1 N T E R N A T ~ O N A LB A N K FOR R E C O N S T R U C T I O N A N D DEVELOPMENT MANAGEMENT'S DISCUSSION AND ANALYSIS J U N E 30, 2 0 0 5 Section 1: Overview 3 Section 2: Basis of Reporting 5 Section 3: Development Activities 10 Loans 10 Guarantees 15 Other Activities 16 Section 4: Liquidity Management 16 Section 5: Funding Resources 18 Equity 18 Borrowings 21 Section 6: Financial Risk Management 22 GovernanceStructure 22 Managing Risk-Bearing Capacity 24 Credit Risk 25 Market Risk 28 Liquidity Risk 30 Operational Risk 30 Section7: Critical AccountingPolicies 32 Section 8: Results of Operations 33 Section 9: Governance 36 Section 10: Reconciliation of Prior Year Current Value FinancialStatements to Reported Basis 39 Glossary of Terms 41 Throughout Management's Discussion and Analysis, terms in boldface type are defined in the Glossaryof Terms on page 41. The Management Discussion and Analysis contains forward looking statements which may be identified by such terms as "anticipates","believes","expects'', "intends" or words of similar meaning. Such state- ments involve a number of assumptions and estimates that are based on current expectations, which are subject to risks and uncertainties beyond IBRD's control. Consequently, actual future results could differ materially from those currently anticipated. 1. OVERVIEW FY 2005 operating income was $1,320 million, $376 million lower than that for FY 2004, thereby The International Bank for Reconstruction and decreasing IBRD'sreturn on equity and net return Development (IBRD) is an international on average earning assets before the effects of "net organization established in 1945 and is owned by its unrealized gains (losses)on non-trading member countries. IBRD's main goals are promoting (borrowings related) derivative instruments, as sustainable economic development and reducing required by FAS 133 and IAS 39"". poverty.It pursues these goalsprimarily by providing loans, guarantees and related technical assistance for During FY 2005, provisioning requirements for projects and programs in its developing member probable losses on loans and guarantees were countries. IBRD's ability to intermediate funds from reduced by $502 million primarily due to a net international capital markets for lending to its improvement in borrowers' risk ratings, and other developing member countries is an important factors, including the reduction in the volume of the element in achieving its development goals. IBRD's loans portfolio. financial objectiveis not to maximize profit, but to In the context of assessing changes in IBRD's earn adequate net income to ensure its financial operating environment, it is management's practice strength and to sustain its development activities. to recommend each year the allocation of net income Box 1 presents selected financial data for the last five to augment reserves, waivers of loan charges to fiscal years. benefit eligibleborrowers, and allocation of net The financial strength of IBRD is based on the income to support developmental activities. support it receives from its shareholders and on its On August 4,2005, the ExecutiveDirectors approved array of financial policies and practices. Shareholder the following allocations from the FY 2005 net support for IBRD is reflectedin the capital backing it income: $589.5 million to the General Reserve and has received from its members and in the record of $68 million to the Pension Reserve. In addition, the its borrowing members in meeting their debt-service Executive Directors recommended to IBRD's Board obligations to it. IBRD's financial policies and of Governors the following transfers from practices have led it to build reserves, to diversify its unallocated net income: $52.5 million to Surplus and funding sources, to hold a large portfolio of liquid $610 million to other development purposes. In investments, and to limit a variety of risks, including addition, the Executive Directors recommended to credit, market and liquidity risks. IBRD's Board of Governors, the transfer of $100 IBRD's principal assets are its loans to member million to the General Reserve out of the $400 countries. The majority of IBRD's outstanding loans million of net income previously retained as surplus are priced on a cost pass-through basis. (SeeTables 5 in FY 2004, and earmarked solely for subsequent and 6 for loan pricing details). transfers to IDA, HIPC, andlor General Reserve.The Executive Directors also approved a 75 basis point To raise funds, IBRD issues debt securities in a waiver of the front end fee on all loans (other than variety of currencies to both institutional and retail special development policy loans) presented to the investors. These borrowings, together with IBRD's ExecutiveDirectors between July1,2005 and the date equity, are used to fund its lending and investment on which the Board approves the next Allocation of activities, as well as general operations. FY 2006 Net Income and Waivers of Loan Charges IBRD holds its assets and liabilities primarily in U.S. Paper in FY 2007. The Executive Directors also dollars, euro and Japanese yen. IBRD mitigates its approved that (i)interest charge waivers will be exposure to exchange rate risks by matching the maintained at 5 basis points for old loans and 25 currencies of its liabilitiesand equity with those of its basis points for new loans, respectively,to eligible assets. However, the reported levels of its assets, borrowers for payment periods commencing during liabilities, income and expensesin the financial FY 2006 and (ii) waivers of 50 basis points on statements are affected by exchange rate movements commitment charges for FY 2006 will be maintained in all the currencies in which IBRD transacts for all loans. compared to IBRD's reporting currency, the U.S. dollar. Since IBRD matches the currencies of its equity with those of its loans, the fluctuations a. For the purpose of this document,"net unrealized gains (losses) on non-trading (borrowings related) derivative instruments, as captured in the cumulative translation adjustment required by FAS 133 and IAS 39" results from IBRD's application for purposes of financial statement reporting do not of FAS 133. FAS 133 refers collectively to the Statement of Finan- significantlyimpact IBRD's risk-bearingcapacity. cial Accounting Standards No. 133, "Accountingfor Derivative Instruments and Hedging Activities",along with its amendments, Lending commitmentsin FY 2005 were$13.6 billion, as well as the derivative accounting-requirements of International . reflectingan increase of $2.6 billion from the FY Accounting Standard (IAS) 39, "Financial Instruments: Recogni- 2004 level of $11.0billion. tion and Measurement" and its subsequent amendments. IBRD MA GENA ME 'S NT DISCUSSION AND ANALYSIS: JUNE30, 2005 3 Box 1: Selected Financial Data As of or for the Years Ended June 30 In millions of U.S. dollars, except ratio and return data in percentaqes Lending Commitments to member countries Gross Dlsbursementsb Net Dlsbursementsb Reported Basis Loan lncome Provlslonfor Losses on Loans and Guarantees decrease (Increase) Investment lncome Borrowing Expenses Net Nonlnterest Expense Operating lncome Net unreallzed galns (losses) on non-tradlng (borrowlngs related) derlvatlve Instruments, as requlred by FAS 133 and IAS 39' Net lncome (Loss) Net Return on Average Earnlng ~ssetsd. after the effects of FAS 133' Gross Return on: Average Earnlng ~ s s e t s ~ Average Outstandlng Loansd Average Cash and Investments Cost of Average Borrowlngs (lncludlng swaps)d after the effects of FAS 133' Interest Coverage after the effects of FAS 133 ' Return on Equlty after the effects of FAS 133 ' Total Assets Due from Banks - Unrestr~cted Loans Outstandlng Accumulated Provlslon for Loan Losses Borrowlngs Outstandlngh Total Equlty Current Value Basis Net lncome of whlch current value adjustment Net Return on Average Earnlng Assets Return on Equlty Equ~ty-to-LoansRatlo Unrestr~ctedCash and Llquld Investments Loans Outstandlng Borrowlngs Outstandlngh Total Equlty The FY2005 comm~tmentsinclude guarantee commltment andguarantee fac111tyof $277 m1111on Amounts include transactions wlth IFCand cap~tal~zedfront-end fees Thls refers to "net unreallzedgalns (losses) on non-trad~ng(borrowlngs related) der~vat~ve~nstruments,as requlredby FAS 133 and /AS39" Amounts arepresentedbefore the effects o f FAS133 Includes lncome from commltment charges Excludes the one-tlme cumulat~veeffect o f the adoptlon of FAS 133 Before the effects of FAS 133 See Sectlon 5, Funding Resources-Equltyfor add~t~onald~scuss~on Borrow~ngsoutstanding, excludingswaps, net of prem~umld~scount Excludes the one-tlme cumulat~veeffect o f the adoptlon of the current value bas15o f account~ng instruments held in IBRD'strading portfolio are market interest rates. The current value for the carried and reported at fair values. Therefore, for the borrowings portfolio includes current value investment portfolio, no additional adjustment is adjustments for borrowings, swaps payable, swaps necessary. Fair value is based on market quotations. receivableand the reduction in other assets due to Instruments for which market quotations are not unamortized issuance costs. readilyavailablehave been valued using market-based At June30,2005, the $2,793 million ($2,411million- methodologies and market information. June30,2004) current value adjustment reflects the BorrowingsPortfolio averagecost of the borrowing portfolio being higher The current value of the borrowings portfolio than the rate at which IBRD could obtain funding at includes debt securities and associated financial the reporting date. The $382 million increase in the derivatives,and represents the present value of current value adjustment was primarily due to losses expected cash flows on these instruments discounted on the euro and Japanese yen denominated debt, by the cost at which IBRD would obtain funding at the consistent with the downward shifts in the respective reporting date. The valuation model incorporates interest rate curves, partly offset by gainsin U.S. dollar available market data in determining the expected denominated debt, reflecting the upward shift in the cash flow and discount rates for each instrument. U.S. dollar interest rate curve at the short end. Market data include exchange rates and reference Table 1: Condensed Current Value Balance Sheets at June 30,2005 and 2004 In millions o f U.S. dollars June 30, 2005 June 30, 2004 Reversal o f Current Current Reported FAS 133 Value Value Current Value Basis Effects Adjustments Basis Basis Due from Banks $ 1,177 $1,177 lnvestments 27,444 27,444 Loans Outstanding 104,401 $3,148 107,549 Less Accumulated Provision for Loan Losses and Deferred Loan Income Swaps Receivable lnvestments Loans Borrowings Other AsseVLiability Other Assets Total Assets Borrowings Swaps Payable lnvestments Loans Borrowings Other AsseVLiability Other Liabilities Total Liabilities Paid in Capital Stock Retained Earnings and Other Equity Total Equity Total Liabilities and Equity * Denotes amounts less than $0.5 m1111on IBRDMANAGEMENT'S DISCUSSION AND ANALYSIS: JUNE30, 2005 7 Table 2: Condensed Current Value Statements of lncome for the years ended June 30,2005 and 2004 In millions o f U.S. dollars FY2005 FY2004 Adjustments Current Value Current Value tocurrent Comprehensive Comprehensive Reported Basis Value Basis Basis lncome from Loans $4,155 $4,155 $4,403 lncome from Investments, net 250 Other lncome 235 Total lncome 4,888 Borrowing Expenses Administrative Expenses Release of Provision for Losses on Loans and Guarantees Other Expenses Total Expenses Operating lncome Current Value Adjustments Release of Provision for Losses on Loans and Guarantees-Current Value Net unrealized gains (losses) on non- trading (borrowings related) derivative instruments, as required by FAS 133 and IAS 39 Net lncome (Loss) Table 3: Summary of Current Value Adjustments In millions of U.S. dollars Total lncome Statement Balance Sheet Effects as o f June 30, 2005 Effect Less Prior Other Years' Loans Borrowings AssetlLiability Effects FY2005 FY2004 Total Current Value Adjustments on Balance Sheet $3,148 $(2,793)a $(I3) ~ ( 5 6 9 ) ~ $4227) $4839) Unrealized Gains on InvestmentsC Currency Translation ~ d j u s t m e n t ~ Total Current Value Adjustments a Amount a net of the current value adustments for swaps, and unamort~zedissuance costs b Includes $1 16 m1111onrepresent~nga one-tlme cumulat~veeffect of recording the adoption, on July 1, 2000, of the current value bas15of account~ng c Unrealized galns on the investment portfol~ohave been moved from Operating lncome under the reported bas15and lncluded as part of current value adustments for current value reportlng d The currency translat~oneffects have been moved from Other Comprehens~velncome under the reported bas15and lncluded ln Current Value Net lncome for purposes of current value reportlng six-month LIBOR in FY2005 (seeFigure 1I), total borrowings portfolio, and 99% of the total non- resultedin higher borrowing expenses. This was U.S. dollar denominated borrowings at June30, partly offsetby a reduction in the average portfolio 2005. During FY2004, the appreciation of the size. Japaneseyen and euro against the U.S. dollar resulted in a positive net currency translation adjustment of Administrative Expenses (Includingcontributions to Special Programs) $272 million on IBRD'snet assets. Administrativeexpenses increased by $81 million Given IBRD'srisk management strategy, the stability during FY2005 compared to FY2004. An increased of the current value equity-to-loansratio is volume of budgeted expenditures in FY2005 considered more significant than fluctuations in the accounted for $37 million of this increase.The net current value adjustments. remaining increasein administrative expenses was due to increased development activities in FY 2005, compared to FY 2004. 3. DEVELOPMENT ACTIVITIES Current ValueAdjustments IBRD offersloans, related derivative products, and guarantees to its borrowing member countries to As part of its risk management strategy, IBRD closely help meet their development needs. It also provides aligns the duration (interest rate sensitivity)and the technical assistance and other advisoryservicesto currency composition of its equity to that of its loan support poverty reduction in these countries. portfolio. Currently, the duration of equity is about one year. Loans The reduction in equity on account of currentvalue From its establishment through June 30,2005, IBRD adjustmentwas $273 million in FY2005 (reduction had approved loans, net of cancellations,totaling of $513million in ~ ~ 2 0 0as )shown in Table3. The 4 $354,058 million to borrowers in 130 countries. A current value adjustment reflectschanges in both summary of cumulativelending is contained in interest rates and currency exchange rates. Table4. During FY 2005, the current value adjustment due to At June30,2005, the total volume of outstanding interest rate changes was negative$227 million, loans was $104,401 million, $5,209 million lower primarily reflecting the negativeeffects resulting than the $109,610 million of outstanding loans at from the movements in the discount curves for June30,2004. This decrease was due primarily to major reference currencieswith the exceptionof the negative net disbursementsof $5,131 million euro. Theselosses were partiallyoffset by net gains including $2,682 million of prepayments. on the euro loans and borrowings portfolio, Undisbursed balances at June30,2005 totaled reflecting the significantdownward shift on the euro $33,744 million, reflecting an increase of $1,616 interest rate curve. IBRD's equity on a current value million from June30,2004. This changewas due to basis declined by $839 million during FY2004 new commitments and positive currency translation primarily reflecting the upward shiftsin the adjustments, partiallyoffset by cancellationsand applicablereferencemarket interest rate curves in the disbursements. short to medium term. Table 4: Lending Status at June 30 During FY2005, there was a negative currency In m~ll~onsof U.S.dollars translation adjustment of $49 million on IBRD'snet assets due primarily to the slight depreciation of the euro (1.6%)and Japaneseyen (0.5%) againstthe U.S. dollar. The current value adjustment for FY2005 due to exchangerate changes for the loans portfolio was a a. Net of cancellat~ons. decrease of $84 million. The euro and the Japanese b. Multlcurrency pool loan repayments are ~ncludedat yen accounted for approximately16% and 5%, of the exchange rates ln effect on the date of or~g~nal disburse- total loans portfolio, and 98% of total non-U.S. ment. All other amounts are based on U.S.dollar equlva- dollar denominated loans at June30,2005. The lents at the tlme of repayment by borrowers. current value adjustment for FY2005 due to During FY 2005, newloans,guarantee commitments exchange rate changes for the borrowings portfolio and guarantee facilitiesto member countries were was a decrease of $52 million, consistent with the $13,611 million, ($11,045 million-FY 2004). exchangerate movements.The euro and the Japanese During both FY 2005 and FY 2004, Latin America yen accounted for approximately11% and 3%, of the On rare occasions, IBRDwill provide enclave lenhng can efficientlyintermediate: variable-spread loans, for a large, foreign exchangegenerating project in a and fmed-spread loans. Variable-spread loans, which member country usually eligible only for loans from were introduced in FY 1993, have a variable spread the International Development Association (IDA).In over LIBOR that is adjusted everysix months. Fixed- these circumstances appropriate risk mitigation spread loans, which were introduced in FY 2000, measures are incorporated (including off-shore have a fmed spread over LIBOR that is fmed for the escrowaccounts and debt-service reserves acceptable life of the loan. to IBRD) to ensure that the risks to IBRD are Borrowers selecting the fmed-spread loan product minimized. At June30,2005, IBRD had $138 million may, for a fee, change the currency or interest rate in outstanding loans for enclave projects ($135 basisover the life of the loan. For example, borrowers million-June30,2004). No new enclave lending have the option to fix, unfm, or re-fm the interest rate was approved during FY 2005 or FY 2004. at market rates on all or a part of the disbursed Financial Terms of Loans amounts for up to the remaining maturity of the loan. FinancialTerms of CurrentlyAvailable Products IBRD currently offers a product mix that is intended Transaction fees range from 0 to 25 basis points of to provide borrowers with the flexibilityto select the notional transaction amount. Any conversion terms that are both compatible with their debt requests accepted by IBRD are executed at market management strategy and suited to their debt- rates. servicing capacity.As of June30,2005, IBRD offers Table 5 summarizes the financial terms for these the following two basic types of loan terms, each types of loans. denominated in the currency or currencies chosen by the borrower provided it is a currency in which IBRD Table 5: Loan Pricing FinancialTerms of Currently Available Products - Vanable Spread FlxedSpreadLoans Spec~alDevelopment Loans (VSL) (FsL) Pol~cyLoans Reference Market Rate SIX month LIBOR SIX month LIBOR SIX month LIBOR Spread Contractual Lendlng Spread 75 (new loans)a 75 400 50 (old loans)b Market Rlsk Premlum - 5 - Fundlng Cost Margln Welghted average Projected fundlng - spread to LIBORof spread to LIBOR debt allocated to VSLs Charges Commltment charge 75 85d Front-end fee 100 (new loans) 100 0 (old loans) Ellglblefor Walvers Interest Yes Yes No Commitment Yes Yes No Front-end feee Yes Yes No Final Matur~ty 15-20 years 15-25 years 5 years Grace ~ e r ~ o d 3-5 vears 3-8 vears 3 vears a. Loans for whlch the mv/tatlonto negotlate was lssued on or after Juiy31, 1998. b. Loans for whlch the mv/tatlonto negotlate was lssued pnor to Juiy 31, 1998. c. The market mk premlum n meant to Compensate IBRD for add~t~onalfund~ngm k assoc~atedw ~ t hthls product. d. The comm~tmentcharge n 85 bas18polnts for the first fouryears and 75 bas18polnts thereafter to Compensate IBRD for add~t~onalfund~ngand refinanc~ngm k assoc~atedw ~ t hthls product. e. On August 4, 2005 the Board of Execut~veDirectors approved a 75 bas18polnt walver of the front end fee on all loans (other than spec~al development pollcy loans) to be presented to the Board between Juiy 1, 2005 and the date on whlch the Board approves a front end fee walver for FY07, ~nthe context of the annual Allocat~onof Net Income and Waiversof Loan Charges paper Repayment terms for fmed-spread loans are more derivative products include currency and interest flexible than for variable-spread loans, subject to rate swaps, and interest rate caps and collars. certain constraints on the average repayment IBRD will pass through its market cost of the maturity and final maturity on a country basis. instrument to the borrower, and will charge a Within these constraints, borrowers have flexibility transaction fee comparable to the fee charged on the to configure grace periods and maturity profiles in a fixed-spread loan conversion features. These manner consistent with the purpose of the loan. instruments may be executed either under a master Repayment profiles may be level repayment of derivativesagreement, which substantially conforms principal, an annuity type schedule, a single lump- to industry standards, or in individually negotiated sum repayment, or a customized schedule. transactions. The first such currency swap Repayment profiles cannot be changed after a loan is transaction was executed in FY 2004 between IBRD signed. and one of its borrowers under a Master Derivatives At June30,2005,63% (56%-June30,2004) of loans Agreement. Further details are provided in the Notes outstanding were variable-spread loans or fixed- to Financial Statements-Note D-Loans, Guarantees spread loans, including special development policy and Derivativesfor Borrowers. loans and loans with non-standard terms. FinancialTerms of PreviouslyAvailable Products Local Currency Lending In previous years, IBRD offered loans with a variety As part of the initiative taken by the Board of of other financial terms including: multicurrency Executive Directors to increase the usability of local pool loans and fmed-rate single currency loans. currency paid-in capital, during FY 2005, IBRD Table 6 summarizes the financial terms for variable- entered into a Local Currency Loan Facility rate multicurrency and single-currency pool loans, Agreement with IFC which is capped at $300 million. and fmed-rate single-currency loans. Under this agreement, IBRD would lend local currencies of its member countries, funded from Prior to 1980, IBRD offered loans at fmed rates paid-in capital, to IFC. These currencies would determined at the time a loan was contracted and set subsequently be used by IFC to finance projects in at a specified spread over then-current borrowing those member countries. Loan commitments under costs. The currency composition of each loan this facilityare subject to consents of the respective depended on the currencies disbursed on that loan. IBRD member countries whose currencyis involved. In 1980, IBRD established the currency pool system, At June 30,2005, a loan commitment equivalent to funded primarily with fmed rate medium-to-long $50 million had been made under this facility. term borrowings. In 1982, IBRD mitigated its interest rate risk by moving from offering a fixed rate Loans with a Deferred Drawdown Option to a variable rate on these loans. A Deferred Drawdown Option (DDO) for use with IBRD development policy loans gives IBRD The currency composition of multicurrency pool borrowers the option of deferring the loan's loans is determined on the basis of a pool, which disbursement for up to three years. Loans with a provides a currency composition that is the same for DDO are subject to a commitment fee of 100 basis all loans in the pool. Pursuant to a policy established points, which is 25 basis points higher than that for by the Executive Directors, and subject to their standard IBRDloans. Also, the front-end fee which is periodic review, at least 90% of the U.S. dollar normally payable at the time a loan becomes equivalent value of the pool is in a fmed ratio of one effective,is only payablefor a DDO loan at the time U.S. dollar to 125 Japaneseyen to one euro. it is disbursed. During FY 1997, IBRD offered borrowers the option Derivative Products to elect to modify their currency choice by Along with the approval of the introduction of the converting multicurrency pool loans to single fixed-spread loan product with its various risk currency loan terms or single currency pool terms. management features such as rate fixing and The lending rate formulation for loans with single currency conversion, the Executive Directors also currency pool terms is the same as that for approved the offer of new derivative products for multicurrency pool loans. borrowers. These products respond to borrowers' Single-currency pool loans are held in U.S. dollars, needs for access to better risk management tools in Japanese yen, and euro. Fixed-rate single currency connection with existing IBRD loans. These loans were offered in all currencies in which IBRD could efficientlyintermediate. IBRD MANAGEMENT'S DISCUSSIONANDANALYSIS: JUNE30, 2005 13 Table 6: Loan Pricing - Financial Terms of Previously Available Products Vanable rate mult~currency Vanable rate slngle Flxedrate slngle pool loans currency pool loansd currency ~ o a n s ~ (1982-2001) (1996-1998) (1995-1999) We~ghtedaverage cost of We~ghtedaverage Cost Base allocated debt cost of allocated debt LIBOR Spread Contractual Lend~ngSpread 75 (new loans)c 50 75 (new loans) 50 (old loans)d 50 (old loans) Market R~skPrem~um - 0-10 Fund~ngCost Marg~n - IBRD's fund~ng slsread to LlBOR Charges Comm~tmentcharge 75 75 Front-end fee 100 (new loans) 100 (new loans) 0 (old loans) 0 (oldloans) El~g~blefor Walvers Interest Yes Yes Yes Comm~tment Yes Yes Yes F~nalMatur~ty 15-20 years based on orlg~nal 12-20 years loan agreement Grace penod 3-5 years based on orlg~nal 3 years loan agreement a. Converted from vanable-rate mult~currencypool loans b. Cost base and spread are fixed on rate-fix~ngdate for amounts d~sbufieddunng the preced~ngSIX months. c. Loans for whlch the mv/tatlonto negot~atewas lssued on or after Juiy31, 1998. d. Loans for whlch the mv/tatlonto negot~atewas lssued pnor to Juiy 3 1, 1998. Any fmed-rate multicurrency pool loans that were annually and have been in effect since FY 1990. All subsequently converted to single currency pools borrowers receivethe commitment charge waiver on continued to carry their fmed rate. their eligibleloans. Table 7 presents a breakdown of IBRD's loan charge waivers. Further details are Fixed-rate single currency loans carry lending rates provided in the Notes to FinancialStatements-Note fmed on semi-annual rate fixing dates for amounts disbursed during the preceding six months. For the D-Loans, Guarantees and Derivativesfor Borrowers. interim period f;om the date each disbursement is made until its rate fixing date, interest accrues at the rate applicable to variable-spread loans. Table 7:Loan Charge Waivers At June30,2005,37% (44%-June30,2004) ofloans outstanding carried these previously available Interest Perlod financial terms. Commencing FY2006 FY2005 FY2004 Figure 4 presents a breakdown of IBRD's loan - -- portfolio by loan product. For more information, see Comm~tmentcharge walvers 50 50 50 the Notes to Financial Statements-Note D-Loans, lnterest walversa Guarantees and Derivativesfor Borrowers. Old loans New loans Waivers Average e l ~ g ~ b ~ l ~ t y n.a. 99% 98% Waiversof a portion of interest owed by all eligible Front-end fee walversb 75 50 - borrowers are determined annually and have been in effect since FY 1992. Eligibilityfor the partial waiver a, o n loans to el~q~bleborrowefi, ofinterest is limited to borrowers that have made full b. On August 4, ;005 the Board of Execut~veD~rectorsapproved a 75 bas18polnt walver of the front end fee on all loans (other payments of principal, interest and other charges than speaai development poilcy loans) to be presented to the within 30 calendar days of the due dates during the Board between Juiy 1, 2005 and the date on whlch the Board approves a front end fee walver for FY07, ~nthe context of the preceding six months, on all their loans. Waiversof a annual Allocat~onof Net lncome and Walvefi of Loan Charges - . i ~ a i ~ e r portion of the commitment charge owed on the undisbursed portion of loans are also determined exchangegenerating projects in a member country countries. One objective of providing the servicesto usuallyeligible only for credits from IDA. Fees central banks is to assist them in developing portfolio charged for enclave guarantees are higher than those management skills. These managed funds are not charged for non-enclave guarantees. The included in the assets of IBRD.See the Notes to commitment of enclave guarantees is limited to an Financial Statements-Note J-Management of aggregateguaranteed amount of $300 million. As of External Funds. June30,2005 commitments made under enclave guarantees stood at $30 million. 4. LIQUIDITY MANAGEMENT IBRD's exposure at June 30,2005 on its guarantees IBRD's liquid assets are held principally in highly- (measured by discounting each guaranteed amount rated fixed income securities. These securities from its first call date) is detailed in Table8. For include obligations of governments and other official additional information see the Notes to Financial entities, time depositsand other unconditional Statements-Note D-Loans, Guarantees and obligations of banks and financial institutions, Derivativesfor Borrowers. currency and interestrate swaps (includingcurrency forward contracts), asset-backed (including Table 8: Guarantee Exposure mortgage-backed) securities, and futures and In m~ll~onsof U.5. dollars options contracts. FY 2005 FY 2004 FY 2003 ---LiquidityriskarisesinthegeneralfundingofIBRD's Part~alr~sk $ 413 $ 418 $ 456 activities and in the management of its financial Part~alcred~t 523 561 570 positions. It includes the risk of being unable to fund Pollcy based 156 157 158 -- - its portfolio of assets at appropriate maturities and Total --- $1,092 $1,136 $1,184 --- rates and the risk of being unable to liquidate a position in a timely manner at a reasonable price. Other Activities The objective of liquidity management is to ensure Consultation:In addition to its financial operations, the availabilityof sufficient cash flows to meet all of IBRD provides technical assistance to its member IBRD's financial commitments. countries, both in connection with, and As one component of liquidity management, IBRD independently of, lending operations. There is a maintains a $500 million line of credit with an growing demand from borrowersfor strategic advice, independent financial institution." This facilityis knowledge transfer, and capacity building. Such used to cover any overnight overdrafts that may assistanceincludes assigning qualified professionals occur due to failedtrades. For further details about to survey developmental opportunities in member this facility, see the Notes to Financial Statements- countries, analyzing their fiscal, economic and Note E-Borrowings. developmental environment, assisting member countries in devising coordinated development Under IBRD's liquidity management policy, programs, appraising projects suitable for investment aggregateliquid asset holdings are kept at or above a and assisting member countries in improving their specified prudential minimum in order to safeguard asset and liability management techniques. against cash flow interruptions. That minimum is equal to the highest consecutive six months of Research and Training:To assist its developing expected debt service obligations for the fiscal year, member countries, IBRD-throughthe World Bank plus one-half of net approved loan disbursements as Institute and its partners-provides courses and other projected for the fiscal year. The FY 2006 prudential training activities related to economic policy minimum liquidity level has been set at $18 billion, a development and administration for governments decrease of $2 billion from that set for FY 2005. and organizations that work closelywith IBRD. IBRD also holds liquid assets over the specified Trust Fund Administration: IBRD, alone or jointly minimum to provide flexibilityin timing its with IDA, administers on behalf of donors, funds borrowing transactions and to meet working capital restricted for specific uses. These funds are held in needs. trust and are not included in the assets of IBRD. See The primary objective for IBRD in the management the Notes to Financial Statements-Note J- of liquid assets is to protect the principal amount of Management of External Funds. these investments. In addition, IBRD seeks to achieve Investment Management: IBRD offers investment management servicesto several types of external a. This line of credit is held jointly with the International Devel- institutions, including central banks of member opment Association (IDA),an affiliated organization. Contractual Obligations 5. FUNDING RESOURCES In the normal course of business, IBRD enters into Equity various contractual obligations that may require Total shareholders' equity, as reported in IBRD's future cash payments. Table 10 summarizes IBRD's balance sheet at June 30,2005, was $38,588million significant contractual cash obligations, by compared to $35,463 million at June 30,2004. The remaining maturity, at June30, 2005. Long-term increase from FY 2004 primarily reflects the increase debt includes direct medium- and long-term in retained earnings resulting from FY 2005 net borrowings excluding swaps, but does not include income. any adjustment for unamortized premiums, discounts or effects of applying FAS 133 (additional IBRD's equity base plays a critical role in securing its information can be found in the Notes to Financial financial objectives.By enabling IBRD to absorb risk Statements-Note E-Borrowings).Capital and out of its own resources, its equity base protects operating lease expenditures primarily represent shareholders from a possible call on callablecapital. future cash payments for real estate-related The adequacy of IBRD's equity capital is judged on obligations and equipment. Other long-term the basis of its ability to generate future net income liabilitiesinclude accrued liabilities for staff sufficient to absorb potential risks and support compensation and benefits. Capital and operating normal loan growth, without reliance on additional leases, contractual purchases and capital shareholder capital. expenditures, and other long term obligations For management purposes, IBRD closely monitors include amounts which will be shared with IDA, IFC equity as defined and utilized in the equity-to-loans and MIGA in accordance with individual cost ratio.Table 11 presents the composition of this sharing agreements (additional information can be measure at June 30,2005 and 2004, respectively. found in the Notes to Financial Statements-Note I-AdministrativeExpenses,Contributions to The equity-to-loansratio is a summary statistic that Special Programs, and Other Income). IBRD uses as one measure of the adequacy of its risk- bearing capacity.IBRD also uses a stress test as a Excluded from Table 10 are a number of obligations measure of income-generating capacity and an input to be settled in cash. These obligations are presented to the assessment of capital adequacy.See discussion in IBRD'sbalance sheet and include undisbursed in Section 6, Financial Risk Management- loans; short-term borrowings; payablefor currency Managing Risk-BearingCapacity. and interestrate swaps;payablefor investment securities purchased, and payable for transfers As presented in Figure 6, IBRD's equity-to-loans approved by the Board of Governors. ratio increased during FY 2005, on both a reported basis (excluding cumulative translation adjustments associated with the FAS 133 adjustments) and a current value basis. Table 9: Liquid Asset Portfolio Returns and Average Balances In m~ll~onsof U.S.dollar5 Average Balances Financial Return (%) FY 2005 FY 2004 FY 2005 FY 2004 IBRD Overall Portfolio Stable Operational Discretionary Table 11: Equity Capital June 30,2005 June 30, 2004 Usable Capital Paid-in Capital Restricted Paid-in Capital Net Payable (Receivable) for Maintenance of Value Total Usable Capital Special Reserve General Reserve, including allocation of FY 2005lFY 2004 net income Cumulative Translation Adjustmenta Equity used in Equity-to-Loans Ratio-Reported Basis Current Value Adjustments Equity used in Equity-to-Loans Ratio-Current Value Basis Loans and GuaranteesOutstanding, net of Accumulated Provision for Losses on Loans and Guaranteesand Deferred Loan Income $101,990 $106,750 Current Value Loans and GuaranteesOutstanding, net of Accumulated Provision for Losses on Loans and Guaranteesand Deferred Loan Income $105.138 $109,748 Equity-to-LoansRatio-Reported Basis Equity-to-LoansRatio-Current Value Basis a. Exclud~ngcumulat~vetranslation amounts assoc~atedwlth the FAS 133 adjustment Callable Capital amount will not be called for use by IBRD in its (iv) $151,774million of IBRD's capital may, under lending activities or for administrative purposes. the Articles,be called only when required to No call has ever been made on IBRD's callable meet obligations of IBRD for funds borrowed or capital. Any calls on unpaid subscriptions are on loans guaranteed by it. This amount is thus required to be uniform, but the obligations of the not availablefor use by IBRD in making loans. members of IBRD to make payment on such calls are Payment on any such call may be made, at the independent of each other. If the amount received on option of the particular member, either in gold, in U.S. dollars or in the currency required to dis- a call is insufficient to meet the obligations of IBRD charge the obligations of IBRD for which the call for which the call is made, IBRD has the right and is is made. bound to make further calls until the amounts received are sufficient to meet such obligations. (v) $26,461million of IBRD's capital is to be called However, no member may be required on any such only when required to meet obligations of IBRD for funds borrowed or on loans guaranteed by it, call or calls to pay more than the unpaid balance of pursuant to resolutions of IBRD's Board of Gov- its capital subscription. ernors (though such conditions are not required At June 30,2005, $103,604 million (58.1%) of the by the Articles). Of this amount, 10% would be uncalled capital was callablefrom the member payable in gold or U.S. dollars and 90% in the countries of IBRD that are also members of the national currencies of the subscribing members. While these resolutions are not legallybinding Development Assistance Committee (DAC)of the on future Boards of Governors, they do record Organization for Economic Cooperation and an understanding among members that this Development (OECD).This amount slightly exceeded IBRD's outstanding borrowings including and credit of the United States, notwithstanding that swaps at June 30,2005. Table12 sets out the capital congressional appropriations have not been obtained subscriptions of those countries and the callable with respect to certain portions of the subscription. amounts. For a further discussion of capital stock, restricted currencies, maintenanceof value and membership Table 12: Capital Subscriptionsof DAC Members of OECD Countries refer to the Notes to Financial Statements-Note A- Summary of Significant Accounting and Related In millions of U.5. dollars Policies and Note B-Capital Stock, Restricted Total Capital Uncalled Portion Currencies, Maintenance of Value and Membership. Member Countrp Subscription of Subscription Borrowings Un~tedStates Source of Funding Japan IBRD diversifies its sources of funding by offering its Germany securities to institutional and retail investors around France the world, both through global offerings and by way Un~tedK~ngdom Canada of bond issues designed to meet the needs of specific Italy markets or types of investors. Under its Articles, Netherlands IBRD may borrow only with the approval of the Belg~um member in whose markets the funds are raised and Spa~n the member in whose currency the borrowing is Sw~tzerland denominated, and only if each such member agrees Australla that the proceeds may be exchanged for the currency Sweden of any other member without restriction. Denmark Austr~a New medium- and long-term funding excluding Norway swaps by currency for FY 2005, as compared to FY F~nland 2004, is shown in Figure 7. New Zealand Portugal Funding Operations Ireland In FY 2005, medium- and long-term debt raised Greece directly in financial markets by IBRD amounted to Luxembourg $12,723 million compared to $12,535 million in FY Total 2004. Table 13 summarizes IBRD's funding operations for FY 2005 and FY 2004. a See details regarding the capital subscriptionsof all members of IBRD at June 30, 2005 in Financial State- ments-Statementof Subscriptions to Capital Stock and Voting Power Table 13: Funding Operations Indicators FY 2005 FY 2004 The United States is IBRD's largest shareholder. Total Med~um-and Long-term Under the Bretton Woods Agreements Act, the Par Borrowlngsa (USD m~ll~on) $12,723 $12,535 Value Modification Act and other U.S. legislation, the Secretary of the U.S. Treasury is permitted to pay up Average ~ a t u r(years) ~ ~ t ~ 5.2 3.9 Number of Transact~ons 283 258 to $7,663 million of the uncalled portion of the Number of Currenc~es 13 10 subscription of the United States, if it were called by IBRD, without any requirement of further a. Includes one-year notes and representsnet proceeds on a settlement date basis. congressional action. The balance of the uncalled b. Average maturity to first call date. portion of the U.S. subscription, $22,303million, has been authorized by the U.S. Congress but not appropriated. Further action by the U.S. Congress would be required to enable the Secretary of the Treasury to pay any portion of this balance. The General Counsel of the U.S. Treasuryhas rendered an opinion that the entire uncalled portion of the U.S. subscription is an obligation backed by the full faith IBRD MANAGEMENT'S DISCUSSION AND ANALYSIS:J UN E30, 2005 21 Corporate Finance Department works with IBRD's The risk that a significant portion of its loan portfolio financial managers, who are responsible for the day- may go into extended arrears is the most significant to-day management of these risks, to establish and risk faced by IBRD, and almost all of IBRD'sequity document processesthat facilitate, control and capital is held against this risk. Credit risk is monitor risk. These processesare built on a measured in terms of both probable and unexpected foundation of initial identification and measurement losses from protracted payments arrears. Probable of risks by each of the business units. Under the losses are covered by IBRD'saccumulated provision direction of the Finance Committee, policies and for losses on loans and guarantees, and unexpected procedures for measuring and managing such risks losses are covered by income-generating capacity and are formulated, approved and communicated equity. throughout IBRD. Senior managers represented on The framework of stress testing provides a basis for the Committee are responsible for maintaining evaluating whether IBRD has sufficient financial sound credit assessments, addressing transaction and capacity to be able to (i) absorb the income loss due product risk issues, providing an independent review to a credit shock,"and (ii) generate sufficient income function and monitoring the loans, investments and to support loan growth in the followingyears. The borrowings portfolios. first requirement on the degree of shock absorption is The primary responsibility for the management of designed to reduce the probability of having to rely operational risk in IBRD'sfinancial operations on additional shareholder support (in terms of resideswith each of IBRD'smanagers. These additional paid-in capital or a callon callablecapital). individuals are responsible for identifying This is intended both to protect shareholders and to operational risks and establishing, maintaining and support IBRD's credit standing, which reduces monitoring appropriate internal control in their borrowing costs and correspondingly, lending rates respectiveareas using an operational risk for borrowers. The second requirement on loan management framework. growth reflects the view that as a development institution, IBRD needs to play a positive role in a This framework requires each business unit to crisisby maintaining the capacity to continue lending document operational risks and controls, assess the to assist recoveryin borrowing member countries. likelihood and impact of operational risks and One of the credit shock events used in the stress evaluate the design and effectiveness of existing testing framework is an estimate of the amount of the controls using guidelines established by IBRD. An loan portfolio that could enter nonaccrual status independent operational risk control unit supports (payment arrears in excess of six months) in the next this process by undertaking periodic reviews, three years at an appropriate confidence level. performing quality assurance testing and reporting exceptions. IBRD'sequity supports its risk-bearingcapacity for its lending operations. IBRD strives to immunize its The processesand procedures by which IBRD risk-bearingcapacity from fluctuations in interest manages its risk profile continually evolve as its and exchange rates. Therefore, IBRD uses the equity- activities change in response to market, credit, to-loansratio (on a current valuebasis) as one tool to product, and other developments. The Executive monitor the sensitivity of its risk-bearingcapacity to Directors, particularly the Au&t Committee movements in interest and exchange rates. One of members, periodically review trends in IBRD's risk IBRD's financial risk management objectivesis to profiles and performance, as well as any significant seek to protect the equity-to-loansratio from developments in risk management policies and movements arising from market risks. controls. The sensitivity of IBRD's operating income to interest Managing Risk-Bearing Capacity rate movements arises primarily from the sensitivity The risk bearing capacity of IBRD is the adequacy of of the "contribution of equity" (the income earned its capital to absorb credit shocks and still be able to from that portion of IBRD's assetsfunded with equity lend for development purposes without the need for additional shareholder support. The Board of Executive Directors assesses IBRD's risk-bearing a. Income loss arises from borrowers in nonaccrual status no longer paying interest on their loans. In addition, an increase in the capacity based on a variety of metrics, including a loan loss provision is typically warranted as a result of the nonac- framework of stress testing and simpler measures crual event. This increase in the provision must be recognized as an such as the equity-to-loansratio, to assess capital expense, which further reduces net income in the yearof the shock, adequacy. and through that, impacts the equity-to-loans ratio. Box 4: Treatment of Overdue Payments Where the borrower is the member country, no new loans to the member country, or to any other borrower in the country, will be presented to the Board of Executive Directors for approval, nor will any previously approved loan be signed, until payments for all amounts 30 days overdue or longer have been received. Where the borrower is not the member country, no new loans to that borrower will be signed or approved. In either case, the borrower will lose its eligibility for any waiver of interest charges in effect at that time. In addition to the provisions cited above for overdue by 30 days, to avoid proceeding further on the notification process leading to suspension of disbursements, the country as borrower or guarantor and all borrowers in the country must pay not only all payments overdue by 30 days or more, but also all payments due regardless of the number of days since they have fallen due. Where the borrower is not the member country, no new loans to, or guaranteed by, the member country, will be signed or approved. Overdue by 60 days In addition to the suspension of approval for new loans and signing of previously approved loans, disbursements on all loans to or guaranteed by the member country are suspended until all overdue amounts have been paid. This policy applies even when the borrower is not the member country. Overdue by more than six All loans made to or guaranteed by a member of IBRD are placed in nonaccrual status, unless IBRD determines that the overdue amount will be months collected in the immediate future. Unpaid interest and other charges not yet paid on loans outstanding are deducted from the income of the current period. To the extent that these payments are received, they are included in income. At the time of arrears clearance, a decision is made on the restoration of accrual status on a case by case basis; in certain cases that decision may be deferred until after a suitable period of payment performance has passed. See Notes to Financial Statements-Note D-Loans, Table 14.The accumulated provision for losses on Guarantees and Derivativesfor Borrowers for a both the accrual and nonaccrual portfolio of loans summary of countries with loans or guarantees in decreasedby $496 million (thiscomprises a release of nonaccrual status at June 30,2005. provision for losses on loans of $500 and negative translation adjustment of $4 million during FY AccumulatedProvision for Losseson Loans and Guarantees 2005). This decrease was primarily due to a net improvement in borrowers' risk ratings and negative IBRD maintains an accumulated provision for losses net disbursementson loans, including $2,682 on loans and guarantees to recognize the probable million of prepayments, which reduced loans losses inherent in both the accrual and nonaccrual outstanding. portfolios. The methodology for determining the accumulated provision for losses on loans and Treatment of ProtractedArrears guarantees is discussed in Section 7, Critical In 1991, the Executive Directors adopted a policy to Accounting Policies. assist members with protracted arrears to IBRD to IBRD'sprovision for losses on loans and guarantees mobilize sufficient resources to clear their arrears covers probable credit losses from protracted arrears. and to support a sustainable growth-oriented The Credit RiskSubcommittee reviewsthe allowance adjustment program over the medium term. This for losses on loans and guarantees at least quarterly policy is conditional on members agreeing to and, if necessary, adjustments are made to the implement certain requirements including an provision. In addition, the Audit Committee is acceptable structural adjustment program, adopting apprised by management at least twice a year on the a financing plan to clear all arrears to IBRD and accumulated provision for losses on loans and other multilateral creditors, and continuing to guarantees. service their obligations to IBRD and other multilateral creditors on time. The accumulated provision for losses on both the accrual and nonaccrual portfolio are presented in Table 14: Accumulated provision for Losses on Loans by Portfolio as a Percentage of Total Loans Outstanding 2005 2004 Accurnuiated Accurnuiated Prov~s~onas a Prov~s~onas a Loans Accurnuiated Percentageof Total Loans Accurnuiated Percentageof Total outstandlng Provlaon Loans Outstandlng outstand~ng Prov~s~on Loans Outstandlng Accrual Portfol~o 100,858 1,578 1.5% 106,422 2,163 2.0% Nonaccrual Portfol~o 3,543 1,431 1.4% 3,188 1,342 1.2% Total Loans Outstanding 104,401 3,009 2.9% 109,610 3,505 3.2% It is IBRD's practice not to reschedule interest or Commercial Credit Risk principal payments on its loans or participate in debt Commercial credit risk is the risk of loss due to a rescheduling agreements with respect to its loans. counterparty not honoring its contractual During FY 1996 and FY 2002, exceptions were made obligations. to that practice with regard to Bosnia and Herzegovina (BiH) and Serbia and Montenegro IBRD's commercial credit risk is concentrated in (SAM),formerly the Federal Republic of Yugoslavia, investments in debt instruments issued by sovereign based on criteria approved by the ExecutiveDirectors governments, agencies, banks and corporate entities. in connection with the financial assistance package The majority of these investments are in AAA and for Bosnia and Herzegovina in 1996. See the Notes to AA rated instruments. Financial Statements-Note A-Summary of In the normal course of its business, IBRD utilizes Significant Accounting and Related Policies, for various derivativesand foreign exchange financial additional information. instruments to meet the financial needs of its The accumulated arrears on loans to the former borrowers, to generate income through its Socialist Federal Republic of Yugoslavia (SFRY),for investment activities and to manage its exposure to which BiH and SAM undertook responsibility, were fluctuations in interest and currency rates. clearedthrough new consolidationloans extended by Derivative and foreign exchange transactions involve IBRD in FY 1996 and FY 2002, respectively.The credit risk.The effectivemanagement of credit riskis reschedulings were structured to maintain the values vital to the success of IBRD's funding, investment of payments to IBRD in accordance with the terms of and assetlliabilitymanagement activities.The the original loan agreements. These reschedulings monitoring and managing of these risks is a did not change IBRD's net exposure to these continuous process due to changing market borrowers. These new loans included the loan environments. principal outstanding assumed by BiH and SAM respectively,as part of their conditions for succession IBRD controls the credit risk arising from to membership of the former SFRY, as well as all investments, derivativesand foreign exchange unpaid interest and charges related to the former transactions through its credit approval process, the SFRY's loans. This resulted in an increase in loans use of collateral agreements and risk limits, and outstanding of $168 million for BiH and $799 monitoring procedures. The credit approval process million for SAM. The offset to these amounts was involves evaluating counterparty creditworthiness, initially classifiedas deferred loan income, which was assigning credit limits and determining the risk presented along with the accumulated provision for profile of specifictransactions. Credit limits are loan losses as a determinant of net loans outstanding calculated and monitored on the basis of potential on the balance sheet. exposures taking into consideration current market values, estimates of potential future movements in During FY 2003, IBRD determined that the offset to those values and collateral agreements with loans outstanding related to BiH and SAM, that was counterparties. If there is a collateral agreement with initially classified as Deferred Loan Income, should the counterparty to reduce credit risk, then the be reclassified to Accumulated Provision for Loan amount of collateral obtained is based on the credit Losses to better reflect the nature of these amounts. rating of the counterparty. Collateral held includes Followingthe reclassification,the required cash and government securities. provisions for these countries were reassessed, which resulted in a positive effect on income of $591 IBRD treats the credit risk exposure as the million in FY 2003. replacement cost of the derivative or foreign IBRD MANAGEMENT'S DISCUSSION AND ANALYSIS: JUNE30, 2005 27 exchangeproduct. This is also referred to as million at June 30,2004 to $8,167 million at June30, replacement risk or the mark-to-market exposure 2005. The swap credit exposure of $8,167 million is amount. While contractual principal amount is the offset by collateral of $6,986 million, which results in most commonly used volume measure in the a total net swap exposure of $1,18lmillion. derivative and foreign exchange markets, it is not a Market Risk measure of credit or market risk. IBRD faces risks which result from market Mark-to-market exposure is a measure, at a point in movements, primarily changes in interest and time, of the value of a derivative or foreign exchange exchange rates. In comparison to country credit risk, contract in the open market. When the mark-to- IBRD's exposure to market risksis small. IBRD has market is positive,it indicates the counterparty owes an integrated assetlliability management framework IBRD and, therefore, creates an exposure for IBRD. to flexibly assess and hedge market risks associated When the mark-to-market is negative, IBRD owes with the characteristics of the products in IBRD's the counterparty and does not have replacement risk. portfolios. When IBRD has more than one transaction AsseVLiability Management outstanding with a counterparty, and the parties The objectiveof assetlliability management for IBRD have entered into a master derivativesagreement is to ensure adequate funding for each loan product which contains legally enforceable close-out netting and liquid asset at the most attractive available cost, provisions, the "net" mark-to-market exposure and to manage the currency composition, maturity represents the netting of the positive and negative profile and interest rate sensitivity characteristics of exposures with the same counterparty. If this net the portfolio of liabilities supporting each lending mark-to-market is negative,then IBRD's exposure to product and liquid asset in accordance with the the counterparty is considered to be zero. For the particular requirements for that product or liquid contractual value, notional amounts and related asset and within prescribed risk parameters. The credit risk exposure amounts by instrument, see the current valueinformationis used in the assetlliability Notes to Financial Statements-Note G-Credit Risk. management process. Table 15 provides details of IBRD's estimated credit Use of Derivatives exposure on its investments (excluding externally- managed assets-$1,383million at June 30, 2005, As part of its assetlliabilitymanagement process, $1,350 million at June 30,2004) and swaps IBRD employs derivatives to manage and align the (excludingthosewith borrowing member countries), characteristics of its assets and liabilities. IBRD uses net of collateral held, by counterparty rating derivative instruments to adjust the interest rate category. repricing characteristics of specificbalance sheet assets and liabilities,or groups of assets and liabilities - A The decrease in the proportion of AA rated with similar repricing characteristics, and to modify investments, compared to the prior Year, is mainly the currency composition of net assets and liabilities. due to the decrease in deposits with commercial banks. After the effects of netting arrangements, the credit exposure from swaps increased from $5,598 Table 15: Credit Exposure, Net of Collateral Held, by Counterparty Rating In m~ll~onsof U.5. dollars At June 30, 2005 At June 30, 2004 At June 30, 2003 lnvestments Agencies, Net Total Exposure Total Exposure Total Exposure Counterparty Banks & Swap on Investments % of on lnvestments % of on lnvestments % of Ratlng Soverelgns Corporate5 Exposure and Swaps Total and Swaps Total and Swaps Total AAA $299 $10,538 $ 3 7 1 $11,208 42 $12,266 40 $10,949 39 AA 32 12,043 756 12,831 49 15,975 51 12,649 46 A 433 1,788 54 2,275 9 Total $764 $24,369 $1,181 $26,314 100 Table 16 details the current value information of sensitivityof IBRD's operating income to changesin each loan product, the liquid asset portfolio, and the market interest rates will increase. debt allocated to fund these assets. The borrowing cost pass-through formulation Interest Rate Risk incorporated in the lending rates charged on most of There are two main sources of potential interest rate IBRD's existingloans has traditionally helped limit risk to IBRD. The first is the interest rate sensitivity the interest rate sensitivityof the net spread earnings associatedwith the net spread between the rate IBRD on its loan portfolio. Such cost pass-through loans earns on its assets and the cost of borrowings, which currently account for approximately 65% of the fund those assets. The second is the interest rate existingoutstanding loan portfolio (68% at the end sensitivityof the income earned from funding a of FY 2004). All cost pass-through loans, including portion of IBRD assets with equity. In general, lower single currency and multicurrency pool loans as well nominal interest rates result in lower lending rates as variable-spread loans, pose residual interest rate which, in turn, reduce the nominal earnings on risk, given the lag inherent in the lending rate IBRD's equity.In addition, as the loan portfolio shifts calculation. from pool loans to LIBOR based loans, the Table 16: Financial Instrument Portfolios In millions o f U.S. dollars A t June 30, 2005 A t June 30, 2004 Current Current Value Value Carrying Contractual Adjust- Carrying Contractual Adjust- Value Yield ments Value Yield ments Loansa Variable-Rate Multicurrency Pool Loans Single Currency Pool Loans Variable-Spread Loans Fixed-Rate Single Currency Loans Special Development Policy LoansC Fixed-Spread Loans Other Fixed Rate Loans Liquid Asset ~ o r t f o l i o ~ Borrowings Allocation (including swaps)e Variable-Rate Multicurrency Pools Single Currency Pools Variable-Spread Fixed-Rate Single Currency Special Development Policy Fixed-Spread Other ~ e b t ~ a. Contractual y~eldn presented before the appl~cat~onof lnterest walvers. b, lncludes fixed-rate slngle currency loans for whlch the rate had not yet been fixed at fiscal year-end. c, lncludes loans w ~ t non-standard terms as descr~bed~nF~nanc~alTerms of Loans. h d. The 11qu1dasset portfol~on camed and reporied at market value and excludes ~nvestmentassets assoc~atedw ~ t hcerialn other postemployment benefits.The y~eld~nformat~onrepresents the welghted average markety~eldto matunty e. Carry~ngarnounts and contractualy~eldsare on a bas18whlch lncludes accrued lnterest and any unamori~zedarnounts, but does not lnclude the effects of appiylng FA8 133. f lncludes arnounts not yet allocated at June 30, 2005 and June 30, 2004. IBRD MANAGEMENT'S DISCUSSION AND ANALYSIS: JUNE30, 2005 29 Another potential risk arises because the cost pass- dates on its floating rate receivables and payables. To through currency pool products have traditionally mitigate its exposure to these timing mismatches, been funded with a large share of medium- and long- IBRD has executed some overlay interestrate swaps. term fixed-rate debt, to provide the borrowers with a ExchangeRate Risk reasonably stable interest basis. Given that the In order to minimize exchange rate risk in a cumulative impact of interest rate changes over time multicurrency environment, IBRD matches its has resulted in a decline in the level of interest rates, the cost of these historical fixed-rate borrowings in borrowing obligations in any one currency (after the multicurrency pool and the singlecurrency pools swap activities) with assets in the same currency, as is currently considerably higher than IBRD's new prescribed by the Articles. In addition, IBRD's policy is to minimize the exchange rate sensitivity of its borrowing costs.The amount of debt allocated to the multicurrency debt pool will exceed the balance of equity-to-loansratio.It carries out this policy by the multicurrency loan pool after FY 2009. The debt undertaking currency conversions periodically to which funds these loans has maturities that extend align the currency composition of its equity to that of beyond those of the loans and this debt overhang its outstanding loans. This policy is designed to presents a risk of loss to IBRD because the debt minimize the impact of exchangerate fluctuationson carries fmed interest rates. the equity-to-loansratio, thereby preserving IBRD's ability to better absorb unexpected lossesfrom Over-funding will reach a maximum of arrears regardlessof the market environment. approximately $6.4 billion in FY 2015. Strategies for managing this risk include changing the interest rate Figure 10 presents the currency composition of characteristics of the over-funded portion of the debt significant balance sheet components (net of swaps) from fmed to floating rates beyond 2009 through the at the end of FY 2005 and FY 2004. use of forward-starting swaps. IBRDbegan executing Liquidity Risk these forward-starting swapsin FY 2000 and the cost Liquidity risk arises from the general funding needs to date has been approximately $594 million. The fair of IBRD's activities and in the management of its value of the debt overhang remaining to be hedged is assets and liabilities. For a discussion on how approximately $94 million as of June 30,2005. The liquidity is managed, refer to Section 4-Liquidity cost of the overhang will vary with interest rates and Management. prepayments. Operational Risk Interest rate risk on non-cost pass-through products, Operational risk is the potential for loss resulting which currently account for 35% of the existing loan from inadequate or failed internal processesor portfolio (32%at the end of FY 2004),is managed by systems,human factors, or external events, and using interestrate swaps to closely align the rate includes business disruption and system failure, sensitivity characteristics of the loan portfolio with transaction processing failures and failures in those of their underlying funding. As the portfolio of execution of legal, fiduciary and agency fmed-spread loans increases, the proportion of non- responsibilities. IBRD, like all financial institutions, cost pass-though products will grow. is exposed to many types of operational risks. The interest rate risk on IBRD's liquid portfolio, IBRD attempts to mitigate operational risk by which includes the risk that the value of assetsin the maintaining a system of internal control that is liquid portfolio will fluctuate due to changes in designed to keep that risk at appropriate levelsin market interest rates, is managed within specified view of the financial strength of IBRD and the duration-mismatch limits and is further limited by characteristics of the activities and markets in which stop-loss limits. IBRD operates. Since 1996, IBRD has used a COSOa- Interest rate risk also arises from a variety of other based integrated internal control framework. factors, including differencesin the timing between the contractual maturity or repricing of IBRD's a. In 1992, the Committee of Sponsoring Organizations of the assets,liabilities and derivativefinancial instruments. Treadway Commission (COSO) issued its Internal Control-lnte- On floating rate assets and liabilities, IBRD is grated Framework, which provided a common definition of inter- exposed to timing mismatches between the re-set nal control and guidance on judging its effectiveness. Figure 10: Relative Currency Composition of SignificantBalance Sheet Components-Current Value Basis At June 30,2005 Others JPY EUR USD 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Assets Liabilities &Equity Loans 78% Borrowings&Other 73% Investments &Other 22% Equity 27% 100% 100% At June 30,2004 Others JPY EUR USD 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Assets Liabilities &Equity Loans 77% Borrowings &Other 76% Investmnts &Other 23% Equity 24% 100% 100% During FY 2005, IBRD updated its framework for Annually IBRD's management has made an assertion operational risk management for its finance, human that, as of June 30 of each fiscal year since 1997, its resources, information technology and procurement system of internal control over its external financial activities.This framework was implemented in reporting has met the criteria for effectiveinternal conjunction with business units and involves the control over external financial reporting as described following core steps: in COSO. Since FY 1997, IBRD's external auditors have provided an attestation report that Key operational risks and mitigating con- management's assertion regarding the effectivenessof trols are identified and documented based internal control over external financial reporting is on a self assessment process.This process is undertaken using a combination of tools fairlystated in all material respects. including business process maps and tai- DisclosureControls andProcedures lored risk and control categories which are applied consistently across business units Disclosure controls and procedures are those and an operational risk database. processeswhich are designed to ensure that information required to be disclosed is accumulated Operational risks are quantified based on and communicated to management, as appropriate likelihood of occurrence and the resulting to allow timely decisions regarding required financial impact using probability and severity parameters. The inherent risks of disclosure by IBRD. Management has undertaken an potential misstatements in financial report- evaluation of the effectiveness of such controls and ing are also assessed. procedures. Based on that evaluation, the President and the Chief Financial Officer have concluded that The design and operating effectiveness of these controls and procedures were effectiveas of controls over financial reporting are evalu- June 30,2005. ated using self assessment workshops, inde- pendent walk through tests of processes, compliance testing and annual internal rep- 7. CRITICAL ACCOUNTING POLICIES resentation letters from business unit man- The Notes to IBRD'sfinancial statements contain a agers. summary of IBRD'ssignificant accounting policies. Action plans are developed for issues identi- The following is a description of those accounting fied and followed up on a periodic basis. policieswhich involve significant management Key risks and control weaknesses are evalu- judgments that are difficult, complex or subjective ated on an annual basis by an internal panel. and relate to matters that are inherently uncertain. The panel evaluates and categorizesthese to Provision for Losses on Loans and determine if they pose a threat to manage- Guarantees ment's ability to make a positive assertion IBRD'saccumulated provision for losses on loans on the adequacy of internal controls sur- rounding IBRD's external financial report- and guarantees reflects the probable losses inherent ing. in its nonaccrual and accrual portfolios. There are several steps required to determine the appropriate The results of the work undertaken to evalu- level of provisions for each portfolio. First, the total ate the effectivenessof internal controls over loan portfolio is segregated into the accrual and financial reporting are reported to the Audit nonaccrual portfolios. In both portfolios, the Committee through an annual report. exposure for each country (definedas loans On a periodic basis, operational risks and outstanding plus the present value of guarantees) is controls are assessed and reviewedto moni- then assigned a credit risk rating. With respect to tor significant changes. loans in the accrual portfolio, these loans are grouped Internal Control Over FinancialReporting according to the assigned risk rating. Each risk rating is mapped to an expected default frequency using Management has carried out an evaluation of IBRD'scredit migration matrix. The provision internal control over external financial reporting for required is calculated by multiplying the outstanding the purpose of determining if there were any changes exposure, by the expected default frequency made in internal controls during the fiscal year (probabilityof default to IBRD) and by the assumed coveredby this report, that had materially affected,or severity of the loss given default. would be reasonably likelyto materially affect IBRD's internal control over external financial reporting. As The determination of a borrower's risk rating is based of June 30,2005 no such significant changes on both quantitative and qualitative analyses of occurred. various factors, which include political risk, external debt and liquidity, fiscal policy and public debt burden, balance of payments risks, economic prices and parameters; ensuring that valuation structure and growth prospects, monetary and models are reviewed and validated both internally exchange rate policy, financial sector risks and and externally; and applying its approach corporate sector debt and other vulnerabilities. IBRD consistently from period to period. periodically reviews such factors and reassesses the Pension and Other Postretirement Benefits adequacy of the accumulated provision for losses on IBRD participates along with IFC and MIGA in loans and guarantees accordingly.Actual losses may pension and postretirement benefit plans that cover differ from expected losses due to unforeseen substantially all of their staff members. All costs, changes in any of the factors that affect borrowers' assets and liabilities associated with the plans are creditworthiness. allocated between IBRD, IFC and MIGA based upon The accumulated provision for loan losses is their employees' respectiveparticipation in the plans. separately reported in the balance sheet as a Costs allocated to IBRD are subsequently shared deduction from IBRD's total loans. The accumulated between IBRD and IDA based on an agreed cost provision for losses on guarantees is included in sharing ratio. The underlying actuarial assumptions other liabilities. Increases or decreasesin the used to determine the projected benefit obligations, accumulated provision for losses on loans and fair value of plan assets and funded status associated guarantees are reported in the Statement of Income with these plans are based on financial market as provision for losses on loans and guarantees. interest rates, past experience, and management's Additional information on IBRD's provisioning best estimate of future benefit changes and economic policy and the status of nonaccrual loans can be conditions. For further details, please refer to Notes found in the Notes to Financial Statements-Note A- to Financial Statements-Note K-Pension and Other Summary of Significant Accounting and Related Postretirement Benefits. policies and Note D-Loans, Guarantees and Derivatives for Borrowers. 8. RESULTS OF OPERATIONS Fair Value of Financial Instruments In FY 2005, operating income declined to $1,320 million as releasesof provisions contributedless than Under the current value basis of reporting, IBRD in FY 2004 and net interest income narrowed. Net carries all of its financial assets and liabilities at income on a reported basis was $3,831 million in FY estimated values. Under the reported basis, IBRD 2005 compared to a net loss of $2,404 in FY 2004. carries its investments and derivatives,as defined by This reflects IBRD's application of FAS 133 and the FAS 133, on a fair value basis. These derivatives decrease in reference market rates. For more details include certain features in debt instruments that, for please refer to Net Unrealized Gains (Losses)on accounting purposes, are separately valued and Non-trading (Borrowings Related) Derivative accounted for as either assets or liabilities.When Instruments, as required by FAS 133 and IAS 39 possible, fair value is determined by quoted market discussed later in this section. prices. If quoted market prices are not available, then fair value is based on discounted cash flow models Interest Rate Environment using market estimates of cash flows and discount During FY 2005, short-term interest rates for the U.S. rates. dollar werehigher than for the comparative period in All the financial models used for input to IBRD's FY 2004. In addition, while interest rates were on a financial statements are subject to both internal and rising trend during FY 2005, they were essentiallyflat external verification and review by qualified during the first nine months of FY 2004 and rising personnel. These models use market sourced inputs, only in the last quarter of FY 2004. Figure 11 such as interest rates, exchange rates and volatilities. illustrates these general trends for the six-month Selection of these inputs may involve some LIBOR U.S dollar rates. judgement. Imprecision in estimating these factors, and changes in assumptions, can impact net income and IBRD's financial position as reported in the financial statements. IBRD believes its estimates of fair value are reasonable given its processesfor obtaining external IBRD MANAGEMENT'S DISCUSSION AND ANALYSIS: JUNE30, 2005 33 During FY 2003 the overall reduction in provision loan products and the effect of lower market interest for losses on loans and guarantees amounted to rates. Lower average loan balances, particularlyin $1,300 million, resulting from the following factors. higher-yielding loan products, as well as lower The provisioning requirements were reduced by$709 margins from cost pass-through products, also million due primarily to a net improvement in contributed to the decline in net interest income. borrowers' risk ratings, and to a lesser extent due to The margins for cost pass-through products in FY changes in the size and distribution of the portfolio 2003 were high, in part reflectingthe effect of including negative net disbursements (of which favorableinterest rate repricing lags in a falling prepayments were $6,972 million). In addition, the interest rate environment as well as significant provisioning requirements for BiH and SAM were prepayment premium income. reassessedin FY2003, resulting in an additional $591 Net Noninterest Expense million being taken into income (seeSection 6- Financial Risk Management). The main components of net noninterest expense are presented in Table18. Net Interest Income FY 2005 versus FY 2004 FY 2005 versus FY 2004 Net noninterest expense increased by $41 million Loan interest income, net of funding costs, decreased primarily due to a $75 million increase in staff costs by $270 million largely due to lower returns on the and operational travel. This was offset by a $40 debt funded component of loans, as a result of the million increase in servicefee revenues and other net lower lending rates of the cost pass-through loan income. products. Lower average loan balances, particularly in higher-yielding loan products, also contributed to FY 2004 versus FY 2003 the decline in net interest income. The margins for Net noninterest expense increased by $42 million cost pass-through products in FY 2004 were high, in primarily due to a $27 million increase in other part reflecting the effect of favorableinterest rate administrative expenses,a $23 million increase in repricing lags in a fallinginterest rate environment. contributions to Special Programs and a $14 million FY 2004 versus FY 2003 increase in staff costs and operational travel.Thiswas offset by a $33 million increase in service fee Loan interest income, net of funding costs, decreased revenues and other net income. by $560 million largely due to lower returns on the equity funded component of loans, as a result of both the lower lending rates of the cost pass-through Table 18: Net Noninterest Expense In m~ll~onsof U.S.dollars Gross Administrative Expenses Staff Costs Operational Travel Consultant Fees Pension and other postretirement benefits Contributions to Special Programs Communications and IT Contractual Services Equipment and Buildings Other Expenses Total Gross Administrative Expenses Less: Contribution to Special Programs Total Net Administrative Expenses Contribution to Special Programs Service Fee Revenues Net Other Income Total Net Noninterest Expense Audit Committee ongoing basis and revisedits terms of referencein FY Membership 2004. The Audit Committee consists of eight members of Communications the Board of ExecutiveDirectors. Membership on the The Audit Committee communicates regularly with Committee is determined by the Board of Executive the full Board through distribution of the following: Directors, based upon nominations by the Chairman of the Board, following informal consultation with The minutes of its meetings. the Executive Directors. In addition, membership of Reports of the Audit Committee prepared the Committee is expected to reflect the economic by the Chairman, which document discus- and geographic diversity of IBRD'smember sions held. These Reports are distributed to countries. Other relevant selection criteria include the Executive Directors, Alternates, World seniority, continuity and relevant experience. Some Bank Group Senior Management and Vice or all of the responsibilities of individual committee Presidents of IBRD. members are performed by their alternates or "Statement(s) of the Chairman" and state- advisors. Generally,Committee members are ments issued by other members of the appointed for a two year term; reappointment to a Committee. second term, when possible, is desirable for The Annual Report to the Board of Execu- continuity. Audit Committee meetings are generally tive Directors, which provides an overview open to any member of the Board who may wish to of the main issues addressed by the Com- attend, and non-Committee members of the Board mittee over the year. may participate in the discussion. In addition, the The Audit Committee's communications with the Chairman of the Audit Committee may speak in that external auditor are described in the Auditor capacity at meetings of the Board of Executive Independence section. Directors, with respect to discussions held in the Audit Committee. Executive Sessions Key Responsibilities Members of the Committee may convene in executive session at any time, without management The Audit Committee is appointed by the Board to present. Under the Committee's terms of reference,it assist it in the oversight and assessment of IBRD's meets separately in executive session with the finances and accounting, including the effectiveness external and internal auditors. of financial policies, the integrity of financial statements, the system of internal controls regarding Access to Resourcesand to Management finance, accounting and ethics (including fraud and Throughout the year, the Audit Committee receives a corruption), and financial and operational risks. The large volume of information, which supports the Audit Committee also has the responsibility for preparation of the financial statements. The Audit reviewingthe performance and recommending to Committee meets both formally and informally the Board the appointment, of the external auditor, throughout the year to discuss financial and as well as monitoring the independence of the accounting matters. Executive Directors have external auditor and meeting with it in executive complete access to management. The Audit session. The Audit Committee participates in Committee reviews and discusseswith management oversight of the internal audit function, including the quarterly and annual financial statements. The reviewingthe responsibilities, staffing and the Committee also reviewswith the external auditor the effectiveness of internal audit. The Committee also financial statements prior to their publication and reviews the annual internal audit plan and meets recommends them for approval to the Board of with the Auditor General in executive session. In the Executive Directors. execution of its role, the Committee discusseswith management, the external auditors, and the internal The Audit Committee has the capacity, under auditors, financial issues and policies which have a exceptional circumstances, to obtain advice and bearing on the institution's financial position and assistance from outside legal, accounting or other risk-bearing capacity. The Audit Committee advisors as deemed appropriate. monitors the evolution of developments in corporate Code of Ethics governance and the role of audit committees on an IBRD strives to foster and maintain a positive work environment that supports the ethical behavior of its IBRD MANAGEMENT'S DISCUSSIONAND ANALYSIS: JUNE30, 2005 37 staff. To facilitate this effort, IBRD has in place a IBRD offers both the Ethics HelpLine, as well as a Code of Professional Ethics-Livingour Values. The Fraud and Corruption hotline run byan outside firm Code applies to all staff (including managers, staffed by trained specialists.This third-party service consultants, and temporary employees) worldwide. offers numerous methods of communication in addition to a toll free hotline in countries where This Code is available in nine languages on IBRD's access to telecommunications may be limited. In website,www.worldbank.org. Staff relations, addition there are other methods by which the conflictsof interest, and operational issues,including Department of Institutional Integrity may receive the accuracy of books and records, are key elements allegations, including directly by email, of the Code. anonymously, or through confidential submission In addition to the Code, an essential element of through its website, as well as the postal service and appropriate conduct is compliance with the telephone. obligations embodied in the Principles of Staff Auditor Independence Employment, Staff Rules, and Administrative Rules, the violation of which may result in disciplinary In FY 2003, the Board of ExecutiveDirectorsadopted actions. In accordance with the Staff Rules,senior a set of principles applicable to the appointment of managers must complete a confidential financial the external auditor for IBRD. Key features of those principles include: disclosure instrument with the Office of Ethics and Business Conduct. Prohibition of the external auditor from the provision of all non audit-related services. Guidance for staff is also provided through programs, training materials, and other resources. All audit-related services must be pre- Managers are responsible for ensuring that internal approved on a case-by-case basis by the systems, policies, and procedures are consistently Board of Executive Directors, upon recom- aligned with IBRD'sethical goals. In support of its mendation of the Audit Committee. efforts on ethics, IBRD offers a variety of methods Mandatory rebidding of the external audit for informing staff of these resources. Many of these contract every five years. efforts are headed by the following groups: Prohibition of any firm serving as external The Office of Ethics and Business Conduct auditors for more than two consecutive five- provides leadership, management and over- year terms. sight for IBRD'sethics infrastructure Mandatory rotation of the senior partner including the Ethics HelpLine, a consoli- after five years. dated conflicts of interest disclosure/resolu- tion system, financial disclosure, ongoing An evaluation of the performance of the training to both internal and external audi- external auditor at the mid-point of the five ences, and communication resources. year term. The Department of Institutional Integrityis In FY 2004, IBRD's external auditor, Deloitte and charged with investigating allegations of Touche, began a new five-year term and will have fraud and corruption in IBRD-funded served 11 years as auditor upon completion of that projects worldwide. The Department also term, pursuant to a one-time grandfathered investigatesallegations of misconduct by exemption from the above-referenced ten-year limit. IBRD staff, and trains and educates staff Even within a five-year term the service of the and clients in detecting and reporting fraud external auditors is subject to recommendation by and corruption in IBRD-funded projects. the Audit Committee for annual reappointment and The Department reports directly to the President and is composed of professionals approval of a resolution by the Board of Executive from a range of disciplines including finan- Directors. cial analysts, researchers, investigators, law- As a standard practice, the external auditor is present yers, prosecutors, forensic accountants, and as an observer at virtually all Audit Committee IBRD staff with operational experience. meetings and is frequently asked to present its IBRD has in place procedures for the receipt, perspective on issues. In addition, the Audit retention and treatment of complaints received Committee meets periodically with the external regarding accounting, internal control and auditing auditor in private session without management matters. present. Communication between the external auditor and the Audit Committee is ongoing, as Presentation of a statement regarding inde- frequently as is deemed necessary by either party. pendence. IBRD'sauditors follow the communication In addition to Committee meetings, individual requirements with audit committees set out under members of the Audit Committee have independent U.S. generallyaccepted auditing standards and access to the external auditor. International Standards on Auditing. In keepingwith these standards, significant formal communications 10. RECONCILIATION OF PRIOR YEAR include: CURRENTVALUE FINANCIALSTATEMENTS TO Quarterly and annual financial statement REPORTED BASIS reporting. IBRD's Condensed Current Value Balance Sheet at Annual appointment of the external audi- June 30,2004 is presented, with a reconciliation to tors. the reported basis, in Table 19 below. Similarly, IBRD's Condensed Current Value Statement of Presentation of the external audit plan. Income for the year ended June30,2004 is presented, Presentation of control recommendations with a reconciliation to the reported basis, in Table and discussion of the COSO attestation and 20. report. Table 19: Condensed Current Value Balance Sheet at June 30,2004 In m1111onsof U.S. dollars June 30, 2004 Reported Reversalo f FAS Current Value Current Bas15 133 Effects Adlustments Value Bas15 Cash $ 1,803 $ 1,803 lnvestments 31,986 31,986 Loans Outstanding 109,610 $ 2,998 112,608 Less Accumulated Provlslon for Loan Losses and Deferred Loan Income Swaps Receivable lnvestments Loans Borrowlngs Other Asset/L~ab~l~ty Other Assets Total Assets Borrowlngs Swaps Payable lnvestments Loans Borrowlngs Other Asset/L~ab~l~ty Other Llabllltles Total Llabllltles Pald In Capltal Stock Retalned Earnlngsand Other Equlty Total Equlty Total Llabllltles and Equlty * Ind~catesamounts leas that $0.5 m1111on Table 20: Condensed Current Value Statement of lncome for the year ended June 30,2004 In m1111onsof U.S.dollars Reported Current Value Comprehenslve Adjustments to Comprehenslve Bas15 Current Value Bas15 lncome from Loans $4,403 $4,403 lncome from Investments, net 304 250 Other lncome 235 235 Total lncome 4.942 4.888 Borrowing Expenses Admlnlstratlve Expenses Release of Provlslon for Losses on Loans and Guarantees Other Expenses Total Expenses Operating lncome Current Value Adjustments Release of Provlslon for Losses on Loans and Guarantees- Current Value Net unrealized galns (losses) on non-tradlng (borrowings related) derlvatlve Instruments as requlred by FAS 133 and IAS 39 Net (Loss) lncome GLOSSARY OF TERMS Asset-backedSecurities:Asset-backedsecurities are instru- scription, of certain restricted currencies. Additional pay- ments whose cash flow is based on the cash flows of a pool ments to (or from) IBRD are required in the event the par of underlying assets managed by a trust. value of the currency is reduced (or increased) to a signifi- cant extent, in the opinion of IBRD. Currency Swaps (includingCurrency ForwardContracts): Currency swaps are agreements between two parties to Net Disbursements:Loan disbursements net of repay- exchangecash flows denominated in different currencies at ments and prepayments. one or more certain times in the future. The cash flows are NewLoans:Loansfor which the invitation to negotiate was based on a predetermined formula reflecting rates of inter- issued on or after July31, 1998. est and an exchangeof principal. Old Loans:Loansfor which the invitation to negotiate was Duration:Duration provides an indication of the interest issued prior to July31, 1998. rate sensitivity of a fixed income security to changes in its underlying yield. Options:Options are contracts that allow the holder of the option the right, but not the obligation, to purchase or sell Equity-to-LoansRatio:This ratio is the sum of usable cap- a financial instrument at a specified price within a specified ital plus the special and general reserves,cumulative trans- period of time from or to the seller of the option. The pur- lation adjustment (excluding amounts associated with chaser of an option pays a premium at the outset to the applying the provisions of FAS 133) and the proposed seller of the option, who then bears the risk of an unfavor- transfer from unallocated net income to general reserves able change in the price of the financial instrument under- divided by the sum of loans outstanding, the present value lying the option. of guarantees, net of the accumulated provision for losses on loans and guarantees and deferred loan income. Repurchase and Resale Agreements and SecuritiesLoans: Repurchase agreements are contracts under which a party Failed Trades: Failed trades are securities transactions that sells securities and simultaneously agrees to repurchase the do not settle on the contractual settlement date. same securities at a specified future date at a fixed price. FAS 133: FAS133 refers collectively to the Statement of The reverse of this transaction is called a resale agreement. Financial Accounting Standards No. 133, "Accountingfor A resale agreement involves the purchase of securities with DerivativeInstruments and Hedging Activities",along with a simultaneous agreement to sell back the same securities its amendments, as well as the derivative accounting at a stated price on a stated date. Securities loans are con- requirements of International Accounting Standard (IAS) tracts under which securities are lent for a specified period 39, "Financial Instruments: Recognition and Measure- of time at a fixed price. ment" and its subsequent amendments. Returnon Equity:This return is computed as net income Forward Starting Swaps:A forward starting swap is an divided by the average equity balance during the year. agreement under which the cash flow exchanges of the Risk-bearing Capacity:The ability to absorb risks in the underlying interest rate swaps would begin to take effect balance sheet while continuing normal operations without from a specified future date. having to call on callablecapital. Futures:Futures are contracts for deliveryof securities or Short Sales:Short sales are sales of securities not held in money market instruments in which the seller agrees to the seller's portfolio at the time of the sale. The seller must make deliveryat a specified future date of a specified purchase the security at a later date and bears the risk that instrument at a specified price or yield. Futures contracts the market value of the security will move adversely are traded on U.S. and international regulated exchanges. between the time of the sale and the time the security must GovernmentandAgency Obligations:These obligations be delivered. include marketable bonds, notes and other obligations Statutory LendingLimit:Under IBRD's Articles of Agree- issued by governments. ment, as applied, the total amount outstanding of loans, Hedging:Hedging is a risk management technique of participations in loans, and callable guarantees may not entering into offsetting commitments to eliminate or mini- exceed the sum of subscribed capital, reserves and surplus. mize the impact of adverse movements in value or cash Swaptions:A swaptionis an option that gives the holder flow of the underlying. the right to enter into an interest rate or currency swap at a InterestRate Swaps:Interest rate swaps are agreements certain future date. involving the exchangeof periodic interest payments of dif- Time Deposits:Time deposits include certificatesof fering character, based on an underlying notional principal deposit, bankers' acceptances, and other obligations issued amount for a specified time. or unconditionally guaranteed by banks and other finan- LIBOR:London interbank offered rate. cial institutions. Maintenanceof Value:Agreements with members provide for the maintenance of the value, from the time of sub- IBRD MANAGEMENT'S DISCUSSION AND ANALYSIS: JUNE30, 200541 ~ N T E R N A T ~ ~ NB A N K FOR R ECO N ST RU CT I O N L A N D D EVELOPM ENT F I N A N CI A L ~ T A T E M E N T SA N D 1 N T ERN A L C O N TRO L R EP O RT S J U N E 30, 2 0 0 5 Management's Report Regarding Effectiveness of lnternal Controls Over External Financial Reporting 44 Report of lndependent Accountants on Management's Assertion Regarding Effectiveness of lnternal Controls Over External FinancialReporting 46 Report of IndependentAccountants 47 Balance Sheet 48 Statement of Income 50 Statement of ComprehensiveIncome 51 Statement of Changes in Retained Earnings 51 Statement of Cash Flows 52 SummaryStatement of Loans 54 Statement of Subscriptionsto Capital Stock and Voting Power 57 Notes to FinancialStatements 61 The World Bank 1818 H Street N.W. (202)477-1234 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Washington, D.C. 20433 Cable Address: INTBAFRAD INTERNATIONALDEVELOPMENT ASSOCIATION U.S.A. Cable Address: INDEVAS Management's Report Regarding Effectivenessof Internal ControlsOver External FinancialReporting August 4,2005 The management of the International Bank for Reconstruction and Development (IBRD) is responsible for the preparation, integrity, and fair presentation of its published financial statements and all other information presented in the accompanying Management's Discussion and Analysis. The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and International Financial ~ e ~ o r tStandards and, as such, include amounts based on informed judgments and estimates i n ~ made by management. The financial statements have been audited by an independent accounting firm, which was given unrestricted access to all financial records and related data, including minutes of all meetings of the Board of Executive Directors and committees of the Board. Management believes that all representations made to the independent auditors during their audit were valid and appropriate. The independent auditors' report accompanies the audited financial statements. Management is responsible for establishing and maintaining effective internal control over external financial reporting for financial presentations in conformity with both accounting principles generally accepted in the United States of America and International Financial Reporting Standards. The system of internal control contains monitoring mechanisms, and actions are taken to correct deficiencies identified. Management believes that internal controls for external financial reporting, which are subject to scrutiny by management and the internal auditors, and are revised as considered necessary, support the integrity and reliability of the external financial statements. There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time. IBRD assessed its internal control over external financial reporting for financid presentations in conformity with both accounting principles generally accepted in the United States of America and International Financial Reporting Standards as of June 30, 2005. This assessment was based on the criteria for effective internal control over external financial reporting described in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based upon this assessment, management believes that IBRD -2- August 4,2005 maintained effective internal control over external financial reporting presented in conformity with both accounting principles generally accepted in the United States of America and International Financial Reporting Standards, as of June 30, 2005. The independent accounting firm that audited the financial statements has issued an attestation report on Management's assessment of IBRD's internal control over external financial reporting. The Board of Executive Directors of IBRD has appointed an Audit Committee responsible for monitoring the accounting practices and internal controls of IBRD. The Audit Committee is comprised entirely of Executive Directors who are independent of IBRD's management. The Audit Committee is responsible for recommending to the Board of Executive Directors the selection of independent auditors. It meets periodically with management, the independent auditors, and the internal auditors to ensure that they are carrying out their responsibilities. The Audit Committee is responsible for performing an oversight role by reviewing and monitoring the financial, accounting and auditing procedures of IBRD in addition to reviewing IBRD's reports. The independent auditors and the internal auditors have full and free access to the Audit Committee, with or without the presence of management, to discuss the adequacy of internal control over external financial reporting and any other matters which they believe should be brought to the attention of the Audit Committee. Vice ~ U d e nand Acting Chief Financial Officer t ~ a ~ e zH.lChoudhury u Charles A. ~ c ~ o n h ~ h Vice President and Controller Director, Accounting Department IBRD FINANCIAL STATEMENTS: JU NE30, 2005 45 Deloitte &Touche LLP Sulte 500 555 12th Street NW Washington. DC 20004-1207 USA Tel: +1 202 879 5600 Fax: +1 202 879 5309 www.deloitte corn INDEPENDENT ACCOUNTANTS' REPORT President and Board of Governors International Bank for Reconstruction and Development We have examined management's assertion, included in the accompanying Management S Report Regarding Effectiveness of Internal Controls over External Financial Reporting, that the International Bank of Reconstruction and Development maintained effective internal control over external financial reporting presented in conformity with both accounting principles generally accepted in the United States of America and International Financial Reporting Standards as of June 30,2005, based on the criteria established in "Internal Control-Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO report). Management is responsible for maintaining effective internal control over external financial reporting. Our responsibility is to express an opinion on management's assertion based on our examination. Our examination was conducted in accordance with attestation standards established by the American Institute of Certified Public Accountants and, accordingly, included obtaining an understanding of internal control over financial reporting, testing, and evaluating the design and operating effectiveness of the internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our examination provides a reasonable basis for our opinion. Because of the inherent limitations of internal control over external financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may occur and not be detected. Also, projections of any evaluation of the effectiveness of the internal control over external financial reporting to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assertion that the International Bank for Reconstruction and Development maintained effective internal control over external financial reporting presented in conformity with both accounting principles generally accepted in the United States of America and International Financial Reporting Standards as of June 30,2005, is fairly stated, in all material respects, based on the criteria established in "Internal Control - Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission. August 4,2005 Member of Deloitte Touche Tohmatsu Oeloitte & Touche LLP Suite 500 555 12th Street NW Washington, DC 20004-1207 USA Tel: +1 202 879 5600 Fax: +1 202 879 5309 www.deloitte corn INDEPENDENT AUDITORS' REPORT President and Board of Governors International Bank for Reconstruction and Development We have audited the accompanying balance sheets of the International Bank for Reconstruction and Development as of June 30,2005 and 2004, including the summary statement of loans and the statement of subscriptions to capital stock and voting power as of June 30,2005, and the related statements of income, comprehensive income, changes in retained earnings, and cash flows for each of the three fiscal years in the period ended June 30, 2005. These financial statements are the responsibility of the International Bank for Reconstruction and Development's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America and International Standards on Auditing. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of the International Bank for Reconstruction and Development as of June 30,2005 and 2004, and the results of its operations and its cash flows for each of the three fiscal years in the period ended June 30,2005 in conformity with accounting principles generally accepted in the United States of America and International Financial Reporting Standards. August 4,2005 Member of Deloitte Touche Tohmatsu B A L A N C E S H E E T June 30,2005 and June 30,2004 Expressed in millions o f U.S. dollars Assets Due from Banks Unrestricted currencies Currencies subject to restrictions-Note B Investments-Trading-Notes Cand G Securities Purchased Under Resale Agreements-Note C Nonnegotiable, Noninterest-bearing Demand Obligations on Account of Subscribed Capital Receivable from Currency and Interest Rate Swaps Investments-Notes C and G Loans-Notes D and G Borrowings-Notes E and G Other AssetILiability-Notes F and G Receivable to Maintain Value of Currency Holdings on Account of Subscribed Capital Other Receivables Receivable from investment securities traded Note C - Accrued income on loans Loans Outstanding (see Summary Statement of Loans, Notes D and G) Total loans Less undisbursed balance Loans outstanding Less: Accumulated provision for loan losses Deferred loan income Net loans outstanding Other Assets Unamortized issuance costs of borrowings Prepaid pension cost-Note K Premises and equipment (net) Miscellaneous Total assets Liabilities Borrowings-Notes Eand G Short-term Medium- and long-term Payable for Currency and Interest Rate Swaps Investments-Notes C and G Loans-Notes D and G Borrowings-Notes E and G Other AssetILiability-Notes F and G Payable to Maintain Value of Currency Holdings on Account of Subscribed Capital Other Liabilities Payable for investment securities purchased - Note C Accrued charges on borrowings Payable for transfers approved by the Board of Governors-Note H Liabilities under other postretirement benefits plans-Note K Accounts payable and miscellaneous liabilities-Notes D and K Total liabilities Equity Capital Stock (see Statement of Subscriptions to Capital Stock and Voting Power, Note B) Authorized capital (1,581,724 shares-June 30, 2005, and June 30, 2004) Subscribed capital (1,572,661 shares-June 30, 2005, and June 30, 2004) Less uncalled portion of subscriptions Amounts to Maintain Value of Currency Holdings-Note B 46 (73) Retained Earnings (see Statement of Changes in Retained Earnings, Note H) 27,171 23,982 Accumulated Other Comprehensive (Loss)Income-Note M Total equity Total liabilities and equity $222,008 $228,910 The Notes to Financial Statements are an integral part of these Statements. IBRD FINANCIALSTATEMENTS: JU NE30, 2005 49 For the fiscalyears endedJune 30, 2005, June 30, 2004 andJune 30, 2003 Expressed in millions o f U.S. dollars Income Loans-Note D lnterest Commitment charges Investments-Trading-Note C lnterest Net losses Other-Notes l and J Total income Expenses Borrowings-Note E lnterest Amortization of issuance and other borrowing costs Administrative-Notes I, J and K Contributions to special programs-Note I 173 179 156 Release of provision for losses on loans and guarantees-Note D (502) (665) (1,300) Other 5 9 9 Total expenses 3,734 3,246 3,341 Operating income 1,320 1,696 3,021 Net unrealized gains (losses)on non-trading (borrowings related) deriva- tive instruments,as required by FAS 133 and /AS39-Note N 2,511 (4,100) 2,323 Net income (loss) $3,831 $(2,404) $5,344 The Notes to Financial Statements are an integral part of these Statements. 50 THE WORLD BANK ANNUAL REPORT 2005 S T A T E M E N T O F C O M P R E H E N S I V E IN C O M E For the fiscalyears endedJune 30, 2005, June 30, 2004 andJune 30, 2003 Expressed in millions o f U.S. dollars 2005 Net income (loss) $3,831 Other comprehensive income-Note M Reclassification of FAS 133 transition adjustment to net income (44) Currency translation adjustments Total other comprehensive (loss) income Comprehensive income (loss) S T A T E M E N T O F C H A N G E S I N R E T A I N E D E A R N I N G S For the fiscalyears endedJune 30, 2005, June 30, 2004 andJune 30, 2003 Expressed in millions o f U.S. dollars Retained earnings at beginning of the fiscal year Transfers approved by the Board of Governors-Note H International Development Association Heavily Indebted Poor Countries Debt Initiative Trust Fund Trust Fund for Gaza and West Bank Low-Income Countries Under Stress Implementation Trust Fund Debt Reduction Facility for IDA-Only Countries Trust Fund for Liberia Multi-Donor Trust Fund for Aceh and North Sumatra Trust Fund for Tsunami Disaster Recovery in India Net income (loss) for the fiscal year Net income (loss) less transfers approved by the Board of Governors Retained earnings at end of the fiscal year The Notes to FinancialStatements are an integralpart of these Statements. IBRD FINANCIALSTATEMENTS: JU NE30, 2005 51 For the fiscalyears endedJune 30, 2005, June 30, 2004 andJune 30, 2003 Expressed in millions o f U.S. dollars Cash flows from investing activities Loans Disbursements Principal repayments Principal prepayments Loan origination fees received Net cash provided by investing activities Cash flows from financing activities Medium- and long-term borrowings New issues Retirements Net short-term borrowings Net currency and interest rate swaps-Borrowings Payments for transfers approved by the Board of Governors New capital subscriptions Net maintenance of value settlements Net cash used in financing activities Cash flows from operating activities Net income (loss) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities Net unrealized (gains) losses on non-trading (borrowings related) derivative instruments, as required by FA5 133 and IAS 39 Depreciation and amortization Release of provision for losses on loans and guarantees Changes in: Investments-Trading Net investment securities tradedlpurchased-Trading Net currency and interest rate swaps-Investments Net securities purchasedlsold under resalelrepurchase agreements and payable for cash collateral received Accrued income on loans Miscellaneous assets Accrued charges on borrowings Accounts payable and miscellaneous liabilities Net cash provided by (used in) operating activities 5,856 Effect of exchange rate changes on unrestrictedcash Net (decrease) increase in unrestrictedcash (633) (121) 844 Unrestricted cash at beginning of the fiscal year Unrestricted cash at end of the fiscal year Supplemental disclosure Increase (decrease) in ending balances resulting from exchange rate fluctuations Loans outstanding $ (78) $ 1,778 $ 2,647 Investments-Trading 322 771 1,205 Borrowings 1,378 4,095 4,922 Currency and interest rate swaps-Investments (294) (805) (1,086) Currency and interest rate swaps-Borrowings (1,435) (2,866) (3,194) Capitalized loan origination fees included in total loans 43 85 112 The Notes to Financial Statements are an integral part of these Statements. IBRD FINANCIAL STATEMENTS: JUNE 30, 2005 53 PURPOSE AND AFFILIATED ORGANIZATIONS valuation of certain financial instruments, the determination of the adequacy of the accumulated The International Bank for Reconstruction and provision for losses on loans and guarantees, the Development (IBRD) is an international organization determination of net periodic income from pension which commenced operations in 1946. The principal and other postretirement benefits plans, and the purpose of IBRD is to promote sustainable economic present value of benefit obligations. development and reduce poverty in its member countries, primarily by providing loans, guarantees Certain reclassificationsof the prior years' and related technical assistancefor specificprojects information have been made to conform with the and for programs of economic reform in developing current year's presentation. member countries. The activities of IBRD are Translation of Currencies:IBRD's financial complemented by those of three affiliated statements are expressedin terms of U.S. dollars solely organizations, the International Development for the purpose of summarizing IBRD's financial Association (IDA),the International Finance position and the results of its operations for the Corporation (IFC),and the Multilateral Investment convenience of its members and other interested Guarantee Agency (MIGA). Each of these parties. organizations is legally and financially independent from IBRD, with separate assets and liabilities,and IBRD is an international organization which conducts IBRD is not liable for their respectiveobligations. its operations in the currencies of all of its members. Transactions with these affiliates are disclosed in the IBRD's resources are derived from its capital, notes that follow. IDA'Smain goal is to reduce poverty borrowings, and accumulated earnings in those through promoting sustainable economic various currencies. IBRD has a number of general development in the less developed areas of the world policies aimed at minimizing exchange rate risk in a included in IDA'S membership by providing a multicurrency environment. IBRD matches its combination of grants and financing on borrowing obligations in any one currency (after concessionary terms. IFC's purpose is to encourage swaps) with assets in the same currency, as prescribed the growth of productive private enterprises in its by its Articles of Agreement. In addition, IBRD member countries through loans and equity periodically undertakes currency conversions to more investments in such enterprises without a member's closely match the currencies underlying its Equity guarantee. MIGA was established to encourage the with those of the net loans outstanding. flow of investments for productive purposes between Assetsand liabilities are translated at market exchange member countries and, in particular, to developing rates in effect at the end of the period. Income and member countries by providing guarantees against expenses are translated at either the market exchange noncommercial risks for foreign investment in its rates in effect on the dates on which they are developing member countries. recognized or at an average of the market exchange rates in effect during each month. Translation NOTE A-SUMMARY OF SIGNIFICANT adjustments are charged or credited to Accumulated ACCOUNTING AND RELATED POLICIES Other Comprehensive Income. IBRD's financial statements are prepared in Valuation of Capital Stock:In the Articles of conformity with the accounting principles generally Agreement, the capital stock of IBRD is expressed in accepted in the United States of America (U.S.GAAP) terms of "U.S. dollars of the weight and fineness in and with International Financial Reporting Standards effect on July1, 1944" (1944 dollars). Followingthe (IFRS). On August 4,2005, the Executive Directors abolition of gold as a common denominator of the approved these financial statements for issue. monetary system and the repeal of the provision of the The preparation of financial statements in conformity U.S. law defining the par value of the U.S. dollar in with generallyaccepted accounting principles requires terms of gold, the pre-existing basis for translating management to make estimates and assumptions that 1944 dollars into current dollars or into any other affect the reported amounts of assets and liabilities currency disappeared. The Executive Directors of and disclosure of contingent assets and liabilities at IBRD have decided, until such time as the relevant the date of the financial statements and the reported provisions of the Articles of Agreement are amended, amounts of income and expensesduring the reporting that the words "U.S. dollars of the weight and fineness period. Actual results could differ from these in effect on July1, 1944" in Article 11,Section 2(a)of estimates. Significant judgments have been used in the the Articles of Agreement of IBRD are interpreted to IBRD FINANCIAL STATEMENTS: JUNE 30, 2005 61 mean the Special Drawing Right (SDR)introduced by The Pension Reserve consists of the difference the International Monetary Fund, as valued in terms between the cumulative actual funding of the Staff of U.S. dollars immediatelybefore the introduction of Retirement Plan (SRP)and other postretirement the basket method of valuing the SDR on July1, 1974, benefits plans, and the cumulative accounting income such value being $1.20635 for one SDR (1974SDR). or expense for these plans, from prior fiscalyears. This Pension Reserve is reduced when pension accounting Maintenance of Value: Article 11,Section 9 of the expenses exceed the actual funding of these plans. Articles ofAgreement provides for maintenance of the value (MOV),at the time of subscription, of restricted Surplus consists of earnings from prior fiscal years currencies (see Note B). Maintenance of value which are retained by IBRD until a further decision is amounts are determined by measuring the foreign made on their disposition or the conditions of transfer exchangevalue of a member's currency against the for specified uses have been met. standard of value of IBRD capital based on the 1974 The Cumulative FAS 133 Adjustments consist of the SDR. Members are required to make payments to effects associated with the application of FAS 133" IBRD if their currencies depreciate significantly from prior years. At June 30,2005, this amount relative to the standard of value. Furthermore, the includes the one-time cumulative effect of the Executive Directors have adopted a policy of adoption of FAS 133 on July1,2000, the reimbursing members whose currencies appreciate reclassificationand amortization of the transition significantlyin terms of the standard of value. adjustments for prior fiscal years, and the unrealized The net MOV amounts relating to restricted gains or losses on certain derivative instruments, as currencies out on loan, invested, swapped, or loaned defined by FAS 133, for prior fiscal years. to the member by IBRD or through IFC, and amounts Unallocated Net Income consists of earnings in the that have been reclassified from receivables for those current fiscal year. Upon recommendation by the countries that have been in arrears for two years or Executive Directors, the Board of Governors, more, are included as a component of equity under consisting of one Governor appointed by each Amounts to Maintain Value of Currency Holdings. member, periodically approves transfers out of For restricted currencies used in IBRD's lending and unallocated Net Income and Surplus to various investing operations, these MOV amounts are shown entities for development purposes consistent with as a component of Equity since MOV becomes IBRD's Articles of Agreement. effective only as such currencies are repaid to IBRD. Transfers Approved by the Board of Governors: In Retained Earnings: Retained Earnings consists of accordance with IBRD's Articles of Agreement, the allocated amounts (SpecialReserve,General Reserve, Board of Governors may exerciseits reservedpower to Pension Reserve,Surplus and Cumulative FAS 133 approve transfers to other entities. Such transfers are Adjustments) and Unallocated Net Income. considered to be transactions with shareholders and The Special Reserve consists of loan commissions set accordingly are accounted for as &rect reductions to aside pursuant to Article IV, Section 6 of the Articles equity. of Agreement, which are to be held in liquid assets. Loans: All of IBRD's loans are made to or guaranteed These assets may be used only for the purpose of by members, except loans to IFC. The majority of meeting liabilities of IBRD on its borrowings and IBRD's loans have repayment obligations based on guarantees in the event of defaults on loans made, specificcurrencies. IBRD also holds multicurrency participated in, or guaranteed by IBRD. The Special loans which have repayment obligations in various Reserve assets are included under Investments- currencies determined on the basis of a currency Trading, and comprise obligations of the UnitedStates pooling system. Government, its agencies,and other official entities. The allocation of such commissions to the Special Any loan origination fees incorporated in a loan's Reserve was discontinued in 1964 with respect to terms are deferred and recognized over the life of the subsequent loans and no further additions are being loan as an adjustment of yield. However, incremental made to it. direct costs associated with originating loans are The General Reserve consists of earnings from prior a. For the purpose of this document, FAS 133 refers collectivelyto the Statement of Financial Accounting Standards (FAS)No. 133, fiscal years which, in the judgment of the Executive Accounting for Derivative Instruments and HedgingActivities, Directors, should be retained in IBRD's operations. along with its amendments, as well as the derivative accounting requirements of International Accounting Standard (IAS) 39, Financial Instruments: Recognition and Measurement. expensed as incurred as such amounts are considered overdue amount will be collected in the immediate insignificant. The unamortized balance of loan future. In addition, if development credits made by origination fees is included as a reduction of Loans IDA to a member government are placed in Outstanding on the balance sheet, and the loan nonaccrual status, all loans made to or guaranteed by origination fee amortization is included in Interest that member government will also be placed in under Income from Loans on the income statement. nonaccrual status by IBRD. On the date a member's loans are placed into nonaccrual status, unpaid It is IBRD's practice not to reschedule interest or interest and other charges accrued on loans principal payments on its loans or participate in debt outstanding to the member are deducted from the rescheduling agreements with respect to its loans. In income of the current period. Interest and other exceptional cases, however, such as when charges on nonaccruing loans are included in income implementation of a financed project has been onlyto the extent that payments havebeen receivedby delayed, the loan amortization schedule may be IBRD. If collectibility risk is considered to be modified to avoid substantial repayments prior to particularly high at the time of arrears clearance, the project completion. member's loans may not automatically emerge from In addition, during fiscal years 1996 and 2002, nonaccrual status, even though the member's exceptions were made to that practice with regard to eligibilityfor new loans may have been restored. In Bosnia and Herzegovina (BiH) and Serbia and such instances, a decision on the restoration of accrual Montenegro (SAM),formerly the Federal Republic of status is made on a case-by-case basis after a suitable Yugoslavia, respectively,in connection with their period of payment performance has passed from the succession to membership of the former Socialist time of arrears clearance. Federal Republic of Yugoslavia (SFRY). One Guarantees:IBRD generallyprovides guarantees of component of the financial assistance packages for loans undertaken for, or securities issued in support BiH and SAM was a plan for the clearance of arrears of, projects located within a member country eligible under all loans to the former SFRY for which they for IBRD loans, as well as loans undertaken or undertook responsibility. Under the arrears clearance securities issued by entities eligible for IBRD plans, the accumulated arrears on loans to the former development policy lending. These financial SFRY which were assumed by BiH and SAM were guarantees are commitments issued by IBRD to cleared through the issuance of new loans extended by guarantee payment performance by a borrower to a IBRD. IBRD's treatment of BiH and SAM was based third party. on criteria approved by the Executive Directors in connection with the financial assistance package for Guarantees are regarded as outstanding when the BiH in fiscal year 1996. These criteria limit eligibility underlying financial obligation of the borrower is for such treatment to a country: (a) that has emerged incurred, and called when a guaranteed party from a current or former member of IBRD; (b) that is demands payment under the guarantee. IBRD would assuming responsibility for a share of the debt of such be required to perform under its guarantees if the member; (c) that, because of a major armed conflict payments guaranteed were not made by the debtor in its territory involving extensive destruction of and the guaranteed party called the guarantee by physical assets, has limited creditworthiness for demanding payment from IBRD in accordance with servicing the debt it is assuming; and (d) for which the terms of the guarantee. In the event that a reschedulinglrefinancing would result in a significant guarantee is called, IBRD has the contractual right to improvement in its repayment capacity,if appropriate require payment from the member country that has supporting measures are taken. This treatment was provided the counter guarantee to IBRD on demand, based on a precedent established in 1975 after or as IBRD may otherwise direct. Bangladesh became independent from Pakistan. For guarantees issued or modified after December 31, IBRD does not believe that any other borrowers with 2002, in accordance with Financial Accounting loans in nonaccrual status currently meet these Standards Board (FASB) Interpretation No. 45 (FIN eligibilitycriteria. 45), Guarantor's Accounting and Disclosure It is the policy of IBRD to place in nonaccrual status Requirements for Guarantees, Including Indirect all loans made to or guaranteed by a member of IBRD Guarantees of Indebtedness to Others, IBRD records if principal, interest, or other charges with respect to the fair value of the obligation to stand ready, and a any such loan are overdue by more than six months, corresponding asset in the financial statements. unless IBRD management determines that the IBRD FINANCIALSTATEMENTS: JU NE30, 2005 63 For guarantees issued prior to January 1,2003, fee 2005 and June 30,2004, all investment securities were income received is deferred and amortized over the held in a trading portfolio. Investment securities and period of benefit. related financial instruments held in IBRD's trading portfolio are carried and reported at fair value, using IBRD records a contingent liability for the probable trade-date accounting. The first-in first-out (FIFO) losses related to guarantees outstanding. This method is used to determine the cost of securities sold provision, as well as the unamortized balance of the in computing the realized gains and losses on these deferred guarantee fee income, and the unamortized instruments. Unrealized gains and losses for balance of the obligation to stand ready, are included investment securities and related financial in Accounts Payableand Miscellaneous Liabilities on instruments held in the trading portfolio are included the balance sheet. in income. Derivative instruments are used in Accumulated Provision for Losses on Loans and liquidity management to take advantage of profitable Guarantees:Delaysin receivingloan payments result trading opportunities. These derivativesare carried at in present value losses to IBRD since it does not fair value. From time to time, IBRD enters into charge fees or additional interest on any overdue forward contracts for the sale or purchase of interest or loan charges. These present valuelosses are investment securities; these transactions are recorded equal to the difference between the present value of at the time of commitment. payments of interest and charges made according to Securities Purchased Under Resale Agreements the related loan's contractual terms and the present and Securities Sold Under Repurchase value of its expected future cash flows. IBRD has not Agreements and Payable for Cash Collateral written off any of its loans. Received:Securities purchased under resale Management determines the appropriate level of agreements, securities lent under securities lending accumulated provisions for losses on loans and agreements, and securities sold under repurchase guarantees. IBRD'saccumulated provision for losses agreements are recorded at historical cost. IBRD on loans and guarantees reflects the probable losses receives securities purchased under resale agreements, inherent in its nonaccrual and accrual portfolios. monitors the fair value of the securities and, if There are several steps required to determine the necessary, closes out transactions and enters into new appropriate level of provisions for each portfolio. repriced transactions. The securities transferred to First, the total loan portfolio is segregated into the IBRD under the repurchase and security lending accrual and nonaccrual portfolios. In both portfolios, arrangements and the securities transferred to the exposure for each country (defined as loans counterparties under the resale agreements have not outstanding plus the present value of guarantees) is met the accounting criteria for treatment as a sale. then assigned a credit risk rating. With respect to Therefore, securities transferred under repurchase countries with loans in the accrual portfolio, these agreements and security lending arrangements are loans are grouped according to the assigned borrower retained as assets on IBRD'sbalance sheet, and risk rating. Each risk rating is mapped to an expected securities received under resale agreements are not default frequency using IBRD'scredit migration recorded on IBRD'sbalance sheet. matrix. The provision required is calculated by Nonnegotiable, Noninterest-bearing Demand multiplying the outstandingexposure, bythe expected Obligations on Account of Subscribed Capital: default frequency (probabilityof default to IBRD)and Payments on these instruments are due to IBRD upon by the assumed severity of the loss given default. demand and are held in bank accounts which bear The determination of borrowers' ratings is based on IBRD's name. Accordingly, these instruments are both quantitative and qualitative analysesof various carried and reported at face value as assets on the factors. IBRD periodically reviews these factors and balance sheet. reassessesthe adequacy of the accumulated provision Premisesand Equipment: Premisesand equipment, for losses on loans and guarantees accordingly. including leasehold improvements, are carried at cost Adjustments to the accumulated provision are less accumulated depreciation and amortization. recorded as a charge or addition to income. IBRD computes depreciation and amortization using Investments:Investment securities are classified the straight-line method over the estimated useful based on management's intention on the date of lives of the owned assets, which range between two purchase, their nature, and IBRD's policies governing and fifty years. For leasehold improvements, the level and use of such investments. At June30, depreciation and amortization is computed over the lesser of the remaining term of the leased facilityor Valuation of Financial Instruments: Derivative the estimated economic life of the improvement. financial instruments and investment securities are recorded in IBRD's financial statements at fair value. Maintenance and repairs are charged to expense as Disclosures related to the fair value of these, and other incurred, while major improvements are capitalized financial instruments are included in Note 0. Fair and amortized over the estimated usefullife. value is based on market quotations when possible. Borrowings:To ensure funds are available for lending Financial instruments for which market quotations and liquidity purposes, IBRD borrows in the are not readily available have been valued based on worldwide capital markets offering its securities to discounted cash flow models using market estimates private and governmental buyers. IBRD issues short- of cash flows and discount rates. All the financial term and medium- and long-term debt instruments models used for valuing IBRD's financial instruments denominated in various currencies with both fixed are subject to both internal and periodic external and adjustable interest rates. Borrowings are carried verification and review. These models use market on the balance sheet at their par value (facevalue), sourced inputs such as interest rates, exchange rates, adjusted for any unamortized premiums or discounts, and volatilities. Selection of these inputs may involve and include adjustments for embedded derivatives some judgement, as does estimating prices when no and fair value hedges that existed at June 30,2000, as external parameters exist. required by FAS 133. Issuance costs associated with a Accounting and Reporting Developments: bond offering are deferred and amortized over the period during which the related indebtedness is International Accounting Standards Board (LASB) outstanding. Amortization of discounts and Improvements Project: In December 2003, as part of premiums is included in Interest under Borrowing its improvements project, the IASB issued fifteen Expenseson the income statement. revised standards to eliminate redundancies and conflicts between existing standards. These revised IBRD uses derivativesin its borrowing and liability standards are to be applied for annual periods management activities. In the borrowing portfolio, beginning on or after January 1,2005. Of the fifteen derivativesare used to take advantage of cost saving standards issued, eight of these are relevant to IBRD, opportunities in non-target currencies in various namely, IAS 1, Presentation of Financial Statements, capital markets. These derivativesare used to modify IAS 8, Accounting Policies, Changes in Accounting the interest rate andlor currency characteristics of the Estimates and Errors, IAS 10, Events After the Balance borrowing portfolio, and are carried at fair value in Sheet Date, IAS 16, Property, Plant and Equipment, IAS accordance with FAS 133. The interest component of 17, Leases, IAS 21, The Effects of Changes in Foreign these derivativesis recognized as an adjustment to the Exchange Rates, IAS 24, Related Party Disclosures, and borrowing cost over the life of the derivative contract IAS 27, Consolidated and Separate Financial and included in Interest under Borrowing Expenses Statements. IBRD is still assessing the impact on its on the income statement. financial reporting, if any, of the adoption of the Accounting for Derivatives: IBRD complies with revision of IAS 21. IBRD has reviewed the remaining the derivative accounting requirements of FAS 133. applicable standards and determined that only two of FAS 133 requires that derivative instruments, as these will have a material impact on its financial defined by these standards, be recorded on the balance reporting. Since IAS 8 requires that, in the absence of sheet at fair value. specifictransitional provisions applying to a change in accounting policy (including adoption of a new IBRD uses derivative instruments in its investments, standard), any such change should be applied loans and borrowings portfolios and for assetlliability retroactively,it will affect IBRD's application and management purposes. In applying FAS 133 for the presentation of future accounting changes in its purposes of financial statement reporting, IBRD has financial reporting in future fiscal years. IAS 24 will elected not to define any qualifying hedging require additional disclosures in the financial relationships. Rather, all derivative instruments, as statements for the fiscal year ended June 30,2006. defined by FAS 133, have been marked to fair value and all changes in fair value have been recognized in Other LASB Amendments: In addition to the fifteen net income. While IBRD believes that its hedging standards issued as part of the IASB improvement strategies achieve its objectives,the application of FAS project, other amendments have also been made. IAS 133 qualifying hedge criteria would not make fully 32, Financial Instruments: Disclosure and Presentation, evident the risk management strategies that IBRD (Revised),issued in December 2003, is effective for employs. annual periods beginning on or after January1,2005. IBRD FINANCIALSTATEMENTS: JU NE30, 2005 65 IBRD is still assessing the impact, if any, of the Entities and Similar Instruments (IFRIC 2), and adoption of this revised standard on its financial Interpretation 4, Determining whether an Arrangement reporting. IAS 39, Financial Instruments: Recognition contains a Lease (IFRIC4), respectively. These and Measurement (Revised), issued in December interpretations are effective for annual periods 2003, is effectivefor annual periods beginning on or beginning on or after January 1,2005 and January1, after January1,2005, and will not have a material 2006, respectively. IBRD has determined that the impact on IBRD'sfinancial reporting. requirements under IFRIC 4 will not have a material impact on its financial reporting. IBRD is still In addition to IAS 39 (Revised), further amendments evaluating the requirements under IFRIC 2. were subsequently made to IAS 39, relating to (i) Transition and Initial Recognition of Financial Assets New FASB Pronouncements: FASB Interpretation 46 and Financial Liabilities, (ii) Cash Flow Hedge (R),Consolidation of Variable Interest Entities, and Accounting of Forecast Intragroup Transactions, (iii) interpretation of Accounting Research Bulletin No. 51 Fair Value Hedge Accounting for a Portfolio Hedge of (FIN 46(R)),was issued in December 2003 and is Interest Rate Risk, and (iv)the Fair Value Option. The effectivefor IBRD for the first annal period beginning Transition and Initial Recognition of Financial Assets after December 15,2004. FIN 46(R),together with its and Financial Liabilities amendment is effectivefor related final FASB Staff Positions will not have a annual periods beginning on or after January1,2005, material impact on IBRD's financial reporting. In May and will not have a material impact on IBRD's 2005, FASB Issued FAS No. 154, Accounting Changes financial reporting. Since IBRD has elected not to use and Error Corrections. This statement is effectivefor hedge accounting, the Cash Flow Hedge Accounting of accounting changes and corrections of errors made in Forecast Intragroup Transactions amendment, which is fiscal years beginning after December 15,2005. As effectivefor annual periods beginning on or after this standard requires that, in the absence of specific January1,2006, and the Fair Value Hedge Accounting transitional provisions applying to a change in for a Porqolio Hedge of Interest Rate Risk amendment accounting policy (including adoption of a new which is effectivefor annual periods beginning on or standard), any such change should be applied after January1,2005, will not have an impact on retroactively,it will affect IBRD's application and IBRD'sfinancial reporting. IBRD is still evaluating presentation of future accounting changes in its the Fair Value Option amendment. This amendment financial reporting in future fiscal years. is applicable for annual periods beginning on or after January1,2006, with specifictransition rules for NOTE B-CAPITAL STOCK, RESTRICTED existing IFRS filers. IAS 19, Actuarial Gains and CURRENCIES, MAINTENANCE OF VALUE, AND Losses, Group Plans and Disclosures, issued in MEMBERSHIP December 2004, is effective for annual periods Capital Stock: At June 30,2005, IBRD's capital beginning on or after January 1,2006, and will result comprised 1,581,724 authorized shares (1,581,724 in additional disclosures in the financial statements. shares-June30,2004),ofwhich 1,572,661shares had New LASB Pronouncements: The IASB issued IFRS 4, been subscribed (1,572,661shares-June30,2004). Insurance Contracts in March 2004. This standard is Each share has a par value of 0.1 million 1974 SDRs, required to be applied for annual periods beginning valued at the rate of $1.20635 per 1974 SDR. Of the on or after January1,2005. Financial guarantee subscribed capital, $11,483million ($11,483 contracts which IBRD issues are within the scope of million-June30,2004) has been paid in, and the this standard. Application of this standard will not remaining $178,235million ($178,235million-June have a material impact on IBRD'sfinancial reporting. 30,2004) is subject to call only when required to meet the obligations of IBRD created by borrowing or In March 2004, IASB also issued IFRS 5, Non-current guaranteeing loans. Assets Held for Sale and Discontinued Operations. This standard is effectivefor annual periods beginning on Currencies Subject to Restrictions: A portion of or after January 1,2005. IBRD has determined that capital subscriptions paid in to IBRD has been paid in the application of this standard will not have a the local currencies of the members. These amounts, material impact on its financial reporting. referred to as restricted currencies, are usableby IBRD in its lending and investing operations, only with the In November and December 2004, the International consent of the respectivemembers, and for Financial Interpretations Committee (IFRIC) issued administrative expenses. Interpretation 2, Members' Shares in Co-operative Maintenance of Value:As of June30,2005, IBRD of a government of a member country, a multilateral had positive $46 million (negative$73 million-June organization or any other official entity other than the 30,2004) of net MOV amounts classified as a government of a member country, with a minimum component of equity. Of this amount, IBRD had a net credit rating of AA-. For corporate and asset-backed MOV payable of $205million ($119 million-June30, securities, IBRD may only invest in securities with a 2004) relating to restricted currencies out on loan, AAA credit rating. invested, swapped, or loaned to the member to IBRD Time deposits include certificates of deposit, bankers' or through IFC, which become payableby IBRD on acceptances and other obligations issued or the same terms as other MOV obligations only after unconditionally guaranteed by banks or other such currencies are repaid to IBRD. The remaining financial institutions. IBRD may only invest if these amount is a net MOV receivable of $159 million ($192 time deposits are issued or guaranteed by financial million-June30, 2004), representing receivables for institutions whose senior debt securities are rated at countries that have amounts in arrears for two years least A-. or more. IBRD still considers these MOV receivables in arrears as obligations due from the members With respect to futures and options, IBRD generally concerned. closes out most open positions prior to maturity or expiration. Futures are settled on a daily basis. For options, IBRD only invests in exchange-traded NOTE C-INVESTMENTS options. IBRD does not write uncovered option As part of its overall portfolio management strategy, contracts as part of its investment portfolio strategy. IBRD invests in government and agencyobligations, As of June 30,2005 and June 30,2004 there were no time deposits, corporate and asset-backed securities, short sales included in Payable for Investment repurchase agreements, securities loans, resale Securities Purchased on the balance sheet. agreements and related financial derivativesincluding futures, currency swaps (including currency forward As of June 30,2005, IBRD had received $713 million contracts), interest rate swaps and options. ($851 million-June30,2004) of securities under resale agreements. None of these securities had been For government and agency obligations, IBRD may transferred under repurchase or security lending only invest in obligations issued or unconditionally agreements as of June 30,2005 or June 30,2004. guaranteed by governments of countries with a minimum credit rating of AA-; however, if such For the fiscal year ended June30,2005, IBRD had obligations are denominated in the home currency of included $3 million of unrealized gains in income the issuer,no rating is required. IBRD may only invest (unrealized gains of $54 million-June30,2004 and in obligations issued by an agencyor instrumentality unrealized losses of $21 million-June30,2003). A summary of IBRD's trading portfolio at June 30,2005 and June 30,2004, is as follows: In m~ll~onso f U.5. dollars 2005 2004 Carrylng Value Carrylng Value Investments-Trading Government and agency obllgatlons Tlme deposlts Asset-backed securltles Total IBRD FINANCIAL STATEMENTS: JU NE30, 2005 67 The following table summarizes the currency composition of IBRD's trading portfolio at June 30,2005 and June 30, 2004: In millions of U.S.dollars equivalent Average Average Carrying Average Repricing Carrying Average Repricing Currency Value Yield (%) @ears) Value Yield (%) (Years) Euro Japanese yen U.S. dollars Others Total a The average repricing represents the remaining period to the contractual repricing or maturity date, whichever a earlier This indicates the average length of time for which interest rates are fixed IBRD manages its investments on a net portfolio basis. The following table summarizes IBRD's net portfolio position as of June30,2005 and June 30,2004: In millions of U.5. dollars Carrying Value Investments-Trading Securitiespurchased under resale agreements Receivable from currency and interest rate swaps Currency forward contracts Currency swaps Interest rate swam Total Payable for currencyand interest rate swaps Currency forward contracts Currency swaps Interest rate swaps Total Cash held in investment portfolioa Receivable from investment securitiestraded Payable for investment securities traded Net Investment Portfolio a. This amount a included in UnrestrictedCurrenciesunder Due from Banks on the balancesheet. The following table summarizes the currency composition of IBRD's net investment portfolio at June 30,2005 and June 30 2004: In millions of U.S.dollars equivalent 2005 2004 Average Average Carrying Average Repricing Carrying Average Repricing Currency Value Yield (%) @ears) Value Yield (%) (Years) U.S. dollars $25,040 3.37 0.17 $28,752 1.40 0.17 Others 1,326 1.55 0.07 2,341 1.58 0.05 Total a The average repricing represents the remaining period to the contractual repricing or maturity date, whichever a earlier This indicates the average length of time for which interest rates are fixed NOTE D-LOANS, GUARANTEES AND waivers have been approved for the fiscal year ended DERIVATIVES FOR BORROWERS June30,2005. For the fiscal year ended June30,2005, the effect of the interest waiver was to reduce net IBRD's loan portfolio includes multicurrency loans, income by $125 million ($112 million-June30, single currency pool loans, single currency loans and 2004, $93 million-June30,2003). For the fiscal year fmed spread loans. Single currency loans (variable ended June30,2005, the effect of the commitment spread loans and fmed-rate singlecurrencyloans), and charge waiver was to reduce net income by $125 mil- fmed spread loans, include special development policy lion ($133million-June30,2004, $146 million- loans. At June30,2005 only variable spread loans and June30,2003). fmed spread loans, including special development On August 3,2004, the ExecutiveDirectors approved policy loans, were available for new commitments. a waiver of 50 basis points of the front-end fee charged on all loans, with the exception of Special Develop- Waiversof Loan Charges ment Policyloans. This waiver is effectivefor allloans Waivers of a portion of interest owed by all eligible presented to the Board in fiscal year 2005, with retro- borrowers, as well as waiversof a portion of the com- active effect to fiscal year 2004 for all loans presented mitment charge on undisbursed balances on all eligi- to the Board on or after March 1,2004. For the fiscal ble IBRD loans, have been approved annually by the year ended June30,2005, the effect of this waiver was ExecutiveDirectors of IBRD since fiscal year 1990 in to reduce net income by $1 million. the case of commitment charge waivers,and since fis- cal year 1992 in the case of interest waivers.These IBRD FINANCIAL STATEMENTS: JUNE 30, 200569 A summary of IBRD's outstanding loans by currency and product at June 30,2005 and June30,2004 follows: In m~ll~onso f U.S. dollars equ~valent Euro Japanese yen U S dollars Others Loans Outstanding Flxed Adlust Flxed Adlust Flxed Adlust Flxed Adlust Flxed Adlust Total Multlcurrency loansa Amount $ 42 $5,128 $ 35 $4,821 $ 111 $4,406 $ 54 $ 451 $ 242 $14,806 $15,048 Welghted average rate (%)b 9.17 4.59 7.91 4.59 8.71 4.59 8.18 4.59 8.55 4.59 4.65 Average Maturlty (years) 0.07 3.50 0.04 3.50 0.69 3.36 0.04 3.50 0.34 3.46 3.41 Slngle currency pools Amount $ - $1,897 $ - $ 1 9 s - $10,780 $ - $ - $ - $12,696 $ 12,696 Welghted average rate (%)b - 3.96 - 0.28 - 5.46 - - - 5.23 5.23 Average Maturlty (years) - 2.68 - 1.80 - 2.80 - - - 2.78 2.78 Slngle currency loans Amount $ 567 $ 3,438 $ - $ 155 $10,143 $41,058 $ - $ 2 $10,710 $44,653 $ 55,363 Welghted average rate (%)b 5.35 2.43 - 0.23 6.23 3.63 - 0.95 6.18 3.52 4.04 Average Maturlty (years) 2.97 6.00 - 5.58 2.94 5.54 - 2.47 2.94 5.58 5.07 Flxed-spreadloans Amount $2,479 $ 3,011 $ 4 $ 4 $ 4,720 $11,076 $ - $ - $7,203 $14,091 $ 21,294 Welghted average rate (%)b 5.66 2.69 2.17 0.56 5.06 3.87 - - 5.26 3.62 4.17 Average maturlty (years) 11.55 9.28 11.12 12.50 7.17 7.45 - - 8.68 7.84 8.13 Total Loans Amount $3,088 $13,474 $ 39 $4,999 $14,974 $67,320 $ 54 $ 453 $18,155 $86,246 $104,401 Welghted average rate (%)b 5.65 3.53 7.42 4.44 5.87 4.02 8.18 4.58 5.85 3.97 4.30 Average Maturlty (years) 9.82 5.32 0.98 3.56 4.26 5.27 0.04 3.50 5.18 5.17 5.17 Total loans Less accumulated provlslon for loan losses and deferred loan Income Net loans outstanding Note: For footnotes see follow~ngpage. In m1111onsof U.S.dollars equivalent Euro Japanese yen U S dollars Others Loans Outstanding Flxed Adlust Flxed Adlust Flxed Adlust Flxed Adlust Flxed Adlust Total Multlcurrency loansa Amount $ 85 $ 6,201 $ 45 $5,895 $ 138 $ 5,239 $ 87 $1,464 $ 355 $18,799 $ 19,154 Welghted average rate (%)b 8.31 3.80 7.81 3.80 8.27 3.80 7.74 3.80 8.09 3.80 3.88 Average Maturlty (years) 0.15 3.81 0.19 3.81 1.05 3.71 0.1I 3.81 0.50 3.78 3.72 Slngle currency pools Amount $ - $ 2,332 $ - $ 26 $ - $14,131 $ - $ - $ - $16,489 $ 16,489 Welghted average rate (%)b - 4.86 - 0.31 - 5.31 - - - 5.24 5.24 Average Maturlty (years) - 3.08 - 2.23 - 3.09 - - - 3.08 3.08 Slngle currency loans Amount $ 652 $ 2,985 $ - $ 166 $12,333 $40,550 $ - $ 2 $12,985 $43,703 $ 56,688 Welghted average rate (%)b 5.42 2.41 - 0.26 6.33 1.76 - 0.64 6.29 1.79 2.82 Average Maturlty (years) 3.34 5.58 - 6.25 3.33 5.65 - 2.97 3.33 5.65 5.12 Flxed-spread loans Amount $2,450 $ 2,432 $ 1 $ 1 $ 3,832 $ 8,563 $ - $ - $6,283 $10,996 $ 17,279 Welghted average rate (%)b 5.69 2.67 2.05 0.51 5.08 1.88 - - 5.31 2.06 3.24 Average maturlty (years) 12.49 10.38 11.34 10.76 8.05 7.60 - - 9.78 8.22 8.79 Total Loans Amount $3,187 $13,950 $ 46 $6,088 $16,303 $68,483 $ 87 $1,466 $19,623 $89,987 $109,610 Welghted average rate (%)b 5.70 3.48 7.70 3.69 6.05 2.66 7.74 3.79 6.01 2.88 3.44 Averaqe Maturlty Total loans Less accumulated provlslon for loan losses and deferred loan Income Net loans outstanding $105,626 a. Includes loans lssued prlor to 1980, and loans to IFC, ~naddltlon to mult~currencypool loans b. Excludes effects of any walversof loan Interest. The maturity structure of IBRD's loans at June 30, 2005 and June30, 2004 is as follows: In m~ll~onsof U.S.dollar5 July 1, 2005 July 1, 2006 July 1, 20 10 through through through ProductlRate Type June 30,2006 June 30, 2010 June 30, 2015 Thereafter Total Multlcurrency loans Flxed $ 209 $ 33 $ - $ - $ 242 Adjustable 2,763 8,306 3,533 204 14,806 Slngle currency pools Flxed - - - - - Adjustable 3,032 7,589 2,062 13 12,696 Slngle currency loans Flxed 2,049 6,857 1,804 - 10,710 Adjustable 4,001 17,676 17,288 5,688 44,653 Flxed-spreadloans Flxed 110 1,602 3,508 1,983 7,203 Adjustable 208 3,153 7,273 3,457 14,091 All Loans Flxed 2,368 8,492 5,312 1,983 18,155 Adjustable 10,004 36,724 30,156 9,362 86,246 Total loans outstanding $12,372 $45.2 16 $35,468 $11,345 $104,401 July 1, 2004 July 1, 2005 July 1, 2009 through through through ProductlRate Type June 30,2005 June 30, 2009 June 30, 2014 Thereafter Total Multlcurrency loans Flxed $ 293 $ 61 $ 1 $ - $ 355 Adjustable 3,080 10,203 5,056 460 18,799 Slngle currency pools Flxed Adjustable Slngle currency loans Flxed Adjustable Flxed-spreadloans Flxed 24 712 3,382 2,165 6,283 Adjustable 31 1,787 6,531 2,647 10,996 All Loans Flxed 2,387 8,769 6,287 2,180 19,623 Adjustable 10,495 38,683 31,701 9,108 89,987 Total loans outstanding $12,882 $47,452 $37,988 $11,288 $109,610 Guarantees by IBRD through regular loans. IBRD's partial IBRD has provided partial guarantees of loans guarantees of such securities are included in the syndicated by other financial institutions for projects. guarantees amount mentioned below. In addition, IBRD has also provided partial Guarantees of $1,157million wereoutstanding at June guarantees of securities issued by an entity eligiblefor 30,2005 million-June 30, 2004). This IBRD loans, or in support of programs also financed amount represents the maximum potential amount of Derivativesfor Borrowers undiscounted future payments that IBRD could be During the fiscal year ended June 30,2004, the first required to make under these guarantees, and are not currency swap transaction was executed between included in the balance sheet. Most of these IBRD and one of its borrowers, under a master guarantees have maturities ranging between 10 and 15 derivativesagreement. No other transactions of this years,and expire in decreasing amounts through 2015. nature have been executed. The net interest income At June 30, 2005, liabilities related to IBRD's associated with this swap is included in Loan Interest obligations under guarantees of $22 million ($23 income on the income statement. As of June30,2005, million-June 30,2004), have been included in the receivable and payablelegs of this swap each had Accounts Payableand Miscellaneous Liabilities on the carrying values of $89 million ($90 million and $93 balance sheet. These include the accumulated million, respectively-June30,2004). This swap provision for guarantee losses of $13 million ($15 matures in 2017. million-June30,2004). OverdueAmounts During the fiscal years ended June 30,2005 and June At June30,2005, there were no principal or interest 30,2004, no guarantees provided by IBRD were called. amounts on loans in accrual status, which were over- due by more than three months. The following tables provide a summary of selected financial information related to loans in nonaccrual status as of June 30: In millionsof U.S. dollan 2005 2004 Recorded investment in nonaccrual loansa Accumulated provision for loan losses on nonaccrual loans Average recorded investment in nonaccrual loans Overdue amounts of nonaccrual loans: Principal lnterest and charges a. A loan loss provlslon has been recorded agalnst each of the loans ~nthe nonaccrualportfol~o In millionsof U.S. dollan lnterest income recognized on loans in nonaccrual status at end of fiscal year $118 $112 $113 lnterest income not recognized as a result of loans being in nonaccrual status $65 $ 37 $ 28 IBRD FINANCIALSTATEMENTS: JU NE30, 2005 73 A summary of countries with loans or guarantees in nonaccrual status follows: In m11110nsof U.S. dollars Pr~ncpal,Interest and Charges Nonaccrual Borrower overdue since With overdoes CBte d'lvo~re $137 November 2004 L~ber~a 391 June 1987 Seychelles 1 August 2002 Z~mbabwe 300 October 2000 Total Without overdoes Serb~aand Montenegro - September 1992 Total During the fiscal year ended June 30,2005, loans payments performance, even though they are current made to or guaranteed by CBte d'Ivoire were placed on all obligations to IBRD. into nonaccrual status. Loan income for the fiscal year Accumulated Provisionfor Losses on Loans and ended June 30,2005 would have been higher by $32 Guarantees million, had these loans not been in nonaccrual status. IBRD has always eventually collected all contractual During the fiscal year ended June30,2005, Iraq principal and interest on its loans. However, IBRD cleared all of their overdue loan principal, interest and sufferslosses resulting from the differencebetween the charges due to IBRD. As a result of this event, loan discounted present value of payments for interest and income for the year ended June30,2005 increased by charges according to the related loan's contractual $56 million, $51 million of which represents income terms and the actual cash flows. Certain borrowers that would have been earned in previous years had have found it difficult to make timely payments for these loans not been in nonaccrual status. protracted periods, resulting in their loans being placed in nonaccrual status. Several borrowers have During the fiscal year ended June 30,2004 there were emerged from nonaccrual status after a period of time no loans placed into nonaccrual status or restored to by bringing up-to-date all principal payments and all accrual status. overdue service payments, including interest and Serbia and Montenegro's arrears to IBRD were cleared other charges. To recognize the probable losses through exceptional rescheduling arrangements in inherent in its loan and guarantee portfolio, IBRD January, 2002. Under these arrangements, all loans to maintains an accumulated provision for losses on the country are to remain in non-accrual status loans and guarantees. pending completion of a period of policy and Changes to the accumulated provision for losses on loans and guarantees for the fiscal years ended June 30,2005, June 30,2004 and June30,2003 are summarized below: In m~ll~onsofU.S.dollars June30,2005 June 30,2004 June 30,2003 Accumulated provision for losses on loans and guarantees, beginning of the fiscal year Release of provlslon for losses on loans and guarantees Translation adjustment Accumulated provision for losses on loans and guarantees, end of the fiscal year Composed of: Accumulated provlslon for loan losses Accumulated provision for guarantee losses Total Reported as Follows BalanceSheet Statement of Income Allowance for Losses on: Loans Accumulated Prov~slonfor Loan Losses Release of Prov~s~onfor Losses on Loans and Guarantees Guarantees Accounts Payable and M~scellaneousL~ab~l~t~esRelease of Prov~s~onfor Losses on Loans and Guarantees IBRD has endorsed a multilateral initiative for At June 30,2005, a loan commitment amounting to addressing the debt problems of a group of countries, $50 million had been made under this facility. identified as heavily indebted poor countries (HIPC), FifthDimension Program to ensure that the reform efforts of these countries will Under IDA'SFifth Dimension program established in not be put at risk by unsustainable external debt burdens. Under this initiative, creditors are to provide September 1988, a portion ofprincipal repayments to debt relief for those countries that have demonstrated IDA are allocated on an annual basis to provide good policy performance over an extended period to supplementary IDA development credits to IDA- bring their debt burdens to sustainable levels. IBRD eligiblecountries that are no longer able to borrow on has not entered into any commitments to provide IBRD terms, but have outstanding IBRD loans debt relief under this initiative. Under the HIPC debt approved prior to September 1988 and have in place initiative, IDA has extended a new credit to an IDA- an IDA-supported structural adjustment program. eligiblecountry no longer able to borrow on IBRD Such supplementary IDA development credits are terms, but with outstanding IBRD debt. This credit is allocated to countries that meet specified conditions, funded by IDA resources other than transfers from in proportion to each country's interest payments due IBRD. In determining the adequacy of the that year on its pre-September 1988 IBRD loans. To be accumulated provision for losses on loans and eligiblefor such IDA supplemental development guarantees, IBRD has taken the situation of these credits, a member country must meet IDA'Seligibility countries into consideration. criteria for lending, must be ineligible for IBRD lending and must not have had an IBRD loan Local Currency Lending approved within the last twelve months. To receivea During the fiscal year ended June30,2005, IBRD supplemental development credit from the program, a entered into a Local Currency Loan Facility member country cannot be more than 60 days Agreement with IFC which is capped at $300 million. overdue on its debt-service payments to IBRD or IDA. IBRD FINANCIAL STATEMENTS: JU NE 30, 2005 75 A summary of cumulative IDA development credits com- NOTE E-BORROWINGS mitted and disbursed under this program from inception, Providing liquidity and minimizing the cost of funds are at June30,2005 and June 30,2004 is presented below: key objectivesto IBRD'soverall borrowing strategy. IBRD uses swapsin its borrowing strategy to lower the overall In millions of U.S. dollan cost of its borrowings for those members who benefit from 2005 2004 IBRD loans. IBRD initiates swap transactions with a list of authorized counterparties. Credit limits have been Commitments $1,715 $1,715 established for each counterparty. Disbursements $1,715 $1,712 The following table summarizes IBRD's borrowing portfolio at June 30,2005 and June30,2004: In m~ll~onsof U.S. dollars 2005 2004 Net Net Net Net Prlnclpal Unamortized unreal~zed Pr~nc~pal Unamortized unreal~zed at Face Premlum (gams) at Face Premlum (gains) Value (D~scount) lossesd Total Value (D~scount) lossesd Total Short-Term Med~um-and Long-Term Currency Swap Agreements (Net) Interest Rate Swap Agreements ( ~ e t ) ~ , ~ a. Thlsrefers to "net unreal~zed(gams)losses on non-trad~ng(borrowingsrelated) der~vatlve~nstruments,as requlredby FAS 133 and /AS39". b. The negat~ve$557 m1111onat June 30, 2005 (negat~ve$43 m~ll~on-June30, 2004) representsthe net unamortlzed premlum (dlscount)on zero coupon trades. c. The net unamort~zedprem~umof $379 mllllon at June 30, 2005 ($304 m~ll~on-June30, 2004), represents the unamortlzed premlum (dlscount)on non zero coupon trades. Thefollowingtablessummarize IBRD'sborrowing portfoliobycurrencyandproduct at June30,2005 andJune30,2004: Medium- and Long-term Borrowings and Swaps at June 30,2005 In millions of U 5 dollars Currency Interest rate Direct borrowings swap agreements swap agreementsa Net currency obligations* Notional Average Amount Average amount Average Amount Average Currency1 WA@ maturity payable WA@ maturity payable WAC^ maturity payable WA@ maturitfl Rate type Amount (%) @ears) (receivable) (%) @ears) (receivable) (%) @ears) (receivable) (%) (years) Euro Flxed $7,821 6.01 6.63 $1,083 5.86 5.13 $1,928 5.50 11.53 $10,833 5.90 7.35 (7,227) 5.78 5.64 (182) 6.53 3.70 (7,409) 5.80 5.60 Adjustable 3,720 6.54 7.45 9,481 2.33 4.11 160 2.10 2.75 13,360 3.50 5.02 (4,406) 6.60 7.18 (1,928) 2.58 11.53 (6,335) 5.37 8.50 Japanese yen Flxed 3,437 4.31 5.56 272 4.94 (1,865) 5.11 Adjustable 11,488 3.51 24.92 1,731 0.21 (11,989) 3.35 U. 5. dollars Flxed 36,601 5.36 5.18 1,431 10.46 Adjustable 2,422 3.69 6.82 49,423 3.01 (12,287) 3.10 Others Flxed 32,503 5.70 5.79 2,042 5.98 (34,324) 5.67 Adjustable 502 5.76 11.91 (624) 5.88 ~otal* Flxed 80,363 5.51 5.58 4,828 (43,415) Adjustable 18,132 4.22 18.55 60,634 (29,306) Principal at face value $98,495 5.27 7.97 $(7,259) a. Excludes forward-starting swaps of $9,019 million (mechanam for managing debt overhang in currency pool products) b WAC refers to weighted averagecost c At June 30, 2005, the average repricing period of the net currency obligations for adlustablerate borrowings was three months * May differ from the sum of individual figuresdue to rounding Medium- and Long-term Borrowings and Swaps at June 30,2004 In m~ll~onsof U.S. dollars equ~valent Currency Interest ratea D~rectborrow~ngs swap agreements swap agreements Net currency obl~gat~ons Not~onal Average Amount Average amount Average Amount Average Currency1 WA@ matur~ty payable WA@ matur~ty payable WAC^ matur~ty payable WA@ matur~tyC Rate type Amount (%) @ears) (rece~vable) (%) @ears) (rece~vable) (%) @ears) (rece~vable) %) years) Euro F~xed $10,425 6.02 5.73 $ 1,225 (9,002) Adjustable 3,674 6.70 8.10 9,182 (4,486) Japanese yen F~xed 5,390 4.43 4.42 130 (3,838) Adjustable 11,631 3.90 24.62 2,903 (11,807) U. 5. dollars F~xed 44,436 5.38 4.28 3,883 (38) Adjustable 1,560 4.34 8.66 45,714 (11,369) Others F~xed 28,518 5.66 6.96 1,269 (28,896) Adjustable 425 6.05 14.18 - (599) Total F~xed 88,769 5.49 5.32 6,507 (41,774) Adjustable 17,290 4.59 19.41 57,799 Principal at face value $106,059 5.34 7.62 $ (5,729) a Excludes forward-startmg swaps of $5,137 m~ll~on(mechannm for manag~ngdebt overhang ~ncurrency pool products) b WAC refers to we~ghtedaverage cost c At June 30, 2004, the average repr~c~ngper~odof the net currency obl~gat~onsfor adlustablerate bowrrow~ngswas three months Short-term Borrowings at June 30,2005 and June 30,2004 In m~ll~onsof U.5. dollars 2005 2004 lnterest rate Swap Agreements Not~onal Currency1 Prlnclpal at wA@ Rece~vable WA@ Net WA@ Prlnclpal at Rate type face valuea (%) (pa~able)~ (%) Obl~gat~on (%) facevalue WAC(%) U. 5. dollars Flxed $2,576 3.07 $(I3) 1.72 $2,563 3.08 $2,406 1.15 Adjustable 644 3.19 13 2.41 657 3.18 742 1.41 Principal at face value $3,220 3.10 $- $3,220 3.10 $3,148 1.21 a. At June 30, 2005, the average reprlclngperlod of the prlnclpal outstanding for short-term borrowings was less than two months (less than two months-June 30, 2004.) b. WAC refers to we~ghtedaverage cost. c. At June 30, 2004, there were no short term lnterest rate swap agreements. The maturity structure of IBRD's Medium-and Long-term borrowings outstanding at June30,2005 and June30, 2004 is as follows: In m~ll~onsof U.S.dollars In m~ll~onsof U.S.dollars Perlod 2005 July 1, 2005 through June 30, 2006 $15,617 July 1, 2004 through June 30, 2005 July 1, 2006 through June 30, 2007 14,912 July 1, 2005 through June 30, 2006 July 1, 2007 through June 30, 2008 13,706 July 1, 2006 through June 30, 2007 July 1, 2008 through June 30, 2009 8,397 July 1, 2007 through June 30, 2008 July 1, 2009 through June 30, 2010 5,909 July 1, 2008 through June 30, 2009 July 1, 2010 through June 30, 2015 1 1,974 July 1, 2009 through June 30, 2014 Thereafter 27,980 Thereafter Total $98,495 Total $106,059 Line ofcredit: IBRD maintains a line of credit with NOTE F-OTHER ASSETILIABILITY SWAPS an independent financial institution. This facilitywas As part of assetlliabilitymanagement, IBRD has created for the benefit of both IBRD and IDA. The entered into currency and interest rate swap available line of credit to each institution is $500 agreements to better align its currency composition million, but usage from both institutions cannot and duration of Equity with that of Loans exceed $500 million in aggregate. The line of credit is Outstanding. A summary of IBRD's other asset1 used to cover any overnight overdrafts that may occur liability swaps at June30,2005 and June 30,2004 is due to failed trades. At June 30,2005 and June 30, presented below: 2004 there were no amounts outstanding under this facility. In m1111onsof U S dollars equlvalent Currency swap agreements Interest rate swap agreements Net Denvatlve AssetlL~ab~l~ty Not~onal Amount We~ghted Average Amount We~ghted Average Amount We~ghted Average Rece~vable Average Matunty Rece~vable Average Matunty Rece~vable Average Mahinty (payable) Cost (%) hears) (payable) Cost (%) hears) (payable) Cost (%) (years) U.S. dollars $726 3.34 1.72 $1,250 3.68 3.31 $1,976 3.55 2.72 Euro Japanese Yen Other Total Rece~v- able (Payable) Net unreal- zed losses (ga~ns)~ Total a. Th~srefers to "net unreal~zed(gams)losses on non-trad~ng(borrow~ngsrelated) der~vat~vemstruments, as requ~redby FAS 133 and /AS39". In m1111onsof U.S.dollars equlvalent Currency swap agreements Interest rate swap agreements Net Denvatlve AssetlL~ab~l~ty Not~onal Amount We~ghted Average Amount We~ghted Average Amount We~ghted Average Rece~vable Average Matunty Rece~vable Average Matunty Rece~vable Average Matunty (payable) Cost (%) hears) (payable) Cost (%) hears) (payable) Cost(%) (years) U.S. dollars $726 1.17 2.72 $1,250 3.68 4.31 $1,976 2.76 3.73 (1,250) 1.30 4.31 (1,250) 1.30 4.31 Euro (382) 2.06 2.71 - - - (382) 2.06 2.71 Japanese Yen Total Rece~v- able (Payable) Net unreal- zed losses (ga~ns)~ Total a. Th~srefers to "net unreal~zed(gams)losses on non-trad~ng(borrow~ngsrelated) der~vat~vemstruments, as requ~redby FAS 133 and /AS39". 80 THE WORLD BANK ANNUAL RE OR 2005 P T NOTE G-CREDIT RISK Country Credit Risk:This risk includes potential application of eligibilitycriteria and volume limits for losses arising from protracted arrears on payments transactions with individual counterparties and from borrowers for loans, guarantees or related through the use of mark-to-market collateral derivatives. IBRD manages country credit risk arrangements for swap transactions. IBRD may through individual country exposure limits according require collateral in the form of cash or other to creditworthiness. These exposure limits are tied to approved liquid securities from individual performance on macroeconomic and structural counterparties in order to mitigate its credit exposure. policies. In addition, IBRD establishes absolute limits As of June30,2005, IBRD had received collateral of on the share of outstanhng loans to any individual $7,278 million in connection with swap agreements borrower. The country credit risk is further managed ($4,169million-June 30,2004), of which by financial incentives such as pricing loans using $4,18lmillion had been transferred under security IBRD's own cost of borrowing and partial interest lending agreements ($nil million-June30,2004). charge waivers conditioned on timely payment that As the transfer of this collateral did not meet the give borrowers self-interest in IBRD's continued requirements of a sale, the collateral has not been strong intermediation capacity. Collectibility risk is included in the assets of IBRD. covered by the accumulated provision for losses on loans and guarantees. IBRD also uses a simulation IBRD has entered into master derivativesagreements model to assess the adequacy of its equity including which contain legally enforceable close-out netting reserves in case a major borrower, or group of provisions. These agreements may further reduce the borrowers, stops servicing its loans for an extended gross credit risk exposure related to the swaps shown period of time. below. Credit risk with financial assets subject to a master derivativesarrangement is further reduced Commercial Credit Risk:For the purpose of risk under these agreements to the extent that payments management, IBRD is party to a variety of financial and receipts with the counterparty are netted at instruments, certain of which involve elements of settlement. The reduction in exposure as a result of credit risk. Credit risk exposure represents the these netting provisions can vary as additional maximum potential loss due to possible transactions are entered into under these agreements. nonperformance by obligors and counterparties The extent of the reduction in exposure may therefore under the terms of the contracts. For all securities, change substantially within a short period of time IBRD limits trading to a list of authorized dealers and following the balance sheet date. counterparties. Credit risk is controlled through IBRD FINANCIAL STATEMENTS: JUNE 30, 2005 81 The contract value/notional amounts and credit risk into account any master derivatives or collateral exposure, as applicable, of these financial instruments arrangements that have been entered into) are given at June30,2005 and June 30,2004 (prior to taking below: In m1111onsof U.S.dollars INVESTMENTS - TRADING PORTFOLIO Exchange traded Options and Futuresa Notional Long position Notional Short position Currency swaps (including currency forward contracts) Credit exposure lnterest rate swaps Notional principal Credit exDosure BORROWING PORTFOLIO Currency swaps Credit exposure lnterest rate swaps Notional principal Credit exposure lnterest rate swaps Notional principal a. Exchange-traded instruments are generally subject to dally margln requ~rementsand are deemed to have no materlal credlt risk. All outstanding optlons and futures contracts as of June 30, 2005 and June 30, 2004, are ~nterestrate contracts. b. There was no credlt exposure for the currency swaps or ~nterestrate swaps ~nthlsportfol~oat June 30, 2005 and June 30, 2004. NOTE H-RETAINED EARNINGS, effects associated with the application of FAS 133 and ALLOCATIONS AND TRANSFERS pension income or expense. On August 3,2004, IBRD'sExecutive Directors approved the allocation of Retained Earnings:Retained Earnings comprises the $680 million of the net income earned in the fiscal following elements at June30,2005 and June30,2004: year ended June 30,2004, to the General Reserve and an increase of $21 million in the Pension Reserve. In m1111onsof U.S.dollars There was a $4,100 million reduction in Cumulative FAS 133 Adjustments, representing the "net unrealized (gains) losses on non-trading (borrowings Specialreserve related) derivative instruments, as required by FAS General reserve 133 and IAS 39': for fiscal year 2004. Pension reserve On October 3,2004, IBRD's Board of Governors Surplus approved the followingtransfers out of the net income Cumulative FAS 133 earned in the fiscal year ended June 30,2004: $300 Adjustments million to the International Development Association Unallocated net income (IDA),$240 million as an immediate transfer to the (loss) HeavilyIndebted Poor Countries (HIPC) Debt Total Initiative Trust Fund, $50 million as an immediate transfer to the Debt Reduction Facilityfor IDA-only Countries, and the retention of $405 million as IBRD makes net income allocation decisions on the Surplus. basis of reported net income, after adjustment for the On October 13,2004, IBRD's Board of Governors from Surplus to the Multi-Donor Trust Fund for Aceh approved the transfer of $25 million from Surplus to and North Sumatra, and the Trust Fund for Tsunami the Trust Fund for Liberia, administered by IDA. Disaster Recoveryin India respectively,to support tsunami recoveryactivities.These trust funds are On April 22,2005, IBRD's Board of Governors being administered by IDA. approved the transfer of $25 million and $2.5 million The aggregatetransfers and amounts payablefor these transfers approved by the Board of Governors at June 30, 2005 and June 30,2004 are included in the following table: In m~ll~onso f U.S. dollars eau~valent F~scalYear 2004 Amount Payable Transfers from at June 30 Aggregate Transfers Unallocated Transfers to through June 30, 2004 Net Income Surplus 2005 2004 --- lnternat~onalDevelopment Assoc~at~on $7,657 Debt Reduction Faclllty for IDA-only Countries 300 Trust Fund for Gaza and West Bank 460 HeavllyIndebted Poor Countries Debt lnltlatlve Trust Fund 1,880 Trust Fund for Llberla - Multl-Donor Trust Fund for Aceh and North Sumatra - Trust Fund for Tsunam~DlsasterRecovery ~nlndla - NOTE I-ADMINISTRATIVEEXPENSES, Other income primarily consists of service fee CONTRIBUTIONS TO SPECIAL PROGRAMS, revenue. IBRD recovers certain of its administrative AND OTHER INCOME expenses by billing third parties, including IFC, MIGA, and certain trust funds for services rendered. Administrative Expensesfor the fiscal year ended June 30,2005 are net of the share of administrative For the fiscal yearsended June30,2005, June30,2004, expenses allocated to IDA of $891 million ($908 and June30,2003, the amount of fee revenue million-June30,2004, $846 million-June30, associated with administrative services is as follows: 2003). The allocation of expenses between IBRD and In m1111onsof U.S. dollars IDA is based on an agreed cost sharing formula that reflects the administrative costs of servicedeliveryto 2005 2004 2003 --- countries that are eligiblefor lending from IBRD and Servlce fee revenue $228 $207 $188 IDA. Included In these amounts are the following: Contributions to special programs represent grants Fees charged to IFC 45 34 34 for agricultural research, and other developmental activities. Fees charged to MlGA 8 6 4 IBRD FINANCIAL STATEMENTS: JU NE 30, 2005 83 At June 30,2005 and June 30,2004, IBRD had the following payables to (receivablesfrom) its affiliated organizations with regard to administrative services and pension and other postretirement benefits. In millions of U.5. dollars 2005 2004 Pension and Pension and Other Other Administrative Postretirement Administrative Postretirement Services Benefits Total Services Benefits Total IDA $ 0 13) $ 820 $507 $040) $ 723 $383 I FC (25) 2I (4) (24) 18 (6) MlGA (4) 1 (3) (3) 1 (2) $042) $ 842 $500 $067) $ 742 $375 The payables (receivables)balances to (from) these affiliated organizations are reported in the balance sheet as follows: Payable (receivable) for: Admlnlstratlve Servlces M~scellaneousAssets Penslon and Other Postretirement Beneflts Accounts Payable and M~scellanousLlabllltles NOTE J-MANAGEMENT OF EXTERNALFUNDS assistance for borrowers including feasibilitystudies and project preparation, globaland regional programs Trust Funds and research and training programs. These funds are IBRD, alone or jointly with IDA, administers on held in trust with IBRD andlor IDA, and are held in a behalf of donors, including members, their agencies separate investment portfolio which is not and other entities, funds restricted for specific uses commingled with IBRD's funds, nor are they included which include the cofinancing of IBRD lending in the assets of IBRD. projects, debt reduction operations, technical The trust fund assets by executing agent at June 30,2005 and June30,2004 are summarized below: Total fiduciary Number of Total fiduciary Number of assets trust fund assets trust fund (In millions of accounts (In millions of accounts U.5. dollars) (unaudited) U.5. dollars) (unaudited) IBRD executed 1,925 1,765 Recipient executed 1,429 1,399 Total The responsibilities of IBRD under these IBRD received $17 million ($14 million-June30, arrangements vary and range from servicesnormally 2004 and $14 million-June30,2003) as fees for provided under its own lending projects to full project administering trust funds. These fees have been implementation including procurement of goods and recorded as Other Income. services. During the fiscal year ended June 30,2005, InvestmentManagementServices NOTE K-PENSION AND OTHER IBRD offersinvestment management services to one POSTRETIREMENTBENEFITS non-affiliated organization and one affiliated IBRD, IFC and MIGA participate in a defined benefit organization. Under these arrangements, IBRD is SRP, a Retired Staff Benefits Plan (RSBP) and a Post- responsible for managing investment account assets Employment BenefitsPlan (PEBP)that cover on behalf of these institutions, and in return receives a all of their staffmembers. quarterly fee based on the average value of the ~ortfolios. The SRP provides regular pension benefits and includes a cash balance plan. The RSBP provides In addition, IBRD offers asset management and certain health and life insurance benefits to eligible technical advisory servicesto central banks of member retirees. The PEBP provides certain pension benefits countries, under the Reserves Advisory and administered outside the SRP. Management Program, for capacity building and other development purposes. One objective of this IBRD uses a June30 measurement date for its pension program is to assist these central banks in developing and other postretirement benefit plans. their portfolio management skills. IBRD receives a fee The amounts presented below reflect IBRD's for these services. respectiveshare of the costs, assets and liabilitiesof the The fee income from all of these investment plans. Since each participating employer presents its management activitiesis included in service fee respectiveshare of these plans, certain prior year revenues described in Note I. disclosures have been amended to reflect only IBRD's proportionate share of these plans. At June 30,2005, the assets managed under these agreements had a value of $9,180 million ($8,789 All costs, assets and liabilities associated with these million-June30,2004). These funds are not plans are allocated between IBRD, IFC, and MIGA included in the assets of IBRD. based upon their employees' respectiveparticipation in the plans. Costs allocated to IBRD are then shared between IBRD and IDA based on an agreed cost sharing ratio. IDA, IFC and MIGA reimburse IBRD for their proportionate share of any contributions made to these plans by IBRD. Contributions to these plans are calculated as a percentage of salary. The following table summarizes the benefit costs associated with the SRP, RSBP, and PEBP for IBRD and IDA for the fiscal years ended June 30,2005, June 30,2004, and June30,2003: In m~ll~onsof U.S. dollars SRP RSBP PEBP 2005 2004 2003 2005 2004 2003 2005 2004 2003 Benefit Cost Serv~cecost Interest cost Expected return on plan assets Amort~zat~onof prlor servlce cost Amort~zat~onof unrecog- n~zednet loss (ga~n) Amort~zat~onof Trans~t~on Asset Net per~od~cpenslon cost of wh~ch: IBRD's share IDA'Sshare * Lessthan $0.5 m~ll~on IBRD FINANCIAL STATEMENTS: JU NE 30, 2005 85 IDA'Sshare of the net periodic pension incornelcost is The following table summarizes the projected benefit included as a payable tolreceivable from IDA in obligations, fair value of plan assets, and funded status Miscellaneous Assets and Accounts Payable and associated with the SRP, RSBP, and PEBP for IBRD Miscellaneous liabilities on the balance sheet. and IDA for the fiscal years ended June 30,2005, June 30,2004, and June30,2003. Since the assets for the The expenses for the SRP, RSBP and PEBP are PEBP are not held in an irrevocable trust separate included in Administrative Expenses. from the assets of IBRD, they do not qualify for off- For the fiscal years ended June 30,2005, June30, balance sheet accounting and are therefore included in 2004, and June 30,2003, expenses for these plans of IBRD'sinvestment portfolio. The assets of the PEBP $16 million, $20 million and $24 million, respectively, are invested in fmed income instruments. were allocated to IFC, and $1 million, $1 million and $2 million, respectively,were allocated to MIGA. In m~ll~onsof U.S. dollars SRP RSBP PEBP 2005 2004 2003 2005 2004 2003 2005 2004 2003 Projected Benefit Obligation Beg~nn~ngof year Serv~cecost Interest cost Employee contr~but~ons Amendments Benef~tspa~d Actuarial loss (ga~n) End of year Fair value of plan assets Beg~nn~ngof year Employee contr~but~ons Actual return on assets Employer contr~but~ons Benef~tspa~d End of year Funded status Plan assets In excess of (less than) projected benef~tobll- gat~on Unrecogn~zednet loss (ga~n) from past experience d~ffer- ent from that assumed and from changes In assump- t~ons Unrecogn~zedprlor servlce cost Prepa~d(accrued) penslon cost Accumulated Benef~t Obl~gat~on The $1,779 million prepaid SRP cost at June 30,2005 Payable and Miscellaneous Liabilities on the balance ($1,622million-June30,2004) is included in sheet. Prepaid Pension Cost on the balance sheet. Of this The $152 million prepaid RSBP cost at June30,2005 amount $748 million was attributable to IDA ($661 ($149 million-June 30,2004), is included in Prepaid million-June30,2004) and is included in Accounts Pension Cost on the balance sheet. Of this amount $54 million was attributable to IDA ($52 million- returns are derived from their relationship to equity June 30,2004) and is included in Accounts Payable and bond markets. The expected long-term rate of and Miscellaneous Liabilities on the balance sheet. return for the RSBP is computed using procedures similar to those used for the SRP. The discount rate Assumptions used in determining the benefit obligation is selected The actuarial assumptions used are based on financial by reference to the year-end AAA and AA corporate market interest rates, past experience, and bonds. management's best estimate of future benefit changes and economic conditions. Changes in these Actuarial gains and losses occur when actual results assumptions will impact future benefit costs and are different from expected results. Amortization of obligations. these unrecognized gains and losses will be included in income if, at the beginning of the fiscal year, they The expected long-term rate of return for the SRP exceed 10 percent of the greater of the projected assets is a weighted average of the expected long-term benefit obligation or the market-related value of plan (10yearsor more) returns for the various asset classes, assets. If required, the unrecognized gains and losses weighted by the portfolio allocation. Asset class are amortized over the expected average remaining returns are developed using a forward-looking servicelives of the employee group. building block approach and are not strictly based on historical returns. Equity returns are generally The following tables present the weighted-average developed as the sum of expected inflation, expected assumptions used in determining the projected realearningsgrowth and expected long-term dividend benefit obligations and the net periodic pension costs yield. Bond returns are generallydeveloped as the for the fiscal yearsended June30,2005, June30,2004, sum of expected inflation, real bond yield, and risk and June30,2003: premiumlspread (as appropriate). Other asset class Weightedaverageassumptionsused to determineprojectedbenefit obligation In percent SRP RSBP PEBP 2005 2004 2003 2005 2004 2003 2005 2004 2003 Dlscount rate 5.25 6.25 5.75 5.25 6.25 5.75 5.25 6.25 5.75 Rate of compensat~onlncrease 5.90 6.40 5.40 Health care growth rates - a t end of flscal year 6.80 7.30 6.10 Ultlmate health care growth rate 4.25 4.75 3.75 Year In whlch ultlmate rate IS reached Weightedaverageassumptionsused to determinenet periodic pensioncost In percent SRP RSBP PEBP 2005 2004 2003 2005 2004 2003 2005 2004 2003 Dlscount rate 6.25 5.75 6.75 6.25 5.75 6.75 6.25 5.75 6.75 Expected return o n plan assets 7.75 7.75 7.75 8.25 7.75 7.75 Rate of compensat~onlncrease 6.40 5.40 6.40 Health care growth rates - a t end of flscal year t o year 2011 and thereafter The medical cost trend rate can significantlyaffect the shows the effects of a one-percentage-point change in reported postretirement benefit income or costs and the assumed healthcare cost trend rate: benefit obligations for the RSBP. The following table In m~ll~onsof U.S. dollars One percentage polnt lncrease One percentage polnt decrease Effect on total servlce and lnterest cost $ 23 $ (19) Effect on postretirement beneflt obllgatlon 279 (222) InvestmentStrategy This analysis,referred to as an asset-liability analysis, also provides estimates of potential future contribu- The investment policy for the SRP and the RSBP is to tions and future asset and liability balances. Plan optimize the risk-return relationship as appropriate to assets are managed by external investment managers the respective plan's needs and goals, using a global and monitored by IBRD's pension investment depart- diversified portfolio of various asset classes. Specifi- ment. The pension plan assets are invested in diversi- cally, the long-term asset allocation is based on an fied portfolios of public equity, fixed income, and analysisthat incorporates expected returns by asset alternative investments. The fmed-income and public classas well as volatilities and correlations across asset equity asset classesare rebalanced on a monthly basis. classesand the liability profile of the respectiveplans. The following table presents the weighted-average asset allocation at June 30, and the respectivetarget allocation by asset category for the SRP and RSRP: In percent SRP RSBP Target % ofPlanAssets Target % of PlanAssets Allocat~on Allocat~on 2005 2005 2004 2005 2005 2004 Asset Class Flxed Income Publlc Equlty Alternatlve Investments Total Alternatlve Investments Include: Prlvate Equlty Real Estate Hedge Funds Estimated Future BenefitsPayments the amount of contributions expected to be paid to The following table shows the benefit payments the SRP and RSBP for IBRD and IDA during the fiscal expected to be paid in each of the next five years and Year beginning July 1,L'005 is $211 million and $63 subsequent five years. The expected benefit payments million, respectively. are based on the same assumptions used to measure NOTE L-SEGMENT REPORTING the benefit obligation at June 30,2005: Based on an evaluation of IBRD's operations, In m~ll~onsof U.S. dollars management has determined that IBRD has only one SRP RSBP PEBP reportable segment since IBRD does not manage its operations by allocating resources based on a July 1, 2005 -June 30, 2006 $319 $27 $9 determination of the contribution to net income from July 1,2006 -June 30, 2007 351 31 9 individual borrowers. In addition, given the nature of July 1,2007 -June 30, 2008 384 35 10 IBRD, the risk and return profiles are sufficiently July 1,2008 -June 30, 2009 418 39 12 similar among borrowers that IBRD does not July 1,2009 -June 30, 2010 447 44 13 differentiate between the nature of the products or July 1, 2010 -June 30, 2015 2,686 285 72 services provided, the preparation process, or the method for providing the services among individual countries. ExpectedContributions For fiscal year 2005, loans to each of two countries IBRD's contribution to the SRP and RSBP varies from generated in excess lo percent loan year to year, as determined by the Pension Finance Loan income from these two countries was $486 million and $466 million. Loan income comprises Committee, which basesits judgement on the results of annual actuarial valuations of the assets and interest, commitment fees, loan origination fees and liabilities of the SRP and RSBP. The best estimate of prepayment premia, net ofwaivers. The followingtable presents IBRD's loan outstanding balances and associated loan income, by geographic region, at June30,2005 and June 30,2004: In m~ll~onsof U.5. dollars 2005 2004 Reglon Loan Income Loans Outstanding Loan Income Loans Outstanding Afrlca $ 42 $ 2,197 East Asla and Paclflc 1,147 27,139 Europe and Central Asla 926 25,735 Latln Amerlca and the Caribbean 1,470 35,123 Mlddle East and North Afrlca 346 6,753 South Asla 219 7,399 Othera 5 55 Total $4,155 $104,401 $4,403 $109,610 a. Represents loans to IFC, an affiliatedorganlzatlon. NOTE M-COMPREHENSIVE INCOME Comprehensive income consists of net income and related to the implementation of FAS 133, currency other gains and losses affectingequity that, under U.S. translation adjustments, and net income. These items GAAP and IFRS, are excluded from net income. For are presented in the Statement of Comprehensive IBRD, comprehensive income comprises the Income. cumulative effects of a change in accounting principle IBRD FINANCIAL STATEMENTS: UNE J 30, 200589 The followingtables present the changes in Accumulated Other Comprehensive Income (Loss)for the fiscalyears ended June 30,2005, June 30,2004, and June 30,2003: In m~ll~ononsof U.S.dollars Total Cumulative Accumulated Cumulative Effectof Change Other Translation ~nAccounting Comprehensive Adustment Pr~nc~ple Reclass~f~cat~on~ Lo55 Balance, beg~nn~ngof the f~scalyear Changes from per~odact~v~ty Balance, end of the f~scalyear In m~ll~ononsof U.S.dollars iota/ Cumulative Accumulated Cumulative Effectof Change Other Translation ~nAccounting Comprehensive Adustment Prlnclple Reclass~f~cat~on~lncome Balance, beg~nn~ngof the f~scalyear Changes from per~odact~v~ty Balance, end of the f~scalyear In m~ll~ononsof U.S.dollars Total Cumulative Accumulated Cumulative Effectof Change Other Translation ~nAccounting Comprehensive Adustment Prlnclple Reclass~f~cat~on~ Lo55 Balance, beg~nn~ngof the f~scalyear Changes from per~odact~v~ty Balance, end of the f~scalyear a Reclass~f~cat~onof Cumulatlveeffect of change ~naccounting pr~nc~pleto net lncome NOTE N-NET UNREALIZEDGAINS (LOSSES) with the requirements of Statement of Financial ON NON-TRADING (BORROWINGS RELATED) Accounting Standards No. 115, Accountingfor Certain DERIVATIVE INSTRUMENTS, AS REQUIRED BY Investments in Debt and Equity Securities. FAS 133 AND IAS 39 Upon adoption of FAS 133, IBRD's net income was On July1,2000, IBRD adopted FAS 133. These increased by $219 million, and an additional $500 standards require that derivativeinstruments, as million was reported in other comprehensive income. defined by FAS 133, be recorded on the balance sheet The allocation between net income and other at fair value. IBRD has not defined any qualifying comprehensive income was based upon the hedging hedging relationships under this standard. relationships that existed under generallyaccepted accounting principles before the initial application of Prior to the adoption of FAS 133, the derivative FAS 133. instruments in the borrowing portfolio were recorded using synthetic accounting. The derivative The $500 million differencebetween the carrying instruments in the investment portfolio were, and value and the fair value of those derivatives that were continue to be, recorded at fair value in accordance hedging a cash flow exposure prior to the initial application of FAS 133, was included in Other time of implementation, and were offset by the mark- Comprehensive Income at the time FAS 133 was to-market adjustments on the related derivative implemented. This amount is being reclassified into instruments. The mark-to-market adjustments on the earnings in the same period or periods in which the bonds are being amortized over the remaining lives of hedged forecasted transactions affect earnings. the related bonds. Any gains or losses on those borrowings for which a The following table reflects the components of the fair value exposure was being hedged prior to effects of applying FAS 133 for the fiscal years ended adoption of FAS 133 were recorded in income at the June 30,2005, June 30,2004, and June 30,2003. In m~ll~onso f U.S. dollars Net unrealized gains (losses) on non-trading derivative instruments, as defined by FAS 133 and /AS 39 $2,527 $(4,052) $2,302 Reclassification and amortization of transition adjustment Reclass~f~cat~onfrom Other Comprehensive Income-Cash Flow Hedges 44 2 117 Amortlzatlon of mark-to-market on borrowings associated wlth falr value hedges (60) (50) (96) Net unrealized gains (losses) on non-trading (borrowingsrelated) derivative instruments, as required by FAS 133 and /AS 39 $2,51 1 $(4,100) $2,323 NOTE 0-ESTIMATED AND FAIR VALUE DISCLOSURES The Condensed Balance Sheets below present IBRD's estimates of fair value of its assets and liabilities along with their respectivecarrying amounts as of June30,2005 and 2004. In m~ll~onso f U.5. dollars June 30,2005 June 30, 2004 Carrylng Carrylng Value Fair Value* Value Fair Value* Due from Banks $ 1,177 $ 1,177 $ 1,803 $ 1,803 Investments 27,444 27,444 31,986 31,986 Loans Outstanding 104,401 107,549 109,610 112,608 Less Accumulated Provlslonfor Loan Losses and Deferred Loan Income (3,491) (3,491) Net Loans Outstanding 100,910 104,058 Swaps Receivable Investments 9,735 9,735 Loans 89 90 Borrowings 75,187 75,187 Other Asset/Llabll~ty 878 878 Other Assets 6,588 6,188 Total Assets Borrowlngs Swaps Payable lnvestments Loans Borrowlngs Other Asset/L~ab~l~ty Other Llabllltles Total Llabllltles Pald In Capltal Stock Retalned Earnlnqsand Other Equlty Total Equlty 38,588 36,943 Total Llabll~tlesand Equlty $222,008 $224,757 * Except for loans andrelated derlvatlves, whlch are on an est~matedvalue (current value) basls. Valuation Methods and Assumptions Due from Banks loans made to IFC. IBRD does not currently sell its The carrying amount of unrestricted and restricted loans, nor does it believe there is a comparable market currencies is considered a reasonable estimate of the for its loans. The current value of loans outstanding fair value of these positions. incorporates management's best estimate of the probable expected cash flows of these instruments to Investments IBRD. IBRD's investment securities and related financial instruments held in the trading portfolio are carried The current value of loans, including associated and reported at fair value. Therefore, for the financial derivativesis based on a discounted cash investment portfolio, no additional adjustment is flow method. The estimated cash flows from principal necessary. Fair value is based on market quotations. repayments and interest are discounted using the rate at which IBRD would originate a similar loan at the Instruments for which market quotations are not readily available have been valued using market-based reporting date. The cash flows of these instruments methodologies and market information. (SeeNote are based on management's best estimnates taking into account market exchange rates and interest rates. A). The current value of net loans outstanding also Net Loans Outstanding includes IBRD's assessment of the appropriate credit All of IBRD's loans are made to or guaranteed by risk, considering its history of collections from countries that are members of IBRD, except for those borrowers. This is reflected in the accumulated Borrowings provision for loan losses. The fair value of borrowings is predominarltly based on discounted cash flow techniques using appropriate Swaps Receivable and Swaps Payable market yield curves. Certain derivatives, as defined by FAS 133, are recorded in the balance sheet at estimated fair value. Other Assetsand Other Liabilities The fair value of swaps is based on market prices, These amounts are generally short-term in nature. where such prices are available. Where no quoted Therefore, the carrying value is a reasonable estimate market price is available, the fair value is estimated of fair value. The differencebetween the carrying using a discounted cash flow method representing the value and fair value of other assets is due to the estimated cost of replacing these contracts on that carrying value of debt issuance costs being included in date. (See Note A). other assets while the fair value of these costs is included as part of the fair value of borrowings. Management's Report Regarding Effectiveness of Internal Controls Over External Financial Reporting 96 Report of lndependent Accountants on Management's Assertion Regarding Effectiveness of Internal Controls Over External Financial Reporting 98 Report of lndependent Accountants on Special Purpose Financial Statements 99 Statement of Sources and Applications of Development Resources 100 Statement of Income 102 Statement of ComprehensiveIncome 103 Statement of Changes in Accumulated Deficit 103 Statement of Cash Flows 104 Summary Statement of Development Credits 105 Statement of Voting Power and Subscriptions and Contributions 108 Notes to Special Purpose Financial Statements 112 Supplementary Information on the Heavily Indebted Poor Countries Debt Initiative 127 The World Bank 1818H Street N.W. (202)477-1234 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Washington,D.C. 20433 Cable Address: INTBAFRAD INTERNATIONAL DEVELOPMENTASSOCIATION U.S.A. Cable Address: INDEVAS Management's Report Regarding Effectiveness of Internal Controls Over External Financial Reporting August 4,2005 The management of the International Development Association (IDA) is responsible for, the preparation, integrity, and fair presentation of its published special purpose financial statements and all other information presented in this annual report. The special purpose financial statements have been prepared in accordance with accounting principles described in Note A to IDA's special purpose financial statements and, as such, include amounts based on informed judgments and estimates made by management. The special purpose financial statements have been audited by an independent accounting firm, which was given unrestricted access to all financial records and related data, including minutes of all meetings of the Board of Executive Directors and committees of the Board. Management believes that all representations made to the independent auditors during their audit were valid and appropriate. The independent auditors' report accompanies the audited special purpose financial statements. Management is responsible for establishing and maintaining effective internal control over external financial reporting for financial presentations in conformity with accounting principles described in Note A to IDA's special purpose financial statements. The system of internal control contains monitoring mechanisms, and actions are taken to correct deficiencies identified. Management believes that internal controls for external financial reporting, which are subject to scrutiny by management and the internal auditors, and are revised as considered necessary, support the integrity and reliability of the external financial statements. There are inherent limitations in the effectiveness of any internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal control can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control may vary over time. IDA assessed its internal control over external financial reporting for financial presentations in conformity with accounting principles described in Note A to IDA's special purpose financial statements as of June 30, 2005. This assessment was based on the criteria for effective internal control over external financial reporting described in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based upon this assessment, management believes that IDA maintained effective internal control over external financial reporting presented in conformity with accounting principles described in Note -2- August 4,2005 A to IDA's special purpose financial statements, as of June 30, 2005. The independent accounting firm that audited the special purpose financial statements has issued an attestation report on Management's assessment of IDA's internal control over external financial reporting. The Board of Executive Directors of IDA has appointed an Audit Committee responsible for monitoring the accounting practices and internal controls of IDA. The Audit Committee is comprised entirely of Executive Directors who are independent of IDA's management. The Audit Committee is responsible for recommending to the Board of Executive Directors the selection of independent auditors. It meets periodically with management, the independent auditors, and the internal auditors to ensure that they are carrying out their responsibilities. The Audit Committee is responsible for performing an oversight role by reviewing and monitoring the financial, accounting and auditing procedures of IDA in addition to reviewingIDA's reports. The independent auditors and the internal auditors have full and free access to the Audit Committee, with or without the presence of management, to discuss the adequacy of internal control over external financial reporting and any other matters which they believe should be brought to the attention of the Audit Committee. John Wilton Vice Prkdent and Acting Chief Financial Officer Charles A. Vice president and ~ontrbller IDA SPECIAL PURPOSE FINANCIAL STATEMENTS: JUNE 30, 2005 97 Deloitte &ToucheLLP Suite 500 555 12th Street NW Washington. DC 20004-1207 USA Tel: +1 202 879 5600 Fax. +1 202 879 5309 www.deloitte.com INDEPENDENT ACCOUNTANTS' REPORT President and Board of Governors International Development Association We have examined management's assertion, included in the accompanying Management's Report Regarding Effectiveness of Internal Controls over External Financial Reporting, that the International Development Association maintained effective internal control over external financial reporting presented in conformity with the accounting principles described in Note A to the International Development Association's special purpose financial statements as of June 30, 2005, based on the criteria established in "Internal Control-Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO report). Management is responsible for maintaining effective internal control over external financial reporting. Our responsibility is to express an opinion on management's assertion based on our examination. Our examination was conducted in accordance with attestation standards established by the American Institute of Certified Public Accountants and, accordingly, included obtaining an understanding of internal control over financial reporting, testing, and evaluating the design and operating effectiveness of the internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our examination provides a reasonable basis for our opinion. Because of the inherent limitations of internal control over external financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may occur and not be detected. Also, projections of any evaluation of the effectiveness of the internal control over external financial reporting to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assertion that International Development Association maintained effective internal control over external financial reporting presented in conformity with the accounting principles described in Note A to the International Development Association's special purpose financial statements as of June 30,2005, is fairly stated, in all material respects, based on the criteria established in "Internal Control- Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission. August 4,2005 Member of Deloitte ToucheTohmatsu Deloitte & Touche LLP Suite 500 555 12th Street NW Washington. DC 20004-1207 INDEPENDENT AUDITORS' REPORT USA Tel: +I 202 879 5600 Fax: +1 202 879 5309 President and Board of Governors www.deloitte.com International Development Association We have audited the accompanying special purpose statement of sources and applications of development resources of the International Development Association as of June 30,2005 and 2004, including the summary statement of development credits and statement of voting power and subscriptions and contributions as of June 30,2005 and the related special purpose statements of income, comprehensive income, changes in accumulated deficit, and cash flows for each of the three fiscal years in the period ended June 30,2005. These special purpose financial statements are the responsibility of the International Development Association's management. Our responsibility is to express an opinion on these special purpose financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the special purpose financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the special purpose financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall special purpose financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. The accompanying special purpose financial statements were prepared to reflect the sources and applications of development resources, operations, and cash flows of the International Development Association to comply with Article VI, Section 11 (a) of the Articles of Agreement of the International Development Association, as discussed in Note A to the special purpose financial statements, and are not intended to be a presentation in conformity with the accounting principles generally accepted in the United States of America or International Financial Reporting Standards. In our opinion, such special purpose financial statements referred to above present fairly, in all material respects, the sources and applications of development resources of the International Development Association as of June 30,2005 and 2004, and the results of its operations and its cash flows for each of the three fiscal years in the period ended June 30,2005 in conformity with the accounting principles described in Note A to the special purpose financial statements. Our audits were conducted for the purpose of expressing an opinion on the basic special purpose financial statements taken as a whole. The Supplementary Information on the Heavily Indebted Poor Countries Debt Initiative listed in the table of contents is presented for the purpose of additional analysis. This additional information is the responsibility of the International Development Association's management. Such information has been subjected to the auditing procedures applied in our audits of the basic special purpose financial statements. This report is intended solely for the information and use of the Board of Governors, management, and members of the International Development Association. However, under the International Development Association's Articles of Agreement, this report is a matter of public record and its distribution is not limited. August 4,2005 Member of Deloitte Touche Tohmatsu IDA SP ECIALPURPOSE FINANCIAL STATEMENTS: JUNE30, 2005 99 D E V E L O P M E N T R E S O U R C E S June 30, 2005 andJune 30, 2004 Expressed in millions o f U.S. dollars Applications of Development Resources Net ResourcesAvailable for Development Activities Due from banks Unrestricted currencies Currencies subject to restriction Investments-Notes Band F Investments-Trading (including securities transferred under repurchase or security lending agreements of $5,259 million-June 30, 2005; $4,676 million-June 30, 2004) 14,674 Net payable on investment securities transactions Nonnegotiable, noninterest-bearing demand obligations on account of member subscriptions and contributions Receivable from the International Bank for Reconstruction and Development-Note D Receivable from the HlPC Debt Initiative Trust Fund-Note I Payable for development grants-NoteJ Other resources, net Total net resources available for development activities Resources Used for Development Credits (see Summary Statement of Development Credits, Notes E and F ) Total development credits Less undisbursed balance Development credits outstanding Less allowance for HlPC Debt Initiative Total resources used for development credits outstanding 109,188 Total Applications of Development Resources $130,378 Sources of Development Resources Member subscriptions and contributions (see Statement of Voting Power, Subscriptions and Contributions, and Note C) Unrestricted Restricted Subscriptions and contributionscommitted Less subscriptions and contributions receivable and unamortized discounts on contributions-Note C Subscriptions and contributions paid in Deferred amounts receivable to maintain value of currency holdings Transfers-NoteD Accumulated other comprehensive income-Note K Accumulated deficit (see Statement of Changes in Accumulated Deficit) Total Sources of Development Resources The Notes to Special Purpose FinancialStatements are an integral part of these Statements. IDA SPECIAL PURPOSE FINANCIALSTATEMENTS: JU NE30, 2005 101 S T A T E M E N T O F I N C O M E For the fiscalyears endedJune 30, 2005, June 30, 2004 andJune 30, 2003 Expressed in millions o f U.S. dollars 2005 lncome lncome from development credits-Note E Service charges Commitment charges lncome from investments, net-Note B Total income Expenses Development grants-Note J Administrative-Notes G and H Amortization of discount on contributions Total expenses Operating (Loss) lncome Effect of exchange rate changes on accumulated income before HlPC Debt lnitiative Net (Loss) Income before HIPC Debt Initiative (1,173) HIPC Debt Initiative-Income (Expenses)-Notes E and I Provision for principal component of debt relief (1,325) Contribution from the HlPC Debt Initiative Trust Fund 200 Total net expenses for HlPC Debt Initiative (1,125) Net (Loss) Income after HIPC Debt Initiative $42,298) The Notes to Special Purpose Financial Statements are an integral part of these Statements. 102 THE WORLD BANK ANNUAL REPORT 2005 S T A T E M E N T O F C O M P R E H E N S I V E I N C O M E For the fiscal years ended June 30, 2005, June 30, 2004 and June 30, 2003 Expressed in millions of U.S. dollars (Loss) Income after HlPCDebt Initiative $42,298) $41,687) $ 681 Other comprehensive (loss) income-Note K Currency translation adjustment on development credits and payable for development grants (549) 4,212 5,222 Comprehensive (loss) income $42,847) $2,525 $5,903 For the fiscal years ended June 30, 2005 and June 30, 2004 Expressed in millions of U.S. dollars Balance at Activity Balance at Balance at Activity Balance at beginning of during the end of the beginning of during the end of the the fiscal year fiscal year fiscal year the fiscal year fiscal year fiscal year Accumulated income before HlPC Debt Initiative $ 4,747 $(1,173) $ 3,574 $ 5,909 $ (1, I 62) $ 4,747 HlPC Debt Initiative: Provision for principal component of debt relief (11,698) (1,325) (13,023) (10,971) (727) (11,698) Contribution from the HlPC Debt lnitiative Trust Fund 1,295 200 1,495 1,093 202 1,295 HlPC grants (330) - (330) (330) - (330) Write down of development credits (572) - (572) (572) - (572) HlPCDebt Initiative (11,305) (1,125) (12,430) (10,780) (525) (11,305) Accumulated Deficit $ (6,558) $42,298) $ (8,856) $ (4,871) $ (1,687) $ (6,558) The Notes to SpecialPurpose FinancialStatements are an integralpart of these Statements. IDA SP ECIA LPURPOSEFINA NCIA LSTATEMENTS: J UN E30, 2005 103 S T A T E M E N T O F C A S H F L O W S For the fiscalyears endedJune 30, 2005, June 30, 2004 andJune 30, 2003 Expressed in millions o f U.S. dollars 2005 Cash Flows from development activities Development credits Disbursements Principal repayments Reimbursements received from the HlPC Debt lnitiative Trust Fund for principal repayments forgiven Net cash used in development credit activities Grant activities Development grant disbursements HlPC grant disbursements Net cash used in grant activities Net cash used in development activities Cash Flows from Member subscriptions and contributions Transfers from the International Bank for Reconstruction and Development Transfers from trust funds Cash Flows from operating activities Operating (loss) income Adjustments to reconcile operating (loss) income to net cash provided by operating activities Development grants Amortization of discount on subscription advances Net changes in other development resources Net cash provided by operating activities Effect of exchange rate changes on unrestricted cash and liquid investments Net Increase in unrestricted cash and liquid investments 641 Unrestricted cash and liquid investments at beginning of the fiscal year 14,421 Unrestricted cash and liquid investments at end of the fiscal year $15,062 Composed of: Due from banks-Unrestricted currencies Investments Supplemental Disclosure (Decrease)/lncrease in ending balances of development credits outstanding, resulting from exchange rate fluctuations $ (574) Principal repayments forgiven under HlPC Debt Initiative (391) Development credits transferred from the Trust Fund for Bosnia and Herzegovina - The Notes to Special Purpose Financial Statements are an integral part of these Statements. 104 THE WORLD BANK ANNUAL REPORT 2005 S U M M A R Y S T A T E M E N T O F D E V E L O P M E N T C R E D I T S June 30, 2005 Expressed in millions o f U.5. dollars Percentage of Total Undisbursed Development development development development credits credits Borrower or guarantor credits credits a outstanding outstanding Afghanistan Albania Angola Armenia Azerbaijan Bangladesh Benin Bhutan Bolivia Bosnia and Herzegovina Botswana Burkina Faso Burundi Cambodia Cameroon Cape Verde Central African Republic Chad Chile China Colombia Comoros Congo, Democratic Republic of Congo, Republic of Costa Rica CBte d'lvoire Djibouti Dominica Dominican Republic Ecuador Egypt, Arab Republic of El Salvador Equatorial Guinea Eritrea Ethiopia Gambia, The Georgia Ghana Grenada Guinea Guinea-Bissau Guyana Haiti Honduras IDA SPECIAL PURPOSE FINANCIALSTATEMENTS: JU NE30, 2005 105 ( c o n t i n u e d ) June 30, 2005 Expressed in millions o f U.S. dollars Percentage o f Total Undisbursed Development development development development credits credits Borrower or guarantor credits credits a outstanding outstanding India Indonesia Jordan Kenya Korea, Republic of Kyrgyz Republic Lao People's Democratic Republic Lesotho Liberia Macedonia, former Yugoslav Republic Madagascar Malawi Maldives Mali Mauritania Mauritius Moldova Mongolia Morocco Mozambique Myanmar Nepal Nicaragua Niger Nigeria Pakistan Papua New Guinea Paraguay Philippines Rwanda St. Kitts and Nevis St. Lucia St. Vincent and the Grenadines Samoa 520 Tome and Principe Senegal Serbia and Montenegro Sierra Leone Solomon Islands Somalia Sri Lanka Sudan Swaziland Syrian Arab Republic Tajikistan Percentage of Total Undisbursed Development development development development credits credits Borrower or guarantor credits credits a outstanding outstanding Tanzania Thailand Togo Tonga Tunisia Turkey Uganda Uzbekistan Vanuatu Vietnam Yemen, Republic of Zambia Zimbabwe Subtotal members West African Development Bank Bank of the States of Central Africa Caribbean Development Bank Subtotal regional development banks African Trade Insurance Agency Other g Total-June 30, 2005 Total-June 30, 2004 * Ind~catesamounts less than $0.05 m1111onor less than 0.005 per cent a. Of the undisbursed balance at June 30, 2005, IDA has entered into irrevocable commitments to disburse $211 million ($281 million-June30, 2004). b. May differ from the sum of individual figures shown due to rounding. c. These development credits are for the benefit of Benin, Burkina Faso, C6te d'lvoire, Mali, N i g e ~Senegal and Togo. d. These development credits are for the benefit of Cameroon, Chad, Central African Republic, Republic of Congo, Gabon and Equatorial Guinea. e. These development credits are for the benefit of Grenada and territories of the United Kingdom (Associated States and Dependencies) in the Caribbean region. f. Represents development credit extended to the African Trade lnsurance Agency (ATI)as implementing agency for the benefit of Burundi, Kenya, Malawi, Rwanda, Tanzania, Uganda and Zambia. g. Represents development credits made at a time when the authorities on Taiwan represented China in IDA (prior to May 15, 1980). The Notes to Special Purpose Financial Statements are an integral part of these Statements. IDA SPECIA LPURPOSEFINA NCIA LSTATEMENTS: J UN E30, 2005 107 S T A T E M E N T O F V OT I N G PO W E R A N D SU B S C R I P T I O N S A N D C O N T R I B U T I O N S June 30, 2005 Expressed in millions o f U.S. dollars Subscriptions and Number o f Percentage o f contributions Member a votes total votes committed Part I Members Australia Austria Belgium Canada Denmark Finland France Germany Greece Iceland Ireland Italy Japan Kuwait Luxembourg Netherlands New Zealand Norway Portugal Russian Federation Slovenia South Africa Spain Sweden 5witzerlandb United Arab Emirates United Kingdom United States Subtotal Part I ~ e m b e r s ~ , ~ Part I1Members Afghanistan Albania Algeria Angola Argentina Armenia Azerbaijan Bangladesh Barbados Belize Benin Bhutan Bolivia Bosnia and Herzegovina Botswana Brazil Burkina Faso Subscriptions and Number o f Percentage o f contributions Member a votes total votes committed Burundi Cambodia Cameroon Cape Verde Central African Republic Chad Chile China Colombia Comoros Congo, Democratic Republic of Congo, Republic of Costa Rica CBte d'lvoire Croatia Cyprus Czech Republic Djibouti Dominica Dominican Republic Ecuador Egypt, Arab Republic of El Salvador Equatorial Guinea Eritrea Ethiopia Fiji Gabon Gambia, The Georgia Ghana Grenada Guatemala Guinea Guinea-Bissau Guyana Haiti Honduras Hungary India Indonesia Iran, Islamic Republic of Iraq Israel Jordan Kazakhstan Kenya Kiribati IDA SPECIAL PURPOSE FINANCIALSTATEMENTS: JU NE30, 2005 109 S T A T E M E N T O F V OT I N G P O W E R A N D SU B S C R I P T I O N S A N D C O N T R I B U T I O N S ( c o n t i n u e d ) June 30, 2005 Expressed in millions o f U.S. dollars Subscriptions and Number o f Percentage o f contributions Member a votes total votes committed Korea, Republic of Kyrgyz Republic Lao People's Democratic Republic Latvia Lebanon Lesotho Liberia Libya Macedonia, former Yugoslav Republic of Madagascar Malawi Malaysia Maldives Mali Marshall Islands Mauritania Mauritius Mexico Micronesia, Federated States of Moldova Mongolia Morocco Mozambique Myanmar Nepal Nicaragua Niger Nigeria Oman Pakistan Palau Panama Papua New Guinea Paraguay Peru Philippines Poland Rwanda St. Kitts and Nevis St. Lucia St. Vincent and the Grenadines Samoa 520 Tome and Principe Saudi Arabia Senegal Serbia and Montenegro Sierra Leone Singapore Slovak Republic Solomon Islands Somalia Subscriptions and Number of Percentage of contributions Member a votes total votes committed Sri Lanka Sudan Swaziland Syrian Arab Republic Tajikistan Tanzania Thailand Timor-Leste Togo Tonga Trinidad and Tobago Tunisia Turkey Uganda Ukraine Uzbekistan Vanuatu Vietnam Yemen, Republic of Zambia Zimbabwe Subtotal Part IIMembers Total-June 30, 2005 b,C Total-June 30, 2004 * Indicates amounts less than $0.05 million or less than 0.005 percent. a. See Notes to Special Purpose Financial Statements-Note A for an explanation of the two categories of membership. b. $512.3 million of Switzerland's subscription and contributions have not been included in the Statement of Sources and Applications of Development Resourcesat June 30, 2005 and June 30, 2004 since this represents the difference between the total cofinancing grants of $580.1 million provided by Switzerland directly to IDA borrowers as cofinancing grants between the fourth and the ninth replenishments of IDA resources, and the July 1992 contribution by Switzerland of $67.8 million. c. May differ from the sum of individual figures shown due to rounding. The Notes to Special Purpose Financial Statements are an integral part of these Statements. IDA SP ECIA LPURPOSEFINA NCIA LSTATEMENTS: J UN E30, 2005 1 1 1 NOTE A-ORGANIZATION, OPERATIONS AND The preparation of these special purpose financial SIGNIFICANT ACCOUNTING AND RELATED statements requires management to make estimates POLICIES and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent Purpose and Affiliated Organizations assets and liabilities at the date of the financial The International Development Association (IDA) is statements and the reported amounts of revenue and an international organization that was established on expenses during the reporting period. Actual results September 24, 1960. IDA'Smain goal is reducing could differ from these estimates. Significant poverty through promoting sustainable economic judgments have been used in the computation of development in the less developed areas of the world estimated fair values of development credits and included in IDA'S membership, by extending allowancesfor the HIPC Debt Initiative. concessionary financing in the form of grants, development credits and guarantees. IDA has three Reclassifications affiliated organizations, the International Bank for Certain reclassificationsof the prior years' Reconstruction and Development (IBRD),the information have been made to conform to the International Finance Corporation (IFC), and the current year's presentation. Multilateral Investment Guarantee Agency (MIGA). Basis of Accounting Each of these other organizations is legally and financially independent from IDA, with separate IDA's special purpose financial statements are assets and liabilities, and IDA is not liable for their prepared on the accrual basis of accounting. That is, respectiveobligations. Transactions with these the effects of transactions and other events are affiliates are disclosed in the notes that follow. The recognized when they occur (and not as cash or its principal purpose of IBRD is to promote sustainable equivalent is received or paid) and are recorded in the economic development and reduce poverty in its accounting records and reported in the financial member countries, primarily by providing loans, statements of the periods to which they relate. guarantees and related technical assistancefor specific IDA follows a special basis of accounting for member projects and for programs of economic reform in subscriptions and contributions and for development developing member countries. IFC's purpose is to credits as described under the discussion on encourage the growth of productive private significant accounting policies below. enterprisesin its member countries through loans and equity investments in such enterprises without a Translationof Currencies member's guarantee. MIGA was established to IDA's special purpose financial statements are encourage the flow of investments for productive expressed in terms of U.S. dollars solely for the purposes between member countries and, in purpose of summarizing IDA'Sfinancial position and particular, to developing member countries by the results of its operations for the convenience of its providing guarantees against noncommercial risksfor members and other interested parties. foreign investment in its developing member IDA is an international organization which conducts countries. its operations in Special Drawing Rights (SDRs)and Summaryof SignificantAccountingand Related U.S. dollars. Applications of development resources Policies and sources of development resources are translated at Due to the nature and organization of IDA, these market exchange rates in effect at the end of the financial statements have been prepared for the accounting period, except Member Subscriptions and specificpurpose of reflectingthe sources and Contributions which are translated in the manner applications of member subscriptions and described below. Income and expenses are translated contributions and other development resources. at either the market exchange rates in effect on the These financial statements are not intended to be a dates of income and expense recognition, or at an presentation in accordance with accounting principles average of the exchange rates in effect during each generallyaccepted in the United States of America or month. Translation adjustments relating to the with International Financial Reporting Standards. revaluation of development credits and development These special purpose financial statements have been grants denominated in SDRs are charged or credited prepared to comply with Article VI, Section 11(a)of to Accumulated Other Comprehensive Income. Other the Articles of Agreement of IDA, and are prepared in translation adjustments are shown in the Statement of accordance with the accounting policies outlined Income. below. On August 4,2005, the Executive Directors approved these financial statements for issue. Member Subscriptionsand Contributions Transfers to IDA from IBRD are recorded under Recognition Sources of Development Resources and are receivable Member Subscriptions and Contributions committed upon approval by IBRD's Board of Governors. for each IDA replenishment are recorded based upon For the purposes of its financial resources, the the full amount of Instruments of Commitment membership of IDA is divided into two categories: (1) received from members upon effectiveness of the Part I members, which make payments of relevant replenishment. Prior to effectiveness, only a subscriptions and contributions provided to IDA in portion of the Instruments of Commitment received convertible currencies which may be freely used or are recorded as Subscriptions and Contributions exchanged by IDA in its operations and (2) Part I1 committed. A replenishment becomes effectivewhen members, which make payments of ten percent of IDA receivesInstruments of Commitment from their initial subscriptions in freely convertible members for subscriptions and contributions of a currencies, and the remaining 90 percent of their specified portion of the full replenishment. Amounts initial subscriptions, and all additional subscriptions not yet paid in, at the date of effectiveness, are and contributions in their own currencies or in freely recorded as Subscriptions and Contributions convertible currencies. Certain Part I1members Receivableand shown as a reduction of Subscriptions provide a portion of their subscriptions and and Contributions Committed. These receivables contributionsin the same manner as mentioned in (1) become due throughout the replenishment period above. IDA'SArticles of Agreement and subsequent (generallythree years) in accordance with an agreed replenishment agreements provide that the currency maturity schedule. The actual payment of receivables of any Part I1member paid in by it may not be used by when they become due from certain members is IDA for projects financed by IDA and located outside conditional upon the respectivemember's budgetary the territory of the member except by agreement appropriation processes. between the member and IDA. The local currency The Subscriptions and Contributions Receivable are portion of subscriptions of Part 11members are settled through payment of cash or deposit of recorded as restricted under Member Subscriptions nonnegotiable, noninterest-bearing demand notes. and Contributions unless released under an The notes are encashed by IDA as provided in the agreement between the member and IDA or used for relevant replenishment resolution over the administrative expenses. The cash paid and notes disbursement period of the credits committed under deposited in nonconvertible local currencies for the the replenishment. subscriptions of Part I1members are recorded either as currencies subject to restriction under Due from In certain replenishments, donors have had the option Banks, or as restricted notes included under of paying all of their subscription and contribution Nonnegotiable, noninterest-bearing demand amounts in cash before they become due, and thereby obligations on account of member subscriptions and receivingdiscounts. In addition, some replenishment contributions. Restricted notes at June 30,2005 were arrangements have incorporated an accelerated $44 million ($44 million-June30,2004). encashment schedule. In these cases, IDA and the donor agree that IDA will invest the cash and retain Valuation the income. The related subscription and The subscriptions and contributions provided contribution is recorded at the full undiscounted through the Third Replenishment are expressed in amount. The discount is recorded as unamortized terms of "U.S. dollars of the weight and fineness in discounts on contributions (a reduction of effect on January1, 1960" (1960 dollars). Following Subscriptions and Contributions Committed) and the abolition of gold as a common denominator of the amortized over the projected encashment period. monetary system and the repeal of the provision of the Under the provisions governing replenishments, IDA U.S. law defining the par value of the U.S. dollar in must encash the notes or similar obligations of terms of gold, the pre-existing basis for translating contributing members on an approximately pro rata 1960 dollars into current dollars or any other currency basis. As discussed in the previous paragraph, donors disappeared. The Executive Directors of IDA decided, sometimes contribute resources on an advanced or an with effect from that date and until such time as the accelerated basis. IDA holds these resources until they relevant provisions of the Articles of Agreement are become available for disbursement on a pro rata basis. amended, that the words "U.S. dollars of the weight and finenessin effect on January1, 1960"in Article 11, Section 2(b) of the Articles of Agreement of IDA are interpreted to mean the SDR introduced by the IDA SPECIAL PURPOSE FINANCIAL STATEMENTS: JUNE 30, 2005 113 International Monetary Fund as the SDR was valued Development Credits in terms of U.S. dollars immediatelybefore the All development credits are made to or guaranteed by introduction of the basket method of valuing the SDR member governments or to the government of a on July1, 1974, such value being equal to $1.20635 for territory of a member (exceptfor development credits one SDR (the 1974 SDR), and have also decided to which have been made to regional development apply the same standard of value to amounts institutions for the benefit of members or territories expressedin 1960 dollars in the relevant resolutions of of members of IDA). In order to qualify for lending the Board of Governors. on IDA terms, a country's per capita income must be below a certain level and the country may have only The subscriptions and contributions provided limited or no creditworthiness for IBRD lending. through the Third Replenishment are expressed on credits carry a service charge 0.75 the basis of the 1974SDR. Prior to the decision of the percent and generally have 35- or 40-year final Executive Directors, IDA had valued these maturities and a 10-year grace period for principal subscriptions and contributions on the basis of the payments. Commitment charges on the undisbursed SDR at the current market value of the SDR. balances of IDA credits are set annually by the Board The subscriptions and contributions provided under of Executive Directors of IDA. For the fiscal year the Fourth Replenishment and thereafter are ended June 30,2005 the rate for undisbursed credits expressed in members' currencies or SDRs and are was set at 0.35 percent (fiscalyear ended June30, payablein members' currencies. Beginning July1, 2004-0.50 percent). For the fiscal year ending June 1986, subscriptions and contributions made available 30,2006 the rate has been set at 0.30 percent. for hsbursement in cash to IDA are translated at Development credits are carried in the Special market exchange rates in effect on the dates they were Purpose Financial Statements at the full face amount made available. Prior to that date, subscriptions and of the borrowers' outstanding obligations. contributions which had been disbursed or converted It is the practice of IDA to place in nonaccrual status into other currencies were translated at market all development credits made to or guaranteed by a exchange rates in effect on dates of disbursement or member government or to the government of a conversion. Subscriptions and contributions not yet territory of a member if principal or charges with available for disbursements are translated at market respect to any such development credit are overdue by exchange rates in effect at the end of the accounting more than six months, unless IDA'Smanagement period. determines that the overdue amount will be collected Article IV, Section 2(a) and (b) of IDA'SArticles of in the immediate future. In addition, if loans by IBRD Agreement provides for maintenance of value to a member government are placed in nonaccrual payments on account of the local currency portion of status, all development credits to that member the initial subscription whenever the par value of the government will alsobe placedin nonaccrual status by member's currency or its foreign exchangevalue has, IDA. On the date a member's development credits are in the opinion of IDA, depreciated or appreciated to a placed in nonaccrual status, charges that had been significant extent within the member's territories, so accrued on development credits outstanding to the long as, and to the extent that, such currency shall not member which remained unpaid are deducted from have been initially disbursed or exchanged for the the income from development credits of the current currency of another member. The provisions of period. Charges on nonaccruing development credits Article IV, Section 2(a) and (b) have by agreement are included in income only to the extent that been extended to cover additional subscriptions and payments have actually been received by IDA. If contributions of IDA through the Third collectibility risk is considered to be particularly high Replenishment, but are not applicable to those of the at the time of arrears clearance, the member's credits Fourth and subsequent replenishments. may not automatically emerge from nonaccrual status, even though the member's eligibilityfor new The ExecutiveDirectors decided on June 30, 1987 that credits may have been restored. A decision on the settlements of maintenance of value, which would restoration of accrual status is made on a case-by-case result from the resolution of the valuation issue on the basis. basis of the 1974 SDR, would be deferred until the Executive Directors decide to resume such In fulfillingits mission, IDA makes concessionalloans settlements. These amounts are shown as Deferred to the poorest countries. Therefore, there is significant Amounts Receivableto Maintain Value of Currency credit risk in the portfolio of development credits. Holdings. Management continually monitors this credit risk. No provision for credit losses, other than allowances member country that has provided the counter for the HeavilyIndebted Poor Countries (HIPC) Debt guarantee to IDA, on demand, or as IDA may Initiative, has been established. Should losses occur, otherwise direct. they would be included in the Statement of Income. For guarantees issued prior to January1,2003, the fee The repayment obligations of IDA'Sdevelopment income received is deferred and amortized over the credits funded from resources through the Fifth period of benefit. Replenishment are expressed in the development For guarantees issued or modified after December 31, credit agreements in terms of 1960 dollars. In June 2002, IDA records the fair value of the obligation to 1987, the Executive Directors decided to value those stand ready in the financial statements. development credits at the rate of $1.20635 per 1960 dollar on a permanent basis. Development credits The unamortized balance of the deferred guarantee funded from resources provided under the Sixth fee income and the unamortized balance of the Replenishment and thereafter are denominated in obligation to stand ready are included in Other SDRs;the principal amounts disbursed under such Resources,net on the Statement of Sources and development credits are to be repaid in currency Applications of Development Resources. amounts currently equivalent to the SDRs disbursed. HeavilyIndebted Poor Countries (HIPC)Debt Development Grants Initiative IDA is authorized to provide a significant portion of The HIPC Debt Initiative was launched in 1996 as a financing under the Thirteenth Replenishment as joint effort by bilateral and multilateral creditors to development grants. The annual net income transfers ensure that reform efforts of HIPCs would not be put from IBRD for fiscal years 1997 through 2005 also at risk by unsustainable external debt burdens. As a authorized the use of such funds for IDA development part of this process, the HIPC Debt Initiative Trust grants. Fund was established on November 7, 1996. It is administered by IDA and constituted by funds of Development grants are charged to income when the donors including the IBRD, to help beneficiaries development grant agreement is signed by the reduce their overall debt, including IDA debt. recipient. Under the Original Framework of the Initiative, Commitment charges on the undisbursed balances of eligiblecountries received relief on IBRD and IDA IDA grants are set annually by the Board of Executive debt through three mechanisms: (i) partial financing Directors of IDA. For the fiscal years ended June 30, of lending operations with development grants; (ii) 2005 and June30,2004, the commitment charge rate purchase and cancellation of IDA credits by the IBRDI on the undisbursed balances of IDA grants was zero IDA component of the HIPC Debt Initiative Trust percent. For the fiscal year ending June 30,2006 the Fund subject to availabilityof funds; and (iii) the rate will continue to be zero percent. provision of debt service on selected IDA credits, in Guarantees certain cases, by the HIPC Debt Initiative Trust Fund. IDA provides guarantees for loans issued in support of Under the Enhanced Framework of the Initiative, projects located within a member country that are which was approved by IDA'SExecutive Directors on undertaken by private entities. These financial January27,2000, implementation mechanisms also guarantees are commitments issued by IDA to include: (i)partial forgivenessof IDA debt serviceas it guarantee payment performance by a borrower to a comes due, to be reimbursed to IDA by the IBRDIIDA third party. component of the HIPC Debt Initiative Trust Fund; and (ii)in the case of countries with a substantial Guarantees are regarded as outstanding when the amount of outstanding IBRD debt, partial refinancing underlying financial obligation of the borrower is by IDA resources (excluding transfers from IBRD) of incurred, and called when a guaranteed party outstanding IBRD debt. demands payment under the guarantee. IDA would be required to perform under its guarantees if the Upon approval of debt relief for a country under the payments guaranteed are not made by the borrower Enhanced HIPC Initiative by the Executive Directors and the guaranteed party called the guarantee by of IDA, the principal component of the estimated debt demanding payment from IDA in accordance with the relief costs is recorded as a reduction of the disbursed terms of the guarantee. and outstanding development credits under the Allowance for HIPC Debt Initiative, and as a charge to In the event that a guarantee is called, IDA has the income. contractual right to require payment from the IDA SPECIAL PURPOSE FINANCIAL STATEMENTS: JUNE 30, 2005 115 This estimate is subject to periodic revision. The securities transferred to counterparties under the Allowance for HIPC Debt Initiative is reduced when resale agreements have not met the accounting criteria debt relief is provided by IDA. for treatment as a sale. Therefore, securities transferred under repurchase agreements and security Upon signature by IDA of the country specificlegal lending arrangements are retained as assets on IDA's notification, immediately following the decision by Statement of Sources and Applications of the ExecutiveDirectorsof IDA to provide debt relief to Development Resources and securities received under the country (thedecision point), a receivable from the resale agreements are not recorded on IDA's HIPC Debt Initiative Trust Fund is created (to the Statement of Sources and Applications of extent that funds are available) and income is Development Resources. recognized. The receivable is limited to the nominal value equivalent of one-third of the net present value NOTE B-INVESTMENTS of the principal component of the total debt relief committed to the specific country. The receivable is As part of its portfolio management strategy, IDA also the maximum debt relief that can be provided invests in the following financial instruments. before the country reaches its completion point as Asset-backed Securities:Asset-backedsecurities are defined by IDA'SExecutive Directors, and the instruments whose cash flow is based on the cash country's other creditors have confirmed their full flows of a pool of underlying assets managed participation in the debt relief initiative to the separately.IDA may only invest in asset-backed satisfaction of IDA. securities with a AAA credit rating. An additional receivable from the HIPC Debt Currency Swaps:Currency swaps are agreements Initiative Trust Fund is created and income is between two parties to exchange cash flows recognized when the country reaches its completion denominated in different currencies at one or more point and the country's other creditors have certain times in the future. The cash flows are based confirmed their full participation in the debt relief on a predetermined formula reflectingrates of interest initiative to the satisfaction of IDA. This additional and an exchange of principal. IDA is authorized to receivable represents the remaining principal enter into currency swaps including currency forward component of the total debt relief committed that was contracts. not recognized at the decision point. Futures:Futures are contracts for deliveryof securities Cash and Liquid Investments or money market instruments in which the seller IDA considers unrestricted cash as well as securities agrees to make deliveryat a specified future date of a held in the investment portfolio, as an element of specified instrument, at a specified price or yield. liquidity in the Statement of Cash Flows, since they Futures contracts are traded on regulated United are readily convertible to known amounts of cash. States and international exchanges.IDA generally IDA carries its investment securities and related closes out most open positions in futures contracts financial instruments at fair value, using trade date prior to maturity. Therefore, cash receipts or accounting. The first-in-first-out (FIFO) method is payments are mostly limited to the change in market used to determine the cost of securities sold in value of the futures contracts. Futures contracts computing the realized gains and losses on these generally entail daily settlement of the variation instruments. Both realized and unrealized gains and margin. losses are included in Income from investments. Government and Agency Obligations: These Securities Purchased Under Resale Agreements and obligations include marketable bonds, notes and other SecuritiesSold Under Repurchase Agreements obligations issued by governments. Obligations issued Securities purchased under resale agreements and or unconditionally guaranteed by governments of securities sold under repurchase agreements are member countries require a minimum credit rating of recorded at historical cost. IDA receives securities AA- if denominated in a currency other than the purchased under resale agreements, monitors the fair home currency of the issuer, otherwise no rating is value of the securities and, if necessary, closes out required. transactions and enters into new repriced Obligations issued by an agencyor instrumentality of transactions. a government of a member country, a multilateral The securities transferred to IDA under the organization or any other official entity other than the repurchase and security lending arrangements and the government of a member country require a minimum credit rating of AA-. Interest Rate Swaps: Interest rate swaps are agreement involves the purchase of securities with a agreements involving the exchange of periodic simultaneous agreement to sell back the same interest payments of differing character, based on an securities at a stated price on a stated date. Securities underlying notional principal amount for a specified loans are contracts under which securities are lent for time. a specified period of time at a fmed price. Options: Options are contracts that allow the holder Short Sales: Short sales are sales of securities not held of the option the right, but not the obligation, to in the seller's portfolio at the time of the sale. The purchase or sell a financial instrument at a specified seller must purchase the security at a later date and price within a specified period of time from or to the bears the risk that the market value of the security will seller of the option. The purchaser of an option pays a move adversely between the time of the sale and the premium at the outset to the seller of the option, who time the security must be delivered. As of June 30, then bears the risk of an unfavorable change in the 2005, IDA had $228 million ($1,010million-June price of the financial instrument underlying the 30,2004) of short sales included in Net payable on option. IDA invests only in exchange-traded options. investment securities transactions in the Statement of The initial price of an option contract is equal to the Sources and Applications of Development Resources. premium paid by the purchaser and is significantly Time Deposits: Time deposits include certificates of less than the contract or notional amount. deposit, bankers' acceptances, and other obligations Repurchase and Resale Agreements and Securities issued or unconditionally guaranteed by banks and or Loans: Repurchase agreements are contracts under other financial institutions. IDA may only invest in which a party sells securities and simultaneously time deposits issued or guaranteed by financial agrees to repurchase the same securities at a specified institutions whose senior debt securities are rated at future date at a fmed price. The reverse of this least A-. transaction is called a resale agreement. A resale IDA SPECIAL PURPOSE FINANCIAL STATEMENTS: JUNE 30, 2005 117 A summary of IDA'Sinvestments, by instrument, at June 30,2005 and June30,2004 is as follows: In m~ll~onsof U.S.dollars equlvalent Carrying Value Government and agency obligations Time deposits Asset-backed securities Gross investment holdings Securities purchased under resale agreements Repurchase agreements and securities loans Receivable from currency and interest rate swaps Payable for currency and interest rate swaps Investments-Trading Receivable from securities traded Payable for securities traded Net payable on investmentssecurities transactions Investments Cash held in lnvestment portfolioa Net lnvestment Portfolio a. Thlsamount n lncluded ln Unrestricted Currencies under Due from Banks on the Statement of Sources and Appl~catlonsof Development Resources. A summary of the currency composition of investments at June30,2005 and June30,2004 is as follows: Gross investment holdings In m~ll~onsof U.S.dollars equlvalent 2005 2004 Average Average Carrying Average Yield Repricing Carrying Average Yield Repricing value (%j hears) value (%j hears) Euro $8,337 2.43 3.49 $ 6,597 3.13 3.90 Pounds sterling 3,410 4.52 3.82 3,l18 4.86 3.86 U.S. dollars 7,047 3.74 3.52 8,663 3.09 7.10 Other 403 4.69 3.28 17 3.97 2.72 Total $19,197 3.33 3.56 $18,395 3.40 5.41 Net lnvestment Portfolio In millions o f U.5. dollars equivalent 2005 2004 Average Average Carrying Average Yield Repricing Carrying Average Yield Repricing value (%j hears) value (%j hears) Euro $7,290 2.38 3.74 $ 5,526 3.31 4.52 Japanese yena 873 - - 1,314 - - Pounds sterling 1,846 4.33 6.73 2,095 5.20 5.06 U.S. dollars 5,026 4.42 7.28 5,423 4.02 10.21 Total $15,035 3.17 5.18 $14,358 3.53 6.33 a. All Japanese yen lnvestments are held ln cash 118 THE WORLD BANK ANNUAL REPORT 2005 For the purpose of risk management, IDA is party to a transferred under repurchase or security lending variety of financial instruments, certain of which agreements. None of these securities have been involve elements of credit risk in excess of the amount included in the assets of IDA. reflectedin the Statement of Sources and Applications At June30,2005, IDA maintained a line of credit of Development Resources. Credit risk exposure facilitywith an independent financial institution. This represents the maximum potential accounting loss facilitywas created for the benefit of both IBRD and due to possible nonperformance by obligors and IDA. The available line of credit to each institution is counterparties under the terms of the contracts. IDA $500 million, but usage from both institutions cannot limits trading to a list of authorized dealers and exceed this amount in aggregate.The line of credit counterparties. Credit limits have been established for facilityis being used to cover any overnight overdrafts each counterpartybytype of instrument and maturity that may occur due to failed trades. At June 30,2005, category. IDA had not drawn down under this facility ($nil In addition, IDA has entered into master derivatives million-June30,2004). agreements which contain legally enforceable close- out netting provisions. These agreements may further NOTE C-MEMBER SUBSCRIPTIONS AND reduce the gross credit risk exposure related to the CONTRIBUTIONS swaps shown below. Credit risk with financial assets Subscriptions and Contributions Receivable:At June subject to a master derivativesagreement is further 30,2005, receivables from subscriptions and reduced under these agreements to the extent that contributions were $934 million ($4,589million- payments and receipts with the counterparty are June 30,2004) of which $355 million ($123 million- netted at settlement. The reduction in exposure as a June 30,2004) was due and $579 million ($4,466 result of these netting provisions can vary as million-June30,2004) was not yet due. additional transactions are entered into under these agreements. The extent of the reduction in exposure Subscriptions and contributions due at June30,2005 may therefore change substantially within a short were as follows: period of time following the balance sheet date. The credit risk exposure and contract value, as In m~ll~onsof U.S. dollars equ~valent applicable, of these financial instruments at June 30, Amounts initially due from 2005 and June 30,2004 (prior to taking into account any master derivativesagreements or collateral July 1, 2004 through June 30, 2005 234 arrangements that have been made) are given below: June 30, 2004 and earlier 121 In m~ll~onsof U.S. dollars equ~valent Total $355 Exchange traded Futures and options Subscriptions and contributions not yet due at June Notional Long position $8,605 $7,769 Notional Short position 1,842 2,682 30, 2005will become due as follows: Currency swaps Credit exposure - - Interest rate swaps In m~ll~onsof U.S. dollars equ~valent Notional principal 1,280 80 Period Credit exposure 5 * "Less than $0.5 m~ll~on. July 1, 2005 through June 30, 2006 $475 July 1, 2006 through June 30, 2007 56 Exchangetraded instruments are normally subject to Thereafter 48 daily margin requirements and are deemed to have no material credit risk. All outstanding futures and Total $579 options contracts at the end of June30,2005 and June 30,2004 were interest rate contracts. As of June 30,2005, IDA had received $1,153 million ($954 million-June30,2004) of securities under resale agreements. Of these instruments held by IDA, $369 million ($130 million-June30,2004) has been IDA SP ECIALPURPOSE FINANCIALSTATEMENTS: JU NE30, 2005 119 FourteenthReplenishment:On March 10,2005, the At June30,2005, $740 million was receivable from Executive Directors approved the Fourteenth IBRD ($1,584million-June30,2004). Of this Replenishment report and subsequently submitted amount, $383 million will be paid after all other the report and draft resolution to the Board of resources available to IDA for the purpose of the Governors for their approval. The Board of Governors Eleventh Replenishment have been drawn down. This adopted the resolution on April 13,2005. Therefore, is expected to occur in January 2006. The remaining during the period July1,2005 to June30,2008, IDA is $357 million will be paid in accordance with the expected to provide concessional financing of about donor encashment schedule for IDA'SThirteenth $35 billion (SDR24 billion), including a significant Replenishment. portion as grants. Of this amount, new donor On June 30,2005, in accordance with the contributions are expected to total about $20 billion administration agreement for the Trust Fund for (SDR 14 billion). The Fourteenth Replenishment will Kosovo, $4 million in cash was transferred from the become effectivewhen IDA has received trust fund to IDA. commitments for subscriptions and contributions of about $10 billion (SDR 7 billion). On September 24,2003, in accordance with the administration agreement for the Trust Fund for NOTE D-TRANSFERS Bosnia and Herzegovina, the Executive Directors of IDA approved the termination of the trust fund and At June 30,2005 and June30,2004, transfers were the transfer of its assets to IDA. These assets included comprised of: the right to receive repayments of credits totaling$124 million and $11 million in cash balances. At June30, In m~ll~onso f U.S.dollars equ~valent 2004, these assets in the form of development credits 2005 2004 and cash had been transferred to IDA. Transfers from the lnternatlonal Bank for Reconstruction and NOTE E-DEVELOPMENT CREDITS Development $8,050 $7,738 Transfers from the Trust Fund for Currency Composition Bosnla and Herzegovina 135 135 Transfer from the Trust Fund for The currency composition of IDA'Sdevelopment Kosovo 4 - credits outstanding at June30,2005 and June30,2004 is as follows: Total Transfers $8,189 $7,873 In m~ll~onso f U.S.dollars equ~valent 2005 2004 IBRD's Board of Governors has approved aggregate USD $ 12,072 $ 12,638 transfers to IDA totaling $7,957 million through June SDR 108,835 103,105 30,2005 ($7,657million-June30,2004). The Development credlts outstanding $120,907 $115,743 aggregatetransfers of $8,050 million reported in the above table differs from the amount of aggregate transfers approved due to exchange rate movements on the value of transfers that were approved in SDR. Overdue Amounts Of the aggregatetransfers, $300 million was approved At June30,2005, there were no principal or charges by the IBRD Board of Governors in October 2004. on development credits in accrual status which were overdue by more than three months. The following table provides a summary of selected financial information related to development credits in nonaccrual status as of June30: In millions of U.S. dollars equivalent Aggregate recorded Investment In nonaccrual credlts Overdue amounts: Prlnclpal Charges $ 877 Servlce charge Income recognlzed on development credlts comlng out of nonaccrual status $ 14 Servlce charge Income not recognlzed as a result of credlts belng In nonaccrual status $ 52 A summary of borrowers with development credits or guarantees in nonaccrual status follows: In millions o f U.S. dollars equivalent June 30,2005 Principal and Principal Charges Nonaccrual Borrower Outstanding Overdue Since Wlth overdues Central Afrlcan Republlc June 2002 CBte d'lvolre November 2004 Llberla Aprll 1988 Myanmar September 1998 Somalla July 1991 Sudan January 1994 Togo May 2002 Zlmbabwe October 2000 Total Wlthout overdues Serbla and Montenegro September 1992 Total On January4,2005, Haiti cleared all overdue these development credits not been in nonaccrual - . payments on principal and servicecharges to IDA and status. development credits made to or paranteed by Haiti During the fiscal year ended June 30,2004, there were were restored to accrual status. As a result, income no development credits which were either placed in from development credits for the year ended June 30, nonaccrual status or restored to accrual status. 2005 increased by $14 million, representing income that would have been accrued in previous fiscal years Serbia and Montenegro's arrears to IBRD were cleared had these credits not been in nonaccrual status. through exceptional rescheduling arrangements in January, 2002. Under these arrangements, all Effective November 2,2004, development credits development credits to the country are to remain in made to or guaranteed by CBte d'Ivoire were placed in nonaccrual status pending completion of a period of nonaccrual status. Income for the year ended June 30, policy and payments performance, even though they 2005 would have been higher by $21 million, had are current on all obligations to IDA. IDA SPECIAL PURPOSE FINANCIAL STATEMENTS: JU NE30, 2005 121 Allowance for HIPC Debt Initiative Changes to the allowancefor HIPC Debt Initiative for Development credits outstanding are presented in the the fiscal years ended June 30,2005 and June 30,2004 Statement of Sources and Applications of are summarized below: Development Resources before any allowancein connection with the HIPC Debt Initiative. In m1111onsof U.S. dollars equivalent The allowancefor HIPC Debt Initiative is the sum of 2005 2004 -- the principal component of debt relief remaining to Balance, beg~nn~ngof the f~scalyear $10,785 $10,395 be provided to those countries that have reached their Prov~s~onfor pr~nc~palcomponent decision points, and in certain cases their completion of debt rel~ef 1,325 727 Prlnc~palcomponent of debt rel~ef points, and the estimated principal component of forg~ven (391) (337) -- debt relief that is expected to be provided to other eligiblecountries. Balance, end of the f~scalyear -- $11,719 $10,785 -- The maturity structure of IDA'S development credits outstanding at June 30,2005 and June 30,2004 were as follows: In m~ll~onso f U.S.dollars equ~valent July 1, 2005 through June 30, 2006 July 1, 2004 through June 30, 2005 July 1, 2006 through June 30, 2007 July 1, 2005 through June 30, 2006 July 1, 2007 through June 30, 2008 July 1, 2006 through June 30, 2007 July 1, 2008 through June 30, 2009 July 1, 2007 through June 30, 2008 July 1, 2009 through June 30, 2010 July 1, 2008 through June 30, 2009 July 1, 2010 through June 30, 2015 July 1, 2009 through June 30, 2014 July 1, 2015 through June 30, 2020 July 1, 2014through June 30, 2019 July 1, 2020 through June 30, 2025 July 1, 2019 through June 30, 2024 July 1, 2025 through June 30, 2030 July 1, 2024 through June 30, 2029 July 1, 2030 through June 30, 2035 July 1, 2029 through June 30, 2034 July 1, 2035 through June 30, 2040 July 1, 2034 through June 30, 2039 July 1, 2040 through June 30, 2045 July 1, 2039 through June 30, 2044 Total Total Fifth Dimension Program IBRD terms, but have outstanding IBRD loans Under the Fifth Dimension program established in approved prior to September 1988 and have in place September 1988, a portion of principal repayments to an IDA-su~~ortedstructural adjustment Program. IDA is allocated on an annual basis to provide Such supplementary IDA development credits are supplementary IDA development credits to IDA- allocated to countries that meet specified conditions eligiblecountries that are no longer able to borrow on in proportion to each country's interest Payments due that year on its pre-September 1988 IBRD loans. To be eligible for such IDA supplemental credits, a At June30, 2005, liabilities related to obligations member country must meet IDA'Seligibilitycriteria under guarantees of $8 million ($nil-June 30,2004), for lending, must be ineligible for IBRD lending and have been included in other resources, net on the must not have had an IBRD loan approved within the Statement of Sources and Applications of last twelve months. To receivea supplemental Development Resources. development credit from the program, a member SegmentReporting country cannot be more than 60 days overdue on its Based on an evaluation of its operations, management debt-service payments to IBRD or IDA. has determined that IDA has only one reportable A summary of cumulative IDA credits committed and segment since IDA does not manage its operations by disbursed under this program from inception, at June allocating its resources based on the contribution to 30,2005 and June30,2004 is given below: net income from individual borrowers. In addition, the risk and return profiles are sufficientlysimilar In m~ll~onsof U.S.dollars equ~valent among its borrowers so that IDA does not differentiate in terms of the nature of products or services provided, the preparation process, or the Commitments $1,715 $1,715 method of providing servicesto its borrowers. Disbursements 1,715 1,712 Charge income comprises service charges on outstanding development credit balances, commitment charges on undisbursed development Guarantees credit balances and guarantee fee income. Guarantees of $191 million at June 30,2005 ($129 million-June30,2004) were not included in For the year ended June30,2005, development credits IDA'SStatement of Sources and Applications of to one country generated in excess of ten percent of Development Resources).These outstanding amounts total income from credits, amounting to $190 million. represent the maximum potential undiscounted The following table presents IDA'S development future payments that IDA be required make credits outstanding and associated charge income, by under these guarantees. geographic region, at June30,2005 and June30,2004. The existing guarantees issued by IDA expire between 2011 and 2026. In m~ll~onso f U.S. dollars equ~valent 2005 2004 Charge Development Credlts Charge Development Cred~ts Reglon Income Outstanding Income Outstanding Afrlca $351 $ 48,119 $344 $ 45,954 East Asla and Paclflc 132 16,648 123 16,328 Europe and Central Asla 45 5,420 38 4,864 Latln Amerlca and the Caribbean 55 5,070 33 4,770 Mlddle East and North Afrlca 28 3,329 27 3,245 South Asla 343 42,321 317 40,582 Total IDA SPECIAL PURPOSE FINANCIAL STATEMENTS: JU NE30, 2005 123 NOTE F-FAIR VALUE OF FINANCIAL months average CIRR as a discount rate provides an INSTRUMENTS alternative estimate for the grant element. Investments: IDA carries its investments at fair value. Since IDA'Sdevelopment credits are denominated These fair values are based on quoted market prices, either in U.S. dollars or SDRs, currency specific rates where available. If quoted market prices are not have been used to discount the corresponding future available, fair values are based on quoted market cash flows for each currency component of the prices of comparable instruments. The fair value of development credits before being aggregated to short-term financial instruments approximates their provide the composite results. carrying value. The grant element calculations consider interest rates, Development Credits: IDA'S development credits have maturity structures and grace periods for the credits. a significant grant element because of the concessional They do not consider credit risk, portfolio seasoning, nature of IDA'sterms. Discounting the future cash multilateral and sovereign credit preferences and flows from IDA'sdevelopment credits using other risks or indicators that would be relevant in government reference rates represented by interest calculating fair value. Estimating the impact of these rates of government securities having similar maturity factors is not practicable. to the portfolio of development credits, provides an However, under either alternative, the estimated fair estimate for the grant element. Under the HIPC Debt values of development credits outstanding are Initiative, development credits identified for sale to substantially lower than the $120,907million reflected the HIPC Debt Initiative Trust Fund are written down on the Statement of Sources and Applications of to their estimated net present value using currency Development Resources at June 30,2005 ($115,743 specificCommercial Interest Reference Rates (CIRRs) million-June 30,2004), as shown in the following published monthly by the Organization for Economic table. Cooperation and Development (OECD).Using the six In m~ll~onsof U.S. dollars equ~valent June 30,2005 June 30, 2004 Government Government reference reference rate- rate-based CIRR-based based CIRR-based fair value fair value fair value fair value Development credits outstanding $120,907 $120,907 $115,743 $115,743 Less grant equivalent (36,947) (46,074) (44,344) (45,410) Estimated value of development credits outstanding $ 83,960 $ 74,833 $ 71,399 $ 70,333 Estimated grant element 31% 38% 38% 39% Discount Rates Used Discount Rates Used Government reference rates -US dollar 3.92% 4.61% -SDRa 3.47% 4.41% CIRRs: Average of six months to June 30 -U.S. dollar 5.05% 4.76% -SDR 4.42% 4.53% a. Impl~eswe~ghtedaveragegovernment reference rates of the component currenc~escontamed ~nthe SDR Discounting the future cash flows from IDA'S NOTE G-ADMINISTRATIVE EXPENSES development credits using the standard 10 percent Administrative expenses represent IDA'Sshare of such discount rate of the Development Assistance expenses jointly incurred by IBRD and IDA. Committee (DAC)of the OECD, provides another alternative for the grant element. The estimated grant The allocation of expenses is based upon an agreed element based on this standard DAC rate for IDA'S cost sharing formula that reflectsthe administrative development credits is 65 percent as of June30,2005 costs of service deliveryto countries that are eligible (65 percent-June30,2004). for lending from IBRD and IDA. NOTE H-TRUST FUNDS ADMINISTRATION studies and project preparation, global and regional programs and research and training programs. These IDA, alone or jointly with IBRD, administers on funds are placed in trust with IDA andlor IBRD, and behalf of donors, including members, their agencies are held in a separate investment portfolio which is and other entities, funds restricted for specific uses not commingled with IDA andlor IBRD funds, nor which include the cofinancing of IDA lending are they included in the development resources of projects, debt reduction operations for IDA members, IDA. technical assistancefor borrowers including feasibility At June 30,2005 and June30,2004, the allocation of trust fund assets by executing agent were as follows: Number of Number of Total fiduciary trust fund Total fiduciary trust fund assets accounts assets accounts (In millions) (Unaudited) (In millions) (Unaudited) IDA executed Recipient executed Total The responsibilities of IDA under these arrangements Receivablefrom the HIPC Debt Initiative Trust Fund varyand range from services normally provided under A summary of changes to the receivable from the its own lending projects to full project HIPC Debt Initiative Trust Fund is presented below: implementation including procurement of goods and services. IDA receives fees for administering trust In m~ll~oonsf U.S. dollars funds as a reduction of the administrative expenses shared with IBRD. During the fiscal year ended June 30,2005, IDA received $20 million ($18 million- Balance, beglnnlng of the flscal year $366 $ 4 9 8 June 30,2004, $17 million-June30,2003) as fees for Contrlbutlon from the HIPC Debt lnltlatlve Trust Fund 200 202 administering trust funds. Relmbursernent recelved for prlnclpal repayments forglven -- (393) (334) NOTE I-IMPACT FROM HEAVILY INDEBTED Balance, end of the flscal year -- $173 $ 3 6 6 POOR COUNTRIES DEBT INITIATIVE -- Debt Service Relief As of June 30,2005, total debt service relief of $1,529 G8 proposalsfor HIPC debt cancellation million has been provided by IDA consisting of $1,304 At the G8 summit held on July6,2005 in Scotland, it million in principal repayments and $225 million in was agreed that a proposal for 100 percent servicecharges.These amounts have been reimbursed cancellation of the outstanding debt obligations to by the HIPC Debt Initiative Trust Fund. IDA of all eligibleHIPCs, be put to the Board of Governors at the September 2005 annual meetings. HIPCGrants As recognition criteria under IDA'Saccounting As of June30,2005, HIPC grants of $101million have policies have not been met, this proposal has not been been disbursed. The HIPC Debt Initiative Trust Fund reflectedin IDA'SStatement of Sources and has reimbursed $19 million of the disbursed grants. Applications of Development Resources. A summary of the debt relief provided under the HIPC Debt Initiative is included in the Supplementary Information appended to these financial statements. I D A SPECIAL PURPOSE FINANCIAL STATEMENTS: JUNE 30, 2005 125 NOTE J-DEVELOPMENT GRANTS NOTE K-COMPREHENSIVE INCOME A summary of changes to the amounts payable for Comprehensive income consists of net income and development grants is presented below: other gains and losses affectingsources of development resources that are excluded from net In m~ll~onso f U.S. dollars equ~valent income. For IDA,comprehensive income is comprised 2005 2004 of income or loss after HIPC Debt Initiative and -- currency translation adjustments on development Balance, beglnnlng of the flscal year $2,088 $1,063 credits and development grants. These items are Commitments 2,035 1,697 presentedin the Statement of Comprehensive Income. D~sbursements (1,200) (751) Translation adjustment The total accumulated other comprehensive income -- (25) 79 represents the cumulative translation adjustment on Balance, end of the flscal perlod --$2,898 $2,088 -- development credits and payablefor development grants. The following table presents the changes in Accumulated Other Comprehensive Income balances At June30,2005, $123 million ($270million - June30, for the years ended June 30,2005,2004 and 2003: 2004) of development grants had been approved by IDA'SExecutive Directors but had not been charged to In m11110nsofU.S.dollarsequ~valent expense pending the signing of agreements with Accumulated Other Comorehenslve Income recipients. Balance, beglnnlng of the flscal year $8,920 $4,708 $ (514) Changes from perlod actlvlty --- (549) 4,212 5,222 Balance, end of the flscal year