Report No. PID9540 Project Name Jamaica-Bank Restructuring and Debt (@) Management Program Adjustment Loan Region Latin America and the Caribbean Sector Finance Project ID JMPE71112 Borrower Jamaica Implementing Agencies Ministry of Finance & Planning (MOF) Ms. Shirley Tyndall Financial Secretary 30 National Heroes Circle Kingston 4, Jamaica, W.I. Date this PID Prepared October 19, 2000 Project Appraisal Date September 14, 2000 Project Board Date November 30, 2000 Country and Sector Background The financial sector in Jamaica suffered a severe shock in the mid-1990s largely due to the spread of a wide variety and number of financial institutions that operated under weak regulation and supervision. In order to avoid a systemic crisis the Government provided extensive assistance to troubled financial institutions in the form of bonds issued by a newly established public sector entity The Financial Sector Adjustment Company Limited (FINSAC). Interest on these bonds was capitalized in the form of fresh bonds and little cash interest was paid. While the Government's action achieved its objective and stabilized and re-capitalized the financial sector, it created two major problems. First, it has generated a large stock of public sector liabilities (FINSAC debt) which continues to grow because of capitalization of interest. As of June 30, 2000 FINSAC debt is estimated to be over 40 percent of GDP. Combined with an already high pre-crisis public debt level of over 100 percent of GDP, FINSAC debt has contributed to the creation of severe adverse public debt dynamics. Second, since FINSAC bonds make up a substantial portion of the assets of intervened financial institutions and the bonds do not pay cash interest, these institutions have become extremely illiquid with little capacity to undertake financial intermediation. Since the beginning of the crisis, Jamaica has experienced negative or zero economic growth and credit to the private sector as a percentage of GDP has been decreasing. An essential element in re-starting economic growth in Jamaica and thereby creating the environment for sustainable poverty reduction is a resolution of the financial sector crisis and reversal of the adverse debt dynamics. The Government has recently committed itself to a program of macroeconomic stability and financial resolution of the crisis, which is being monitored by the staff of the International Monetary Fund. This program is intended to enable Jamaica to get back on to a sustainable growth path and gradually reduce the high level of public debt. This Government's Bank Restructuring and Debt Management Program (BRDP) includes the following key elements: Re-capitalization and resolution of financial institutions by FINSAC of the financial institutions that have received assistance from the Government. FINSAC has closed, merged, restructured, and sold several financial institutions that were intervened. FINSAC still owns substantial equity in two large banks and one large insurance company and it is making efforts to bring these institutions to resolution. FINSAC is also actively disposing of a large portfolio of non-core assets such as real estate, commercial and residential property, and art work that came into its possession as a result of the intervention process. It is also developing a strategy to dispose the large portfolio of non-performing loans that it acquired from distressed financial institutions. Improvements in the supervisory and regulatory framework including strengthening the powers of the Bank of Jamaica, improving coordination between various supervisory agencies, and forming an integrated regulatory agency for insurance, securities, and pensions. The Government has also introduced: changes to the definition of regulatory capital in line with international norms; tighter guidelines on asset classification and provisioning; improvements in the enforcement of regulations by the Bank of Jamaica; improvements in effectiveness of powers of intervention; and revised norms for disclosure and audit. Restructuring and management of the government's public debt arising from the resolution of the financial crisis including write-off and off-set of FINSAC debt held by other public sector entities such as the MOF and the Bank of Jamaica; utilizing proceeds from asset disposal to bring down the stock of debt; restructuring the debt by using longer maturity and cheaper multilateral debt to replace shorter maturity and more expensive domestic debt; taking steps to arrest the growth of FINSAC debt by undertaking to service all outstanding FINSAC debt (after the steps identified above) in cash out of fiscal resources from April 1, 2001 onwards. Loan objectives, description, and financing The Bank loan would support the Government's Bank Restructuring and Debt Management Program described above. Bank funds would help finance part of the Government's debt-servicing needs arising from the implementation of its bank resolution program, complementing other sources of funds available such as fiscal resources and proceeds from asset disposal/recovery. The proposed operation would be the first of a series of two loans in support of the Government's BRDP for a total amount of US$150 million. The proposed loan will be for US$75 million, to be disbursed in full in a single tranche, upon effectiveness. Program implementation The Ministry of Finance and Planning (MOF) is the implementing agency for the operation. FINSAC will be closely involved with the MOF in the implementation of the actions supported by this operation. Program sustainability The actions being supported under the proposed loan are intended to ensure the sustainability of the financial sector in Jamaica. Resolution of the financial sector crisis is essential if the Jamaican economy is to achieve sustained economic growth in the future. The resolution transactions to be supported by this operation are expected to create stronger institutions with greater liquidity that will be able to operate and expand credit availability in the Jamaican market. Lessons learned from past operations in the country/sector The operation has been designed to take into account the lessons learned from the Bank's past experience in Jamaica and in other countries in the region. - 2- It is being structured taking into account the capacity of the Government to take actions on various issues. The operation is based on strong borrower ownership that is necessary in complicated, time-intensive banking sector operations. Loan disbursements are being restricted to specific policy actions and transactions that are part of the Government's overall reform strategy. Poverty category The proposed loan would have little social impact in the short-run. In the longer run, however, the measures supported by this operation would have important social implications as they would assist in the creation of an environment conducive to the resumption of prudent lending to the private sector, with the associated benefits in terms of output growth and employment generation. The ultimate objective of the restructuring/resolution process supported by the proposed operation is a better functioning financial sector, able to withstand external shocks and better able to lend to the private sector. Given the extremely low level of new lending in Jamaica as a result of the financial crisis, it is hoped that new lending would spur economic growth and thereby create more job opportunities. A banking system less vulnerable to crises will be better able to sustain growth and, therefore, improve the welfare of the poor, who tend to be severely affected by generalized banking system dislocations. Environmental aspects The bank restructuring and debt management program to be supported by the proposed loan is not expected to have any environmental impact. For that reason, it has been placed in Category "C", in accordance with the Bank's Operational Policy on Environmental Assessment (OP 4.01). Program Objective Category. The Program Objective Category is Economic Management (EA). Contact Points: Task Manager P.S. Srinivas The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 473-8939 Fax: (202)522-2106 The InfoShop The World Bank 1818 H Street NW Washington , D.C. 20433 Telephone: (202) 458-5454 Fax: (202) 522-1500 This PID was processed by the InfoShop during the week ending October 20, 2000. -3-