion Million US$ Western Targeted Total end-April, 2005 region region Total credits 1,980 693 2,673 Net NPLs 51 0 51 Gross NPLs 802 61 863 Source: Halk~ank. Halkbank's participationinthe project is thus WE-- aligned with its strategy. I-ilkbankis seeking to strengthen its position as an SME bank by increasing its product range and growing its portfolio to that segment. As its large portfolio of non-tradable investment securities mature, the portfolio will shift towards tradable securities and loans. Halkbank has the lowest loans-to-deposit ratio in Turkey, at 30 percent, compared to an average loans-to-deposit ratio o f 62 percent in the banking system. This suggests that Halkbank has a large customer base that i s currently not exploited interms o f extending credit. 6B.3 FinancialSoundness andRiskExposures Halkbank is a well-capitalized and profitable bank with relatively small market risk exposures. The bank's assets are not very liquid, but the liability side does not appear to be risky from a liquidity perspective. The loan portfolio has performed well in the past two years, and the bank appears to be run in a sound manner. Table 6B.3 includes Halkbank's financial statements compared with those o fthe Turkishbanking system. The section below includes a detailed evaluation o f Halkbank's financial and operational performance. `'Asof December 2003, based on the most recent available data. Figures calculated onthe basis ofthe Regional distribution includedinAnnex 4.A. 46As ofApril 2005. 55 May 18,2006 Table 6B.3: Summary balance sheet and income statementfor Halkbank and the banking system HaIkhk T ~ h Mllimrs!&LkadJer#w)s Y I L m m A L YIL F x m A L 68 135 6.672 4.499 11.171 237 1.302 5.678 7.270 12.948 456 562 9.131 14.612 23.743 176 1.321 39.397 18.808 58.205 514 4,644 80.656 31.842 112.548 898 5.450 149 5.599 883 4.896 131 5.m 723 10.055 28.937 6.717 35.654 243 808 4.013 6.845 10.858 532 5.564 10 5.514 lIAmmEs Y I L F x m A L YII, m m A L CmXl-Is 12265 3.342 15.607 115.437 66.132 181.569 30 30 10.846 2422 13.268 165 180 345 7.230 33.354 40.584 760 5 765 4.067 4 4.071 497 14 511 5.751 337 6.088 -m 408 151 559 1.522 3.231 10.753 2387 - 2387 39.710 418 40.128 mAL- 16512 3.a 20.m l90.563 105m 296.461 738 15.324 1.936 14.072 2.086 1790 690 13.668 116 4.103 160 1.582 201 2.248 1.167 21.a1 86 4.840 522 10.291 559 6.4x) 9 287 568 6.757 171 2.492 397 4.265 ~ ~ Y ~ . ~ T ~ NFT- 397 4.265 Source: Banking Regulation and Supervision Agency and Staff Calculations. 56 May 18,2006 Solvency, With a capital adequacyratio of 50percent (see Table 6B.4), the bank is highly solvent when measuredagainst risk-weightedassets, Themuch lower capital-to-assets ratio o f 12percent reflects the bank's largeholdingo f Government debt securities with 0 percent risk weighting. Table 6B.4: Solvency Banking System Halkbank SeP Dec Sep Dec Percent 2005 2005 2005 2004 Tier llrisk weighted assets 24.1 49.9 57.4 60.7 Cauital adeauacvratio Capitalhotal*assets - 23.3 49.6 56.2 58.9 11.9 11.8 11.2 11.4 Source: BAT and sta~calculat~ons. Credit risk and loanportfolio performance. The bank's gross NPL-to-total loans ratio is high at 19 percent47(see Table 6B.5). However, it largely reflects old non-performing loans that have been fully provisioned for but not written off. Current portfolio performance i s sound. A substantial portion of the NPLs are carried over from Emlak Bank, which failed during the crisis and was mergedwith Halkbank. Specific provisions are made for 98 percent o f gross NPLs4*, and no loans have been written off inthe past three years. New non-performing loans (including sub-standard) net o f collections during the period 2003 to 2005 amounted to less than 1.5 percent o f the bank's current loan portfolio. The recent performance o f Halk's loan portfolio i s thus sound. Halkbank's borrowers are widely dispersed, and concentrations are not a concern. In contrast to privatebanks, Halkbank extends 89 percent of loans inlocal currency and therefore does not expose itselfto indirect currency depreciation risk4' such as is otherwise common in Turkey. Table 6B.5: Credit risk Banking System Halkbank SeP Sep Dec Percent 2005 2005 2004 GrossNPLsJgrossloans 4.6 18.7 21.0 Gross NPLs (incl. substandard)Jgrossloans 5.1 20.0 22.1 GrossNPLslcapital 15.2 38.5 39.7 LoanprovisionsJNPLs(incl. substandard) 89.6 98.2 96.5 Loanprovisionslcapital 15.2 40.4 40.3 Source: BAT and sta~calculati~ns~ 47NPL ratio is 14percent as of the end ofMarch, 2006 inpart as a result of improved collections and in part as a result of loangrowth. 48Halkbankhas apolicy to provision 100percentfor non-performing loans. The difference between provisioning levels and 100percentreflect loansguaranteedby the TurkishTreasury for whichthe provisioningpolicy does not apply. 49Indirect currencydepreciationriskrefers to the credit risk associatedwith lending inforeign currency. In Lira terns, depreciationwill increase the value ofthe loan, while the borrower's financials as well as the value ofthe collateral is likely to remain constant. 57 May 18,2006 ProfitabiZity. The bank is highly profitable by both Turkish and international standards, with real ROA of 2.1 and real ROE of 17.5 (see Table 6B.6). As the Turkish banking market evolves, new sources of profits must be developed. Halkbank's non-marketable securities are currently being remunerated above would-be-market prices, and as they mature they will be partially replaced with lower yielding assets. Halkbank has a greater portion of its assets invested in Government securities than private Turkish banks, and return on this position is likely to decline in the future. Halkbank's ability to sustain its current high level o f profitability will depend on its ability to shift its portfolio in response to changing profit opportunities. However, even a lower level of profitability wouldnot endanger Halkbank's financial soundness. Table 6B.6: Profitability Banking System Halkbank Dec Dec Dec Percent 2005 2005 2004 Return on average assets 1.7 2.1 2.9 Return on average equity 11.8 17.5 23.7 Net interest income lessprovisionslaverage assets 3.5 3.1 6.7 Net interest income lessprovisionslgross income 40.9 51.8 73.3 Other operating expenseslgrossincome 47.6 44.7 32.0 Source: BAT and sta~calculations. Liquidity. Halkbank's liquidityratios are below the rest ofthe bankingsystem (see Table 6B.7), because 79percent ofits securities are investment securities heldto maturity. Most of these are non-tradable Government securities issued to recapitalize the bank after the 2001 crisis, and as they mature they will be partially replaced by marketable securities, thus improving the liquidity of the bank over the medium term. The improved liquidity position is evident from the change between 2004 and 2005. Even in the near term, the liquidity position does not appear risky. In part, short term liabilities are only slightly higher than short term assets, and in part the bank enjoys an implicit guarantee on its liabilities from its Government ownership, thus reducing the risk of a runon deposits and other short term liabilities. Table 6B.7: Liquidity Banking System Halkbank Dec Dec Dec Percent 2005 2005 2004 Liquidassetsitotal assets 39.4 20.4 9.6 Liquidassetsishorttermliabilities I1 280 93.2 88.7 Source: 3ATand sta~calculations. 112005 data reflect September Market risk exposures. Halkbank's market risk exposures are very moderate. The bank maintains almost balanced foreign currency positions both on and off balance sheet (see Table 6B.8). The securities held by Halkbank, although they have long maturities, carry little interest rate risk because they are repriced frequently, 58 May 18,2006 Table 6B.8: Exchangerate risk Banking System Halkbank Dec Dec Dec Percent 2005 2005 2004 Net foreign exchangepositiononbslcapitalI1 -5.8 0.8 0.6 Netforeign exchangepositionon andoff bsicapital1'1 -1.5 0.0 0.6 Foreigncurrency denominatedloansltotal loans 28.3 11.1 10.9 Foreigncurrency denominatedassetsltotalassets 31.7 12.3 17.7 Foreigncurrency denominatedliabilitiesltotalliabilities 35.7 18.3 24.6 Source: BAT and s ~ a ~ c a l c u l a ~ ~ o ~ s . 112005 data reflect September 6B.4 SubsidizedCredits Halkbank extends two types of subsidized credits, "find credits" and "cooperative credits," that account for 38 percent o f total loans5' (see Table 6B.9 for an overview o f loans by type and region). The subsidy elements are hlly financed by sponsors outside Halkbank, and the subsidized credits are structured in a way that does not distort Halkbank's credit decision or interest rate setting for other loans. Table 6B.9: Halkbank loanportfolio by loantype andregion, end-April2005 Million US$ Western Targeted region region Total Coop credits 712 285 998 Fund loans 392 219 610 Other loans 826 189 1,014 Total credits 1,980 693 2,673 Source: Halkbank. Directly subsidized "cooperative credits" Cooperative credits are extended to small individualborrowers under credit cooperatives, and only borrowers organized under these credit cooperatives are eligible. The borrowers are small, and the scheme is akin to microfinance schemes seen in many other places. Halkbank receives a 6 percent subsidy from the Government in order to reduce interest on the loans. Credit risk is reduced by the joint liability o f the cooperative and the borrower. When payment from aborrower is late, the amount i s charged directly from the cooperative's account. This program is only offered by Halkbank, and it is expectedto be phasedout over time. The loans are carried on Halkbank's balance sheet. Indirectly subsidized `ffundloans'' Fund loans are financed by below market rate liabilities provided in the form of loans from, for instance, Turkish EXM bank and IFIs including EIB. Halkbank is requiredto lendthe funds according to certain criteria, such as locationinspecific industrialzones or to special groups of borrowers such as SMEs. The proposed World Bank credit line will also fall inthis category. The loans are priced fairly close to market prices, and Halkbank earns a normal spread, carries the credit risk for these loans, and has the loans recorded 50As ofDecember 2005. 59 May 18,2006 on its balance sheet. Some of the fund loans are available to other banks inthe market, including private banks, andHalkbank does not enjoy a favorable position vis-&vis other banks with respect to these loans. 6B.5 OperationalPolicy 8.30 (OP 8.30) Considerations OP 8.30 applies to Halkbank for the proposed operation. Insummary, the conditions are viewed as being met for Halkbank as an intermediary. Regardingthe specific issues for financial intermediaries under OP 8.30: (a) Adequate profitabili~,capital, and portfolio quality, as confirmed by financial statements prepared and audited in accordance with accounting and auditingprinciples acceptable to the Bank Halkbank is profitable, well capitalized, and its loan portfolio has performed well over the past two years-see the section on financial soundness and risk exposures. Halkbank prepares statements in accordance with regulations, and the statements are viewed as adequate. (b) Acceptable levels of loan collections Although Halkbank carries a large stock of old non-performing loans, current loan collections are good-see the section on credit risk and loanportfolio performance under the section on financial soundnessandrisk exposures. (c) Appropriate capacity, including staffing, for carrying out sub-project appraisal (including environmental assessment)andfor supervising sub-project implementation On appropriate capacity, includingstaffing, see section 6.B.5 (Implementation Capacity). Halkbank has US$669 million worth of loans to SMEs in the targeted region, equaling more than 10 times the amount o f credit to be extended to Halkbank under the proposed operation. Some o f the loans are extendedwith subsidies andmay therefore not be a good indicator for the potential size o f the market. However, Halkbank still lends US$332 million, or 6 times the proposed credit line, in the targeted region excluding the cooperative loans. NPLs inthe targetedregion are small-both net and gross NPL levels are less in the targeted region than for the bank as a whole. This evidence suggests that Halkbank i s able to extend sound credit inthe targetedregion. (d) Capacity to mobilize domestic resources Halkbank has US$12.3 billion worth of domestic deposits, provingits ability to mobilize domestic resources. (e) Adequate managerial autonomy and commercially oriented governance Halkbank i s owned by the Government and about to be privatized, possibly through an IPO. Incase of an IPO, the Government will retain control until a private sector partner 60 May 18,2006 takes a majority stake in the bank. In preparation for privatization, business objectives have shifted to a commercial basis in order to maximize the value o f the bank when the shares are sold. Since the Government still owns and controls the bank, it i s clearly not totally autonomous and commercially oriented in its decision making. However, the team's assessment indicates that decisions are made sufficiently autonomously and that they are commercially oriented, as also evidencedbythe soundfinancials o fthe bank. flAppropriateprudential policies, administrative structure, and businessprocedures. Halkbank complies with the regulations, and its balance sheet has a low risk profile. Credit decisions are made on a commercial basis (see section on subsidized credits for details), and the bank has a risk management unit reporting to the bank's board o f directors, according to international practice. Separate procurement and financial management assessments are included inAnnexes 7 and 8. 61 (v W May 18,2006 Annex 7: FinancialManagement and Disbursement Arrangements TURKEY:Access to Financefor SMEs A. Summary of Financial ManagementArrangements The task team has conducted an assessment o fthe adequacy of the project financial management systems at TSKB and Halkbank. The current financial management arrangements for the project are satisfactory at bothbanks. A summary of the conclusions for bothbanks is as follows: TSKB HALKBANK RATING RATING COMMENTS 1.Implementing Entity Satisfactory Satisfactory 2. Funds flow Satisfactory Satisfactory 3. Staffing Satisfactory Satisfactory 4.Accounting Policies andprocedures Satisfactory Satisfactory 5. InternalAudit Satisfactory Satisfactory 6. External Audit Satisfactory Satisfactory 7. Reporting and Monitoring Satisfactory Satisfactory 8. Informationsystems Satisfactory Satisfactory OVERALLFINANCIAL MANAGEMENTRATING Satisfactory Satisfactory CountryIssues. Until 2001-02, public financial management in Turkey was based on an outdated legal framework. Enactment o f the Public Financial Management and Control Law in 2003 was a definingmoment for public financial management inTurkey. The law articulates a modem view o f performance-oriented public sector management. It clarifies the nature of ministers' and officials' accountability to the public by strengthening public expenditure and financial management processes in line with EUpractice. The results of the implementation of the law, however, still need to be evaluated. Turkey has also implemented a state-of-the-art accounting system, adopted accrual-basis o f accounting, established a Government Accounting Standards Board as the general government's sole standard-setting authority, several extra budgetary funds have been closed down, and a new law has been drafted for the Turkish Court o f Accounts to strengthenthe audit function. The Banking Regulation and Supervision Agency (BRSA) issued a new comprehensive regulation on accounting standards for banks inJuly 2002, which brings these standards in line with International Financial Reporting Standards (IFRS). However, the BRSA regulation does not require full application o f IFRS 27 (consolidation o f subsidiaries), as banks only have to consolidate their financial subsidiaries, while for non-financial subsidiaries separate financial statement disclosure is mandated. The statements o f such non-financial subsidiaries are not IFRS-based," however, andthus their disclosure will not allow the user to consolidate these with Only ifall non-financialsubsidiariesofa bank are listedor publicly held, andonly ifthe Capital MarketsBoardofTurkey requiresthe use of full IFRSfor all listedor publicly heldentities, will the financial statements for such non-financialsubsidiaries 63 May 18,2006 the IFRS-based consolidated statements ofthe parentbank and its financial subsidiaries. Also, as the IFRS are subject to change, any such change will necessitate an adjustment o f the BRSA regulation. The BRSA also issues rules governing the external audit o f bank financial statements, and only auditors approved by the BRSA may carry out such audits. The "Regulation on Principles for Independent Auditing" and the "Regulation on Authorization o f the Auditing Institutions and Permanent or Temporary Withdrawal o ftheir Authorities", bothpublished inthe Official Gazette' Nr.24657 onJanuary31,2002 arebroadlyinlinewithISA. TSKB and Halkbank have been assessed for compliance with BRSA prudential regulations by the project team and found to be in compliance. The participating financial institutions are not yet determined. Their compliance with BRSA prudentialregulations i s a conditionality for initial andcontinued eligibility. Risk Analysis A summaryofthe risk assessment for the project is as follows Risk Comments ~ INHERENT ~ S K 1. Country Financial Management Risk Moderate 2. Project FinancialManagementIssues Negligible Overall Inherent Risk Moderate CONTROLRISK Risk Mitigation Strategy Country financial management risk-the project team's assessment o f the banks` compliance with the BRSA prudential regulations showed that both banks are in compliance. Since the accounting standards applicable to the banks differ with respect to consolidation from IFRS, be IFRS-basedandallow full consolidationwith the IFRS-basedfinancial statementsofthe parent bank and its financial subsidiaries. 64 May 18,2006 TSKB and Halkbank will submit their IFRS-based audited financial statements to the Bank in addition to their audited financial statements prepared in accordance with the BRSA accounting standards. I ~ ~ l e ~ e n tEntig i n g The largest component of the project will be implemented by TSKB (100 million), which will act as an Apex. Halkbank (50 million Euro) will act as a retailer and lend directly to eligible SMEs. The Treasury willbethe guarantorofthe loan. Assessments for TSKB and Halkbank are available in Appendix 6A and 6B o f the Project Appraisal Document respectively. Criteria for selection o fthe PFIsare includedinAppendix 4B. Compliance with the prudential regulations set out by Banking Regulatory Supervisory Authority (BRSA) is required for the continuing eligibility o f Halkbank, TSKB and the PFIs. This will be monitored through (a) prudentialregulation compliance certificates and (b) annual audit reports. Therisk associated with both implementing entities is assessed as negligible. Funds Flow Funds from the TSKB portion of the loan will bemade available to PFIs following certification of eligibility by the PFIs. PFIs will send a list and a copy o f invoices for eligible expenditures submitted by the SMEs for investment loans extended. When a working capital loan i s extended to the SMEs, the PFIs will obtain andretain financial statements o fthe SMEs on an annual basis. The submission ofinvoices for working capital loans i s not required. Halkbank will apply its usual lending procedures for loans given from the World Bank. A potential beneficiary enterprise will make its application to a Halkbank branch, which will prepare a pre-appraisal file and send it to the RegionallGeneral Directorate. The investigation department will collect the first information from the market and, based on the firm's good standing, will give their report to the branch, which inturn will make the evaluation and prepare the loan proposal for the Loans Department. The loan will then be submitted to the General ManagerlDeputy General Manager, to the Credit Committee, and to Halkbank's Board o f Directors. After the approval o fthe board, the branch will preparethe loan contract and send it to the loan customer. Management o f the special account will be the responsibility o f the Loans Department. The branches will be responsible for controlling the already paid or to be paid invoices. They will be checking for mathematical correctness as well as compliance with the project framework. Upon their approval, the Loans Department will make fimds available to the beneficiary enterprises. A list and copies o f the invoices for the eligible expenditures financed through investment loans will be available at Halkbank's head office. These documents will be reviewed by designated staff at the head office before the funds are made available to the SMEs. Halkbank branches will obtain six monthly financial statements from SMEs where working capital loans have been extended, and a copy of these financial statements will be made available at the head office, The changes in the working capital requirements of the companies will be 65 May 18,2006 monitored through these financial statements. The submission o f invoices for working capital loans is not required. Therisk associated withfundsflow is assessed as negligible TSKB andHalkbankhave qualifiedfinancial management staff, andproject related transactions will be executed as part o ftheir regular work. Therisk associated with stafing is assessed as negligible. Accounting Policies andProcedures The accounting and financial management capacities at both TSKB and Halkbank are satisfactory. They both have qualified personnel, adequate manuals and guidelines to conduct efficient financial management. The accounting and reporting systems at both banks are geared toward producing statements and information as required by Turkish law and regulations. TSKB also has accounting and reporting systems geared toward producing financial statements in accordance with IFRS. Considering that both banks have adequate accounting and reporting systems, the main transactions, (i.e., movements in the special account, credit lines made available to the beneficiary enterprises and uses from these credit lines) will be inTSKB's and Halkbank's main accounting systems. The main accounting system will be supported by a sub-system for project reporting purposes. TSKB has developed a web based application, approval and monitoring system for the loans where it acts as an APEX bank. The system is accessible to the PFIs fiom the web. The PFIs make their initial application as well as their applications for withdrawals from the project loans by usingthe system and are able to monitor the status o f each application on a real time basis from the web. The system has adequate security levels and is fully integrated into the management information system o f the bank. Semi-annual FMRs for the project loans are generatedautomatically by the system; the agreed-upon FMRtemplates for the SME project will also be generated by the system automatically. The system i s very efficient and has contributed to the rapid implementation o f the EFIL I1and EFIL I11projects. The same system will also be usedfor the SME project. TSKBhasamanualthat explains the work flow for EFIL11, andthe same manualwill be usedas a basis for the SME project. TSKB has provided training to EFIL I1PFIs on the use o f the web basedsystem andhas distributedcopies o fthe manual. The same procedureswill be followed for newPFIsinthe SMEproject. Therisk associatedwith accountingpolicies andprocedures in TSKB is assessed as negligible, 66 May 18,2006 Halkbank will be using its own accounting system and accounting department for project accounting purposes. Semi-annual FMRswill beproducedbythe Project EvaluationDepartment through the use o f Excel worksheets, in the format agreed upon with the Bank. The operations manual for the project will include the work flows for the SMEproject. The risk associated with accounting policies and procedures in Halkbank is assessed us negligible. Internal Audit Both Halkbank and TSKB have internal audit departments staffed with qualified audit professionals. Transactions under the loanwill be subject to internal audit as a part o f the banks' credit portfolio audits. InHalkbank, the internal audit department refers to the "General Letter" for the audit of loans grantedfrom foreign funds and ensures that branches are incompliance with the loan covenants set forth inthe General Letter. Inorder to make sure that the necessary documentation for the use o f funds in line with project objectives is made, details of World Bank requirements as to the investment andworking capital loans will be set out inthe General Letter. Therisk associated with internal audit is assessed as negligible. Reporting and Monitoring TSKB and Halkbank will maintainrecords andwill ensure appropriate accounting for the funds provided. The FMRswill bepreparedsemi-annually andwill be submitted to the World Bank no later than 45 days after the end o f the period. The formats o f the FMRs have been agreed upon with bothTSKB andHalkbank. Reporting will include the number of employees o f the sub-borrower, its annual turnover, the province inwhich the sub-borrower i s located, andthe sector to which the borrower belongs. The loans that will be extended to SMEs will be investment and working capital loans. Documentation that is currently received by both banks for the investment and working capital loans from their customers (by the PFIs incase o f TSKB) will be relied upon for the purposes of this project, and this information will be submitted to the World Bank on a summary basis as a part o fthe FMRs. Therisk associated with reporting and monitoring is assessed as negligible. I nformation Systems The main transactions @e., movements of the special account, credit lines made available to the beneficiary enterprises, andwithdrawals from the credit lines) will be inTSKB's and Halkbank's main accounting systems. 67 M a y 18,2006 Details of TSKB's information system are provided in the Accounting Policies and Procedures section above. Halkbank will b e using its own accounting system and accounting department for project accounting purposes. The semi-annual FMRs will be produced by the Project Evaluation Department through the use of Excel worksheets. Therisk associated with information systems is negligiblefor both banks. Strengthsand Weaknesses The significant strengths that provide the basis for reliance on the project financial management system include: (a) hnds will be disbursed throughT S D (which will act as an APEX bank) and Halkbank, which have been selected for their financial strength, their capacity to appraise potential beneficiaries, and their capacity to supervise project implementation, (b) bothbanks are experienced at implementing World Bank projects and projects funded by other international organizations, and (c) funds inthe TSKB portion of the loan will be disbursed through PFIs that will be selected for their financial strength and capacity to appraise and supervise credit lines. The banks will also have a right to ask for audited financial statements o f the beneficiary enterprises ifdeemed necessary. There are no significant weaknesses inthe project. Action Plan It is concluded that the financial management arrangements for the project satisfy the Bank's minimumrequirements and no actionplanisproposed. SupervisionPlan During project implementation, the World Bank will supervise the project's financial management arrangements in two main ways: (i) reviewing the project's semi-annual financial management reports as well as the implementing banks` and project's annual audited financial statements and auditor's management letter; and (ii)during the World Bank's supervision missions, reviewing the project's financial management and disbursement arrangements (including a review of a sample o f SOEs and movements o n the special account) to ensure compliance with the World Bank's minimum requirements. Spot audits will be carried out on lending limits and SME eligibility criteria as outlined inAnnex 4, as well as review of the credit approval process applied for individual loans. As required, a World Bank-accredited Financial Management Specialist will assist inthe supervision process. B. External Audit TSKB and Halkbank will prepare separate project financial statements for the portions o f the project they will implement. 68 May 18,2006 Annual and six-monthly (limited review) audits o f TSKB are undertaken on an International Financial Reporting Standards (IFRS) basis in accordance with International Standards of Auditing (ISA) by a reputed international auditing firm. The current auditors of TSKB are Deloitte and Touche's member firm inTurkey. The last three years' audit reports (inaccordance with IFRS and ISA) were reviewed and all had clean audit opinions. Audit of the SME project financial statements (project balance sheet, sources and uses o f funds and special account statement) will also be included inthe auditors' terms o f reference. TSKB has been engaging the services of international auditors for several years, and the engagement o f an auditor will therefore not be a specific Boardcondition. The PFIs will also submit annual audited accounts to TSKB. It is common practice for the expected PFIs to have their accounts prepared in accordance with International Financial Reporting Standards (IFRS) and audited in accordance with ISA, As the PFIs under the SME project are not known at this stage, the engagement o f auditors for them will not be a specific Boardcondition. Annual and six-monthly (limited review) audits o f Halkbank are undertaken on an International Financial Reporting Standards (IFRS) basis in accordance with International Standards of Auditingby a reputedinternational auditing firm. The current auditors of Halkbank are Deloitte andTouche. 2003 financial statements were audited byErnst&Young. The last three years' audit reports (in accordance with IFRS and ISA) were reviewed. Financial statements for the years- endedDecember 31,2002 and2003 were unqualified, while there was aqualifiedopinion for the year-ended December 31, 2004, the qualification being "the methodology used to calculate the actuarial deficit on the funds acquired with the transfer o f insolvent Pamukbank's pension fund maydiffer from the methodologyrequiredbyrevised IAS 19." Audit ofthe SME project financial statements (project balance sheet, sources and uses of funds and special account statement) will also be includedinthe auditors' terms o freference. Therisk associatedwith external audit is assessed as negligible. C. DisbursementArrangements As mentioned inthe main document and in other sections of this Annex, the proposedloan will be allocated to TSKB for the amount of 100 million and Halkbank for 50 million under separate loan agreements, which will be on-lent to SMEs. A ceiling o f about 30% of the loan amounts can be allocated to the tourism sector. The two tables below include a summary allocation of loanproceeds. 69 May 18,2006 1. Sub-loans and sub-loans leasesto SMEs I I 2. Front endfee I 250y000 I I ~ 3. Premia for caps 0 and collars Total 100,000,000 HALKBANK Total(e) 49,875,000 I 100%of eligible 1.Sub-loans to sub-loans SMEs 2. Front end fee I 125,000 1 I I 3. Premia for caps and collars O I Total I 509000y000 I Special account arrangements-In order to facilitate prompt disbursements for this operation, TSKB and Halkbank will each have one designated (or special) account. The account will be maintained at the institutions themselves under terms and conditions acceptable to the World Bank. The authorized allocation will be established as follows: for TSKB, 20 million and for Halkbank, 10 million. These amounts are based on an estimated implementation period of 4 years. Disbursement methods-Traditional disbursements will be used for TSKB and Halkbank. Traditional disbursements require that, when requesting a disbursement, the borrower submits Form 1903, statements o fexpenditures (SOEs) and summary sheets (samples ofthese documents will be attached to the Operational Manual). Applications for replenishment-Withdrawal applications will be submitted to the World Bank at regular intervals and will be accompanied by detailed statements of expenditures and 70 May 18,2006 reconciled bank statements. Statement o f expenditure procedures will apply regardless of the currency of expenditure for payments against sub-loans that are valued at less than 2.5 million equivalent (which is also the maximum amount of a sub-loan). TSKB and Halkbank will retain supporting documentation in accordance with normal commercial practices on all sub-loans and makethese available for project supervision by World Bankstaff and for external audit purposes. Minimum withdrawal application size-Withdrawal o f loan proceeds will be subject to a minimum application size of 2million equivalent for TSKB and 1million equivalent for Halkbank -10% o f the authorized allocation of the designated account. These limits apply to applications for reimbursements and for replenishment ofthe designatedaccount. Retroactive financing-Provisions have been made to allow for retroactive financing under the project. Up o f 20 million equivalent for TSK_B and 10 million equivalent for Halkbank has been set aside to cover payments made 12 months prior to signing. The sub-loans for which T S D and Halkbank request reimbursement must have been made in accordance with criteria and procedures set forth in the Loan Agreement and Operational Manual including that for Halkbank such loans must have been made on or after July 31St,2005, and for TKSB such loans musthavebeenmade onor after September30th, 2005. Submission of withdrawal applications-To accommodate the special needs o f this project, withdrawal requests in a format to be agreed with the borrower will be submitted to the World Bank's Country Office for action. These requests will be accompanied by form 1903, SOEs and summary sheets. Conversion procedure: The World Bank's loan to TSKB and Halkbank will start as a Euro FixedSpreadLoan(FSL) with the optionto convert into TRY. The loans to bothbankswill start in Euros. Withdrawals can be converted into TRY at any time during the life of the loans, resulting in a local currency obligation for the converted portion o f the loans. To re-denominate part of the loan obligation in TRY, the World Bank Treasury executes, with a market counterpart, a Euro-TRY swap. The World Bank passes to the borrower the terms o f the swap it obtains inits market transaction. Ifthe maturity of the conversion i s shorter than the maturity of the loan, then at the maturity o f the conversion, the borrower will have the option to roll over the conversion (if swap market still exists at that time), or to revert the remaining obligation to the Euros. If the borrower choosesto rollover the conversion, it will not be exposed to currency risk, but there will be interest rate risk because the loan will be converted at market interest rates at that time. Our survey o f the market indicates that, at this point intime, it is possible to execute Euro-TRYswaps for up to 10 years. For conversion of disbursed amounts to TRY, a minimum amount of 3 million equivalent will be required in order for the World Bank Treasury to enter into a swap with the market counterpart to effect the transaction. The Conversion Date (which i s the start of the Conversion Period) will always fall on the Interest Payment Date next following the Execution Date o f the Conversion Request. The FSL Conversion Guidelines will apply when requesting, accepting and effecting conversions on Fixed-Spread Loans. The guidelines are posted on the World Bank Treasury's page at the web address: http://treasury. worldbank.orgiSen/icesiFinancial+ProductslC~ent+Products~ixed+Spread+Loan+( FSL).html. Additional information on the structure of the loan will be includedinthe Operational Manuals of TSKB andHalkbank. 71 May 18,2006 Annex 8: ProcurementArrangements TURKEY: Access to Financefor SMEs A. General The procurement for the proposed project would be carried out in accordance with the World Bank's"Guidelines: Procurementunder IBRD Loansand IDA Credits'' datedMay 2004 and provisionsstipulatedinthe LoanAgreement. The procurementarrangementsare describedbelow. Procurement of Goods: Procurement of goods and related services (installation and maintenance) financed under the proposed project will be according to the World Bank Procurement Guidelines. For contracts below 2.5 million equivalent, established local private sector commercial practices will be followed in accordance with paragraph 3.12 o f the Procurement Guidelines. Care has to be taken o f other relevant factors such as time o f delivery, efficiency and reliability of the goods, availability of maintenance facilities and spare parts thereof, and in case of non-consultant services, o f the quality and competence of the parties renderingthem. Advertising inthe localand international press will not bemandatory. However, International Competitive Bidding (ICB) may be the most appropriate procurement method for the purchase of large single items. The procurement of goods and related services under all ICB contracts will be subject to the World Bank's prior review. Contracts placedby sub-borrowers on their subsidiary or affiliated companies will not be eligible for financing out o f the loan. The procurement o f secondhandgoods is not eligible for financing out o fthe loan. Procurement of Works. Procurement of works financed under the proposed project will be according to the WorldBankProcurement Guidelines. For civil works estimated to cost lessthan 2.5 million equivalent per contract, established localprivate sector commercial practices will be followed inaccordance with paragraph3.12 of the Procurement Guidelines. Contracts placedby sub-borrowers on their subsidiaryor affiliated companies will not be eligible for financing out of the loan. B. Assessment of the Agency's Capacityto ImplementProcurementand PrivateSector ProcurementPracticeinTurkey Procurement Capacity Assessment: In case o f procurement under sub-loans and leases, the Participating Financial Intermediaries (PFIs) and Halkbank branches will be responsible for ensuringthat the procurement rules for sub-loans and leases specified below are followed by the sub-borrowers. TSKB and Halkbank will be responsible for reviewing and monitoring the compliance with the procurement rules by the intermediary banks, regional branches of Halkbank and leasing companies, and their sub-borrowers (beneficiary enterprises). Specialists assigned for the procurement arrangements within the TSKB and Halkbank Project Implementation Units (PIU) will be responsible for all procurement oversight for the managemento f the project. The P N s will keep the records of the procurements handled through the intermediary banks and leasing companies, or Halkbank's branches, respectively. The documents related to the working capital expenditures will be kept by the SMEs, and these documents will be provided to the Bank whenever requested. The World Bank will conduct 72 May 18,2006 regular post reviews o f the sub-projects not requiring a prior review. The PIUs will be responsible for assembling the documentation related to specific procurement transactions from the PFIs, sub-bon-owers andHalkbank branches inorder to facilitate the Bank's reviews. TSKB was responsible for the implementationofthe similar EFIL-IandEFIL-I1projects, andno procurement problem was encounteredinthese projects. The EFIL-I11project was approved by the Bank's Board in FY06. An assessment o f the capacity of TSKB to implement procurement actions for the project was carried out by the procurement specialist on March 22, 2005. The assessment reviewedthe organizational structure for implementing the project andthe interaction among the project staff responsible for the procurement activities. The overall project risk for procurement i s low. Halkbank i s a public Bank and has implemented two World Bank financed loans inthe past: the Second Small and Medium Scale Industry Project (L3067) and the Agro Industry Project (L3077). Halkbank has very wide experience insimilar transactions as the principal objective of its establishment. An assessment of the procurement capacity o fHalkbankwas carried out by the SalihKemalKalyoncu on July 18,2005. The overall risk for procurement i s average. Private Sector Procurement Practice in Turkey: In the Country Procurement Assessment Report dated June 2001, it was determined that there are well established commercial practices for the procurement o f goods, works and services by private sector enterprises, autonomous commercial enterprises and individuals. In case o f goods, the local practice is to prepare the technical specifications and solicit quotations from the local andlor international market, Incase of medium and large works, the technical specifications are usually prepared by consulting companies, andbids are collected from qualifiedcontractors. Minor works are generallytendered on a lump sumbasis by collecting bids from a number o f local contractors. When equipment and machinery is needed for expansion o f existing facilities, the purchasers usually preferproprietary goods from a single source for the sake o f standardization and minimization of operational and maintenance costs. Therefore, local private sector or commercial practices can be considered to be consistent with the World Bank's criteria with respectto economy and efficiency. The general rule inthe sector i s to procure the least cost goods, works and services consistent with minimum qualityrequirements. All SMEsfinanced under this loanshould haveprivateownership. C. Procurement Plan and General Procurement Notice At the appraisal stage or duringthe implementation of the project, it is not possible to estimate either the sub-borrowers or their procurement requirements. Therefore, it i s not possible for the borrower to develop a Procurement Planwhich provides the basis for the procurementmethods. Similarly, since the contract sizes and the methods cannot be estimated, it i s not possible to prepare and publish a General Procurement Notice. It i s expected that each sub-borrower will provide a list ofprocurements planned under the sub-loan. Incase any sub-project includes ICB, a specialprocurement notice will bepublishedinaccordance with the Procurement Guidelines. 73 May 18,2006 D. Frequency of Procurement Supervision andReview Procedures The Bank will review the procurement arrangements proposedperformed by TSKB and Halkbank inevery year, including contract packaging, applicable procedures, and the scheduling o f the procurement processes, for their conformity with Bank Procurement Guidelines and the proposedimplementation program anddisbursement schedule. (a) Prior Review: The following procurement action and documentation would be subject to Prior Review by the Bank in accordancewith the procedures set forth inparagraphs 2 and 3 o f Appendix 1to the Procurement Guidelines. For Contracts awarded through ICB: prior review o f all Bidding Documents, Bid Evaluation Reports, Recommendations o f Contract Award and drafi Contracts will be conducted. For Contracts awarded through Commercial Practices: prior review of first two contracts will be conducted for TSKB and Halkbank. (b) Post Review: The procurement documents for all other contracts shall be subject to the Bank's post review inaccordancewith the procedures set forth inparagraph 5 ofAppendix 1to the Procurement Guidelines on a random basis, one in five contracts. Post review o f the procurement documents will normally be undertaken during the annual Bank supervision missionor as the Bank may request to review any particular contracts at any time. Insuch cases, TSKB and Halkbank shall providethe Bank with the relevant documentation for its review. The post review shall be conducted bythe Bank's Procurement Specialist. Table 8.1: Thresholds for procurement methods andprior review (inEuro million) ExpenditureCategory Procurement Method Thresholds I C B Commercial Practice 1. Sub-loans and leases Goods No threshold (Apply 12.5 when needed) Works 12.5 Prior Review All contracts Firsttwo contracts from Halkbank and fust two contracts from TSKB 74 May 18,2006 Annex 9: EconomicandFinancialAnalysis TURKEY:Accessto Financefor SMEs NA 75 May 18,2006 Annex 10: SafeguardPolicyIssues TURKEY:Access to Financefor SMEs EnvironmentalAssessment, OPlBPlGP4.01 Inaccordance with World Bank safeguard policy OPIBPIGP4.01(Environmental Assessment), the project has been assigned Category "FI". Under this assignment, TSKB and Halkbank each preparedanEnvironmentalAssessment Framework document acceptable to the World Bankthat defines environmental assessment procedures to be used in sub-project evaluation. These Framework documents will be included as separate chapters inthe banks' respective Operations Manuals. Both TSKB and Halkbank wish to include the possibility o f sub-projects that may, by Turkish environmental regulations, require an Environmental Impact Assessment Report. The proceduresdefined for eachbank are consistent with both Government o f Turkey Environmental Assessment requirements and World Bank Environmental Assessment policies and procedures utilizedinprevious Financial Intermediary operations inTurkey. Both Framework documents identify institutional responsibilities for each o f the following elements: Sub-proiect Loan Preparation 0 0 Environmental assessment documentation 0 Public consultation (TSKBhIalkbank: EIArequired) 0 Review andapproval 0 Disclosure (TSKBiHalkbank: EIArequired) 0 Loan conditionality Sub-uroiect Implementation 0 Arrangements for environmentalmanagement (mitigation andmonitoring) 0 Reporting A briefdescription o farrangementsto beutilizedis presentedbelow: For sub-projects that do not require anEIA, the PFIs inthe case of TSKB (Halkbank branchesin the case o f Halkbank), in cooperation with the sub-project sponsor, will prepare an environmental screening form to define the environmental issues associated with the sub-project and how they will be mitigated and monitored. The sub-borrower will also be responsible for 52 Specific projects identified inTurkishenvironmental assessmentregulations (Regulations on Environmental Impact Assessment, Official Gazette, dated 16December 2003, Number 25318 from the Ministryof Environment and Forests-MoEF) Annex Irequire an EIA, and those identified inAnnex I1require information (Project IntroductionFile). For Annex I1projects, after further evaluation by MoEF, there is a decision that either an EIA is requiredor no further environmental documentation is necessary. Projects not identifiedineither Annex Ior 11require no environmental documentation. The Annex Ilist is consistent with World Bank classifications of "Category A" projects, and the Annex I1list is consistent with World Bank screening procedures ("Category A" or "Category B , depending on specific project circumstances). 76 May 18,2006 ensuring that all Government environmental approvals, permits and licenses are secured.53 Demonstration of this due diligence would be provided to the PFIs (Halkbank branches) who will review this information as an element of their sub-project appraisal process. TSKB (Halkbank) andlor the World Bank will monitor PFIs' (Halkbank branches') performance in implementing these procedures and, if appropriate, examine selected sub-projects at their discretion. For sub-projects that do require an EIA, the sub-project sponsor would be requiredto submit to the PFIs (Halkbank branches): (a) the MoEF EIA approval statement (Environmental Impact Assessment Positive Decision), (b) the MoEF approved EIA together with an Addendum that would include any supplemental information required by World Bank for "Category A" EIA projects. The EIA and "World Bank Addendum" would be reviewed and approved by the World Bank, and disclosed in Turkey (Turkish language version) and the World Bank InfoShop (English language version). The PFIs ~~alkbanbranches) would not be permitted to continue k processing the sub-project until World Bank approval of the EIA and Addendum is oHered and disclosure in Turkey and the World Bank Infoshop has been completed. The World Bank will have the authority to review and post review all sub-projects. The review of evaluations will ensure that: screening was performed consistently and accurately, the work was o f satisfactory quality, recommendations specified by the granting of the approvals were followed, all documentation was properly filed and recorded, and the conditions o f approval bythe Provincial Directorate of MoEFor any other Government institutions and postreview were met. Duringthe project implementation, World Bank missions will supervise the overall screening process and implementation of environmental recommendations for the selected enterprise. The World Bank supervision team will also review, ad hoc, environmental documentation. 53 Sub-projects involving working capital (purchase o f materials) andlor purchase o f equipmendmachinery are not subject to Turkishor World Bank EIA requirements. The sub-project sponsor must demonstrate that any hazardous materials or riskyequipment (as defined by Turkishregulations) purchased has all necessary Government documentation for environment and worker health and safety. 77 May 18,2006 Annex 11: ProjectPreparationandSupervision TURKEY:Access to Financefor SMEs Planned Actual PCNreview 0412012005 0412012005 Initial PID to PIC 0412512005 Initial ISDS to PIC 04/25/2005 Appraisal 03/05/2006 04/06/2006 Negotiations 04/25/2006 04/25/2006 BoardlRVP approval 06/08/2006 Planned date of effectiveness for Halkbank 713012006 Planned date o f effectiveness for TSKB 11/1/2006 Planned date o fmid-termreview 0612012008 Plannedclosing date 0812012010 Keyinstitutions responsible for preparation ofthe project: Halkbank, TSKB, The Turkish Treasury (guarantor). Bank staff and consultantswho worked on the project included: Name Title Unit HalilAgah Senior Rural Development Specialist, Environmental Advisor ECSSD AndrinaAmbrose Senior Finance Officer LOAGl Seda Aroymak Sr. Financial Management Specialist ECSPF Dilek Barlas Sr. Legal Counsel LEGEC Furuzan Bilk Operations Officer, Disbursement Specialist ECCU6 SteenByskov Consultant, Financial Economist ECSPF Marie-Helene Bricknell Country Manager ECCU6 Rodrigo Chaves Lead Economist ECSPR Roy Gooi Principal Financial Officer BCFAL Salih Kalyoncu Procurement Specialist ECSPS Selma Karaman ProgramAssistant ECCU6 Hala Khattar Sr. Financial Officer BCFBD Aarre Laakso Consultant, Editor ECSPF Weenarin Lulitanonda Young Professional BCFBD Zeynep Lalik Mete Consultant, FinancialManagement Specialist ECSPF Marialisa Motta Sr. Private Sector Development Specialist, Task Team Leader ECSPF Jaap van Opstal LeadCounselor LEGFI GurhanOzdora Sr. Operations Officer ECSPF Susana Sanchez Sr. Financial Economist LCSFF Carlo Segni Consultant, FinancialSpecialist ECSPF Hannah Thomas ProgramAssistant ECSPF StevenWeisbrod Consultant, FinancialAdvisor LCSFF 78 May 18,2006 Annex 12: Documents inthe Project File TURKEY: Accessto Financefor SMEs Commissionofthe EuropeanCommunities, 2004. "Working Paper SEC," Commissionofthe EuropeanCommunities, 2004. "Regular Report on Turkey's Progress towards Accession." InternationalMonetaryFund. 2005, "Turkey Article N Consultation." OECD, 2004 ``Economic SurveyofTurkey," Paris. Turkish MinistryofEnvironmentandForests.December 16,2003. "Regulations on EnvironmentalImpactAssessment, Official Gazette" Number25318. Turkish Treasury, 2004. "List of Credit Lines" (Internal Document). Turkish StatePlanningOrganization(SPO), November 2004. "Pre-Accession Economic Program." Turkish State PlanningOrganization(SPO), 2003. "Preliminary NationalDevelopmentPlan" (2004-2006). Turkish StatePlanningOrganization(SPO), 2004. "SME StrategyandAction Plan." World Bank,January 2005. "Aide Memoireofthe December Identification Mission for the SME Project andrelatedcommentsfrom the Treasury." World Bank, May2005. "Aide Memoireofthe June Pre-appraisalMission for the SME Project." World Bank, SoledadMartinez Peria, June 2005. "Financial Sector Depthand Outreachacross Turkey." World Bank, InternationalFinance Corporation, 2004. "SME Strategy." World Bank, Motta, M.andByskov, S., April 2005. (Internal Document) "Private Sector Development inTurkey", backgroundnotepreparedfor the World Bank meeting with the ForeignAdvisory Council. World Bank, Verghis, M., 2006. "Turkey: Labor Market Study." 79 May 18,2006 Annex 13: StatementofLoansandCredits TURKEY: Access to Financefor SMEs Differencebetween expected andactual Original Amount in US$Millions disbursements ProjectID FY Purpose IBRD IDA SF GEF Cancel. Undisb. Orig. Frm. Rev'd PO66149 2005 SEC EDUC 104.00 0.00 0.00 0.00 0.00 96.49 0.00 0.00 PO77328 2005 RAILRESTRUCT 184.70 0.00 0.00 0.00 0.00 173.32 0.00 0.00 PO78359 2005 SEISMIC RISK MITIGATION 400.00 0.00 0.00 0.00 0.00 373.91 0.00 0.00 PO81880 2005 MUNICIPAL SERVICES 275.00 0.00 0.00 0.00 . 0.00 256.79 0.00 0.00 PO93568 2005 EFIL 3 (CRL) 305.00 0.00 0.00 0.00 0.00 298.04 0.00 0.00 PO94167 2005 PSSP 2 465.40 0.00 0.00 0.00 0.00 434.2 1 0.00 0.00 PO94176 2005 ECSEEAPL #2 (TURKEY) (CRL) 66.00 0.00 0.00 0.00 0.00 61.03 0.00 0.00 PO82801 2004 EFIL2 303.10 0.00 0.00 0.00 0.00 75.00 -155.10 0.00 PO82996 2004 PFPSAL 3 1,000.00 0.00 0.00 0.00 0.00 500.00 0.00 0.00 PO75094 2004 WATERSHED REHAB (GEF) 0.00 0.00 0.00 7.00 0.00 6.75 0.25 0.00 PO74053 2004 HEALTH TRANSIT (APL #1) 60.61 0.00 0.00 0.00 0.30 56.34 7.22 0.00 PO70950 2004 ANATOLIA WATERSHED REHAB 20.00 0.00 0.00 0.00 0.10 19.55 0.15 0.00 PO72480 2004 RENEW ENERGY 202.03 0.00 0.00 0.00 1.01 196.33 7.31 0.00 PO59872 2003 BASIC ED 2 (APL #2) 300.00 0.00 0.00 0.00 0.00 291.46 283.05 80.46 PO74408 2002 SRMP 500.00 0.00 0.00 0.00 0.00 223.31 187.94 -13.89 PO70286 2002 ARIP 600.00 0.00 0.00 0.00 0.00 268.71 268.71 66.01 PO69894 2001 PRIV SOC SUPPRT 250.00 0.00 0.00 0.00 0.00 7.21 7.21 -28.79 PO68368 2000 MARMARA EARTHQUAKEEMG 505.00 0.00 0.00 0.00 0.00 281.59 281.59 37.37 RECON PO44175 2000 BIODIVINTRL RES MGMT (GEF) 0.00 0.00 0.00 8.19 0.00 4.12 3.52 0.18 PO09073 1999 INDUSTRIAL TECH 155.00 0.00 0.00 0.00 0.00 13.37 13.37 0.00 PO48852 1998 NAT'L TRNSM GRID 270.00 0.00 0.00 0.00 34.48 116.60 151.08 78.76 Total: 5,965.84 0.00 0.00 15.19 35.89 3,754.13 1,056.30 220.10 TURKEY STATEMENT OF IFC's Held andDisbursedPortfolio InMillionsofUSDollars Committed Disbursed IFC IFC FY Approval Company Loan Equity Quasi Partic. Loan Equity Quasi Partic. 2005 Acibadem 20.00 0.00 0.00 0.00 10.00 0.00 0.00 0.00 Altematif Bank 0.50 0.00 0.00 0.00 0.50 0.00 0.00 0.00 1996/01103105 Arcelik 103.36 0.00 0.00 103.36 103.36 0.00 0.00 103.36 2000 Arcelik LG Klima 8.29 0.00 0.00 0.00 8.29 0.00 0.00 0.00 2002 Assan 22.50 0.00 0.00 0.00 22.50 0.00 0.00 0.00 2002 Atilim 6.50 0.00 0.00 0.00 6.50 0.00 0.00 0.00 2000 Banvit 8.33 5.00 0.00 0.00 8.33 5.00 0.00 0.00 May 18,2006 BayindirbankA S 1S O 0.00 0.00 0.00 1.so 0.00 0.00 0.00 2002 Beko 32.75 0.00 0.00 28.07 32.75 0.00 0.00 28.07 2001 Bilgi 8.00 0.00 0.00 0.00 8.00 0.00 0.00 0.00 1994196197 Borcelik 8.18 3.21 0.00 0.00 8.18 3.21 0.00 0.00 2004 BorusanHolding 30.00 0.00 10.00 0.00 30.00 0.00 10.00 0.00 1994 CBS Holding 3.50 0.00 0.00 0.00 3.50 0.00 0.00 0.00 1990102 Conrad 3.15 0.00 0.00 0.00 3.15 0.00 0.00 0.00 2002 EKS 10.96 0.00 0.00 0.00 10.96 0.00 0.00 0.00 2004 Ege 10.00 0.00 0.00 8.00 10.00 0.00 0.00 8.00 1995 Entek 19.00 0.00 0.00 9.94 19.00 0.00 0.00 9.94 1999 Finansbank 2.22 0.00 0.00 0.00 2.22 0.00 0.00 0.00 2004 Garanti Leasing 10.00 0.00 0.00 0.00 10.00 0.00 0.00 0.00 1999 GumussuyuKap 4.00 0.00 3.66 0.00 4.00 0.00 3.66 0.00 2001 Gunkol 4.53 0.00 0.31 0.00 4.53 0.00 0.31 0.00 1998 IndoramaIplik 4.38 0.00 0.00 0.00 4.38 0.00 0.00 0.00 2005 Intercity 15.00 5.00 0.00 27.75 4.44 5.00 0.00 8.21 1998100102 Ipek Paper 10.85 0.00 0.00 0.00 10.85 0.00 0.00 0.00 1990 KepezElekhik 2.43 0.00 0.00 0.00 2.43 0.00 0.00 0.00 1988190 Kirk 11.33 0.00 0.00 0.00 11.33 0.00 0.00 0.00 2004 Koclease 30.00 0.00 0.00 0.00 30.00 0.00 0.00 0.00 1991 Kula 5.20 0.00 0.00 0.00 5.20 0.00 0.00 0.00 2003 MESAGroup 11.00 0.00 0.00 0.00 11.00 0.00 0.00 0.00 2004 MeteksanSistem 0.00 0.00 8.50 0.00 0.00 0.00 8.50 0.00 2002 MilliRe 50.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1998102 ModemKarton 8.33 0.00 0.00 0.00 8.33 0.00 0.00 0.00 1991 NASCO 10.18 0.00 0.00 3.55 10.18 0.00 0.00 3.55 2004 OPET 25.00 0.00 0.00 40.00 8.33 0.00 0.00 25.00 2004 Oyak Bank 50.00 0.00 0.00 0.00 50.00 0.00 0.00 0.00 2002 Pasabahce 3.75 0.00 0.00 0.00 3.75 0.00 0.00 0.00 1998 Pinar ET 3.14 0.00 0.00 0.00 3.14 0.00 0.00 0.00 2000 Pinar SUT 11.45 0.00 0.00 0.00 7.77 0.00 0.00 0.00 1999 SAKoSa 9.91 0.00 6.61 6.64 9.91 0.00 6.61 6.64 1990 Silkar Turizm 1.89 0.00 0.00 2.15 1.89 0.00 0.00 2.15 2002103 Sise ve Cam 43.93 0.00 18.18 36.56 43.93 0.00 18.18 36.56 2002 Soktas 2.00 0.00 0.00 0.00 2.00 0.00 0.00 0.00 2005 TSKB 0.00 0.00 50.00 0.00 0.00 0.00 50.00 0.00 1982183189191196199 Trakya Cam 0.00 0.36 0.00 0.00 0.00 0.36 0.00 0.00 2002 Turk EkonBank 11.11 0.00 15.00 0.00 11.11 0.00 15.00 0.00 2001 TurkishPEF 0.00 9.59 0.00 0.00 0.00 2.17 0.00 0.00 1999 UnyeCement 8.22 0.00 0.00 0.00 8.22 0.00 0.00 0.00 1999 Uzel 8.40 0.00 0.00 4.95 8.40 0.00 0.00 4.95 1998 Viking 7.62 0.00 0.00 0.00 7.62 0.00 0.00 0.00 Totalportfolio: 662.39 23.16 112.26 270.97 571.48 15.74 112.26 236.43 81 May 18,2006 Approvals PendingCommitment FY Approval Company Loan Equity Quasi Partic. 2001 Akbank 0.03 0.00 0.00 0.00 2004 Akbank BLoan Inc 0.00 0.00 0.00 0.02 2005 Avea 0.12 0.00 0.00 0.30 2005 Bandirma Dogalga 0.00 0.00 0.00 0.00 2005 Gemlik Dogalgaz 0.00 0.00 0.00 0.00 2002 MilliReasurans 0.00 0.01 0.00 0.00 2005 PALEN 0.00 0.00 0.00 0.00 2005 Palgaz 0.01 0.00 0.00 0.00 2005 Sivas Dogalgaz 0.00 0.00 0.00 0.00 2002 TEB I11 0.00 0.00 0.00 0.05 2005 YUCE 0.00 0.00 0.00 0.00 Totalpendingcommitment: 0.16 0.01 0.00 0.37 82 May 18,2006 Annex 14: Country at a Glance TUFNEY: Access to Financefor SMEs Europe 8 Lower- POVERTY and SOCIAL Central middle- Turkey Asia income Development diamond* 2003 Population, mid-year(millions) 70.7 473 2,655 Lffeexpectancy GNIpercapita (Atlas method, US$) 2,aoo 2,570 1480 GNI(Atlas method, US$ billions) 87.8 121 3,934 - Average annual growth, 1997-03 Population (%) 17 0.0 0.9 Laborforce (%) 2.3 0.2 12 GNI Gmss M o s t recent estimate (latest year available, 1997-03) per primary capita enrollment Poverty(%of population belownationalPOvertyline) Urbanpopulation(%oftotalpopulation) 66 63 50 Life expectancyat birth (years) 70 69 69 - Infantmortality(per ?,OOOlive births) 35 31 32 Childmalnutrition (%ofchildrenunder5) a n Access to improvedwater source Access to an improvedwater source (%ofpopulation) a2 91 a1 Hliteracy(% of population age 69 14 3 8 Gross primaryenrollment 94 8 3 it? -Turkey Male 98 8 4 113 ___ Lower-middle-incomegroup Female 91 8 2 in KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1983 1993 2002 2003 I GDP (US$ billions) 615 l79.4 183.9 240.4 Economic ratios* Gross domestic investmentlGDP 15.3 27.6 213 22.8 Exports of goods and serviceslGDP P.5 13.7 29.2 274 Trade Gross domestic savingslGDP P2 219 8.8 8.5 Gross national savingslGDP 8.3 24.8 20.8 8.5 Currentaccount balancelGDP -3.1 -3.6 -0.8 -2.8 Domestic InterestpaymentslGDP 2.9 2.2 3.8 3.2 savings TotaldebtlGDP 33.0 38.2 713 6t2 Total debt servicelexports 39.2 316 50.7 40.3 Present value of debtlGDP 73.1 Present value of debtlexports 234.2 Indebtedness 1983-93 1993-03 2002 2003 2003-07 (average annualgrowth) GDP 5.0 2.7 7.9 5.8 5.6 -Turkey GDP oer caDita * . 2.8 0.9 6.2 4.2 4.1 - i o wr-middle-income or0uo 7 . - . . . STRUCTURE o f the ECONOMY I 1983 1993 2002 2003 Growth of investment and GDP (X) (%ofGDP) Agriculture 214 15.2 13.0 13.4 50 Industry 25.0 29.8 23.7 219 Manufacturing 15.8 18.3 14.0 13.3 Services 53.6 54.0 63.3 64.7 Privateconsumption 78.4 65.0 66.2 66.9 Generalgovernment consumption 9.4 13.0 14.0 13.6 Imports of goods andservices 6.6 8.3 30.7 30.7 -GDI +GDP I 1983-93 1993-03 2002 2003 ________ Growth of exports and Imports (%) (averageannualgrowth) Agriculture 25 10 7.4 -2.4 40- Industry 6.7 2.2 5.6 5.O Manufacturing 6.9 3.0 8.2 8.4 Services 4.3 3.0 7.3 6.4 Privateconsumption 4.7 19 2.2 6.7 Generalgovernment consumption 4.O 3.9 5.4 -2.4 -40- Gross domestic investment 7.7 10 35.9 20.4 -Expolls -o-lnports Imports of goods andservices 114 7.8 5.8 27.1 - - ~~ 83 May 18,2006 Turkev ~ PRICES and GOVERNMENT FINANCE 1983 1993 2002 2003 Inflation (X) Domestic prices 1 (77 change) Consumer prices 314 66.4 44.8 252 bnplicit GDP deflator 263 67.8 44.1 22.5 Government finance 25 - (%of GDP, includescurrent grants) Current revenue 8.0 3t2 30A 98 99 00 01 02 03 Current budgetbalance -3.1 -5.1 -5.3 Overallsumlusldeficit - E O -129 -6.1 -GDPdeflaor -CFI I TRADE 1983 1993 2002 2003 (US$ millions) Export and import levels (US$ mill.) Totalexports (fob) 5,905 15,345 40.t24 51206 80.000 - Agricultural and livestock 1032 1044 2,089 2,545 II Miningandquarryproducts 8 8 233 387 543 Manufactures 4,685 44,068 33,565 43,9P Total imports (cif) 9235 29,428 51554 69,340 Food P 3 969 2245 2,006 Fueland energy 3,851 3,903 9,82 ll.568 I Capital goods 2 9 n 7,499 9,n3 ll.792 Exportpriceindex(S95=%JO) 89 92 75 82 97 98 99 00 01 Import priceindex(S95=00) uo 85 73 83 EXPOrtS rn InportsO2 O3 Terms of trade (S95=%JO) 89 TI9 102 99 BALANCE of PAYMENTS I 1983 1993 2002 2003 Current account balance t o GDP (X) (US$ millions) Exports of goods and services 7,865 26,264 54,907 70331 Imports of goods and Services u,is 33,721 55,365 73,760 Resource balance -2253 -7,457 -458 -3,529 Net income -1430 -2,744 -4,554 -5,427 Net currenttransfers 1760 3,768 3,490 2,TI6 Currentaccount beiance -2923 -6,433 -1522 -6,850 Financingitems (net) 2,075 6,741 7,675 6,897 Changes innetreserves -252 -308 -6,153 -4,047 Memo: Reserves includinggold (US$ mi//iOflS) 2,253 V,762 38,051 44,957 Conversion rate (DEC,/ocaVUS$) 226.0 11046.7 1509,471 2496,668 EXTERNAL DEBT and RESOURCE FLOWS 1983 1993 2002 2003 (US$ millions) Composition o f 2003 debt (US$ mill.: Total debtoutstanding and disbursed 20,324 68,605 132058 447,035 iBRD 2,336 5,285 5,367 5214 A:5244 IDA 8 4 I42 89 83 B:a3 Total debtservice 3x58 a,664 29,092 29,V2 IBRD 274 183 708 728 IDA 4 7 7 7 Composition of net resoumeflows Officialgrants 98 403 Officialcreditors 327 -740 224 -22V Private creditors 139 6,64 6,901 -5n Foreigndirectinvestment 48 622 863 1063 Portfolio equity 0 8 9 -1183 2,250 F World Bank program 86,624 Commitments 675 207 1650 0 A IBRD E Bilatetal ~ Disbursements 486 354 1031 276 -- D -Other mltilaterai ~ 8 IDA F PriMte ~ Principalrepayments 125 753 443 502 I C - I M F G- Shart-tm 84 May 18,2006 Annex 15: Maps TUFWEY: Access to Financefor SMEs 85 TURKEY PROVINCE CAPITALS* NATIONAL CAPITAL RIVERS TURKEY MAIN ROADS Prut RAILROADS PROVINCE BOUNDARIES* This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other information INTERNATIONAL BOUNDARIES shown on this map do not imply, on the part of The World Bank Group, any judgment on the legal status of any territory, or any endorsement or acceptance of such boundaries. *Province names are the same as their capitals. 26°E 28°E 30°E 32°E 34°E 36°E 38°E RUSSIAN FEDERATION BULGARIA Black Sea 0 50 100 150 200 Kilometers To To To To 42°N Burgas Kurdzhali 0 50 100 150 Miles GEORGIA 42°N Edirne Sinop Kirklareli To To Bartin E Bosporus Batumi Zonguldak GREECKomatini Tekirdag Istanbul Kastamonou Kuzey Samsun Artvin Kura To To To Karabük Karabük Ardahan Sea of Kocaeli A nadolu Ordu Trabzon Kirovakan AZER- Dardanelles (Izmit) Düzce Düzce Marmara Devrez Rize Yalova D a g l a r i BAIJAN Sakarya Giresun Bolu Kars (Adapazari) Çankiri Çankiri Kizil Amasya Çorum Çorum Çoruh ARMENIA 40°N ¸ Çanakkale Çanakkale 40°N Bursa Bilecik Kelkit Gümüshane Gümüshane Tokat Bayburt Mt. Ararat Sakarya Aras (5166 m) Balikesir Eskisehir ANKARA Cekerek Igdir Erzurum Agri Kirikkale Erzincan Yozgat Sivas Kütahya Kütahya Firat To To AZER. Kizil Maku Kirsehir Tunceli Afyon Bingöl Bingöl Manisa Mus Izmir Lake ISLAMIC Usak TTuz uz To To Elazig Murat Van Van Van Aksehir Gölü Gölü Nevsehir Salmas Kayseri REP. OF 38°N Gölü Gölü Bitlis Aksaray Aydin Malatya Hoyran IRAN Gölü Gölü Diyarbakir Siirt Denizli Nigde Batman To To Baysehir Adiyaman Burdur Oroumieh IspartaG Gölü ölü Konya Kahraman Tigris Hakkari GREECE Mugla Seyhan Ceyhan Maras Sirnak Euphrates Mardin To To Osmaniye Gaziantep Sanliurfa To Damir Dahuk Antalya GöksuKaraman Kabu Adana To To Al Hasakah Gulf of Icel Kilis JANUAR Antalya IRAQ IBRD 36°N Toros Daglari (Mersin) To To Hatay (Antakya) Aleppo SYRIAN ARAB 33501 Y Mediterranean Sea 2005 28°E 30°E 32°E 34°E REPUBLIC To Ladhiqiyah 42°E 44°E