ASIAN DEVELOPMENT BANK PCR: SRI 27009

PROJECT COMPLETION REPORT

ON THE

FOURTH DEVELOPMENT FINANCE LOAN PROJECT (Loan 1302-SRI[SF])

IN SRI LANKA

October 2002

CURRENCY EQUIVALENTS (as of 26 February 1999)

Currency Unit – Sri Lanka rupees (SLRs)

At Appraisal At Project Completion 30 April 1994 26 February 1999 SLRs1.00 = $0.0205 $0.0144 $1.00 = SLRs48.79 SLRs69.53

ABBREVIATIONS

ADB – Asian Development Bank CBOC – Commercial Bank of Ceylon Ltd. CBSL – Central Bank of Sri Lanka CLCL – Commercial Leasing Company Ltd. CRIB – Credit Information Bureau of Sri Lanka DFCC – Development Finance Corporation of Ceylon DFI – development finance institution DFL – Development Finance Loan DFL III – Third Development Finance Loan Project DFL IV – Fourth Development Finance Loan Project EIRR – economic internal rate of return EPF – Employees Provident Fund ETF – Employees Trust Fund FIRR – financial internal rate of return HNB – Hatton National Bank Ltd. HRD – human resource development LOLC – Lanka Orix Leasing Company Ltd. MFI – multilateral financing institution MIS – management information systems MLL – Mercantile Leasing Ltd. NDBSL – National Development Bank of Sri Lanka NIC – National Insurance Corporation NSB – National Savings Bank Orix – Orient Leasing Company of Japan PCR – project completion report PDCB – private domestic commercial bank PFI – participating financial institution PLC – private leasing company QEs – qualified enterprises QPs – qualified projects RRP – report and recommendation of the President Sampath – Sampath Bank Ltd. Seylan – Seylan Bank Ltd. SLIC – Sri Lanka Insurance Corporation SMEs – small and medium-sized enterprises TA – technical assistance

NOTES

(i) The fiscal year (FY) of the Government and all PFIs (except DFCC, LOLC, and MLL) corresponds to the calendar year. The FY of DFCC, LOLC, and MLL runs from 1 April to 31 March. “FY” used in this report denotes the year in which the FY ends, e.g., FY2002 ended on 31 March 2002.

(ii) In this report, "$" refers to US dollars. The Sri Lankan rupee is allowed to float against a weighted average basket of Sri Lanka’s major trading partners.

CONTENTS

Page BASIC DATA i I. PROJECT DESCRIPTION 1 A. History 1 B. Scope of Operations 2 C. Asian Development Bank’s Relationship with Other Lenders and 3 Participating Financial Institutions D. Relevance of Design and Formulation 3 E. Related Technical Assistance 4 II. IMPLEMENTATION 5 A. Lending Policies 5 B. Characteristics of Subloans and Leases 5 C. Implementation and Internal Operations of Subprojects 5 D. Operational Performance of Participating Financial Institutions 6 E. Financial Performance of Participating Financial Institutions 7 F. Financial Statements and Ratios 7 G. Covenants 8 H. Performance of the Asian Development Bank 10 III. EVALUATION 10 A. Loan Appraisal 10 B. Implementation 11 IV. ASSESSMENT AND RECOMMENDATIONS 12 A. Relevance 12 B. Efficacy in Achievement of Purpose 12 C. Efficiency in Achievements of Outputs and Purpose 12 D. Preliminary Assessment of Sustainability 12 E. Other Impacts 13 F. Overall Assessment 13 G. Lessons Learned and Recommendations 13 APPENDIXES 16 1. Development Finance Corporation of Ceylon 16 2. National Development Bank of Sri Lanka 25 3. Commercial Bank of Ceylon Ltd. 34 4. Hatton National Bank Ltd. 38 5. Sampath Bank Ltd. 47 6. Seylan Bank Ltd. 56 7. Commercial Leasing Company Ltd. 65 8. Lanka Orix Leasing Company Ltd. 73 9. Mercantile Leasing Company Ltd. 81 10. Technical Assistance Completion Report for TA 2111: Institutional Strengthening 89 of National Savings Bank 11. Technical Assistance Completion Report for TA 2112: Development of an 91 Institutional and Regulatory Framework for the Leasing Industry in Sri Lanka 12. Implementation Status of Policy Reform Measures Under the Fourth 93 Development Finance Loan Project 13. Compliance with Principal Loan Covenants: Fourth Development Finance Loan 94 Project 14. Assessment of Overall Project Performance 97

BASIC DATA

A. Loan Identification

1. Country Sri Lanka 2. Loan Number 1302-SRI(SF) 3. Project Title Fourth Development Finance Loan Project 4. Borrower Government of Sri Lanka 5. Participating Financial Institutions Development Finance Corporation of Ceylon National Development Bank of Sri Lanka Commercial Bank of Ceylon Ltd. Hatton National Bank Ltd. Sampath Bank Ltd. Seylan Bank Ltd. Commercial Leasing Company Ltd. Lanka Orix Leasing Company Ltd. Mercantile Leasing Ltd. 6. Amount of Loan SDR53.312 million ($75 million) 7. Project Completion Report Number PCR: SRI 27009

B. Loan Data 1. Appraisal – Date Started 21 February 1994 – Date Completed 8 March 1994

2. Loan Negotiations – Date Started 18 May 1994 – Date Completed 19 May 1994

3. Date of Board Approval 28 June 1994

4. Date of Loan Agreement 17 August 1994

5. Date of Loan Effectiveness – In Loan Agreement 15 September 1994 – Actual 28 November 1994 – Number of Extensions 1

6. Terminal Date for Commitments – In Loan Agreement 28 November 1996 – Actual 28 May 1997 – Number of Extensions 1

7. Closing Date – In Loan Agreement 28 November 1996 – Actual 28 May 1997 – Number of Extensions 1

8. Terms to the Borrower – Interest Rate 1% per annum – Maturity (number of years) 40 – Grace Period (number of years) 10 – Free Limit development finance institutions: $1 million; private domestic commercial banks: $300,000; private leasing companies: $100,000 (after evaluation of the first three leases). ii

9. Terms of Relending (if any) 15 year, including a 3-year grace period, if any, with interest at variable rates equal to the average weighted deposit rate of commercial banks

10. Interest Rate for Subloans/Leases – Original variable at market rates – Revised

11. Disbursements a. Dates Initial Disbursement Final Disbursement Time Interval

12 April 1995 3 August 1999 51.5 months

Effective Date Original Closing Date Time Interval

28 November 1994 28 November 1998 48 months

b. Amount $73,410,165.69

C. Implementation Data

1. Number of Subloans and Leases 262 2. Sectoral Distribution of Subloans and Leases

Amount Sector ($million) Percentage Agriculture, Forestry, and Fishing 1.37 1.9 Food and Beverages 12.87 17.5 Textiles, Wearing Apparel, and Leather 9.40 12.8 Wood and Wood Products 0.95 1.3 Paper, Printing, and Publications 2.57 3.5 Chemicals, Petroleum, Coal, Rubber, and Plastics 14.43 19.7 Basic Metals 0.00 0.0 Nonmetallic Minerals 0.07 0.1 Fabricated Metals, Machinery, and Equipment 3.04 4.1 Construction 1.41 1.9 Wholesale, Retail, Restaurants, and Hotels 6.54 8.9 Transport, Storage, and Communication 14.95 20.4 Financing and Business Services 0.65 0.9 Community, Social, and Personal Services 0.89 1.2 Other Industries 4.27 5.8 Total 73.41 100.0

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3. Size of Subloans and Leases (actual) ($73,410,165.69)

Aggregate Amount Range Number % ($million) % Up to $50,000 78 29.8 16.03 21.8 From $50,000–$100,000 57 21.8 8.21 11.2 From $100,001–$300,000 54 20.6 9.10 12.4 From $300,001–$500,000 38 14.5 12.70 17.3 From $500,001–$1,000,000 16 6.1 6.70 9.1 Over $1,000,000 19 7.2 20.67 28.2 Total 262 100.0 73.41 100.0

4. Other Breakdown of Subloans and Leases

Amount Criteria Number % ($million) % I. Purpose New 44 16.8 17.51 23.9 Expansion 198 75.6 53.26 72.5 Balancing, modernization and 20 7.6 2.64 3.6 replacement Total 262 100.0 73.41 100.0

II. Maturity Up to 5 years 230 87.8 56.13 76.5 Over 5–10 32 12.2 17.28 23.5 Over 10–15 0 0.0 0.00 0.0 Total 262 100.0 73.41 100.0

III. Region Western 220 84.0 59.54 81.1 Central 8 3.0 3.91 5.3 Northwestern 7 2.7 0.95 1.3 Southern 20 7.6 7.83 10.7 Sabaragamuwa 6 2.3 1.08 1.5 Northern 0 0.0 0.00 0.0 Uva 0 0.0 0.00 0.0 Eastern 1 0.4 0.10 0.1 Total 262 100.0 73.41 100.0

IV. Procurement Procedures Reasonable 197 75.2 55.90 76.1 International Shopping 16 6.1 4.61 6.3 Proprietary Basis 49 18.7 12.90 17.6 Total 262 100.0 73.41 100.0 iv

Amount Criteria Number % ($million) % V. Procurement by Country Austria 0.95 1.3 Belgium 0.19 0.3 Canada 0.33 0.5 People’s Republic of China 0.25 0.3 Denmark 0.98 1.3 Finland 0.55 0.8 France 1.19 1.6 Germany 8.69 11.8 Hong Kong, China 0.36 0.5 India 5.32 7.2 Italy 4.64 6.3 Japan 5.78 7.9 Republic of Korea 0.74 1.0 Malaysia 1.47 2.0 Netherlands 0.31 0.4 Spain 0.07 0.1 Singapore 7.21 9.8 Sri Lanka 21.11 28.8 Sweden 0.49 0.7 Switzerland 0.26 0.4 Taipei,China 3.13 4.3 Thailand 0.18 0.2 United Kingdom 2.95 4.0 United States 6.26 8.5 Total 73.41 100.0

5. Subloans and/or Leases Above Free Limit ($36,336,254.17)

Subloans and/or Leases Number Amount ($) National Development Bank of Sri Lanka 47 11,256,588.25 Development Finance Corporation of Ceylon 9 17,266,053.62 Hatton National Bank Ltd. 5 3,556,313.37 Seylan Bank Ltd. 4 1,801,864.73 Sampath Bank Ltd. 1 564,418.67 Commercial Leasing Company Ltd. 0 0.00 Lanka Orix Leasing Company Ltd. 1 460,290.00 Mercantile Leasing Company 6 1,430,725.53 Commercial Bank of Ceylon Ltd. 0 0.00 Total 73 36,336,254.17

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D. Data on Asian Development Bank Missions No. of No. of Specialization Name of Mission Date Persons Person-Days of Members1 Fact-Finding 31 Oct–12 Nov 1993 4 48 a, b, c, Appraisal 21 Feb–8 Mar 1994 7 98 a, b, d, e, f, g Review 1 5–6 Apr 1995 1 2 a Review 2 10–12 Dec 1995 3 18 a, h, c Review 3 14–18 Oct 1996 4 18 a, b, c, d Review 4 for DFL IV & SMI II 27 Oct–7 Nov 1997 3 18 a, c, h Review 5 for DFL IV & SMAP 30 Nov–11 Dec 1998 3 18 a, i, l, Project Completion Review2 5–24 May 2002 2 27 j, k DFL IV = Fourth Development Finance Loan Project, SMAP = Small and Medium Enterprise Assistance Project, SMI II = Second Small and Medium Industries. 1 a - sr. investment officer, b - investment officer, c - assistant-project administration, d – sr. environmental specialist, e - counsel, f - programs officer, g - young professional, h - sr. assistant-project administration, i - assistant project analyst; j - sr. financial economist, k – consultant. 2 Project Completion Report was prepared by V. T. Velasco, Senior Financial Economist, with the assistance of S.A.B.R. Thalakada, Staff Consultant.

E. Related Loans Date of Amount Name of Project Loan No. Agreement ($million) Development Finance Corporation of Ceylon 288-SR(SF) 17 Jan 1977 5.0 Second Development Finance Corporation of Ceylon 451-SRI(SF) 1 Aug 1980 10.0 Development Financing 754-SRI(SF) 27 Dec 1985 20.0 Second Development Financing 896-SRI(SF) 4 Oct 1988 40.0 Financial Sector Program 1051-SRI(SF) 5 Dec 1990 80.0 Third Development Financing 1090-SRI(SF) 27 Aug 1991 50.0 National Development Bank of Sri Lanka 519-SRI(SF) 17 Jul 1981 10.0 Small and Medium Industries 873-SRI(SF) 11 Feb 1988 15.0 Second Small and Medium Industries 1084-SRI(SF) 26 Jun 1991 30.0 Total 260.0

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I. PROJECT DESCRIPTION

A. History

1. In June 1994, the Asian Development Bank (ADB) approved Loan 1302-SRI(SF), the Fourth Development Finance Loan Project (DFL IV), for $75 million (SDR53.312 million) from ADB’s Special Funds, to finance private enterprises in the fast-growing manufacturing, service, and tourism sectors of Sri Lanka. DFL IV included two technical assistance (TA) grants, TA 2111-SRI: Institutional Strengthening of National Savings Bank (NSB), for $713,000; and TA 2112-SRI: Development of an Institutional and Regulatory Framework for the Leasing Industry in Sri Lanka, for $198,000. Approval of DFL IV came soon after Loan 1090-SRI(SF), the Third Development Finance Loan Project (DFL III), for $50 million (SDR38.103 million), approved in July 1991, was fully committed in March 1994.

2. DFL IV aimed to continue ADB’s support for private sector-led economic growth, with more focus on deepening and diversifying the financial sector. DFL IV’s principal objective was to (i) meet demand from manufacturing, service, and tourism private enterprises for subloans and/or leases for financing new, expansion, and modernization projects; (ii) adapt their operations to a competitive environment; and thus (iii) increase economic growth and improve the balance of payments. A corollary objective of DFL IV was to expand and deepen the financial sector through (i) adoption of policy reforms; (ii) development of the leasing industry; and (iii) institutional strengthening of selected financial institutions, including the nine private participating financial institutions (PFIs) and NSB.

3. Like DFL III, DFL IV was designed as an umbrella credit line. Under this modality, the Government would relend the proceeds of DFL IV, in local currency, to the PFIs on a first-come- first-served basis. The PFIs, in turn, would on-lend in local currency to eligible manufacturing, service, and tourism subprojects to widen the outreach network and promote competition among PFIs.

4. DFL IV expanded the policy dialogue on financial sector reforms, which was carried out under the first three loans for development financing and intensified under Loan 1051-SRI(SF): Financial Sector Program Loan. The reform agenda discussed during the processing of DFL IV included (i) increased flow of domestic savings to the private sector, (ii) market orientation of the bond market, (iii) enhanced competition and efficiency of insurance and leasing companies, and (iv) strengthened supervision and prudent regulations for financial institutions. During negotiations for DFL IV, the Government submitted to ADB a letter outlining 30 proposed financial sector reform measures agreed upon earlier during policy dialogue with ADB. These measures were minuted during negotiation to monitor the Government’s financial reforms. Specified in the Loan Agreement were three conditions for loan effectiveness and seven time- bound conditions for continuing use of loan proceeds to finance subloans and/or leases (Appendix 12). The three policy conditions for loan effectiveness were (i) gazette notification of a bill to amend the NSB Act in accordance with the restructuring plan, (ii) at least 10% of the total investment portfolio of NSB invested in the private sector, and (iii) abolition of the withholding tax on Treasury bills and rupee securities. Five of the seven policy reform measures under DFL IV pertained to the capital market: (i) gazette notification by 31 December 1994 of legislative amendments to allow the Employees Provident Fund (EPF) and the Employees Trust Fund (ETF) to invest in listed private sector securities, (ii) at least 10% of ETF contributions to be invested in private sector securities by 30 June 1995, (iii) at least 5% of EPF contributions to be invested in private sector securities by 31 December 1995, (iv) gazette notification by 31 December 1994 of the amendment to the Rupee Securities Ordinance to allow the issuance of government securities with coupons and the auctioning thereof, and (v) at least 10% of the 2 combined investment portfolios of the Sri Lanka Insurance Corporation (SLIC) and National Insurance Corporation (NIC) to be invested in private sector securities by 31 December 1994. The remaining two policy reform measures pertained to leasing: (i) gazette notification by 30 June 1995 of a finance leasing law, and (ii) establishment of a computerized lease register. TA 2111 was intended to help restructure NSB by strengthening its investment function, human resource development, and information technology. The scope of TA 2112 included preparing a finance leasing law and helping to establish the lease registry.

5. After ADB Board approval of DFL IV in June 1994, the loan and project agreements were signed in August 1994, and the loan became effective in November 1994, 2.5 months after the date specified in the Loan Agreement. Accordingly, loan commitment was set to November 1996, and loan closing to November 1998. Loan commitment was extended to May 1997, and loan disbursement closing to February 1999. The extension was due to a slower-than-expected loan utilization rate and suspension by ADB of the commitment of loan proceeds to finance subloans and/or leases in 1995.

B. Scope of Operations

6. Participating Financial Institutions. DFL IV’s nine PFIs, all in the private sector, included (i) two development finance institutions (DFIs): Development Finance Corporation of Ceylon (DFCC) and National Development Bank of Sri Lanka (NDBSL); (ii) four private domestic commercial banks (PDCBs): Commercial Bank of Ceylon Ltd. (CBOC), Hatton National Bank Ltd. (HNB), Sampath Bank Ltd. (Sampath), and Seylan Bank Ltd. (Seylan); and (iii) three private leasing companies (PLCs): Commercial Leasing Company Ltd. (CLCL), Lanka Orix Leasing Company Ltd. (LOLC), and Mercantile Leasing Ltd. (MLL). Inclusion of PLCs as PFIs was a first for a development finance credit line in Sri Lanka, in recognition of the increasingly important role of leasing in financing development, particularly to provide equipment finance to small and medium-sized enterprises (SMEs). The DFL IV appraisal was of the view that only private sector-owned PFIs were most capable of efficiently meeting the credit needs of private enterprises. Detailed descriptions of the organization and management, staff, policies and procedures, and operational and financial performance of the PFIs are in Appendixes 1–9.

7. Performance Criteria. DFL IV specified criteria for initial eligibility and continued participation of PFIs in the loan (paras. 90–92 of the Report and Recommendation of the President [RRP]: SRI 27009). The PFIs had to comply with covenants for financial soundness, capital adequacy, risk exposure, profitability, loan recovery, and asset quality. Specifically, the PFIs had to meet the criteria for eligibility to participate in DFL IV: (i) a minimum annual collection ratio for the total portfolio of 80%; (ii) a maximum portfolio infection ratio of 20%; (iii) a minimum return on average assets (after tax) of 2% for DFIs and PLCs and 1% for PDCBs; (iv) a minimum debt service cover of 1.25 times; (v) a maximum debt-equity ratio of 8:1 for DFIs; 6:1 for PLCs; and compliance with Central Bank of Sri Lanka (CBSL) capital-risk adjusted assets ratio (8% of Tier-1 and Tier-2 capital) based on Basle Guidelines for PDCBs; (vi) a single borrower or group loan limit of not more than 10% of total assets; and (vii) a single economic sector loan limit of not more than 30% of total loan portfolio. The criteria were based on ADB’s standards for financial institutions to act as a conduit for ADB credit, and on the need to establish a strong and efficient financial sector. Adherence to the prudential ratios and the required timely audit by reputable auditors of accounts of PFIs promoted their financial discipline.

8. Subproject Eligibility Criteria. To become eligible for financing under DFL IV, subprojects were required to meet the following criteria (paras. 82-89 of the RRP): (i) a 3 maximum long-term debt-equity ratio of 70:30 (for the enterprise setting up the subproject); (ii) a minimum debt service coverage ratio of 1.25 times; (iii) a financial internal rate of return (FIRR) of at least 15%; and (iv) an economic internal rate of return (EIRR) of at least 10% for subloans or leases above $1 million. A FIRR of at least 15% was required for every subloan and lease, irrespective of size.

9. Main Terms and Conditions. The main loan terms and conditions were given in paras. 74–81 of the RRP: (i) the loan from ADB’s Special Funds would be made available to the Government of Sri Lanka in various currencies and would be repayable over 40 years, including a grace period of 10 years, and with a service charge of 1% per annum; (ii) the Government would relend the proceeds, in local currency, to the PFIs for a fixed period of 15 years, including a grace period of 3 years, if any, at variable rates equal to the average weighted deposit rate of commercial banks, as published weekly by CBSL and prevailing on the date of withdrawal; and (iii) the loan proceeds would be on-lent by the PFIs to subborrowers, in local currency, with a maximum maturity of 15 years, including a grace period of 3 years, at variable interest rates reflecting credit risks and market conditions. The PFIs would recycle the principal recoveries from subloans and leases to eligible enterprises, pending repayment by the PFIs to the Government. The subloans would be from $50,000 to $4 million, while leases would be from $20,000 (to cater to equipment lease requirements of smaller enterprises) to $4 million. The free limit would be $1 million for DFIs; $300,000 for PDCBs (except for Seylan, for which prior ADB approval of the first three subloans and/or leases, irrespective of size, was required); and $100,000 for leasing companies after receiving ADB approval for the first three leases.

C. ADB’s Relationships with Other Lenders and Participating Financial Institutions

10. ADB has been closely coordinating with other multilateral financial institutions (MFIs) in actively supporting the industrial and financial sectors, including the International Development Association, United States Agency for International Development (USAID), and the International Finance Corporation. ADB supplements their financial assistance to the industrial sector. ADB and these agencies also mutually support each other in reforming the industrial, financial, and capital market sectors (RRP, paras. 42 and 43).

11. ADB has a long and successful relationship with the two DFIs and four PDCBs. In 1977– 1991, ADB channeled through them eight credit lines for a total of $180 million to develop private industrial enterprises. ADB’s relationship with the three PLCs began only with DFL IV. The eight credit lines have generally been satisfactorily utilized (RRP, paras. 44–52). The DFIs and PLCs have been supplementing ADB and other MFI credit lines with local term borrowings; PDCBs, with term deposits. However, the PFIs have not been able to borrow from the local financial and capital markets to replace the term borrowings from MFIs. To reduce their dependence on MFIs and strengthen their financial structures, the PFIs have to tap the local financial and capital markets.

D. Relevance of Design and Formulation

12. DFL IV was designed and formulated in line with ADB’s operational strategy for Sri Lanka to focus assistance on raising rates of economic growth, improving the environment for private sector development, and strengthening the financial sector to support private investments. The DFL IV umbrella credit line was patterned after that of DFL III and previous DFL loans. The umbrella credit line allowed ADB to reach a large number of private sector projects through the PFIs and play a catalytic role in the country’s development. The modality enabled the PFIs to enhance their project-financing capability and become financially disciplined, and allowed ADB to pursue certain policy reform measures with the Government. 4

Borrowers could choose from a wide network of PFIs, which were encouraged to compete with each other, as loans were available on a first-come-first-served basis, allowing borrowers to obtain more efficient service at a lower cost. The inclusion of leasing companies gave borrowers a choice between loan or lease finance.

13. DFL IV could have been better formulated to balance utilization of the loan amount among PFI groups. The eligibility criteria, which were oriented to project finance, were applicable equally to subloans and leases. Prospective applicants for lease financing, mainly SMEs, found it difficult to meet the criteria, particularly the FIRR and EIRR requirements, and sought other sources of finance. As a result, leasing companies used only $2.8 million out of $15.0 million allocated for them under DFL IV. Relaxation of the FIRR and EIRR requirements for leases could have encouraged leasing companies to use a greater portion of DFL IV.

14. DFL IV included policy reform measures to promote growth of the capital market and establishment of a legal and regulatory framework for a well-organized leasing industry. However, the project could have had a more achievable timeframe to implement the various policy reforms. The implementation schedule was too tight, with specified dates less than 1 year from loan approval. The date to gazette the lease financing law was only 7 months from loan effectiveness, and to establish the lease registry, 11 months, but TA 2112, which would help accomplish the reforms, was expected to be completed 2 years from loan effectiveness. The Government could not meet the due dates, resulting in suspension of subloan and lease commitments.

15. DFL IV was appraised in February-March 1994, almost 3 years before the project completion report (PCR) for DFL III was completed in December 1996 (Doc. SRI 23339). Therefore, DFL III’s lessons and the PCR’s recommendations could not be taken into account in the formulation of DFL IV, particularly the following: (i) improve the effectiveness of the monitoring systems at ADB and participating credit institutions to promptly detect any noncompliance with key policy conditions or financial covenants during loan administration and adopt corrective measures; and (ii) offer special ADB workshops at the inception of future DFL lines to familiarize participating credit institution staff with project-financing skills, particularly in the monitoring system and ADB reporting requirements. Weak monitoring by ADB contributed to lapses in meeting the policy reform conditions. Inadequate PFI project-financing skills continued, perhaps explaining the small amount of the loan used by PDCBs (12%) and PLCs (4%).

E. Related Technical Assistance

16. TAs 2111 and 2112 are described in detail in the RRP (paras. 99–100 and Appendixes 12–13). TA 2111 was intended to (i) help transform NSB into an autonomous and commercially oriented savings bank to provide term funds for private investment; and (ii) mobilize domestic resources and invest the funds in various instruments to support economic development. The TA components included (i) establishment of an investment department to manage the investment portfolio, (ii) training and human resource development, and (iii) development and implementation of an information technology master plan. TA 2112’s objective was to (i) develop an institutional and regulatory framework for the leasing industry to deepen and diversify the financial sector; and (ii) provide an alternative to collateral-based bank lending, especially to SMEs. The TA scope included (i) preparation of a finance leasing law, (ii) training of CBSL supervisory departments to supervise and monitor the leasing companies and the leasing activities of banks and other financial intermediaries, and (iii) establishment of a computerized lease registry.

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II. IMPLEMENTATION

A. Lending Policies

17. PFI lending policies (RRP, para. 62 and Appendixes 3–11) were formulated to ensure prudent lending, keep recovery of loans and leases on schedule, avoid overexposure to a single group of borrowers and concentration on an economic sector, spread risks, and keep the PFIs profitable and in sound financial health. Since appraisal, the PFIs have maintained the same policies. Faced with economic adversities, the PFIs have put business expansion on hold and started to consolidate their operations through rigorous portfolio management and reduction of nonperforming loans, strict risk management of new investments, management of liquidity, and reduction of operational costs, improvement of service quality and efficiency through electronic banking, and mobilization of domestic resources through innovative savings products.

18. Loan Utilization Rate. The amount of loan utilized was $73.4 million (97.88%), and the amount unutilized, $1.6 million (2.12%). The two DFIs utilized the largest portion of the loan (84%); three PDCBs, 12%; and the leasing companies, 4%. The fourth PDCB—CBOC—did not utilize any portion of the loan, as the institution could finance most of its subprojects (with maturities of less than 5 years) from its own deposits with rollover facility and had access to other credit lines from MFIs such as ADB’s Second Small and Medium Industries Project (approved in May 1991 and closed in June 1999) and the World Bank’s projects for small and medium industries. CBOC reported that it could not find suitable subprojects to finance under DFL IV. Perhaps applicants found DFL IV eligibility criteria too rigorous.

B. Characteristics of Subloans and Leases

19. Profiles of PFI-financed subprojects are detailed in the first tables of Appendixes 1–9. DFL IV financed 262 subloans and leases, of which 189, worth $37.07 million or 50.5% of the total, were below the free limit; 73 subloans and leases, worth $36.34 million or 49.5% of the total, were above the free limit and subjected to ADB’s detailed scrutiny and PFIs’ appraisal. Most of the subloans and leases were for expansion subprojects (76% of the total number of subloans and leases and 73% of the loan amount), and most were for less than 5 years (88% and 76%). The western region (including Colombo) received the largest number of subloans and leases (84%), followed by the southern region (8%), while the rest of the country (eight regions) received the balance (8%). The industrial sector breakdown of the amount of subloans and leases was 13% for textiles, apparel, and leather; 18% for food and beverage; 20% for chemicals, petroleum, coal, rubber, and plastics; 20% for the transport, storage, communication; and 29% for the rest. The industrial sector breakdown of the number of subprojects was 19% for textiles, apparel, and leather; 14% for food and beverage; 16% for chemicals, petroleum, coal, rubber, and plastics; 12% for transport, storage, and communication; and 39% for the rest.

20. Most PFIs used the reasonable-competition method of procurement (75% by the number of subloans and leases and 76% of the loan amount), followed by the international-shopping method (19% and 18%), and proprietary method (6% and 6%).

C. Implementation and Internal Operation of Subprojects

21. Information on the implementation and financial performance of the PFI-financed subprojects and their economic impact—export sales in absolute amount and as percentage of gross sales, incremental employment, investment cost, and incremental value added—was compiled. Some data on subprojects—capacity utilization, sales, profitability, etc.—were not 6 available at all, resulting in information gaps. The compiled data on individual subprojects, being voluminous, are not included in the appendixes.

22. Most of the assisted subprojects have been implemented satisfactorily and were operating profitably and meeting their debt service obligations on time. Out of the 262 subloans and leases financed, 80 (31%) have been fully repaid; 141 (54%), repaid on schedule; 17 (6%), regularly repaid after being rescheduled; 21 (8%), in arrears with irregular repayments; and 3 (1%), under litigation or written off.

23. Subloans and leases in arrears, under litigation, or written off were for tourism and textile manufacturing. Tourism was severely affected by the terrorist attack on the Colombo international airport in July 2001 and the 11 September 2001 tragedy in New York. The PFIs have placed a temporary moratorium on debt repayment of 11 tourism-related subloans and leases (including the four hotels visited by the PCR Mission) until the tourist business recovers. Prospects for recovery beginning in the next tourist season, September 2002 to March 2003, appear promising as tourist arrivals increased in the first quarter of 2002. Textile manufacturing was adversely affected by import liberalization in the mid-1990s. To alleviate the debt problems of the affected firms, the Government set up the Textile Debt Recovery Fund in February 1998. Eight subprojects under DFL IV have availed themselves of this facility to repay the PFIs.

24. The 262 subprojects financed by DFL IV generated incremental exports equivalent to $107 million per annum, created incremental employment for about 6,300 persons, and contributed about $122 million to capital formation. DFL IV contributed to the country’s socioeconomic development. The annual incremental exports exceeded the appraisal estimate ($75 million per annum), but the figures for incremental employment and capital formation were much lower than their corresponding estimates at appraisal (10,000 persons and $185 million respectively).

D. Operational Performance of Participating Financial Institutions

25. The nine PFIs form the core of the country’s banking system. Well organized and competently managed, they ensure efficient operations and customer satisfaction. The PFIs’ branch network has been expanded to reach outlying areas and decentralize operations. Staffs have been increased and their quality enhanced through rigorous training. Policies have been laid down to increase deposit mobilization and make quality investments. Supervision, internal controls, and internal audits have been put in place to ensure that policies, procedures, and controls are adhered to and effective. The PFIs’ annual accounts are audited, on time, by reputable auditing firms. The operational performance of each PFI is described in Appendixes 1–9.

26. In the face of economic adversities (paras. 23 and 28), all the PFIs have started consolidating their operations (para. 15). The PFIs have been able to withstand competition from foreign banks such as the Hong Kong and Shanghai Bank, Standard Chartered Bank, and Grindlays Bank in terms of mobilizing deposits, lending, and recruiting staff. Public confidence in the PFIs is reflected in their stocks’ strong performance on the Colombo Stock Exchange. Although the stock market is sluggish, the market price per share (par value SLRs10.00) in the first two weeks of May 2002 stood as follows: DFCC (SLRs120.00), NDBSL (SLRs67.75), CBOC (SLRs159.50), HNB (SLRs55.00), Sampath (SLRs60.00), Seylan (SLRs28.00), CLCL (SLRs22.00), LOLC (SLRs54.50), and MLL (SLRs13.00).

7

E. Financial Performance of Participating Financial Institutions

27. The PFIs have been profitable with positive rates of return on average equity and assets (after tax). All have maintained strong balance sheets, with DFIs and PLCs having adequate debt-equity ratios, and PDCBs having sufficient capital adequacy ratios. The debt service capability of the PFIs has been adequate. The quality of their portfolios has also been sound as indicated by high annual cash collection ratios and low portfolio infection ratios. Each PFI’s financial performance is analyzed in Appendixes 1–9.

28. The financial performance of the PFIs during 1996–2000 was generally satisfactory but deteriorated in 2001, perhaps one of the worst years for the economy. For the first time, Sri Lanka recorded negative economic growth and reduced demand for exports due to a significant slowdown in the world economy. Other factors that adversely affected the economy in 2001 were the prolonged drought, power cuts, the terrorist attack on the international airport, and the September 11 tragedy in New York. Investor confidence dropped, demand for banking facilities fell, provisions against nonperforming loans became stricter, borrowing interest rates rose, and interest rate spreads narrowed. However, PFIs’ financial performance improved in the first quarter of 2002 due to increased interest rate spreads. Average interest rate spreads of the PFIs (excluding DFCC and CBOC, for which data were not available) dropped from 4.98 percentage points in 2000 to 4.19 in 2001, but increased to 6.34 at the end of the first quarter of 2002. During that quarter, excess liquidity resulted in a slight drop in the deposit rates of PDCBs and borrowing rates of PLCs and DFIs, with their lending rates remaining constant, raising the expectation of PFIs that they would regain their previous high levels of profitability and financial soundness starting in 2002.

29. Government authorities considered a proposal to replace the goods and services tax of 12.5% with a value-added tax of 20% on the lessee. Another proposal was to make the proposed debit tax of 0.1% applicable to leasing transactions. Implementation of these proposals would make leasing costs prohibitive and hinder the leasing industry in its role as a major financier of private entrepreneurs, especially the smaller ones. Unable to raise deposits from the public, leasing companies would be dependent on local banks and foreign lending institutions for their funds, including overnight borrowing. Payment of the debit tax on bank borrowings and other long-term loans would unduly burden leasing companies and hamper their future operations. The Leasing Association of Sri Lanka asked the Government to reduce the value-added tax to 12.5% (the previous level of the goods and services tax) and exempt leasing transactions from the debit tax. The Government has not yet decided on the appeal.

F. Financial Statements and Ratios

30. The income statements and balance sheets (together with ratios) and analyses of loan portfolio quality of the PFIs in 1996–2001 are in the second, third, and fourth tables of Appendixes 1–9, which analyze the PFIs’ financial performance. Financial ratios based on the financial results for 2000 and 2001 are summarized in the table. The ratios are returns on average equity and on average assets (after tax); debt service coverage ratios; annual cash collection ratios; portfolio infection ratios for all PFIs; debt-equity ratios of DFCC, NDBSL, CLCL, LOLC, and MLL; and capital adequacy ratios of PDCBs. In general, the financial performance of PFIs has been satisfactory as indicated by their financial ratios. However, the financial performance of most of the PFIs deteriorated in 2000 and 2001, and several failed to comply with ADB’s financial covenants (para. 31).

8

Financial Performance Ratios of the PFIs, 2000 and 2001

Return on Return on Average Average Capital Debt Service Cash Portfolio Equity Assets Debt- Adequacy Coverage Collection Infection (after tax) (after tax) Equity Ratio Ratio Ratio Ratio PFI (%) (%) Ratio (%) (times) (%) (%) FY 2000 2001 2000 2001 2000 2001 2000 2001 2000 2001 2000 2001 2000 2001 DFCC 10.04 11.50 2.15 2.52 3.12 3.00 2.41 2.34 85.40 86.20 11.45 11.77 NDBSL 9.29 10.63 1.38 1.59 5.36 5.27 3.14 2.62 84.01 77.86 12.08 11.30 CBOC 20.09 17.13 2.05 1.86 16.6 16.2 6.18 5.69 97.69 93.46 8.73 9.95 HNB 15.16 5.36 0.98 0.32 11.0 9.5 1.80 1.61 82.00 82.00 9.00 9.30 Sampath 18.89 13.34 1.30 0.88 12.1 12.6 2.88 1.98 92.27 83.00 12.90 15.40 Seylan 13.13 12.93 0.48 0.47 1.24 1.24 8.74 9.5 1.92 1.70 — — 15.92 15.71 CLCL 8.11 15.97 1.64 2.81 4.60 3.90 1.14 1.18 91.00 93.00 9.96 11.00 LOLC 10.04 15.59 2.11 3.24 3.25 3.49 1.22 1.40 89.81 94.32 11.50 10.16 MLL 21.27 8.63 2.03 0.82 6.80 6.00 4.39 2.49 89.00 87.40 4.80 6.20 — = not available, CBOC = Commercial Bank of Ceylon Ltd., CLCL = Commercial Leasing Co. Ltd., DFCC = Development Finance Corporation of Ceylon, FY = fiscal year, HNB = Hatton National Bank, LOLC = Lanka Orix Leasing Co. Ltd., MLL = Mercantile Leasing Ltd., NDBSL = National Development Bank of Sri Lanka, PFIs = participating financial institutions, Sampath = Sampath Bank Ltd., Seylan = Seylan Bank Ltd. .Note: The fiscal year of DFCC, LOLC, and MLL ended on 31 March; that of the other PFIs, on 31 December.

G. Covenants

31. Compliance with Financial Covenants. During 1996–2001, DFCC and LOLC consistently complied with all financial covenants. In contrast, Seylan consistently failed to meet the ADB covenanted minimum return on average assets (after tax) of 1% for PDCBs. In 2000 and 2001, NDBSL had a return on average assets below the ADB-covenanted minimum of 2% for DFIs and in 2001, it had a cash collection ratio of 78%, which fell short of the minimum ratio of 80%. In 2000, HNB’s return on average assets was very close to the 1% minimum ratio for PDCBs and in 2001, it dipped below the minimum. In 2001, Sampath’s return also fell below the 1% minimum ratio, and MLL had a return less than the 2% minimum for PLCs. In 2000 and 2001, CLCL had debt service coverage ratios that were lower than the required 1.25 times. LOLC did not achieve the debt service coverage ratio in 2000 but exceeded it in 2001.

32. The general loan covenants for subloan and lease approvals with respect to eligibility criteria, allocation of loan proceeds, subloan and lease terms, and procurement have been complied with (Appendix 13). However, some PFIs did not meet the reporting requirement and did not comply with the initial and continued participation criteria. In 2001, five PFIs (NDBSL, HNB, Sampath, Seylan, and MLL) could not comply with the return on average assets covenant. Some PDCBs (CBOC, Sampath, and Seylan) found it difficult to calculate the cash collection ratio and debt service coverage ratio because of the revolving nature of their short-term loans and advances and deposits. Despite computation difficulties, CBOC and Sampath came up with the computed ratios for 2000 and 2001, and Sampath and Seylan did the same in the first quarter of 2002, but the PCR Mission could not confirm the accuracy of those figures. Greater compliance with the financial covenants was expected in 2002, considering the improved financial performance of all the PFIs in the first 3 months, when interest rate spreads increased and tourist arrivals started to pick up. As tourism recovers, nonperforming loans of the PFIs are expected to decrease and their profitability to improve.

33. The performance of the PFIs was mixed. While they contributed significantly to achieving almost full loan utilization, some failed to comply fully with the financial loan covenants and reporting requirements. ADB provided the PFIs a subproject benefit monitoring and evaluation worksheet model for financial intermediaries and trained the PFIs on its use, but some did not adopt it and others discontinued its use before the end of project implementation. Quarterly reporting was not regular. None of the PFIs submitted to ADB completion reports on loan 9 utilization, execution of subprojects financed by the PFI under DFL IV, cost of subprojects, or performance of the PFI of its obligations, as required after closing of withdrawals from the DFL IV loan account (as specified in the Project Agreement between ADB and each PFI).

34. Compliance with Policy Measures. Subloan and lease commitment was suspended twice. The first time was January-March 1995 when the Government failed to comply with the policy on gazette notification of the amendments to the EPF Act and Rupee Ordinance Act by 31 December 1994. The Government that came to power in August 1994 with a one-seat majority in Parliament met strong resistance from the political opposition, trade unions, and labor groups in amending the EPF Act to allow investment in private securities, principally because of apprehension that the workers’ savings might dissipate if invested in risky assets such as equities. The legislative process took much longer than expected based on the assurances made to ADB staff during loan appraisal and negotiation by the previous political party in power. In March 1995, the Government requested an extension of time to comply until the end of June 1995. ADB granted the extension. However, in July, because of continued noncompliance with these two policy measures and delay in enactment of a new finance leasing law, which was targeted for gazette notification by 30 June 1995, subloan and lease commitment was suspended again. The second suspension was for 7 months until January 1996. The two loan suspensions impeded the smooth commitment of DFL IV, which probably contributed to loan cancellations resulting in an unutilized loan amount of about $1.6 million. Although the suspensions were later lifted and qualified projects financed by the PFIs with their own funds during the suspension period were eligible for disbursement from the DFL IV credit line, loan utilization was adversely affected. Some PFIs reported a slowdown in finding prospective subprojects. Leasing companies found alternative sources of funding and did not wait to process sublease applications under DFL IV. Loan utilization picked up after considerable delay. On the loan closing date in February 1999, the loan was almost fully utilized.

35. In October 1995, Parliament passed the Registered Stocks and Securities (Amendment) Act, which amended the Rupee Security Ordinance. In December 1995, the Monetary Board decided to allow the EPF to invest in debt securities of DFCC and NDBSL, which both had the majority of their shares privately-owned, after the Attorney General confirmed it was not necessary to amend the EPF Act to invest in listed private sector securities. By 28 December 1995, EPF invested SLRs300 million (more than 5% of monthly flows) in DFCC and NDBSL debentures.1 With assistance from the ADB TA consultant, the legislation on finance leasing was drafted. In February, ADB considered the policy measure on the EPF Act to be substantially implemented and took note of the substantial work accomplished in drafting the legislation on finance leasing. The embargo on new subloan and lease commitments was consequently lifted in February 1996. The lease financing law was gazetted in August 2001, more than 6 years past the 30 June 1995 date agreed upon with ADB. In revising the draft bill, consultations were held with market players and the relevant ministries. The January 1996 terrorist attack on CBSL also contributed to the delay in the bill’s finalization. Nonetheless, the delay was excessively long. The Government did not take the necessary steps to expedite the implementation of those policy reform measures within the dates agreed upon with ADB. The implementation delays showed the Government’s lack of commitment to the policy reforms. As a consequence of the two loan suspensions, the loan closing date for commitment as well as disbursement had to be extended. Overall, the performance of the Government was partly satisfactory.

1 EPF invested up to SLRs1,200 million in DFCC and NDBSL debentures in 1996. On 3 March 1998, the Monetary Board allowed EPF to invest in shares listed in the Colombo Stock Exchange commencing on 21 April 1998. 10

H. Performance of the Asian Development Bank

36. ADB’s performance was partly satisfactory. ADB fielded five missions to administer and review DFL IV. However, although the missions engaged in policy dialogue, some of the policy reform measures under DFL IV were not fully implemented by the specified dates. ADB accepted government officials’ assurances of compliance with policy reform measures, without adequate evaluation of risk factors. For instance, on the lifting of the suspension of subloan and lease commitments in February 1996, the ADB Review Mission reported that gazette notification of the finance leasing law was expected before 31 March 1996. This expectation was way off, as the law was enacted in August 2000 and gazetted a year afterwards. ADB also did not take steps to suspend subloan and lease authorizations under DFL IV for Seylan, as provided in schedule 6 of the Loan Agreement, for failing to satisfy the covenant on return on assets. Suspension could have pressured Seylan to comply, but it continued to participate under DFL IV, with noncompliance continuing to date. ADB also failed to monitor and follow up use by the PFIs of the computerized benefit monitoring and evaluation model. At the start of the project, ADB provided training to PFI staff on use of the model but the training was not sustained and the PFIs stopped using the model after a while. Consequently, as the PCR Mission found out, the PFIs could not quickly retrieve data to monitor performance of subloans and/or leases and subprojects. The ADB review missions, however, contributed significantly to achieving almost full loan utilization and to ensuring that the two TAs were implemented without delay. The PCR Mission was fielded 3 years after loan closing, more than a year after the normal 12–24 months from loan completion. The PCR was in the 2001 work program of the previous Industry and Finance Division (West) but could not be carried out during that year due to staff constraints.

III. EVALUATION

A. Loan Appraisal

37. The DFL IV appraisal appropriately defined the rationale and objectives of the project and the mechanism and structure of the loan. The overall objective was to facilitate much- needed economic growth through incremental exports, employment, and capital formation. The loan was aimed at financing investments in new, expansion, and modernization projects in the manufacturing, service, and tourism sectors. Supporting private enterprises and using private financial institutions to channel ADB assistance was appropriate. The DFL IV line of credit contributed to the country’s required foreign currency resources, and the institutional and policy reforms under the project promoted the financial sector’s capacity to efficiently mobilize and allocate domestic resources. However, the long delay in the implementation of some policy reforms diluted their impact.

38. The DFL IV umbrella line of credit, which operated on a first-come-first-served basis, facilitated loan disbursement by having a wide network of PFIs while encouraging competition between them. The inclusion of three leasing companies, for the first time under a DFL loan for Sri Lanka, gave the potential borrower a choice between loan finance and lease finance instruments. The structure of the loan was appropriate, in terms of repayment terms, market- oriented interest rates, size of subloans and leases, and free limits. TA 2111 was suitably designed to facilitate efficient domestic resource mobilization and investment, particularly in private sector securities, and TA 2112 was aimed at making leasing available as an additional instrument of financing for private enterprises. The policy reform measures pursued under DFL IV were appropriate as they sought to develop the capital market for the benefit of private entrepreneurs. However, the timetable for implementing these measures was too tight. 11

39. DFL IV could have been better if it had (i) established appropriate eligibility criteria to encourage greater utilization of DFL IV by leasing companies, particularly to promote SMEs; (ii) fixed appropriate cash collection ratios and debt service coverage ratios for PDCBs; and (iii) specified a more realistic timeframe for the policy reform measures for continued loan utilization.

40. The DFL IV design could have (i) strengthened measures to monitor compliance with loan covenants; (ii) offered workshops to upgrade project finance skills of PDCBs and PLC staff; and (iii) ensured PFIs’ adequate reporting, including submission of quarterly reports, information for benefit monitoring and evaluation, and completion reports on loan utilization and performance of subprojects. The lessons from DFL III could have been incorporated into DFL IV’s project design.

41. DFCC and NDBSL have had long experience with credit lines. The term maturity of up to 15 years with a grace period of 3 years enabled the two DFIs to match the maturity of loans and borrowings. However, the DFIs have been dependent on credit lines from MFIs such as DFL IV and need to be more self-reliant in their term resource requirements. The DFIs could help mobilize term capital and develop the domestic debt market. DFL IV did not have a resource mobilization mechanism.

B. Implementation

42. Project implementation was satisfactory. Of the loan of $75 million equivalent, $73.4 million was fully utilized. The closing dates for commitment and disbursement were extended for reasons explained in para. 34. The participation levels of the PDCBs (12% of the loan) and PLCs (4%) were, however, less than expected at appraisal. The three PLCs used only $2.8 million out of their original allocation of $15 million. The less-than-anticipated participation of the PDCBs was due to their general lack of familiarity with project finance practices and procedures, and the nonparticipation of CBOC under DFL IV. The lower-than-anticipated participation of PLCs was due to the inappropriate eligibility criteria fixed for them. Most subprojects financed from the loan through the PFIs operated satisfactorily and met their debt service obligations on time.

43. The two TAs under DFL IV were implemented successfully. TA 2111 helped NSB become more autonomous and commercially oriented, mobilize more deposits, and increase investment in various securities, including those of the private sector. Deposits of NSB increased from SLRs77 billion in 1997 to SLRs119 billion in 2001, while investments in securities increased from SLRs74 billion in 1997 to SLRs112 billion in 2001. The objectives of TA 2112 were achieved satisfactorily as the leasing industry was strengthened and promoted leasing as an additional funding source for private entrepreneurs. A workshop was conducted by the TA lease training consultant in June 1996 for officers of the Supervision of Nonbank Financial Institutions Department and the Bank Supervision Department of CBSL. The finance leasing law was passed by Parliament on 18 August 2000 and put into operation by gazette notification on 1 August 2001. Under the TA, a regulatory framework for the leasing industry was established and a computerized lease registry set up within the Credit Information Bureau of Sri Lanka, an autonomous unit supervised by CBSL. The Leasing Association of Sri Lanka proposed two amendments to the finance leasing law: (i) provision to assign a lease, other than to a registered leasing company, to facilitate securitization of leased assets; and (ii) reduction of the “reasonable notice” needed to recover a leased asset. The Government agreed to both proposals. The “reasonable notice” was reduced to a “maximum of 21 days.” The Ministry of Finance planned to present the amendments to Parliament in August 2002. The technical assistance completion reports of TAs 2111 and 2112 are in Appendix 10 and 11, respectively. 12

44. The policy reform measures pursued under DFL IV were implemented satisfactorily, despite the delays particularly in passing and gazetting the finance leasing law. The reform measures have contributed to promoting capital market development. Appendix 12 summarizes the implementation status of the seven policy conditions.

IV. ASSESSMENT AND RECOMMENDATIONS

A. Relevance

45. DFL IV was considered relevant to Sri Lanka’s and ADB’s objectives to promote private sector-led economic growth and contribute to institutional development of financial institutions. The objectives of DFL IV during the PCR remained the same as at appraisal and were achieved satisfactorily. DFL IV helped 262 private enterprises and has yielded incremental exports, jobs, and capital formation, thereby contributing to private sector-led economic growth. DFL IV promoted institutional development of the PFIs by requiring them to maintain financial discipline by adhering to financial covenants and having the PFI accounts audited, on time, by reputable auditing firms. The two associated TAs for institutional strengthening of NSB and strengthening of leasing industry operations were implemented successfully. The policy reform measures were implemented, albeit with delays, and helped promote capital market development.

B. Efficacy in Achievement of Purpose

46. Of DFL IV’s $75 million equivalent, $73.4 million was utilized. Cancellations of $2.8 million, effected on 3 August 1999, included overcommitments made by the PFIs. The 262 private sector subprojects promoted socioeconomic development. Most were implemented satisfactorily and operated profitably, and their subloans or leases had been fully repaid or were being repaid on schedule. The nine PFIs continued to be well organized, competently managed, and profitable, and most of them maintained basically sound financial positions. The DFL IV TAs were implemented satisfactorily and on time. Implementation of the policy reform measures was considerably delayed but eventually completed.

C. Efficiency in Achievements of Outputs and Purpose

47. The outputs and purpose were achieved commensurate with the inputs of the Government, executing agencies (PFIs), and ADB. The only inefficiency was in the extension, on two occasions, of the closing dates for commitment and disbursement of DFL IV. The first extension was due to delay in loan effectiveness, and the second, to the suspension of subloan and lease commitments for financing from DFL IV as a result of delay in implementing some of the policy reform measures. Consequently, the closing date of the DFL IV was delayed by 3 months, from November 1998 to February 1999.

D. Preliminary Assessment of Sustainability

48. The various components of DFL IV were sustainable. Out of its 262 subprojects, 80 (31%) have fully repaid their subloans and/or leases, 141 (54%) were repaying their subloans and/or leases on schedule, and 17 (6%) were doing so regularly after the subloans and/or leases were rescheduled. The sustainability of 24 subprojects appeared questionable, as they were either in arrears (21 or 8%) or in litigation or to be written off (3 or 1%). The satisfactory repayments of the subloans and leases allowed recycling of funds by the PFIs to promote private enterprise. The financial health of the PFIs deteriorated in 2001, due to the adverse economic environment. The PFIs, however, were expected to regain their previous higher levels 13 of financial performance beginning in 2002. Capacity-building of NSB continued after completion of TA 2111. Staff training, human resource development, and information technology development made significant progress. Savings mobilized were invested in a range of securities, including private sector securities. Leasing companies have registered under the finance leasing law, introduced by TA 2112. The certificates to be issued by CBSL would be effective on 1 August 2002. The Department of Supervision of Nonbank Financial Institutions of the CBSL would be monitoring the operations of the leasing companies using the supervision and regulatory framework put in place by the TA. At that time, the Credit Information Bureau would request the registered leasing companies to submit details of the leased assets to make the computerized lease register fully operational. Policy reform measures, introduced under DFL IV, continued to help the public insurance corporations (SLIC and NIC), EPF, and ETF invest in private sector securities.

E. Other Impacts

49. DFL IV promoted institutional development and had other positive impacts. With some exceptions, the PFIs continued to adhere to ADB’s financial covenants and were thus profitable and financially sound. The PFIs’ annual accounts also continued to be audited by reputable firms as required by ADB. Due to the adverse economic environment, some PFIs did not comply with particular covenants, particularly in 2001, but were expected to improve compliance in 2002. TA 2111, for institutional strengthening of NSB, was highly successful. TA 2112 was successful in strengthening the leasing industry. The 262 DFL IV subprojects adhered to the country’s environmental regulations. DFL IV’s policy reforms to help develop the capital market strengthened the capacity of NSB, SLIC, NIC, EPF, and ETF to invest in private sector securities.

F. Overall Assessment

50. The objectives of DFL IV were achieved. It encouraged competition between PFIs for funding, although not to the extent anticipated at appraisal (paras. 18, 42). DFL IV supported private sector-led economic growth by financing 262 subprojects (para. 19) and contributed to socioeconomic growth by increasing exports, jobs, and capital formation (para. 24). The strengthening of the leasing industry and NSB helped deepen and diversify the financial sector (para. 43). DFL IV’s policy reforms also helped develop the financial sector and capital market (para. 44). DFL IV’s relevance, efficacy, efficiency, sustainability, and other impacts are summarized in Appendix 14. Overall, DFL IV was assessed as successful.

G. Lessons Learned and Recommendations

51. Lessons Learned. Project finance-oriented eligibility criteria such as FIRR and EIRR were not appropriate for lease applicants (mainly SMEs). A simpler return measure should be used. Because of the revolving nature of short-term advances, overdrafts, and deposits, PDCBs found the cash collection and debt service coverage ratios difficult to calculate. They should only be made applicable for term loan portfolios and term deposits and borrowings.

52. The PFIs should be required to maintain a computerized system for subproject benefit monitoring and evaluation, which would facilitate quarterly reporting to ADB and preparation by the PFIs of their own completion reports, required under DFL IV. Otherwise, data on subprojects would be difficult to retrieve, especially on those funded by leases, which, being generally 3–4 years, became inactive sooner than term subloans. After certain leases were fully paid, no active files on them were maintained and the old files could not be located easily.

14

53. The DFL III PCR was completed almost 3 years after DFL IV was approved, which prevented ADB from reflecting on the lessons of DFL III during formulation of DFL IV. It could have given more attention and resources to setting up a monitoring system to track the progress of policy reforms and to obtain subproject and PFI data required by ADB. Budgetary or TA resources could have been allocated to sustain training of PFI staff in using the subproject benefit monitoring and evaluation worksheet model and system review, and to refine the model to enhance its usefulness.

54. Protected industries should not be eligible for financing under future ADB credit lines to avoid, for example, nonperforming subloans and leases in textile manufacturing under DFL IV. Had appropriate economic pricing been applied in EIRR calculation, heavily protected subprojects would have been screened out.

55. Project-Related Recommendations. ADB should take up the following with the Government (Ministry of Finance and CBSL) and the PFIs: (i) noncompliance of certain financial covenants by NDBSL, HNB, Sampath, Seylan, CLCL, and MLL; (ii) approval by Parliament of the two proposed amendments to the finance leasing law (para. 43); and (iii) review of the Government’s proposals to subject leases to the proposed value-added tax of 20% and debit tax of 0.10%, and their impact on the leasing industry. How the Government deals with these concerns should be carefully evaluated and considered by ADB in the design and formulation of future projects and programs.

56. ADB should review the subproject eligibility criteria and financial covenants for umbrella lines of credit. ADB should consider requiring annual cash collection and debt service coverage ratios for PDCBs only on their term loan portfolios and term deposits and borrowings.

57. An umbrella type lease financing facility deserves serious consideration by ADB and the Government to develop SMEs, which make up most of the clients of leasing companies and leasing departments of commercial, merchant, and development banks. Particular attention should be given to the characteristics of SMEs in fixing the eligibility requirements for lease financing. Greater participation of PLCs as intermediaries should be encouraged.

58. To encourage DFCC and NDBSL to become more self-reliant in their term resource requirements, ADB lending to them could be on a matching basis: for every $1 of ADB credit, they would raise $1 equivalent in term resources from the domestic market by way of term deposits, issues of bonds and/or debentures, or collateralization of loan and lease assets.

59. ADB-Related Recommendations. ADB should require that data on subloans and/or leases, subprojects, PFIs, and information needed for subproject monitoring and evaluation be included in the computerized data system of the executing agencies. For project readiness, each PFI should have a subproject monitoring and reporting system in place on or about loan inception. Technical support and financial assistance should be provided as needed to PFIs under the umbrella credit line and/or lease financing facility.

60. Policy reform measures should be appropriately phased and supported by TA. In setting due dates for compliance with policy measures or conditions requiring legislation, reasonable time should be given to drafting of the law, study by the concerned ministries, stakeholder consultations, and gazetting the law and its approval by Parliament.

61. PCR preparation should be undertaken not later than 2 years after project completion. The advantage of early scheduling of the PCR is having subproject files still active and persons familiar with particular subprojects still present. The processing of follow-up loans should be 15 properly sequenced with the PCRs of previous similar completed loans so that lessons learned from them can be taken into account in formulating the succeeding loan.

62. Below-par performance under a previous loan and failure to comply with loan covenants are negative factors that should be carefully weighed in screening participants for a follow-up loan.

63. Protected industries should not be eligible for financing under future ADB credit lines.

64. Project administration procedures should be strengthened to ensure regular monitoring of compliance with covenants, timely submission of various reports as required by ADB, and implementation of subproject benefit monitoring and evaluation.

16 Appendix 1

DEVELOPMENT FINANCE CORPORATION OF CEYLON

A. Background

1. Brief History and Ownership

1. Since the appraisal of the Loan 1302-SRI(SF), the Fourth Development Finance Loan Project (DFL IV) in March 1994, the Development Finance Corporation of Ceylon (DFCC) has undergone considerable changes. Its share capital increased from SLRs226.6 million on 31 March 1994 to SLRs352.6 million on 31 March 2002 as a result of bonus issues in June 1995 and April 1998. The shareholding structure also changed when the shareholding of the Government-owned People’s Bank dropped from 15% to 4.5%. As of 31 March 2002, shares were held by individuals (9.8%), local institutions (44.4%), and foreign institutions (45.8%). At appraisal, the shareholding structure was individuals (11.1%), local institutions (44.8%), and foreign institutions (44.1%). On 11 May 2002, DFCC’s SLRs10.00 share stood at SLRs120.00 per share on the Colombo Stock Exchange. The board of directors continued to have 10 members but was now chaired by E. M. Wijenaike, an ex-civil servant, who replaced C. A. Coorey on his retirement in 1999.

2. Activities, Policies, and Procedures

2. In 1999, DFCC adopted a new corporate strategy formulated by Pricewaterhouse Coopers of the United States (US): (i) the branch network was enlarged; (ii) operations decentralized; (iii) systems for controls and supervision strengthened; and (iv) new activities undertaken such as management information systems, treasury operations, marketing of services, and financial planning. An audit committee was set up as a subcommittee of the board to review the effectiveness of internal controls. The other noteworthy development was that DFCC became a licensed specialized bank in 1995, thereby coming under the direction and supervision of the Central Bank of Sri Lanka. DFCC also purchased a 30% stake in the Commercial Bank of Ceylon Ltd., a participating financial institution under DFL IV. In 1997, DFCC’s name was changed to "DFCC Bank."

3. Faced with adverse economic conditions in Sri Lanka and its main trading partners such as the US and Europe, DFCC began to develop, in addition to its traditional project finance business, new activities such as financing infrastructure development and trade finance. DFCC also tried to (i) reduce the level of nonperforming assets instead of promoting aggressive portfolio growth, (ii) diversify funding sources to reduce the cost of funds, and (iii) focus on debt market development in a depressed equity market.

4. In 1999, lending activity was reorganized. The previously separate units for approval, disbursement, and monitoring have been reorganized to suit the nature of the client (retail or wholesale market, for example) to benefit from the different specialized skills needed to handle different market segments and thereby improve the quality of lending and strengthen loan recovery. An asset-liability management unit and an asset-liability committee have been established. Risks associated with lending and investments are now being better managed in terms of profitability and growth. The accounts are audited, on time, by an independent and reputable auditing firm.

Appendix 1 17

B. Loan Utilization

1. Characteristics of Subloans and Leases

5. The characteristics of the subloans and leases are given in Table A1.1. DFCC was the largest user of DFL IV, financing 132 subloans and leases for $37.5 million (50%). The subloans and leases were mainly for expansion subprojects (77%), followed by new subprojects (12%); 38% of the subloans and leases were less than $50,000 each while 17% were above the free limit of $1 million each. Most of the subloans and leases were in the western region, including Colombo, (77%), followed by the southern region (12%). In industry, the chemical, petroleum, coal, rubber, and plastics subsector received the most number of subloans and leases (28%); followed by transport, storage, and communication (16%); and textile, apparel, and leather (15%). About 70% of procurement was done following the reasonable-competition method of procurement; the rest, the proprietary method. Sri Lanka was the main source of procurement (42%), followed by Germany (10%), United States (9%), and Singapore (8%).

2. Implementation Status of Subprojects

6. Data compiled on a sample of 81 subprojects (61% of 132 subloans and leases financed under DFL IV) showed that most were implemented fairly close to the estimated time and cost frames: 31 (38%) were not delayed; 44 (54%) were delayed marginally by less than three months; 2 were delayed by four months—1 due to late arrival and installation of imported machinery, and the other to delays in construction work; 3 were delayed by five months—1 due to machinery installation delays, 1 to delays in final finishing work of building, and 1 to delays in opening of letters of credit for import of machinery; and 1 was delayed by as much as 20 months due to delays in construction work arising from change in building design. Out of a sample of 50 subprojects (38% DFL IV subprojects), 24 (48%) had cost overruns ranging from SLRs29,000 to SLRs40 million mainly due to cost underestimation and to delays arising from time overruns. The cost overrun of SLRs40 million was for the subproject that had a time overrun of 5 months arising from delays in final finishing work of building construction. Cost savings, ranging from SLRs1.3 million to SLRs28.7 million, for four subprojects were mainly due to cost overestimation.

3. Financial Performance of Subprojects

7. Out of a sample of 30 subprojects (23% of DFL IV subprojects), 23 (77%) were profitable in the second year of operation while the rest were making losses. The repayment position of the 132 DFL IV subloans and leases was satisfactory: 12 (9%) have been fully repaid; 102 (77%) were regular in their repayment; 9 (7%) were regular in their repayment after being rescheduled; and 9 (7%) were overdue in their repayments.

4. Economic Impact of Subprojects

8. Out of a sample of 129 subprojects (98% of DFL IV subprojects), 12 (9%) had incremental exports of SLRs2,193 million ($23 million), and 77 (58%) provided incremental employment to 1,739 persons. Capital formation was SLRs5,090 million ($54 million) for 108 subprojects (82%).

18 Appendix 1

C. Institutional Performance

1. Organization, Management, and Personnel

9. The board of directors provided DFCC with overall management, direction, and policy formulation. The general manager and chief executive officer and his executive management team of 52 professional managers conducted the bank’s operations and day-to-day management. DFCC has a new general manager and chief executive officer, Nihal Fonseka, formerly a senior staff member of the Hong Kong and Shanghai Bank Ltd., who replaced M. R. Prelis on his retirement in 2000.

10. DFCC’s organizational structure has changed since the appraisal. As of 31 March 2002, the staff size was 289, including 152 executive staff (compared to 200, including 97 executive staff at appraisal). The staff size was increased considerably to strengthen existing operations as well as handle new business activities. DFCC also had a well-organized staff training program and a scheme to link employee compensation to DFCC’s performance. The number of branches, through which regional operations were conducted, was increased from two at appraisal to eight.

2. Financial Performance and Position

11. DFCC’s income statements from 1996 to 2000 are in Table A1.2. DFCC continued to be a profitable institution, although its net income was declining. Net income increased from SLRs418 million in 1997 to SLRs672 million in 1999, then declined by 21% to SLRs530 million in 2000 but increased by 19% to SLRs630 million in 2001. The interest rate spread in percentage points increased from 3.37 in 2000 to 4.77 in 2001. After-tax returns on average equity and assets have remained at satisfactory levels and stood at 11.5% and 2.5%, respectively, in 2001.

12. DFCC’s balance sheets from 1996 to 2001 are shown in Table A1.3: total assets increased by 69% from SLRs15.28 billion to SLRs25.91 billion, which were financed by equity of SLRs5.64 billion, and liabilities of SLRs20.27 billion. The debt-equity and debt service coverage ratios have remained at satisfactory levels and stood at 3:1 and 2.34 times, respectively, in 2001, indicating DFCC’s sound financial position and strong debt service capability.

3. Operational Performance and Portfolio Quality

13. The total portfolio as a percentage of total assets decreased from 73% in 1998 to 71% in 1999, but increased to 75% in 2000 and again to 81% in 2001. The portfolio quality remained satisfactory although deteriorating to some extent over the last three years, reflecting the adverse economic environment and the debt repayment problems faced by borrowers. The portfolio infection ratio increased from 7.28% in 1999 to 11.45% in 2000, and increased again slightly to 11.77% in 2001 (Table A1.4). Similarly, the cash collection ratio decreased from 89.9% in 1999 to 85.4% in 2000, but improved slightly to 86.2% in 2001. The worsening positions of these two ratios need to be monitored closely by DFCC.

D. Compliance with Loan Covenants

14. DFCC has complied fully with all the DFL IV financial covenants as follows: (i) cash collection ratio (minimum of 80%); (ii) portfolio infection ratio (maximum of 20%); (iii) return on average assets (after tax) (minimum 2%); (iv) debt service coverage ratio (minimum 1.25 times); Appendix 1 19

(v) debt-equity ratio (maximum 8:1); (vi) single borrower or group lending limit (not more than 10% of total assets); (vii) single economic sector lending limit (not more than 30% of total loan portfolio); and (viii) timely submission to ADB of regular reports and annual accounts, audited by independent and reputable auditors. 20 Appendix 1

Table A1.1: Characteristics of Subprojects

Amount Item Number % ($ million) % A. Purpose 1. New 16 12.1 10.25 27.3 2. Expansion 102 77.3 25.89 69.0 3. Balancing, Modernization, and Replacement 14 10.6 1.38 3.7 Total 132 100.0 37.52 100.0

B. Size 1. Up to $50,000 43 32.6 14.30 38.1 2. $50,001–$100,000 32 24.2 6.60 17.6 3. $100,001–$300,000 26 19.7 4.60 12.3 4. $300,001–$500,000 17 12.9 5.27 14.0 5. $500,001–$1,000,000 6 4.5 0.40 1.1 6. over $1,000,000 8 6.1 6.35 16.9 Total 132 100.0 37.52 100.0

C. Maturity 1. Up to 5 years 125 94.7 28.29 75.4 2. Over 5–10 years 7 5.3 9.23 24.6 3. Over 10–15 years 0 0.0 0.00 0.0 Total 132 100.0 37.52 100.0

D. Region 1. Western (including Colombo) 110 83.3 28.81 76.8 2. Central 5 3.8 3.62 9.6 3. Northwestern 4 3.0 0.61 1.6 4. Southern 12 9.1 4.38 11.7 5. Sabaragamuwa 1 0.8 0.10 0.3 6. Northern 0 0.0 0.00 0.0 7. Uva 0 0.0 0.00 0.0 8. Eastern 0 0.0 0.00 0.0 Total 132 100.0 37.52 100.0

E. Industry Sector 1. Agriculture, Forestry, and Fishing 6 4.6 0.95 2.5 2. Food and Beverages 14 10.6 3.34 8.9 3. Textiles, Wearing Apparel, and Leather 25 18.9 5.77 15.4 4. Wood and Wood Products 2 1.5 0.55 1.5 5. Paper, Printing, and Publications 11 8.3 1.90 5.1 6. Chemicals, Petroleum, Coal, Rubber, and Plastics 27 20.5 10.55 28.1 7. Basic Metals 0 0.0 0.00 0.0 8. Nonmetallic Minerals 1 0.8 0.07 0.2 9. Fabricated Metals, Machinery, and Equipment 11 8.3 3.03 8.1 10. Construction 6 4.6 0.58 1.5 11. Wholesale, Retail, Restaurants, and Hotels 13 9.8 3.56 9.5 12. Transport, Storage, and Communication 10 7.6 6.02 16.0 13. Financing and Business Services 4 3.0 0.63 1.7 14. Community, Social, and Personal Services 2 1.5 0.57 1.5 15. Other Industries 0 0.0 0.00 0.0 Total 132 100.0 37.52 100.0 Appendix 1 21

Amount Item Number % ($ million) % F. Procurement Procedures 1. Reasonable Competition 26.26 70.0 2. International Shopping 0.00 0.0 3. Proprietary Basis 11.26 30.0 Total 37.52 100.0

G. Procurement by Country 1. Austria 0.95 2.5 2. Canada 0.33 0.9 3. Denmark 0.38 1.0 4. France 0.19 0.5 5. Germany 3.69 9.8 6. Hong Kong, China 0.31 0.8 7. India 1.23 3.3 8. Italy 0.59 1.6 9. Japan 4.23 11.3 10. Malaysia 0.37 1.0 11. Netherlands 0.06 0.2 12. Singapore 2.90 7.7 13. Sri Lanka 15.88 42.3 14. Taipei,China 1.74 4.6 15. United Kingdom 1.16 3.1 16. United States 3.51 9.4 Total 37.52 100.0 Source: Development Finance Corporation of Ceylon. Table A1.2: Income Statements (SLRs million) 22

Year Ending 31 March1996 1997 1998 1999 2000 2001

Projected Actual Actual A ppendix 1 Revenue Net Interest Income 281.3 499.8 353.5 634.0 619.6 567.0 723.0 Interest Income 1,855.2 1,711.2 1,856.9 2,140.1 2,310.4 2,545.0 2,658.0 Interest Expenses 1,573.9 1,211.4 1,503.4 1,506.1 1,690.9 1,978.0 1,935.0 Leasing Income 0.6 396.3 432.6 450.6 325.6 335.0 307.0 Noninterest Income 1,164.5 157.4 121.5 171.4 322.7 579.0 499.0 Total Revenue 1,446.4 1,053.4 907.5 1,256.0 1,267.8 1,481.0 1,529.0

Operating Expenses Administrative Expenses 162.9 158.5 172.4 188.6 256.0 196.0 212.0 Provision for Doubtful Accounts 51.5 41.9 68.5 114.4 109.7 412.0 501.0 Depreciation 12.3 14.1 17.0 25.6 39.7 42.0 51.0 Others 0.6 28.0 — 31.8 108.4 342.0 246.0 Total Operating Expenses 227.3 242.5 257.9 360.4 513.7 992.0 1,010.0 489.0 519.0 Profit Before tax 1,219.1 810.9 649.6 895.6 754.1 489.0 519.0 Associate Company Profit/Loss — — (27.2) 46.2 159.3 244.0 301.0 Income Tax 329.8 220.6 204.2 289.6 241.5 203.0 190.0 Profit After Tax 889.3 590.3 418.2 652.1 671.9 530.0 630.0

Ratios Return on Average Equity (%) 24.5 16.7 10.6 14.5 13.3 10.0 11.5 Return on Average Assets (%) 6.1 4.5 2.6 3.6 3.0 2.1 2.5 — = not available. Source : Development Finance Corporation of Ceylon. Table A1.3: Balance Sheet (SLRs million)

Year Ending 31 March1996 1997 1998 1999 2000 2001 Projected Actual Actual Assets Current Assets Cash and Bank Deposits 15 973 474 764 383 354 239 Current Maturities of Loan Portfolio 7,672 4,926 5,448 6,008 7,942 7,472 6,920 Other Current Assets 452 1,198 2,072 686 3,123 3,456 3,092 Total Current Assets 8,139 7,097 7,994 7,458 11,448 11,282 10,251 Net Loan Portfolio 7,616 6,424 7,162 7,908 9,934 10,480 13,984 Net Fixed Assets 45 64 75 100 265 285 277 Other Assets 330 1,692 1,754 3,558 3,638 2,023 1,395 Total Assets 16,129 15,277 16,985 19,024 25,285 24,070 25,907

Liabilities and Equity Current Liabilities Current Maturities of Long-Term Debt 1,301 1,066 1,052 2,663 3,464 1,935 3,537 Other Current Liabilities 649 540 1,096 1,402 917 1,165 1,071 Total Current Liabilities 1,950 1,606 2,148 4,065 4,381 3,100 4,608 Net Term Liabilities 10,144 9,892 10,694 10,087 15,655 15,658 15,658 Total Liabilities 12,094 11,498 12,842 14,152 20,036 18,758 20,266 Equity Paid-In Capital 226 303 302 302 353 353 353 Reserves 3,810 3,476 3,841 4,570 4,896 4,959 5,288 Total Equity 4,036 3,779 4,143 4,872 5,249 5,312 5,641

Total Liabilities and Equity 16,129 15,277 16,985 19,024 25,285 24,070 25,907 Appendix 1

Ratios Current Ratio (times) 4.2 4.4 3.7 1.8 2.6 3.6 2.2

Debt-Equity Ratio 2.8 2.2 2.8 2.6 2.7 3.1 3.0

Debt-Service Coverage Ratio (times) 2.5 3.0 2.7 2.8 1.6 2.4 2.3 23 Source: Development Finance Corporation of Ceylon. Appendix 1 24

Table A1.4: Analysis of Loan Portfolio Quality (SLRs million)

Infected Total Portfolio Infection Collection As of 31 March Principal Outstanding Ratio (%) Ratio (%) 1996 907 12,759 7.10 89.93 1997 1,896 14,463 13.11 82.99 1998 1,357 15,552 8.75 90.17 1999 1,429 19,623 7.28 89.89 2000 2,254 19,694 11.45 85.44 2001 2,525 21,444 11.77 86.19 Source: Development Finance Corporation of Ceylon. Appendix 2 25

NATIONAL DEVELOPMENT BANK OF SRI LANKA

A. Background

1. Brief History and Ownership

1. The National Development Bank of Sri Lanka (NDBSL) was set up as a wholly state- owned institution by an act of Parliament in 1979. In February 1993, 61% of NDBSL’s restructured capital was offered to the public and to a group of institutional investors to privatize the bank’s ownership. NDBSL’s shares began trading on the Colombo Stock Exchange in April 1993. NDBSL continued to be a private sector development finance institution, with its share capital increasing by 260% from SLRs175 million in 1995 to SLRs629 million in 2001 through the issue of bonus shares. NDBSL’s five largest shareholders were the Government (7.33%), Investors Pacific International Fund (6.84%), Bank of Ceylon (6.11%), Central Bank of Sri Lanka (4.88%), and Hong Kong Shanghai Bank Corporation International Nominees (3.71%). On 10 May 2002, NDBSL’s share price on the Colombo Stock Exchange stood at SLRs.67.75 against the par value of SLRs10 per share.

2. NDBSL had a 13-member board of directors (10 directors at appraisal), mostly from the private sector, and eminent business personalities. S. K. Wickramasinghe, a prominent businessman and former Sri Lanka High Commissioner to the United Kingdom, was the chair. He replaced B. Mahadeva in 2001.

2. Activities, Policies, and Procedures

3. NDBSL’s predominant activities continued to be project lending, equity investment, and mobilization of domestic and foreign capital resources. NDBSL also provided a range of other financial facilities in other areas such as equipment leasing, bills discounting, and working capital finance. Merchant banking activities included underwriting of public share issues, loan syndication, feasibility studies, diagnostic studies, corporate and financial advisory services, and stimulation of capital markets. Subsidiaries and associate companies provided venture capital, stock brokerage, fund management, and insurance brokerage, enabling NDBSL to provide a wider range of financial services and products to its clients. In 1999, NDBSL was allowed to provide finance for individuals to undertake real estate development. In 2001, NDBSL purchased the ABN AMRO Bank, Colombo branch, which was expected to let NDBSL mobilize savings, become more self-reliant in resource generation, and reduce the cost of funds.

4. NDBSL’s policy statement laid down guidance for prudent banking based on profit and risk considerations. Project appraisals and due diligence continued to be done for all lending applications, but these procedures could have been more thorough to avoid time and cost overruns. Approval authorities have been delegated and the number of branches expanded to help decentralize operations and provide efficient service. Accounting and auditing procedures and systems followed international standards. The accounts were audited, on time, by an independent and reputable auditing firm.

B. Loan Utilization

1. Characteristics of Subprojects

5. NDBSL had utilized $24.1 million (33%) under Loan 1302-SRI(SF), the Fourth Development Finance Loan Project (DFL IV) to finance 58 subprojects, 12 of which were 26 Appendix 2 leases. The subprojects’ purpose, size, maturity, geographical distribution, and sector distribution are shown in Table A2.1. NDBSL utilized the second-largest portion of DFL IV loan proceeds.

6. Of the subprojects 56 (97%) were for expansion; 2 (3%), for new projects; and 9 (16%), above the free limit of $1 million. By subsector, subloans and leases went to transport, storage, and communication (33%); textile, apparel, and leather (16%); food and beverages (16%); and chemicals, petroleum, coal, rubber, and plastics (14%).

7. Most subprojects financed (53) were in the western region, which includes Colombo; the central and southern regions had 2 each; 97% had maturities of less than 5 years; and 3% had maturities of 5–10 years.

8. NDBSL’s procurement procedures conformed to requirements of the Asian Development Bank (ADB). All the subprojects followed the reasonable-competition method of procurement. Procurement was well spread among various countries such as France, Germany, India, Italy, Malaysia, Singapore, Sri Lanka, United Kingdom, and United States (Table A2.1).

2. Implementation Status of Subprojects

9. The implementation status of subprojects was fairly satisfactory. Only nine (16%) experienced time overruns of 5–27 months due to construction delays, delays in arrival of machinery, building foundation problems, delays in obtaining Government approval (newspaper subproject), delays in Board of Investment approval (dairy subproject), and collateral problems. Thirteen subprojects (22%) experienced cost overruns ranging from SLRs10,000 to SLRs89 million, mainly due to time overruns. Cost saving of about SLRs178 million was realized from five subprojects (9%).

3. Financial Performance of Subprojects

10. The profitability of the sample subprojects in general was much lower than the estimates. The net income of about 71% of the sample subprojects was less than that estimated in the second year of operations. Of the sample subprojects, 30 were operating profitably in the second year of operations, while 9 were operating at a loss and closely monitored by NDBSL.

11. The repayment status of subloans and leases has been satisfactory: 28 (48%) were fully repaid on time; 24 (41%) were regular in their repayments; 3 (5%) are making repayments on time after being rescheduled; and 2 rescheduled subloans are still having repayment problems. One subloan was written off to the extent of 50%, and the 50% balance transferred to a new borrower, which makes repayments on schedule.

4. Economic Impact of Subprojects

12. Eleven subprojects (19%) generated SLRs5,042 million ($53 million) worth of exports. The sample subprojects created incremental employment for 1,283 persons at an investment cost per job of SLRs2.9 million. The 58 subprojects led to a capital formation of SLRs3,729 million ($39 million).

Appendix 2 27

C. Institutional Performance

1. Organization, Management, and Personnel

13. NDBSL was headed by general manager N. S. Welikala, formerly deputy general manager, who replaced R. M. S. Fernando on his retirement on 31 December 2001. NDBSL’s total staff strength was 365, of whom 216 were experienced and qualified professionals. NDBSL had a strong commitment to staff training as an investment in human resources and as a motivation to upgrade skills. The bank increased its 5 branches at appraisal to 13 to build an outreach system, provide a more efficient service, and mobilize deposits.

2. Financial Performance and Position

14. NDBSL’s income statements from 1996 to 2001 are in Table A2.2. NDBSL continued to be profitable, albeit less and less so. Net income declined considerably, reflecting the adverse economic environment and the slowdown in demand for financial services. NDBSL’s profitability was reduced by larger loss provisions for nonperforming loans and smaller interest rate margins. Net income increased from SLRs707 million in 1996 to SLRs774 million in 1998, but declined by 4.5% to SLRs739 million in 1999, and by 2% to SLRs519 million in 2000. Net income, however, increased by 18% in 2001, largely as a result of a revaluation of NDBSL’s equity investment portfolio due to recent increases in the value of equity investments. The interest rate spread dropped from a high of 4.06 percentage points in 1997 to 2.77 in 1999, 2.73 in 2000, and 2.64 in 2001. The interest rate spread improved to 2.88 percentage points in the first quarter 2002 due to a slight drop in borrowing interest rates. The returns on average equity and assets (after tax) also showed a similar downward trend and stood at 10.6%, and 1.6%, respectively, in 2001.

15. Total assets increased by 57% from SLRs19.92 billion in 1996 to SLRs31.37 billion in 1998 (Table A2.3). Total assets increased by 15.7% to SLRs37.20 billion in 1999, and stabilized at SLRS38.19 billion in 2000, and at SLRs38.97 billion in 2001. Total assets of SLRs38.97 billion in 2001 were funded by equity of SLRs629 million and reserves of SLRs5.24 billion. The debt-equity and debt service coverage ratios have remained at satisfactory levels. The debt- equity ratio increased from 4.8:1 in 1998 to 5.3:1 in 2001. The debt service coverage ratio improved from 2.2 in 1998 to 2.6 in 2001.

3. Operational Performance and Portfolio Quality

16. The total portfolio increased from 79% of total assets in 1998 to 82% in 1999, but dropped to 72% in 2001, reflecting the slowdown in the demand for financial services. The reduced portfolio size, in turn, reduced earning capacity. The portfolio, however, continued to be well diversified in terms of single group borrower and economic sector lending limits, thereby mitigating the risks of overexposure. The portfolio infection ratio rose until 2000 (Table A2.4) then dipped from 12.1% in 2000 to 11.3% in 2001. The portfolio infection ratios have historically been within the ADB covenanted limit of 20%. Prior to 2001, the cash collection ratio was above the ADB-covenanted minimum of 80.0% but came down to 77.9% in 2001. The worsening trend in the portfolio infection ratio until 2000 and the decline in the cash collection ratio in 2001 reflected the debt repayment problems faced by borrowers and signaled the need for NDBSL to pay greater attention to portfolio management.

28 Appendix 2

D. Compliance with Loan Covenants

17. NDBSL has complied with the following ADB financial covenants: (i) portfolio infection ratio (maximum of 20%); (ii) maximum debt-equity ratio of 8:1; (iii) minimum debt service coverage ratio of 1.25 times; (iv) single borrower group lending limit of 10% of total assets; (v) single economic sector lending limit of 30% of total loan portfolio; and (vi) submission of regular reports and audited accounts to ADB on time. NDBSL, however, did not comply with the (i) minimum cash collection ratio of 80.0% (77.9% in 2001) and (ii) minimum return on average assets (after tax) of 2.0% (1.4% in 2000 and 1.6% in 2001). NDBSL expected the cash collection ratio to increase above 80% in 2002 through more aggressive collection efforts and writing-off of unrecoverable loans, and with an improved economic environment as seen in the first quarter 2002. These factors, together with the improvement in the interest rate spreads in the first quarter 2002, were expected to bring the return on average assets (after tax) above 2% at the end of 2002. ADB needs to closely monitor compliance with these two covenants.

18. By considering indirect lending and collection on refinance portfolio and other adjustments approved by the NSDBL board, NSDBL computed the collection ratio as of 31 March 2002 at 84%, which exceeds the minimum of 80% required under the DFL IV covenant.

Appendix 2 29

Table A2.1: Characteristics of Subprojects

Amount Item Number % ($ million) % A. Purpose 1. New 2 3.4 1.93 8.0 2. Expansion 56 96.6 22.13 92.0 3. Balancing, Modernization, and Replacement 0 0.0 0.00 0.0 Total 58 100.0 24.06 100.0

B. Size 1. Up to $50,000 7 12.1 0.17 0.7 2. $50,001–$100,000 7 12.1 0.41 1.7 3. $100,001–$300,000 16 27.6 2.29 9.5 4. $300,001–$500,000 11 18.9 3.63 15.1 5. $500,001–$1,000,000 8 13.8 5.15 21.4 6. over $1,000,000 9 15.5 12.41 51.6 Total 58 100.0 24.06 100.0

C. Maturity 1. Up to 5 years 56 96.6 22.62 94.0 2. Over 5–10 years 2 3.4 1.44 6.0 3. Over 10–15 years 0 0.0 0.00 0.0 Total 58 100.0 24.06 100.0

D. Region 1. Western (including Colombo) 53 91.3 23.07 95.9 2. Central 2 3.5 0.19 0.8 3. Northwestern 1 1.7 0.29 1.2 4. Southern 2 3.5 0.51 2.1 5. Sabaragamuwa 0 0.0 0.00 0.0 6. Uva 0 0.0 0.00 0.0 Total 58 100.0 24.06 100.0

E. Industry Sector 1. Agriculture, Forestry, and Fishing 1 1.7 0.05 0.2 2. Food and Beverages 9 15.5 7.31 30.4 3. Textiles, Wearing Apparel, and Leather 9 15.5 1.83 7.6 4. Wood and Wood Products 0 0.0 0.00 0.0 5. Paper, Printing, and Publications 1 1.7 0.51 2.1 6. Chemicals, Petroleum, Coal, Rubber, and Plastics 8 13.8 3.08 12.8 7. Basic Metals 0 0.0 0.00 0.0 8. Nonmetallic Minerals 0 0.0 0.00 0.0 9. Fabricated Metals, Machinery, and Equipment 0 0.0 0.00 0.0 10. Construction 1 1.7 0.24 1.0 11. Wholesale, Retail, Restaurants, and Hotels 5 8.7 1.49 6.2 12. Transport, Storage, and Communication 19 32.8 7.63 31.7 13. Financing and Business Services 0 0.0 0.00 0.0 14. Community, Social, and Personal Services 1 1.7 0.31 1.3 15. Other Industries 4 6.9 1.61 6.7 Total 58 100.0 24.06 100.0 30 Appendix 2

Amount Item Number % ($ million) % F. Procurement Procedures 1. Reasonable Competition 58 100.0 24.06 100.0 2. International Shopping 0 0.0 0.00 0.0 3. Proprietary Basis 0 0.0 0.00 0.0 Total 58 100.0 24.06 100.0

G. Procurement by Country 1. Belgium 0.18 0.7 2. Denmark 0.52 2.1 3. Finland 0.55 2.3 4. France 1.01 4.2 5. Germany 3.36 14.0 6. Hong Kong, China 0.06 0.2 7. India 2.09 8.7 8. Italy 2.64 11.0 9. Japan 0.81 3.4 10. Malaysia 1.10 4.6 11. Netherlands 0.25 1.0 12. Singapore 3.19 13.3 13. Sri Lanka 2.95 12.3 14. Sweden 0.50 2.1 15. Taipei,China 0.96 4.0 16. Thailand 0.18 0.7 17. United Kingdom 1.52 6.3 18. United States 2.19 9.1 Total 24.06 100.0 Source: National Development Bank of Sri Lanka. Table A2.2: Income Statements (SLRs million)

Year Ending 31 March1996 1997 1998 1999 2000 2001 Projected Actual Actual Revenue Net Interest Income 1,022.3 782.8 900.2 857.9 659.3 853.3 859.3 Interest Income 2,769.8 2,566.2 3,042.8 3,353.9 3,880.1 4,403.0 4,687.3 Interest Expenses 1,747.5 1,773.3 2,142.6 2,495.9 3,220.8 3,549.8 3,828.1 Leasing Income 131.5 132.6 171.0 152.2 254.2 306.2 315.1 Noninterest Income 397.5 167.8 303.3 438.3 445.2 575.6 488.0 Total Revenue 1,551.3 1,083.2 1,374.5 1,448.4 1,358.7 1,735.1 1,662.4

Operating Expenses Administrative Expenses 154.7 102.6 201.6 303.1 378.5 401.8 481.4 Provision for Doubtful Accounts 173.7 28.2 135.3 141.3 (28.1) 473.9 303.9 Depreciation 15.4 14.5 15.6 24.8 50.9 71.0 93.7 Others 343.8 145.3 352.5 469.2 401.3 946.7 879.0 Total Operating Expenses

Profit Before tax 1,207.5 937.9 1,022.1 979.2 957.4 788.4 783.4 Income Tax 324.0 231.0 283.9 205.7 218.6 269.3 170.4 Profit After Tax 883.5 706.9 738.2 773.5 738.8 519.1 613.0 Appendix 2 Ratios Return on Average Equity (%) 22.6 17.4 16.9 15.8 13.8 9.3 10.6 Return on Average Assets (%) 4.6 3.3 3.2 2.7 2.2 1.4 1.6 Source : National Development Bank of Sri Lanka. 31 Table A2.3: Balance Sheets (SLRs million) 32

Year Ending 31 March1996 1997 1998 1999 2000 2001 A

Projected Actual Actual ppendix 2 Assets Current Assets Cash and Bank Deposits 427 1,299 3,967 885 571 1,012 2,688 Current Maturities of Loan Portfolio 3,309 3,308 5,845 8,076 8,653 9,722 8,011 Other Current Assets 207 90 574 755 987 1,052 1,643 Total Current Assets 3,943 4,697 10,386 9,716 10,211 11,786 12,342 Long-Term Loans and Lease Receivables 15,961 12,268 12,003 16,691 21,721 20,837 19,893 Fixed Assets 168 119 140 200 308 386 397 Investments 744 2,834 3,746 4,764 4,959 5,183 6,334 Total Assets 20,816 19,918 26,275 31,371 37,199 38,192 38,966

Liabilities and Equity Current Liabilities Current Maturities of Long-Term Debt 1,136 1,743 3,576 7,085 9,381 8,540 9,338 Other Current Liabilities 1,053 1,497 1,951 1,538 1,799 2,184 2,183 Total Current Liabilities 2,189 3,240 5,527 8,623 11,180 10,724 11,521 Net Term Liabilities 14,309 12,553 16,118 17,576 20,511 21,803 21,577 Total Liabilities 16,498 15,793 21,645 26,199 31,691 32,527 33,098 Equity Paid-In Capital 175 175 450 450 450 629 629 Reserves 3,868 3,675 4,180 4,364 4,700 4,498 4,701 Statutory Reserve Fund 0 0 0 358 358 538 538 Convertible Stock 275 275 00000 Total Equity 4,318 4,125 4,630 5,172 5,508 5,665 5,868 Total Liabilities and Equity 20,816 19,918 26,275 31,371 37,199 38,192 38,966

Ratios Current Ratio (times) 1.8 1.5 1.9 1.1 0.9 1.1 1.1 Debt-Equity Ratio 3.8 3.8 4.2 4.8 5.0 5.4 5.3 Debt-Service Coverage Ratio (times) 2.3 2.3 1.8 2.2 2.9 3.1 2.6 Source: National Development Bank of Sri Lanka. Appendix 2 33

Table A2.4: Analysis of Loan Portfolio Quality (SLRs million)

Infected Total Portfolio Infection Collection As of 31 December Principal Outstanding Ratio (%) Ratio (%) 1996 1,350 13,166 10.29 — 1997 1,398 14,725 9.49 — 1998 1,985 22,097 8.98 — 1999 2,737 25,636 10.68 — 2000 3,116 25,785 12.08 84.01 2001 2,675 23,675 11.30 77.86 — = not available. Source: National Development Bank of Sri Lanka. 34 Appendix 3

COMMERCIAL BANK OF CEYLON LTD.

A. Background

1. History and Ownership

1. The Commercial Bank of Ceylon Ltd. (CBOC) was established in June 1969 as a public company and began operations in November that year, taking over the operations of Eastern Bank Ltd., Colombo branch. The four largest shareholders were DFCC (29.77%), Sri Lanka Insurance Corporation (29.72%), Distilleries Company of Sri Lanka (2.30%), and Ceylon Petroleum Corporation (1.92%). CBOC is listed on the Colombo Stock Exchange. CBOC’s SLRs10.00 share was quoted on the Colombo Stock Exchange at SLRs159.50 on 11 May 2002. CBOC was considered the premier private domestic commercial bank in terms of financial performance.

2. Activities, Policies, and Procedures

2. CBOC was a full-service bank providing a wide variety of commercial and consumer banking services in Colombo and throughout Sri Lanka. Several new banking products have been introduced recently: a corporate credit card, mobile phone banking, innovative savings schemes, and a bullion trading center. Procedures were in place to ensure prudent and efficient management of assets. Stringent systems for processing loan applications and their supervision and control were also in place. An assets and liabilities committee was established to ensure risk management. CBOC’s accounts were being audited, on time, by an independent and reputable auditing firm.

B. Loan Utilization

3. CBOC did not utilize any portion of DFL IV. CBOC could finance most of its subprojects (with maturities of less than 5 years) from its own deposits with rollover facility and had access to other credit lines from multilateral financial institutions such as the Second Small and Medium Industries Project of the Asian Development Bank (ADB) (approved in May 1991 and closed in June 1999). The World Bank’s Fourth Small and Medium Industries credit line provided finance up to SLRs8 million at a concessionary rate. Most of the financial requirements of its clientele could be accommodated from its own deposits or from the credit lines for small and medium industries. CBOC reported that it could not identify suitable subprojects for financing under DFL IV. Perhaps the applicants found the DFL IV eligibility criteria too rigorous.

C. Institutional Performance

4. CBOC had a board of directors of nine prominent Sri Lankan bankers and entrepreneurs. The board was responsible for overall management, supervision, control, and policy formulation. A corporate and senior management team of 31 was responsible for operations and day-to-day management. CBOC steadily developed a national branch network comprising 100 branches in 2001, up from 41 in 1996. The number of automated tellers’ machines increased from 29 in 1996 to 115 in 2001.

1. Organization, Management, and Personnel

5. A growing banking staff serviced the bank and branch network. CBOC had 2,259 employees in 2001, up 30% from 1,837 in 1996. Bank executives have increased 203% from Appendix 3 35

236 in 1996 to 715 in 2001, reflecting the need for experienced management to maintain profitability during high growth and expansion periods. CBOC staff had been well trained in the bank’s extensive bank management and employee training program. Training was an ongoing employee obligation, and the bank required a minimum of 60 hours annual training to update or expand the staff’s banking knowledge and skills. The in-house training program was supplemented with local and international bank training programs offered by the Central Bank of Sri Lanka and private bank institutes, as needed, to meet the increasing job demands.

6. CBOC has improved its infrastructure during the last 5 years, installing the Globus management information and loan accounting system to fully computerize and automate the entire bank’s operations. The Colombo head office was linked to every branch in Sri Lanka. CBOC claimed that its improved information technology system has been a major factor in improving financial performance.

2. Financial Performance and Position

7. The financial performance and position are given in Tables A3.1 and A3.2. The net profit after tax increased from SLRs433.4 million in 1996 to SLRs1,010 million in 2001. The after-tax returns on average equity and assets have been fairly steady at 17.0% and 1.9%, respectively in 1996, and 17.1% and 1.9% in 2001. Total assets have grown considerably from SLRs25,335.3 million in 1996 to SLRs41,887.3 million in 1999 (a 65% increase or 18% per year). Total assets increased by 19% per year in the next 2 years to SLRs49,610.7 million in 2000 and SLRs59,095.9 million in 2001. Total assets in 2001 were funded by equity of SLRs6,744.9 million and liabilities of SLR52,351.0 million. During 2000-2001, the current ratio averaged 1, and the loan-deposit ratio averaged 84%. The capital adequacy ratio has been satisfactory since 1996. In 2001, tier-1 capital adequacy ratio was 15.7% and tier-2 capital adequacy ratio stood at 16.2%.

3. Operational Performance and Portfolio Quality

8. The loans and advances portfolio increased from 54% of total assets in 1996 to 64% in 2001, reflecting an increase in CBOC’s earning capacity. The quality of CBOC’s portfolio was satisfactory from 1996 to 2001. The portfolio infection ratio dropped from 11.3% in 1996 to 8.9% in 1999 and 8.7% in 2000 but increased slightly to 9.9% in 2001. The cash collection ratio stood at 97.7% in 2000 and 93.5% in 2001.

D. Compliance with Loan Covenants

9. CBOC complied with the following ADB financial covenants: (i) a minimum annual collection ratio for the total portfolio of 80%; (ii) a maximum portfolio infection ratio of 20%; (iii) a minimum debt service cover of 1.25 times; (iv) a capital-risk adjusted assets ratio of 8% based on the Basle Guidelines; (v) single borrower group lending limit of not more than 10% of total assets; (vi) loans to a single economic sector not more than 30% of total loan portfolio; and (vii) submission of reports and audited accounts to ADB on time. CBOC’s debt service coverage ratio was 6.2 times in 2000 and 5.7 times in 2001, well above the minimum of 1.25 times. CBOC explained to the Project Completion Report Mission that the revolving nature of short-term advances and overdrafts made the calculation of the cash collection ratio difficult. Because of the fluctuating nature of deposits, the bank’s major source of funding, CBOC found it difficult to calculate the debt service coverage ratio. Table A3.1: Income Statements 36 (SLRs million) Appendix3

Year Ending 31 March1996 1997 1998 1999 2000 2001 Projected Actual Actual Revenue Net Interest Income 1,169.6 980.9 1,154.4 1,426.5 1,603.7 2,019.8 2,335.8 Interest Income 3,338.9 2,552.9 2,936.0 3,031.7 3,762.2 4,796.2 6,509.9 Interest Expenses 2,169.3 1,572.0 1,781.6 1,605.2 2,158.5 2,776.4 4,174.1 Noninterest Income 765.8 680.4 759.8 801.7 791.8 1,020.3 1,295.6 Total Revenue 1,935.4 1,661.3 1,914.3 2,228.2 2,395.5 3,040.1 3,631.4

Operating Expenses Staff Costs 484.9 467.8 508.0 615.2 728.3 819.2 1,022.3 General and Administrative 71.8 428.7 536.2 596.1 582.1 530.9 615.9 Others 479.6 184.5 217.2 133.9 146.3 176.0 150.7 Total Operating Expenses 1,036.3 1,080.9 1,261.4 1,345.1 1,456.8 1,526.2 1,788.9

Profit Before tax 899.1 580.4 652.9 769.5 809.5 1,150.5 1,325.0 Income Tax 338.5 147.0 110.0 178.0 151.0 214.5 315.0 Profit After Tax 560.6 433.4 542.9 591.5 658.5 936.0 1,010.0

Ratios Return on Average Equity (%) 23.9 17.0 16.8 16.2 16.2 20.1 17.1 Return on Average Assets (%) 1.9 1.9 2.0 1.9 1.7 2.0 1.9 Source : Commercial Bank of Ceylon Ltd. Table A3.2: Balance Sheets (SLRs million)

Year Ending 31 March1996 1997 1998 1999 2000 2001 Projected Actual Actual Assets Current Assets Cash and Bank Deposits 4,020.0 6,636.9 6,577.8 10,688.9 9,762.9 8,039.5 7,362.3 Bills of Exchange 1,569.4 2,135.3 2,074.1 1,596.9 1,873.0 2,331.0 2,367.8 Short-Term Loans and Advances 17,980.2 13,379.7 15,817.7 14,848.3 19,985.1 24,766.2 26,828.7 Other Current Assets 4,281.3 1,592.9 1,225.9 1,439.3 2,501.3 4,257.2 8,742.7 Total Current Assets 27,850.9 23,744.7 25,695.5 28,573.3 34,122.3 39,394.0 45,301.5 Long-Term Loans 4,286.0 211.3 361.4 4,193.4 5,754.5 8,066.6 11,272.3 Fixed Assets 670.0 671.2 796.7 1,058.7 1,263.3 1,305.6 1,409.5 Investments 351.3 708.2 805.5 760.5 747.2 844.5 1,112.7 Total Assets 33,158.2 25,335.3 27,659.2 34,585.9 41,887.3 49,610.7 59,095.9

Liabilities and Equity Current Liabilities Short-Term Deposits 24,242.6 15,944.2 19,661.6 24,200.9 28,054.6 31,890.6 41,351.7 Short-Term Borrowings 2,066.1 2,601.0 1,321.2 1,124.2 1,350.2 2,316.7 1,862.7 Other Current Liabilities 2,609.0 3,091.3 2,762.1 3,819.7 5,640.7 4,223.5 3,682.6 Total Current Liabilities 28,917.7 21,636.4 23,744.8 29,144.8 35,045.5 38,430.8 46,896.9 Long-Term Deposits 891.8 667.1 493.9 1,073.6 2,073.5 5,632.4 4,954.1 Long-Term Borrowings 749.8 — — 500.0 500.0 500.0 500.0 Total Liabilities 30,559.3 22,303.5 24,238.8 30,718.4 37,619.0 44,563.2 52,351.0 Equities Paid-In Capital 125.0 267.9 267.9 348.3 348.3 348.3 1,324.5 Reserves 2,472.9 2,763.9 3,152.5 3,519.3 3,920.0 4,699.3 5,420.4 Retained Earnings 1.0 — Total Equity 2,598.9 3,031.8 3,420.4 3,867.5 4,268.3 5,047.5 6,744.9 Total Liabilities and Equity 33,158.2 25,335.3 27,659.2 34,585.9 41,887.3 49,610.7 59,095.9 Appendix3 Ratios Current Ratio (times) 1.0 1.1 1.1 1.0 1.0 1.0 1.0 Loans to Deposit Ratio (%) 74.2 81.8 80.3 75.3 85.4 87.5 82.3 Capital Adequacy Ratio (%) - Tier 1 — 17.1 16.7 15.5 14.9 15.0 15.7 Capital Adequacy Ratio (%) - Tier 2 10.6 17.5 17.6 18.5 17.1 16.6 16.2

Debt-Service Coverage Ratio (times) — — — — — — 5.7 37 — = not available. Source: Commercial Bank of Ceylon Ltd. 38 Appendix 4

HATTON NATIONAL BANK LTD.

A. Background

1. History and Ownership

1. Hatton National Bank Ltd. (HNB) was incorporated in May 1970 after consolidation of Hatton Bank and the two branches of the National and Grindlays Bank. At appraisal, HNB had the largest assets and deposits among private domestic commercial banks in Sri Lanka.

2. HNB’s six directors (seven at appraisal) were well qualified and had wide financial and commercial knowledge and experience. HNB’s paid-up capital as of 31 December 2001 stood at SLRs650 million, of which 59.6% was held by 20 large shareholders, with the balance held by approximately 15,200 small shareholders and private institutions. HNB shares (par value SLRs10.00 per share) were trading at SLRs55.00 on the Colombo Stock Exchange on 21 May 2002.

3. HNB had 123 branches, (50 at appraisal), with its headquarters in Colombo. The greatest concentration of its branches—68—was in the western region.

2. Activities, Policies, and Procedures

4. HNB has been the forerunner in development banking among the private banks in Sri Lanka and has provided perennial services to small, medium-sized, and large enterprises. When the credit lines for small and medium industries and the development financing credit lines of the Asian Development Bank (ADB) were exhausted, HNB used its own resources to finance the small and medium-sized enterprise sector. HNB provided a variety of new products and services such as Gami Pubuduwa (rural credit scheme), Pathum Vimana, (a lottery scheme to encourage savings), and Silverline Pension Scheme.

5. HNB’s core business of customer advances showed 18% growth during financial year 2001. Deposits also increased by 20%. The bank’s policy was to gradually outsource some nonbanking activities to improve customer service. HNB’s strategy was to focus on loan growth in corporate, commercial and trading, and consumer lending.

6. In accordance with the recent strategic redirection exercise, HNB has formulated a comprehensive plan to promote long-term deposits and attract more demand deposits. HNB will emphasize using its large customer service network, multitude of products and services, and its large established clientele to offer specialized personal banking services professionally.

7. HNB accounts were audited by an independent and reputable auditing firm; the audited accounts were prepared on time.

B. Loan Utilization

1. Characteristics of Subprojects

8. The Fourth Development Finance Loan Project subproject characteristics are in Table A4.1. HNB financed 23 subprojects aggregating $5 million, of which 15 (65%) were for expansion. About half of the subprojects were below $100,000 accounting for about 10% of the aggregate loan amount, while one-fourth were $300,000–$500,000 accounting for about 40% of the total Appendix 4 39 amount. Most subprojects were short term (78%) and concentrated in the western region (70%). The largest recipient was the miscellaneous industrial subsector (35%), followed by food and beverages (17%) and construction (13%). Procurement was mainly through international shopping (56%) followed by reasonable competition (44%). India was the largest source of supply at $1.3 million, followed by Germany ($1.1 million) and Italy ($650,000).

2. Implementation Status of Subprojects

9. Out of 23 subprojects, 21 were completed on time and within the estimated costs. One subproject had problems getting started as completion of its facilities was delayed by one year. Another subproject was not completed at all with a cost overrun and was placed under liquidation. ADB provided 54% of these subprojects’ financing; the sponsors, 46%.

3. Financial Performance of Subprojects

10. Of the 23 subloans/leases, 18 (74%) were settled in full as the subprojects were completed on time and operated profitably. However, two subprojects have not achieved the estimated sales turnover and net income and were in arrears. Another subproject was under liquidation, and two others, although completed on time, have also fallen into arrears.

4. Economic Impact of Subprojects

11. The 23 subprojects showed an incremental export sales turnover of SLRs151.2 million ($1.6 million) in the second year of operation. They have generated incremental employment for about 918 persons at a cost of SLRs670,000 per job. Capital formation by these subprojects totaled SLRs612.72 million, funded by loans and sponsors’ equity.

C. Institutional Performance

1. Organization, Management, and Personnel

12. HNB operated 123 branches throughout Sri Lanka with a work force of 4,126 at the end of 2001. Eight more branches were to be opened during 2002. Branch network expansion enabled HNB to gather more deposits. HNB conducted management development and skills developments programs and launched a productivity improvement program to maintain a committed and contented workforce. HNB possessed a highly qualified corporate management team of 23 professionals supported by a senior management team of 45, all experienced and qualified in various banking disciplines.

13. Launching of the Hatna-Net marked the commencement of HNB’s drive to achieve excellence through technology. Hatna-Net provided a unibanking facility as a basic tool, with many innovative online products possible, such as e-commerce. Hatna-Net, an island-wide communications network, complemented by over 123 branches, gave HNB a distinct advantage over its competitors.

2. Financial Performance and Position

14. HNB’s income statements from 1996 to 2001 are in Table A4.2. After over thirty years of existence, HNB underwent its greatest difficulty in 2001. As a result of the high interest rates payable on deposits, and higher operating costs, net income dropped sharply from SLRs800 million in year 2000 to SLRs303 million in 2001. 40 Appendix 4

15. Profitability indicators also revealed this declining trend. The rate of return on average assets dropped from 1.3% in 1996 to 0.3% in 2001 due to the adverse economic environment, which reduced the demand for banking business, required stronger provisions against nonperforming loans, and narrowed the interest rate spreads, which dropped from 4.5 percentage points in 2000 to 3.2 in 2001.

16. The balance sheets from 1996 to 2001 are in Table A4.3. They show a steady increase in HNB capital through issue of shares and building up of reserves with retained earnings. The shareholder base increased from SLRs200 million in 1996 to SLRs650 million in 2001. Total equity grew 123% from SLRs2.59 billion in 1996 to SLRs5.75 billion in 2001. The capital adequacy ratio stood at 9.5% at the end of 2001, above the 2002 statutory requirement of 9% for commercial banks.

17. HNB has managed its liquidity risk using its asset and liability committee According to the committee’s guidelines, liquidity risk was measured using cash flow. HNB has maintained a liquidity reserve of 20% in accordance with CBSL’s directives. At the end of 2001, HNB had a ratio of liquid assets to liabilities of 29%, which was 4% higher than in 2000.

3. Operational Performance and Portfolio Quality

18. Portfolio analysis showed that 92% of revenue was realized from banking activities, with interest income accounting for 76%. Leasing operations were next in line with approximately 4.3% of revenue.

19. The status of HNB’s infected loans is in Table A4.4. Due to the economic slowdown in 1997 and thereafter, HNB’s infection ratio decreased from 5.7% in 1997 to 5.2% in 1998, but improved to 9.00% in 2000, and 9.30% in 2001. HNB’s collection ratio also dropped from 87% in 1996 to 82% in 2001, adversely affecting HNB’s profitability and return on average assets. Based on the first quarter results of 2002, such as the improvement of the interest rate spread to 4.9 percentage points. HNB expected the situation to improve in 2002.

D. Compliance with Loan Covenants

20. HNB has complied with the following ADB financial covenants: (i) a minimum annual collection ratio for the total portfolio of 80%; (ii) a maximum portfolio infection ratio of 20%; (iii) a minimum debt service cover of 1.25 times; (iv) a capital-risk adjusted assets ratio of 8% based on the Basle Guidelines; (v) single borrower group lending limit of not more than 10% of total assets; (vi) loans to a single economic sector not more than 30% of total loan portfolio; and (vii) submission of reports and audited accounts to ADB on time. At 0.3%, however, HNB’s minimum return on average assets (after tax) did not meet the required 1.0% in 2001.

21. HNB cited the following as contributing to its declining performance and profitability: (i) high interest rates on Treasury bills, preventing HNB from sustaining low-cost funds and shifting its deposit base from low to high cost; (ii) borrowers’ difficulties in repaying loans, causing HNB to make substantial loss provisions for nonperforming loans; and (iii) HNB investment of SLRs1.8 billion in the head office building, tying up funds without any direct return for several years.

22. HNB expected that with the change in Government in December 2001, the economy would improve with better economic management. HNB has started to reduce its idle assets and improve its productivity. The interest rate spread improved to 4.9 percentage points in the first Appendix 4 41 quarter 2002 (compared to 3.2 in 2001). HNB expected that by the end of 2002, its return on average assets would exceed 0.5%, and that in 2003, the ratio would reach and exceed the covenanted minimum of 1.0%. ADB must closely monitor this development.

42 Appendix 4

Table A4.1: Characteristics of Subprojects

Amount Item Number % ($ million) % A. Purpose 1. New 6 26.1 2.38 47.2 2. Expansion 15 65.2 2.49 49.4 3. Balancing, Modernization, and Replacement 2 8.7 0.17 3.4 Total 23 100.0 5.04 100.0

B. Size 1. Up to $50,000 5 21.7 0.15 3.0 2. $50,001–$100,000 7 30.4 0.42 8.3 3. $100,001–$300,000 3 13.1 0.52 10.3 4. $300,001–$500,000 6 26.1 1.96 38.9 5. $500,001–$1,000,000 0 0.0 0.00 0.0 6. over $1,000,000 2 8.7 1.99 39.5 Total 23 100.0 5.04 100.0

C. Maturity 1. Up to 5 years 18 78.3 3.07 60.9 2. Over 5–10 years 5 21.7 1.97 39.1 3. Over 10–15 years 0 0.0 0.00 0.0 Total 23 100.0 5.04 100.0

D. Region 1. Western (including Colombo) 16 69.6 2.50 49.6 2. Central 0 0.0 0.00 0.0 3. Northwestern 0 0.0 0.00 0.0 4. Southern 4 17.4 2.27 45.0 5. Sabaragamuwa 2 8.7 0.17 3.4 6. Uva 1 4.3 0.10 2.0 Total 23 100.0 5.04 100.0

E. Industry Sector 1. Agriculture, Forestry, and Fishing 2 8.7 0.35 6.9 2. Food and Beverages 4 17.5 0.87 17.2 3. Textiles, Wearing Apparel, and Leather 2 8.7 0.15 3.0 4. Wood and Wood Products 1 4.3 0.44 8.7 5. Paper, Printing, and Publications 1 4.3 0.02 0.4 6. Chemicals, Petroleum, Coal, Rubber, and Plastics 1 4.3 0.20 4.0 7. Basic Metals 0 0.0 0.00 0.0 8. Nonmetallic Minerals 0 0.0 0.00 0.0 9. Fabricated Metals, Machinery, and Equipment 0 0.0 0.00 0.0 10. Construction 3 13.1 0.10 2.0 11. Wholesale, Retail, Restaurants, and Hotels 1 4.3 0.97 19.3 12. Transport, Storage, and Communication 0 0.0 0.00 0.0 13. Financing and Business Services 0 0.0 0.00 0.0 14. Community, Social, and Personal Services 0 0.0 0.00 0.0 15. Other Industries 8 34.8 1.94 38.5 Total 23 100.0 5.04 100.0 Appendix 4 43

Amount Item Number % ($ million) % F. Procurement Procedures 1. Reasonable Competition 10 43.5 1.21 24.0 2. International Shopping 13 56.5 3.83 76.0 3. Proprietary Basis 0 0.0 0.00 0.0 Total 23 100.0 5.04 100.0

G. Procurement by Country 1. Germany 1.07 21.2 2. India 1.30 25.8 3. Italy 0.65 12.9 4. Japan 0.08 1.6 5. Singapore 0.63 12.5 6. Sri Lanka 0.28 5.6 7. Switzerland 0.26 5.2 8. Taipei,China 0.32 6.3 9. United Kingdom 0.03 0.6 10. United States 0.42 8.3 Total 5.04 100.0 Source: Hatton National Bank Ltd. Table A4.2: Income Statements

(SLRs million) 44

Year Ending 31 March1996 1997 1998 1999 2000 2001 Appendix 4 Projected Actual Actual Revenue Net Interest Income 1,202 852 1,157 1,631 1,903 2,660 2,135 Interest Income 3,869 3,664 4,512 4,947 5,991 7,941 9,336 Interest Expenses 2,667 2,812 3,355 3,316 4,088 5,281 7,201 Leasing Income 0.0 373 452 453 488 528 516 Noninterest Income 787 755 1,152 1,296 1,243 1,173 1,711 Total Revenue 1,989 1,980 2,761 3,380 3,634 4,361 4,362

Operating Expenses Staff Costs 585 613 745 990 1,194 1,403 1,626 General and Administrative 284 287 413 454 543 709 884 Others 466 508 877 1,079 1,004 1,300 1,551 Total Operating Expenses 1,335 1,408 2,035 2,523 2,741 3,412 4,061

Profit Before tax 654 573 725 858 894 949 301 Income Tax 105 120 172 175 176 149 (2) Profit After Tax 549 453 553 683 718 800 303

Ratios Return on Average Equity (%) 27.6 19.2 19.7 20.8 16.8 15.2 5.4 Return on Average Assets (%) 1.6 1.3 1.2 1.2 1.0 1.0 0.3 Source : Hatton National Bank Ltd. Table A4.3: Balance Sheets (SLRs million)

Year Ending 31 March1996 1997 1998 1999 2000 2001 Projected Actual Actual Assets Current Assets Cash and Bank Deposits 7,146 9,124 10,585 14,495 17,325 14,734 20,221 Bills of Exchange 2,393 3,517 3,941 3,824 3,122 4,546 3,152 Short-Term Loans and Advances 20,598 8,939 9,130 11,039 12,732 15,609 17,081 Other Current Assets 3,579 3,419 4,775 6,516 6,292 7,792 8,549 Total Current Assets 33,716 24,999 28,431 35,874 39,471 42,681 49,003 Long-Term Loans and Lease Receivables 2,682 14,272 21,745 25,906 31,423 37,049 37,690 Fixed Assets 1,376 1,261 1,437 1,675 1,914 2,720 2,822 Investments 287 850 960 1,135 3,546 5,205 9,616 Total Assets 38,061 41,382 52,573 64,590 76,354 87,655 99,131

Liabilities and Equity Current Liabilities Short-Term Deposits 30,461 3,845 4,621 4,837 5,928 5,759 6,005 Short-Term Borrowings 26 2,543 1,855 3,014 5,090 6,572 3,458 Other Current Liabilities 4,582 6,104 7,448 9,877 9,763 10,123 11,757 Total Current Liabilities 35,069 12,492 13,924 17,728 20,781 22,454 21,220 Long-Term Deposits 129 25,389 34,682 41,195 47,930 56,998 69,594 Long-Term Borrowings 657 914 953 2,129 2,635 2,655 2,564 Total Liabilities 35,855 38,795 49,559 61,052 71,346 82,107 93,378 Equity Paid-In Capital 120 200 200 300 650 650 650 Reserves 2,003 481 481 481 495 512 517 Retained Earnings 83 1,906 2,333 2,757 3,863 4,386 4,586 Total Equity 2,206 2,587 3,014 3,538 5,008 5,548 5,753 Total Liabilities and Equity 38,061 41,382 52,573 64,590 76,354 87,655 99,131

Ratios Appendix4 Current Ratio (times) 1.0 2.0 2.0 2.0 1.9 1.9 2.3 Debt-Equity Ratio — 4.8 4.8 7.1 4.1 2.5 2.4 Loans to Deposits Ratio (%) 67.6 86.0 85.0 85.0 82.0 84.0 71.0 Capital Adequacy Ratio (%) 9.4 8.8 8.4 11.4 11.8 11.0 9.5 Debt-Service Coverage Ratio (times) 2.2 1.7 1.8 2.0 1.9 1.8 1.6 — = not available. 45 Source: Hatton National Bank Ltd. 46 Appendix 4

Table A4.4: Analysis of Loan Portfolio Quality (SLRs million)

As of 31 December Infection Ratio (%) Collection Ratio (%) 1996 4.5 87.0 1997 5.7 84.0 1998 5.2 85.0 1999 5.6 83.0 2000 9.0 82.0 2001 9.3 82.0 Source: Hatton National Bank Ltd. Appendix 5 47

SAMPATH BANK LTD.

A. Background

1. History and Ownership

1. Sampath Bank Ltd. (Sampath) was incorporated as an investment and credit bank in 1987 with an authorized capital of SLRs500 million and a paid-up capital of SLRs175 million. Sampath was one of the most broadly based commercial banks, with more than 16,671 shareholders owning 44 million shares. Its four largest shareholders each owned 5% of the bank. Distilleries Company of Sri Lanka and Stassen Exports are among the large shareholders. The paid-up share capital at the end of December 2001 stood at SLRs442.8 million. Sampath’s shares (par value SLRs10.00) were being traded on the Colombo Stock Exchange at SLRs60.00 on 17 May 2002.

2. The board of directors consisted of the chair, veteran banker Edgar Gunatunge, and eight other nonexecutive directors, with the managing director being the only executive director. All came from diverse disciplines and had a wealth of experience in various sectors of the economy.

2. Activities, Policies and Procedures

3. Sampath’s principal business activities were banking and related financial services. The core businesses of deposits grew by 20% in 2001 over 2000, and deposits, by 11%. Lending in 2001 focused on quality rather than quantity, with stringent measures to ensure that investment in new ventures and existing businesses remained on track.

4. Sampath’s policy concentrated on innovation. Sampathnet was introduced in 2000, enhancing “banking anytime anywhere” and expanding web-based products. Sampath was the first bank to introduce products such as Sampath Vishwa, the Internet Payment Gateway (internet-based credit card [web card]). Sampath also introduced wireless application protocol, which took the convenience of modern banking to customers’ doorsteps. ‘Double S’ was an unprecedented success, as was ‘Express Money’, linking clients to the global money- transferring facility.

5. Sampath also ensured that its professionals were highly computer literate in the increasingly competitive banking sector, and endeavored to make bank processes more efficient using internationally recognized information technology solutions. The resulting enhanced productivity will accrue to the shareholder in the medium to long term.

6. The accounts of Sampath were audited, on time, by an independent and reputable auditing firm.

B. Loan Utilization

1. Characteristics of Subprojects

7. Table A5.1 shows the characteristics of the 10 subprojects funded by Sampath, aggregating $1.27 million: 7 were for expansion; 4 ranged from $50,000 to $100,000; 1 was over $500,000, accounting for 45% of the total value of the 10 subprojects; 6 were for 5–10 years; and 7 were in the western region. Food and beverages; chemicals, petroleum, coal, 48 Appendix 5 rubber, and plastics; and other miscellaneous industrial subsectors each got 20%. Procurement was mainly through reasonable competition (70%) with Sri Lanka as the largest source of supply, accounting for $797,000, followed by Singapore ($193,000), and Hong Kong, China ($127,000).

2. Implementation Status of Subprojects

8. Of 10 subprojects 9 were completed on time and were in operation; 7 were implemented within the cost estimates; 1 had a cost savings of SLRs1.25 million; and 2 had cost overruns of SLRs24.5 million due to cost underestimation. The aggregate financing of the 10 subprojects was from sponsors (53%), other sources (22%), and the Asian Development Bank (ADB) and Sampath (25%).

3. Financial Performance of Subprojects

9. Nine subprojects were completed on time and operating satisfactorily from year 1. Five exceeded the estimated capacity utilization in year 2. Six realized net sales in excess of the estimates starting from year 1, and eight yielded satisfactory net profits from year 1. One, however, suffered a substantial net loss of SLRs936,000 in year 2 due to cost overruns resulting from implementation delays. However, the subproject was able to turn around and realized after-tax profit of SLRs3.435 million in 2000. In general, the ratio of net income to total assets was below the estimates for seven subprojects, while two realized 14.1% and 9.3%, respectively, in year 2. The return on equity of three was satisfactory in years 1 and 2, giving investors a reasonable return. The present status of the 10 subprojects is satisfactory: 1 subloan has been fully repaid; repayment on 8 others was regular; and repayments on 1 were being received but irregularly.

4. Economic Impact of Subprojects

10. Three subprojects realized incremental export sales turnover of SLRs637 million ($6.7 million) in year 2. The 10 subprojects created jobs for 173 persons. Capital formation in these subprojects aggregated SLRs537.4 million ($5.7 million).

C. Institutional Performance

1. Organization, Management, and Personnel

11. Sampath was managed by a board of 9 directors (11 at appraisal) with extensive experience in banking, business, accounting, law, and academia. The board had a corporate management team of 10 experienced professionals, supported by an executive management team of 18 professional senior bank managers. Sampath operated through an island-wide network of 45 branches (18 at appraisal) with 1,430 employees (763 at appraisal). Sampath limited its branch expansion to five annually due to the high cost of operating, maintaining, and equipping fully computerized main branches.

12. Recruitment was based on merit. Sampath also conducted in-house training programs and sent its staff for foreign training courses to acquire a solid grounding in the basic practices of sound banking. Training was mandatory for a minimum of 50 hours annually.

13. The growing emphasis on internet banking made Sampath expand its web-based products. Sampath also used its information technology systems to provide updated and Appendix 5 49 accurate information on the quality and performance of its loan portfolio, investments, and other assets.

2. Financial Performance and Position

14. Table A5.2 shows the income statements of Sampath for the last six years (1996-2001). The external market uncertainties and lackluster economic growth rate in 2001 hindered Sampath’s financial performance. During the second half of 2001, demand for credit slowed down. However, Sampath was able to harness existing business and exploit niche markets with innovative strategies. Sampath registered an increase in revenue from SLRs2.12 billion in 2000 and SLRs2.17 billion in 2001.

15. Profitability, however, declined 20% from SLRs402 million in 2000 to SLRs322 million in 2001. Although Sampath had a strong 2.1% return on average assets for 1996, it steadily declined to 1.3% in 2000 and stood at 0.9% in 2001 due to the bad economy, drop in demand for banking facilities, need for increased provisions for nonperforming loans, and narrowing interest rate spreads. Sampath’s interest rate spreads dropped from 5.4 percentage points in 2000 to 4.3 in 2001, but rose to 4.8 in the first quarter 2002. Sampath’s return on average assets improved to 1.1% as of 31 March 2002. Based on improved financial performance in the first quarter, profitability was expected to increase at the end of 2002.

16. The balance sheets for 1996-2001 (Table A5.3) show a steady increase in Sampath’s equity through issue of shares in 1999 and build up of reserves with retained earnings to aggregate SLRs2.53 billion in December 2001, 10.7% more than in 2000. Capital growth has kept pace with growth in loans and deposits to exceed the capital adequacy standards of Central Bank of Sri Lanka. Sampath has maintained adequate capital, as indicated by the tier-1 and -2 capital adequacy ratios during 1996-2001. Tier-2 capital adequacy ratio stood at 12.6% in 2001, which was above Central Bank of Sri Lanka's requirement of 9%.

17. Sampath’s current ratio of 1.25 times was also satisfactory and averaged 1.5 during 1999-2000. The liquidity ratio was just above the central bank’s requirement of 20% in 1999– 2000 but increased to 27.9% in December 2001.

18. Sampath’s total assets have more than doubled from SLRs14.90 billion in 1996 to SLRs34.60 billion in 2000. Total assets grew 12.1% to SLRs38.78 billion in 2001.

3. Operational Performance and Portfolio Quality

19. Loans and advances (local and foreign currency) increased rapidly from SLRs8.40 billion in 1996 to SLRs24.60 billion in 2000 and 4.5% more to SLRs25.64 billion in 2001. Deposits also increased substantially from SLRs9.62 billion in 1996 to SLRs24.69 billion in 2000 and 20% more in 2001 to SLRs29.67 billion.

20. Sampath has had difficulty controlling its costs. Since the beginning, Sampath has endeavored to be innovative and introduced new products and services into the banking sector. Sampath reduced its 70.4% ratio of operating expenses to income in 1991 down to 49.2% in 1995. Since then, however, the ratio of cost to income has steadily increased to 65.0% in 1999 and to 70.6% in 2001. Sampath should monitor its operating expenses closely to reduce that ratio and thereby increase profitability.

50 Appendix 5

21. The quality of the loan portfolio of Sampath deteriorated in the late 1990s. Its nonperforming loans (in arrears by more than 3 months) increased to 7.6% of the total loan portfolio in 1997 following the economic slowdown, and rose further to 17.1% in 1999. The nonperforming loan ratio decreased to 15.2% in 2000 and 12.07% in 2001. However, Sampath’s infection ratio, computed as the percentage of total loans and advances in arrears by 6 months or more, increased from 12.9% in 2000 to 15.4% in 2001 (Table A5.4). Although below the 20% maximum specified as financial covenant under the Fourth Development Finance Loan Project, the infection ratio would have to be monitored closely.

22. Sampath’s annual cash collection ratio declined from 92.3% in 2000 to 83.0% in 2001 (Table A5.4). Although still above the minimum 20% collection ratio specified under the Fourth Development Finance Loan Project, the steep decline should be a matter of concern.

D. Compliance with Loan Covenants

23. Sampath complied with the following ADB financial covenants: (i) a minimum cash collection ratio for the total portfolio of 80%; (ii) a maximum portfolio infection ratio of 20%; (iii) a minimum debt service cover of 1.25 times; (iv) a capital adequacy ratio of not less than 8% (tier- 1 and -2 capital) based on the Basle Guidelines; (v) a single borrower group lending limit of 10% of total assets; (vi) a single economic sector lending limit of 30% of total loan portfolio; and (vii) submission of reports and annual audited accounts to ADB on time. Sampath, however, was not able to comply with the financial covenant on the after-tax return on average assets. This ratio was 0.9% in 2001 as against the ADB covenant of at least 1.0%. Based on the improvement in its financial performance in the first quarter 2002, Sampath expected to comply with the covenant in 2002. ADB needs to monitor closely the compliance status of this covenant.

Appendix 5 51

Table A5.1: Characteristics of Subprojects

Amount Item Number % ($ million) % A. Purpose 1. New 3 30.0 0.77 60.6 2. Expansion 7 70.0 0.50 39.4 3. Balancing, Modernization, and Replacement 0 0.0 0.00 0.0 Total 10 100.0 1.27 100.0

B. Size 1. Up to $50,000 3 30.0 0.08 6.3 2. $50,001–$100,000 4 40.0 0.33 26.0 3. $100,001–$300,000 2 20.0 0.30 23.6 4. $300,001–$500,000 0 0.0 0.00 0.0 5. $500,001–$1,000,000 1 10.0 0.56 44.1 6. over $1,000,000 0 0.0 0.00 0.0 Total 10 100.0 1.27 100.0

C. Maturity 1. Up to 5 years 4 40.0 0.22 17.3 2. Over 5–10 years 6 60.0 1.05 82.7 3. Over 10–15 years 0 0.0 0.00 0.0 Total 10 100.0 1.27 100.0

D. Location 1. Western (including Colombo) 7 70.0 0.55 43.3 2. Central 0 0.0 0.00 0.0 3. Northwestern 0 0.0 0.00 0.0 4. Southern 2 20.0 0.65 51.2 5. Sabaragamuwa 1 10.0 0.07 5.5 6. Northern 0 0.0 0.00 0.0 7. Uva 0 0.0 0.00 0.0 8. Eastern 0 0.0 0.00 0.0 Total 10 100.0 1.27 100.0

E. Industry Sector 1. Agriculture, Forestry, and Fishing 0 0.0 0.00 0.0 2. Food and Beverages 2 20.0 0.19 14.9 3. Textiles, Wearing Apparel, and Leather 1 10.0 0.02 1.6 4. Wood and Wood Products 0 0.0 0.00 0.0 5. Paper, Printing, and Publications 1 10.0 0.09 7.1 6. Chemicals, Petroleum, Coal, Rubber, and Plastics 2 20.0 0.16 12.6 7. Basic Metals 0 0.0 0.00 0.0 8. Nonmetallic Minerals 0 0.0 0.00 0.0 9. Fabricated Metals, Machinery, and Equipment 0 0.0 0.00 0.0 10. Construction 0 0.0 0.00 0.0 11. Wholesale, Retail, Restaurants, and Hotels 1 10.0 0.57 44.9 12. Transport, Storage, and Communication 0 0.0 0.00 0.0 13. Financing and Business Services 1 10.0 0.01 0.8 14. Community, Social, and Personal Services 0 0.0 0.00 0.0 15. Other Industries 2 20.0 0.23 18.1 Total 10 100.0 1.27 100.0

52 Appendix 5

Amount Item Number % ($ million) % F. Procurement Procedures 1. Reasonable Competition 7 70.0 0.50 39.4 2. International Shopping 0 0.0 0.00 0.0 3. Proprietary Basis 3 30.0 0.77 60.6 Total 10 100.0 1.27 100.0

G. Procurement by Country 1. Germany 0.07 5.5 2. Hong Kong, China 0.13 10.2 3. Italy 0.08 6.3 4. Singapore 0.19 15.0 5. Sri Lanka 0.80 63.0 Total 1.27 100.0 Source: Sampath Bank Ltd. Table A5.2: Income Statements (SLRs million)

Year Ending 31 March1996 1997 1998 1999 2000 2001 Projected Actual Actual Revenue Net Interest Income 718.4 655.8 784.9 935.6 1,006.3 1,362.6 1,293.0 Interest Income 1,901.0 1,589.3 1,977.6 2,198.2 2,632.8 3,531.8 4,484.1 Interest Expenses 1,182.6 933.5 1,192.7 1,262.6 1,626.5 2,169.2 3,191.1 Noninterest Income 342.9 354.3 408.9 516.6 550.9 760.8 872.9 Total Revenue 1,061.3 1,010.1 1,193.8 1,452.2 1,557.2 2,123.4 2,165.9

Operating Expenses Staff Costs 186.8 217.2 246.5 337.3 426.4 591.6 654.1 General and Administrative 235.8 306.1 382.5 469.0 553.7 691.0 773.2 Others 124.0 80.7 115.9 159.2 235.2 305.3 309.7 Total Operating Expenses 546.6 604.0 744.9 965.5 1,215.3 1,587.9 1,737.0

Profit Before tax 514.7 406.1 448.9 486.7 341.9 535.5 428.9 Income Tax 180.2 124.1 127.2 115.1 80.7 133.8 107.1 Profit After Tax 334.5 282.0 321.7 371.6 261.2 401.7 321.8

Ratios Appendix 5 Return on Average Equity (%) 42.0 26.7 24.7 23.3 14.0 18.9 13.3 Return on Average Assets (%) 2.6 2.1 1.9 1.8 1.0 1.3 0.9 Source : Sampath Bank Ltd. 53 Table A5.3: Balance Sheets

(SLRs million) 54

Year Ending 31 March1996 1997 1998 1999 2000 2001 Projected Actual Actual A

Assets ppendix 5 Current Assets Cash and Bank Deposits 3,923.2 3,353.1 1,893.0 2,214.9 2,919.5 2,986.4 3,503.4 Bills of Exchange 1,245.0 1,113.8 1,225.6 1,645.8 1,468.4 1,720.3 1,904.0 Short-Term Loans and Advances 6,308.8 7,820.5 10,944.0 14,177.6 17,220.6 22,216.7 24,005.0 Other Current Assets 743.0 443.4 567.4 550.7 551.1 885.3 1,375.2 Total Current Assets 12,220.0 12,730.8 14,630.0 18,589.0 22,159.6 27,808.7 30,787.6 Long-Term Loans 1,992.3 1,580.8 1,663.3 1,745.8 1,487.0 2,386.2 1,633.8 Fixed Assets 313.9 349.5 490.9 686.8 892.5 914.5 1,032.2 Investments 54.0 239.5 1,627.9 1,618.1 2,787.4 3,486.7 5,329.1 Total Assets 14,580.2 14,900.6 18,412.1 22,639.7 27,326.5 34,596.1 38,782.7

Liabilities and Equity Current Liabilities Short-Term Deposits 8,229.2 6,367.7 7,873.0 9,740.0 11,317.3 11,994.2 14,530.2 Short-Term Borrowings 205.7 794.8 780.1 1,247.6 886.4 1,827.6 1,349.1 Other Current Liabilities 1,446.3 2,736.8 3,059.2 2,767.3 3,721.3 4,380.4 3,332.2 Total Current Liabilities 9,881.2 9,899.3 11,712.3 13,754.9 15,925.0 18,202.2 19,211.5 Long-Term Deposits 3,526.8 3,248.0 4,282.9 6,371.3 8,561.1 12,702.9 15,138.5 Long-Term Borrowings 332.6 584.6 979.1 757.1 876.8 1,401.6 1,898.0 Total Liabilities 13,740.6 13,731.9 16,974.3 20,883.3 25,362.9 32,306.7 36,248.0 Equity Paid-In Capital 354.3 354.3 354.3 354.3 442.8 442.8 442.8 Reserves 34.1 127.6 212.9 231.6 244.6 264.7 280.8 Retained Earnings 451.2 686.8 870.6 1,170.5 1,276.2 1,581.9 1,811.1 Total Equity 839.6 1,168.7 1,437.8 1,756.4 1,963.6 2,289.4 2,534.7 Total Liabilities and Equity 14,580.2 14,900.6 18,412.1 22,639.7 27,326.5 34,596.1 38,782.7

Ratios Current Ratio (times) 1.2 1.3 1.2 1.4 1.4 1.5 1.6 Loans to Deposits Ratio (%) 70.6 97.3 104.1 102.7 102.4 105.1 97.1 Capital Adequacy Ratio (%) Tier 1 10.0 12.9 11.3 11.4 10.5 9.6 10.5 Capital Adequacy Ratio (%) Tier 2 14.3 12.4 12.5 14.0 12.1 12.6 Debt-Service Coverage Ratio (times) 2.9 2.0 Source: Sampath Bank Ltd. 55 Appendix 5

Table A5.4: Analysis of Loan Portfolio Quality (SLRs million)

As of 31 December Infection Ratio (%) Collection Ratio (%) 1996 — — 1997 — — 1998 — — 1999 — — 2000 12.9 92.3 2001 15.4 83.0 — = not available. Source: Sampath Bank Ltd. 56 Appendix 6

SEYLAN BANK LTD.

A. Background

1. History and Ownership

1. Seylan Bank Ltd. (Seylan) began in 1987 as an indigenous private bank and has since grown into one of the largest in Sri Lanka. Seylan’s authorized share capital consisted of 350 million ordinary shares of SLRs10.00 each; 100 million nonredeemable, noncumulative, nonconvertible, and nonvoting preference shares of Rs.10.00 each; and 50 million unclassified shares aggregating SLRs5 billion. The issued and paid-up capital consisted of SLRs435 million of ordinary shares and SLRs10.5 million of preference shares. The five largest shareholders each held 5.00%, with Ceylinco Securities and Services holding 9.24% as of December 2001. Seylan was broad-based, with 8,298 shareholders. Seylan shares (par value SLRs10.00) were being traded on the Colombo Stock Exchange at SLRs28.00 per share on 11 May 2002.

2. The board of directors, chaired by Deshamanya Lalith Kotelawala, comprised five executive directors (seven at appraisal) and six nonexecutive directors, all with wide experience in all aspects of finance, banking, and business. The board’s innovative spirit enabled Seylan to operate successfully and move banking away from traditional into new activities.

3. Seylan has established an island-wide network of 90 branches (71 at appraisal) with 3,403 staff (1,682 at appraisal). The steps taken to increase the branch network and staff strength reflected Seylan’s effort to expand, particularly to the outlying areas.

2. Activities, Policies, and Procedures

4. Seylan’s core business consisted of deposits and advances. Seylan’s deposits were second largest among listed commercial banks and grew by 14.8% during 2001, while advances rose by 11.2%. Treasury-bill business and placement with other banks also increased substantially, resulting in 24% income growth, while international and treasury operations showed significant improvement and rose by 18.8% in 2001. In 2001, Seylan followed a policy of controlled lending to ease the capital adequacy ratio and reduce the level of nonperforming advances.

5. The implementation of new systems using the latest technology was the kingpin in Seylan’s strategy to enhance customer service and, consequently, productivity. Internet banking was introduced in 2001, and Seylan’s website was updated to provide all the bank’s information. The Visa Electronic Debit Card (which was accepted by 8.6 million merchants worldwide for use at 650,000 automated tellers’ machines) was also introduced, with the Visa Plus brand. The bank also tied up with Dialog to provide banking facilities on telephones with wireless application protocol.

6. New products were launched, such as the Govisarupatha Credit Card Scheme for farmers; the Western Union Money Transfer service was expanded; and the Tikiri minors’ savings account was expanded to the Tikiri Fund to reward good results at examinations, or extracurricular activities.

7. Seylan improved performance and profitability by reengineering operations to ensure best allocation of resources. Seylan focused on its key strengths to increase foreign currency banking, trade financing, corporate banking, and technology-based services. Seylan thus Appendix 6 57 eliminated unprofitable activities and concentrated on profitable sectors through constant review and enhanced staff productivity.

8. Seylan accounts were audited by an independent and reputable auditing firm. Audited statements were prepared on time.

B. Loan Utilization

1. Characteristics of Subprojects

9. Seylan used the Fourth Development Finance Loan Project (DFL IV) to finance 13 subprojects aggregating $2.73 million (Table A6.1). Six subloans were for new (46% of total) and expansion (46%) subprojects. Most subloans (69%) were between $50,000 and $300,000, and 8 (62%) had a maturity of less than 5 years; 11 (85%) were in the western region. The textile, weaving, apparel, and leather subsector received the most subloans (23%), followed by food and beverage; wholesale, retail, restaurants, and hotels; and other industrial sectors, with 15% each. All the subloans followed the reasonable-competition method of procurement. Equipment was obtained mainly from the Republic of Korea, Sri Lanka, and India.

2. Implementation Status of Subprojects

10. Four subprojects were completed on time or early, and six were slightly delayed. One was delayed by one year due to delay in procurement of machinery and building construction. A hotel subproject was delayed by 39 months due to change in concept and increase in number of rooms, and another subproject was not completed as reduction of import duty on vegetable oils from 35% to 5% affected the subproject’s financial viability and the sponsors did not contribute the required equity. This subproject was being restructured and Seylan had made arrangements to pass the subproject on to another company. Four subprojects had small cost overruns, except the hotel, which had an overrun of SLRs144 million (136%). Cost savings of SLRs48 million were realized on two subprojects, while seven were implemented within their estimated cost. The aggregate financing of these 13 projects amounted to SLRs667 million, with 24% from DFL IV, 18% from Seylan, 49% from sponsors, and 9% from other sources.

3. Financial Performance of Subprojects

11. Of the 13 subprojects, 3 were profitable in year 2, and 5 suffered losses. Financial data were not available on the other five subprojects. Five subloans have been fully repaid; four were regular in their repayments; one has been rescheduled, with repayments expected to commence in mid-2002; and the other three were irregular with their repayments. Seylan expected to receive repayments on a textile subproject through a Government-assisted program. One subproject was projected to have positive financial results after setting up a restructuring program. Seylan has taken legal action against a borrower that had adequate collateral to cover the subloan amount.

4. Economic Impact of Subprojects

12. Of the 13 subprojects, 4 were export oriented, realizing additional exports of SLRs294.81 million ($3.1 million) in year 2. The 13 subprojects created jobs for 465 people and saw capital formation of approximately SLRs663 million ($7 million), with SLRs160 million from DFL IV, SLRs128 million from Seylan, SLRs330 million from sponsors, and SLRs45 million from other sources. 58 Appendix 6

C. Institutional Performance

1. Organization, Management, and Personnel

13. Seylan was being managed by its board of directors, which had a high degree of expertise in banking and finance and was responsible for directing and controlling the bank and giving policy guidance. The board was ably supported by a corporate management team of 26 highly committed and experienced professionals.

14. Seylan had a wide branch network and a relatively large staff. In 2001, the bank continued to invest in its human resources by training its staff at in-house training programs (153) as well as outside programs conducted in-country (106) and overseas (24). Training covered fields such as information technology, strategic management, credit, foreign exchange, and treasury operations.

2. Financial Performance and Position

15. Seylan’s income statements (Table A6.2) showed income increasing from SLRs1.62 billion in 1996 to SLRs3.18 billion in 2000, and by 13% to SLRs3.47 billion in 2001. Seylan’s net Income also increased from SLRs205 million in 1996 to SLRs246 million in 2000, and by 11% to SLRs272 million in 2001. These increases were noteworthy in an adverse economic environment. In 2001, the return on average assets (after tax) was 0.5%, and on equity (after tax), 12.9%. Both profit indicators were slightly lower than in 2000 due to adverse market conditions, narrowing interest rate spreads, and increased provisions for nonperforming loans. The interest rate spreads dropped from 6.19 percentage points in 2000 to 5.92 in 2001, but increased to 6.25 in the first quarter of 2002 due to a slight drop in borrowing interest rates.

16. Seylan’s balance sheets (Table A6.3) showed a steady increase in equity through building up of reserves through retained earnings and an increase of convertible stocks from SLRs1.30 billion in 1996 to SLRs1.97 billion in 2000, and a 13.6% increase to SLRs2.24 billion in 2001. Seylan’s capital adequacy ratio was 9.5% for total capital base, which was above the minimum 9.0% requirement of the Central Bank of Sri Lanka.

17. Seylan’s liquidity ratio was also satisfactory and above the Central Bank of Sri Lanka requirement of 20%. The ratio was 24.0% in 1999, dropped to 21.0% in 2000, and increased to 26.1% in 2001. Seylan’s debt-equity ratio was satisfactory at 1.24 in 2001. The debt service coverage ratio remained satisfactory and dropped from 3.00 times in 1996 to 1.92 in 2000, and to 1.70 in 2001, remaining above the norm of 1.25 times stipulated by the Asian Development Bank (ADB).

3. Operational Performance and Portfolio Quality

18. Seylan’s loan portfolio increased further by 11.2% from SLRs19.04 billion in 1996 to SLRs33.83 billion in 2000, and again by 11.7% to SLRs37.3 billion in 2001. Deposits increased 14.8% from SLRs41.69 billion in 2000 to SLRs47.86 billion in 2001. International and treasury operations increased, as did the volume of export bills negotiated and purchased (by 18.8% to SLRs4.86 billion) and import bills purchased (up 2.39% from 2000 to SLRs25.8 billion in 2001). Seylan has recorded a ratio of lending to deposits of 81.0% in 2001, compared to 84.9% in 2000. That was over and above the expected industry ratio of 75%.

Appendix 6 59

19. Like other banks, Seylan also had problems with nonperforming loans. The portfolio infection ratio dropped from 19.4% in 1999 to 15.9% in 2000 and 15.7% in 2001 (Table A6.4), indicating that Seylan is consistently reducing its nonperforming loan ratio. The ratio of 15.7% in 2001 was within the maximum 20% limit stipulated by ADB. Seylan did not report its annual collection ratios for 1996-2001. With data obtained from its branches, Seylan manually calculated its annual cash collection ratio as of 31 March 2002 at 82.3%. The computer program for calculation was under testing and needed improvement. The computer program for the cumulative principal collection ratio was still to be developed. Seylan said that the computation was complicated by the fact that short-term advances and overdrafts were being rolled over often.

D. Compliance with Loan Covenants

20. Seylan complied with the following ADB financial covenants: (i) maximum portfolio infection ratio of 20%; (ii) a minimum of debt service coverage ratio of 1.25 times; (iii) a maximum capital adequacy ratio of 8%; (iv) single group borrower lending limit of 10% of total assets; (v) single economic sector lending limit of 30% of total loan portfolio; and (vi) submission of annual audited accounts to ADB on time. Seylan, however, has not met the minimum return on average assets ratio of 1% since 1996 (Table A6.2). However, that ratio was expected to improve in 2002 based on financial results of the first quarter of 2002 (net profit after tax was SLRs137 million compared to SLRs36 million for the same period in 2001). Seylan reported that, based on unaudited first-quarter accounts, its return on average assets improved to 0.9% as of 31 March 2002, and that, based on preliminary half-yearly results, the ratio was estimated at 1.0% as of 30 June 2002.

21. Seylan has not been submitting figures for the cash collection ratio because of difficulty with data for calculating the ratio. The bank assured the Project Completion Review Mission that the new computerized system would be able to produce the data to calculate the ratio and that the data and ratio would be available by the end of 2002.

60 Appendix 6

Table A6.1: Characteristics of Subprojects

Amount Item Number % ($ million) % A. Purpose 1. New 6 46.2 1.48 54.2 2. Expansion 6 46.2 1.20 44.0 3. Balancing, Modernization, and Replacement 1 7.6 0.05 1.8 Total 13 100.0 2.73 100.0

B. Size 1. Up to $50,000 0 0.0 0.00 0.0 2. $50,001–$100,000 5 38.4 0.29 10.6 3. $100,001–$300,000 4 30.8 0.55 20.2 4. $300,001–$500,000 1 7.7 0.33 12.1 5. $500,001–$1,000,000 3 23.1 1.56 57.1 6. over $1,000,000 0 0.0 0.00 0.0 Total 13 100.0 2.73 100.0

C. Maturity 1. Up to 5 years 8 61.5 0.75 27.5 2. Over 5–10 years 5 38.5 1.98 72.5 3. Over 10–15 years 0 0.0 0.00 0.0 Total 13 100.0 2.73 100.0

D. Region 1. Western (including Colombo) 11 84.6 1.97 72.2 2. Central 1 7.7 0.09 3.3 3. Northwestern 0 0.0 0.00 0.0 4. Southern 1 7.7 0.67 24.5 5. Sabaragamuwa 0 0.0 0.00 0.0 6. Uva 0 0.0 0.00 0.0 Total 13 100.0 2.73 100.0

E. Industry Sector 1. Agriculture, Forestry, and Fishing 1 7.7 0.09 3.3 2. Food and Beverages 2 15.4 0.50 18.3 3. Textiles, Wearing Apparel, and Leather 3 23.0 0.33 12.1 4. Wood and Wood Products 0 0.0 0.00 0.0 5. Paper, Printing, and Publications 1 7.7 0.06 2.2 6. Chemicals, Petroleum, Coal, Rubber, and Plastics 1 7.7 0.33 12.1 7. Basic Metals 0 0.0 0.00 0.0 8. Nonmetallic Minerals 0 0.0 0.00 0.0 9. Fabricated Metals, Machinery, and Equipment 0 0.0 0.00 0.0 10. Construction 1 7.7 0.46 16.8 11. Wholesale, Retail, Restaurants, and Hotels 2 15.4 0.72 26.4 12. Transport, Storage, and Communication 0 0.0 0.00 0.0 13. Financing and Business Services 0 0.0 0.00 0.0 14. Community, Social, and Personal Services 0 0.0 0.00 0.0 15. Other Industries 2 15.4 0.24 8.8 Total 13 100.0 2.73 100.0 Appendix 6 61

Amount Item Number % ($ million) % F. Procurement Procedures 1. Reasonable Competition 13 100.0 2.73 100.0 2. International Shopping 0 0.0 0.00 0.0 3. Proprietary Basis 0 0.0 0.00 0.0 Total 13 100.0 2.73 100.0

G. Procurement by Country 1. China, People's Republic of 0.24 8.8 2. Denmark 0.08 2.9 3. India 0.41 15.0 4. Japan 0.13 4.7 5. Korea, Republic of 0.74 27.1 6. Singapore 0.04 1.5 7. Sri Lanka 0.72 26.4 8. Taipei,China 0.11 4.0 9. United Kingdom 0.16 5.9 10. United States 0.10 3.7 Total 2.73 100.0 Source: Seylan Bank Ltd. Table A6.2: Income Statements 62 (SLRs million) A

Year Ending 31 March1996 1997 1998 1999 2000 2001 ppendix 6 Projected Actual Actual Revenue Net Interest Income 611 959 1,206 1,448 1,724 2,048 2,050 Interest Income 2,021 3,747 4,173 4,186 4,957 5,720 7,228 Interest Expenses 1,410 2,788 2,967 2,738 3,233 3,672 5,178 Leasing Income 0 172 174 171 148 156 229 Noninterest Income 615 493 520 639 791 977 1,188 Total Revenue 1,226 1,624 1,900 2,258 2,663 3,181 3,467

Operating Expenses Staff Costs 336 519 740 798 1,014 1,079 1,219 General and Administrative 473 688 800 973 1,181 1,444 1,587 Others 107 164 159 247 286 402 383 Total Operating Expenses 916 1,371 1,699 2,018 2,481 2,925 3,189

Profit Before tax 310 253 201 240 182 256 278 Income Tax 108 48 1 10 10 10 6 Profit After Tax 202 205 200 230 172 246 272

Ratios Return on Average Equity (%) 23.1 16.8 14.5 14.8 10.0 13.1 12.9 Return on Average Assets (%) 1.1 0.7 0.6 0.6 0.4 0.5 0.5 Source: Seylan Bank Ltd. Table A6.3: Balance Sheets (SLRs million)

Year Ending 31 March1996 1997 1998 1999 2000 2001 Projected Actual Actual Assets Current Assets Cash and Bank Deposits 6,565 1,308 1,420 1,549 1,296 5,235 4,991 Bills of Exchange 751 748 897 779 787 2,009 1,502 Short-Term Loans and Advances 7,764 14,471 15,689 18,749 20,470 21,526 22,849 Other Current Assets 1,965 8,651 11,145 11,426 14,805 11,108 7,117 Total Current Assets 17,045 25,178 29,151 32,503 37,358 39,878 36,459 Long-Term Loans and Lease Receivables 2,140 4,570 4,532 5,921 6,824 12,299 19,397 Fixed Assets 298 622 903 1,215 1,677 2,092 2,801 Investments 343 1,024 1,205 1,414 1,454 1,658 1,646 Total Assets 19,826 31,394 35,791 41,053 47,313 55,927 60,303

Liabilities and Equity Current Liabilities Short-Term Deposits 10,500 19,802 21,793 25,604 28,265 32,346 36,566 Short-Term Borrowings 946 5,084 7,189 6,385 7,274 10,030 7,663 Other Current Liabilities 2,577 — — — — — — Total Current Liabilities 14,023 24,886 28,982 31,989 35,539 42,376 44,229 Long-Term Deposits 4,613 4,793 5,171 6,533 8,815 9,348 11,293 Long-Term Borrowings 105 415 175 882 1,182 851 923 Covertible Debentures 100 — — — — 1,382 1,620 Total Liabilities 18,841 30,094 34,328 39,404 45,536 53,957 58,065 Equity Paid-In Capital 400 436 436 436 436 436 446 Reserves 172 510 545 550 566 651 842 Retained Earnings 413 354 482 663 775 883 950 Total Equity 985 1,300 1,463 1,649 1,777 1,970 2,238 Total Liabilities and Equity 19,826 31,394 35,791 41,053 47,313 55,927 60,303 Appendix6

Ratios Current Ratio (times) 1.2 1.0 1.0 1.0 1.1 0.9 0.8 Loans to Deposits Ratio (%) 0.0 0.3 0.1 0.5 0.7 1.2 1.2 Capital Adequacy Ratio (%) Tier 1 0.7 0.8 0.8 0.8 0.7 0.8 0.9 Capital Adequacy Ratio (%) Tier 2 9.2 0.0 7.9 9.2 8.6 8.7 9.5 Debt-Service Coverage Ratio (times) 1.2 3.0 4.0 2.0 1.0 1.9 1.7

— = not available. 63 Source: Seylan Bank Ltd. 64 Appendix 6

Table A6.4: Analysis of Loan Portfolio Quality (SLRs million)

Infected Total Portfolio Infection As of 31 December Principal Outstanding Ratio (%) 1996    1997 4,210 20,726 20.31 1998 4,760 26,330 18.08 1999 5,563 28,639 19.42 2000 5,475 34,391 15.92 2001 5,681 36,158 15.71 — = not available. Source: Seylan Bank Ltd. Appendix 7 65

COMMERCIAL LEASING COMPANY LTD.

A. Background

1. History and Ownership

1. Commercial Leasing Company Ltd. (CLCL) was incorporated as a private company in April 1988 and publicly listed in 1992. It applied for registration under the new finance leasing law before the deadline of 30 July 2002. About 85% of the shares (75% at appraisal) were held by three institutional shareholders as of 31 December 2001: Chemanex Ltd. (35%; 15% at appraisal); Singer Sri Lanka (30%; same at appraisal); and Commercial Bank of Ceylon Ltd. (20%; 30% at appraisal). The remaining 15% (25% at appraisal) was publicly held. On 9 May 2002, CLCL’s shares (par value of SLRs10.00 per share) were being traded on the Colombo Stock Exchange at SLRs22.00 per share.

2. Activities, Policies, and Procedures

2. CLCL’s core business activity remained leasing of equipment, plant, and machinery to industrial, commercial, and agricultural enterprises. CLCL also successfully launched its new financial product—factoring. Factoring receivables, however, were reduced from SLRs129 million in 2000 to SLRs100 million in 2001, because of the adverse economic environment.

3. CLCL laid down clearly defined, well-documented, strictly followed guidelines for leasing and factoring. All credit proposals were analyzed for credit, operational, and legal risks. Operational procedures were considered satisfactory. Credit approvals have been decentralized to the branches. Adequate supervision and controls were in place. An internal audit committee, comprising three directors, was also in place to ensure adequacy of procedures and effectiveness of the various systems and controls. The accounts were audited, on time, by a reputable audit firm. Procedures to manage interest rate risk, and assets and liabilities were also in place. A new information technology infrastructure was being installed, including plans to bring all the branches and customers into an online computerized and integrated business network.

B. Loan Utilization

1. Characteristics of Leases

4. CLCL used the Fourth Development Finance Loan Project to finance only two leases for $81,990. Both were for new projects: a textile subproject for $21,815, and an electronics subproject for $60,175. They had a maturity of less than five years; were in the Western region; and used reasonable competition to procure equipment from India, Germany, and Spain.

2. Implementation Status of the Leases

5. Both leases have been implemented satisfactorily within the time and cost estimates.

3. Financial Performance of the Leases

6. Both subprojects were profitable and the leases were repaid in full without any problem.

66 Appendix 7

4. Economic Impact of the Leases

7. The two leases resulted in incremental exports of SLRs5.9 million ($62,000), jobs for 19 persons for SLRs300,000 per job, and led to capital formation of about SLRs15 million ($150,000).

C. Institutional Performance

1. Organization, Management, and Personnel

8. The board of five directors (six at appraisal) provided CLCL with overall supervision, control, and policy guidance, while an executive committee supervised operations. CLCL’s top management was competent, and its general manager and chief executive had many years of experience in finance. Since appraisal, CLCL’s operational base has been expanded from the Colombo head office to five provincial branches. Another branch in Trincomalee was being planned. Staff increased from 21 at appraisal to 33. Staff members have been sent on regular training programs on credit evaluation, risk management, and lease control and supervision.

2. Financial Performance and Position

9. CLCL’s income statements from 1996 to 2001 are in Table A7.2. Net income increased from SLRs34 million in 1998 to SLRs48.2 million in 1999, but decreased to SLRs22.7 million in 2000 as a result of increases in borrowing costs and income tax. Net income increased to SLRs40.2 million in 2001 as a result of increased revenue and slightly lower taxation. The interest rate spread dropped from 2.2 percentage points in 2000 to 1.4 in 2001, but improved to 6.8 in the first quarter of 2002. In 2001, the after-tax returns on average equity (15.5%) and on average assets (2.8%) were satisfactory.

10. CLCL’s balance sheets from 1996 to 2001 are in Table A7.3. Total assets increased by 35% from SLRs0.95 billion in 1998 to SLRs1.29 billion in 1999, and increased again, by 14% to SLRs1.48 billion in 2000. Total assets, however, decreased by 6% to SLRs1.39 billion in 2001. The paid-up share capital remained at SLRs73 million from 1996 to 2001. In 2001, total equity stood at SLRs259 million, made up of paid-in capital of SLRs73.3 million and reserves of SLRs185.7 million. The debt-equity ratio has been satisfactory and stood at 3.9:1 in 2001. The debt service coverage ratio also remained at 1.18 times.

3. Operational Performance and Portfolio Quality

11. The lease receivable portfolio increased by 36% from SLRs0.76 billion in 1998 to SLRs1.03 billion in 1999, and by 12% to SLRs1.15 billion in 2000, but decreased by 8% to SLRs1.06 billion in 2001. Portfolio size decreased slightly from 78% of total assets in 2000 to 76% in 2001, reflecting the adverse economic environment and resulting drop in the demand for lease financing. The quality of the portfolio has remained satisfactory. The cash collection ratio has always been kept above 90%. The portfolio infection ratio, which has been maintained at a satisfactory level, stood at 11% in 2001 (Table A7.4).

D. Compliance with Loan Covenants

12. CLCL has complied with the following Asian Development Bank (ADB) covenants: (i) cash collection ratio (minimum 80%); (ii) portfolio infection ratio (maximum 20%); (iii) minimum after-tax return on assets (2%); (iv) maximum debt-equity ratio (6:1); (v) single borrower group Appendix 7 67 limit (not more than 10% of total assets); (vi) single economic sector limit (not more than 30% of total loan portfolio); and (vii) submission of reports and audited accounts to ADB on time. In 2001, CLCL’s debt service coverage ratio was 1.18 times and did not comply with the ADB stipulated minimum of 1.25. CLCL, however, expected that ratio to be above 1.25 in 2002 based on improved first-quarter profitability of SLRs12.7 million compared to SLRs5.0 million in the same period of 2001. The interest rate spread improved to 6.8 percentage points at the end of the first quarter of 2002, compared to 1.4 in 2001. 68 Appendix 7

Table A7.1: Characteristics of Subprojects

Amount Item Number % ($ million) % A. Purpose 1. New 2 100.0 0.08 100.0 2. Expansion 0 0.0 0 0.0 3. Balancing, Modernization, and Replacement 0 0.0 0 0.0 Total 2 100.0 0.08 100.0

B. Size 1. Up to $50,000 2 100.0 0.08 100.0 2. $50,001–$100,000 0 0.0 0.00 0.0 3. $100,001–$300,000 0 0.0 0.00 0.0 4. $300,001–$500,000 0 0.0 0.00 0.0 5. $500,001–$1,000,000 0 0.0 0.00 0.0 6. over $1,000,000 0 0.0 0.00 0.0 Total 2 100.0 0.08 100.0

C. Maturity 1. Up to 5 years 2 100.0 0.08 100.0 2. Over 5–10 years 0 0.0 0.00 0.0 3. Over 10–15 years 0 0.0 0.00 0.0 Total 2 100.0 0.08 100.0

D. Region 1. Western (including Colombo) 2 100.0 0.08 100.0 2. Central 0 0.0 0.00 0.0 3. Northwestern 0 0.0 0.00 0.0 4. Southern 0 0.0 0.00 0.0 5. Sabaragamuwa 0 0.0 0.00 0.0 6. Uva 0 0.0 0.00 0.0 Total 2 100.0 0.08 100.0

E. Industry Sector 1. Agriculture, Forestry, and Fishing 0 0.0 0.00 0.0 2. Food and Beverages 0 0.0 0.00 0.0 3. Textiles, Wearing Apparel, and Leather 1 50.0 0.06 75.0 4. Wood and Wood Products 0 0.0 0.00 0.0 5. Paper, Printing, and Publications 0 0.0 0.00 0.0 6. Chemicals, Petroleum, Coal, Rubber, and Plastics 0 0.0 0.00 0.0 7. Basic Metals 0 0.0 0.00 0.0 8. Nonmetallic Minerals 0 0.0 0.00 0.0 9. Fabricated Metals, Machinery, and Equipment 0 0.0 0.00 0.0 10. Construction 0 0.0 0.00 0.0 11. Wholesale, Retail, Restaurants, and Hotels 0 0.0 0.00 0.0 12. Transport, Storage, and Communication 0 0.0 0.00 0.0 13. Financing and Business Services 0 0.0 0.00 0.0 14. Community, Social, and Personal Services 0 0.0 0.00 0.0 15. Other Industries 1 50.0 0.02 25.0 Total 2 100.0 0.08 100.0 Appendix 7 69

Amount Item Number % ($ million) % F. Procurement Procedures 1. Reasonable Competition 2 100.0 0.08 100.0 2. International Shopping 0 0.0 0.00 0.0 3. Proprietary Basis 0 0.0 0.00 0.0 Total 2 100.0 0.08 100.0

G. Procurement by Country 1. Germany 0.04 50 2. India 0.02 25 3. Spain 0.02 25 Total 0.08 100.0 Source: Commercial Leasing Company Ltd. Table A7.2: Income Statements 70 Appendix7 (SLRs million)

Year Ending 31 December 1996 1997 1998 1999 2000 2001 Projected Actual Actual Revenue Lease Income 194.5 152.9 146.6 130.8 191.1 228.6 249.7 Other Income 0.6 12.8 13.0 20.3 37.7 46.0 64.9 Total Revenue 195.1 165.7 159.6 151.1 228.8 274.6 314.6

Operating Expenses Interest Expenses 56.8 79.8 75.0 67.7 118.7 161.2 221.3 Staff Costs 5.8 11.8 13.3 16.6 20.3 30.8 35.6 General & Administrative Expenses 10.1 15.4 19.5 21.2 26.5 32.0 35.0 Operating & Marketing 13.6 1.3 1.7 2.0 2.1 4.7 1.9 Others 3.1 8.0 7.8 11.2 17.2 (24.8) Total Operating Expenses 86.3 111.4 117.5 115.3 178.8 245.9 269.0

Profit Before tax 108.8 54.3 42.1 35.8 50.0 28.7 45.6 Income Tax 0.0 0.0 0.0 1.8 1.8 6.0 5.4 Profit After Tax 108.8 54.3 42.1 34.0 48.2 22.7 40.2

Ratios Return on Average Equity (%) 32.0 19.1 14.4 11.4 15.8 8.1 16.0 Return on Average Assets (%) 16.1 6.9 5.6 4.1 4.3 1.6 2.8 Source: Commercial Leasing Co. Ltd. Table A7.3: Balance Sheets (SLRs million)

Year Ending 31 March1996 1997 1998 1999 2000 2001 Projected Actual Actual Assets Current Assets Cash and Bank Deposits 0.1 17.5 2.8 3.6 8.6 29.4 35.4 Lease Receivable-Current Maturities 276.0 319.5 343.2 365.3 494.0 536.3 573.4 Debtors and Prepayments 27.3 28.7 23.0 41.9 49.1 67.3 80.2 Other Current Assets 0.2 79.5 92.9 133.4 183.2 207.7 186.7 Total Current Assets 303.6 445.2 461.9 544.2 734.9 840.7 875.7 Long-Term Lease Receivables-Net 414.0 333.5 243.4 390.4 537.1 615.8 487.7 Fixed Assets 1.9 9.0 10.7 10.5 8.7 8.5 8.2 Investments 1.3 1.6 1.3 9.5 11.2 12.1 14.5 Total Assets 720.8 789.3 717.3 954.6 1,291.9 1,477.1 1,386.1

Liabilities and Equity Current Liabilities Short-Term Borrowings 170.6 307.3 211.1 407.0 865.8 1,053.3 845.5 Creditors and Acrrued Expenses 21.3 10.6 7.8 9.2 10.6 21.5 37.9 Dividends Payables 11.0 11.0 14.6 14.6 18.3 19.8 25.6 Other Current Liabilities 20.7 21.0 27.3 23.0 44.7 54.0 41.3 Total Current Liabilities 223.6 349.9 260.8 453.8 939.4 1,148.6 950.3 Long-Term Deposits 113.8 154.6 154.6 203.0 34.8 80.2 170.6 Long-Term Borrowings 1.0 1.2 1.9 2.6 3.8 6.2 Total Liabilities 337.4 505.5 416.6 658.7 976.8 1,232.6 1,127.1 Equity Paid-In Capital 73.3 73.3 73.3 73.3 73.3 73.3 73.3 Reserves (Premium) 87.2 87.2 87.2 87.2 87.2 87.2 87.2 Reserves (General) 108.0 138.5 124.5 144.9 72.6 82.6 Retained Earnings 222.9 15.3 1.7 10.9 9.7 11.4 15.9 Total Equity 383.4 283.8 300.7 295.9 315.1 244.5 259.0 Total Liabilities and Equity 720.8 789.3 717.3 954.6 1,291.9 1,477.1 1,386.1 Appendix 7 Ratios Current Ratio (times) 1.4 1.3 1.8 1.2 0.8 0.7 0.9 Debt-Equity Ratio (times) 0.9 1.6 1.2 2.1 2.9 4.6 3.9 Debt-Service Coverage Ratio (times) 2.9 1.7 1.6 1.5 1.4 1.1 1.2 Source: Commercial Leasing Co. Ltd. 71 72 Appendix 7

Table A7.4: Analysis of Loan Portfolio Quality (SLRs million)

Total Portfolio As of 31 December Infected Portfolio Outstanding Infection Ratio (%) 1996    1997    1998 94.2 755.7 12.47 1999 129.9 1031.1 12.60 2000 114.8 1152.1 9.96 2001 116.7 1061.1 11.00 — = not available. Source: Commercial Leasing Company Ltd. Appendix 8 73

LANKA ORIX LEASING COMPANY LTD.

A. Background

1. History and Ownership

1. Lanka Orix Leasing Company Ltd. (LOLC) was established in March 1980 as a joint venture leasing company between International Finance Corporation, Orient Leasing Company of Japan (Orix), National Development Bank of Sri Lanka, Bank of Ceylon, and Development Finance Corporation of Ceylon. International Finance Corporation held 15%, and Orix, 30%. Since then, there have been frequent rights and bonus issues of shares, the latest being a bonus issue of one-for-one in 2001, enhancing the issued share capital to SLRs237.6 million. LOLC had a strong institutional shareholder base comprising local and foreign investors, totaling 1,235 individuals and 182 institutions. Major shareholders as of March 2001 (34% foreign, 66% local) included Orix (30%) and Asia Capital (23.6%). LOLC applied for registration under the new finance leasing act of 2000 by the deadline of 30 July 2002. On 20 May 2002, LOLC’s shares (par value of SLRs10.00 per share) were being traded on the Colombo Stock Exchange at SLRs54.50 per share.

2. LOLC’s first branch was opened in Kandy in 1995. LOLC opened five more branches in other regions during the next six years. Staff strength increased to 170, with 86 professionals and 84 minor staff.

2. Activities, Policies, and Procedures

3. LOLC’s principal activity was the leasing of plant, machinery, equipment, and commercial vehicles mainly to industrial, commercial, and agricultural small and medium-sized enterprises, which have difficulty obtaining financing from banks. LOLC also provided development finance to small and medium-sized enterprises; hire purchase facilities for productive equipment; mortgage loans; consumer finance and leasing of consumer durables; Orix Autolease, a flexible and economical car rental package; fleet management services; and equity and debt finance syndication.

4. Despite severe competition in the market, new leases grew 10% from SLRs2.2 billion in 2000 to SLRs2.4 billion in 2001. In 1995, LOLC borrowed heavily in the short-term money market to finance its leasing operations, which resulted in short-term loans accounting for almost 62% of total liabilities. That mismatch has since been overcome by securing long-term borrowings.

5. Over the past five years, LOLC continued to adhere to its credit policies. It adopted a conservative policy of ensuring that annual average bad debts were less than 0.5% of the lease receivables portfolio. LOLC exercised extreme caution in selecting leasing clients and transactions. LOLC’s management has also established a comprehensive credit approval process and an ongoing lease supervision program.

6. LOLC was faced with increased competition from 38 players in the leasing industry. LOLC planned to reorganize its marketing functions by appointing a new innovative marketing manager. It also proposed the opening of two branches in the coming financial year, and expansion of the divisions for strategic alliances, fleet management operations, and consumer durables. LOLC has created several innovative debt investments in the past such as debentures, bonds, and securitized assets. 74 Appendix 8

7. LOLC accounts were audited by an independent and reputable auditing firm.

B. Loan Utilization

1. Characteristics of Subprojects

8. LOLC utilized the Fourth Development Finance Loan Project to the extent of $778,000 for 12 leases (Table A8.1); 50% of the number of leases were given for balancing, modernization, and replacement subprojects; and the balance, for expansion subprojects. Most leases (83%) were up to $50,000. All 12 were up to 5 years, and most (83%) were in the western region (including Colombo). Most leases (58%) were in the textile, apparel, and leather subsector; followed by food and beverages, and other industries (17% each); and agriculture, forestry, and fishing (8%). Lease equipment was procured mainly from Sri Lanka, Japan, Singapore, United States, and United Kingdom, using only the reasonable-competition procedure.

2. Implementation Status of Leases

9. All leases financed under the Fourth Development Finance Loan Project were implemented on time, within the estimated costs, and completed successfully.

3. Financial Performance of Leases

10. Ten leases (83%) were repaid in full; the other two faced financial difficulties due to removal of duties on imported fabric. LOLC expected the Government to help settle in full these two leases through the Textile Debt Recovery Fund.

4. Economic Impact of Leases

11. Eight leases were export oriented and resulted in incremental exports of SLRs1 billion ($10.6 million) in year 1 of operations, and SLRs1 billion in export sales in year 2. All the subprojects together generated 1,121 jobs. The subprojects also contributed to capital formation of SLRs48.5 million ($510,000).

C. Institutional Performance

1. Organization, Management, and Personnel

12. The overall supervision, control, and policy direction rested with the board of 12 directors, chaired by Deshamanya C.P. de Silva, former chair of Aitken Spence & Co. Ltd., who possesses wide experience, foresight, and business acumen. The board was assisted by subcommittees for audit and remuneration. LOLC also had a senior management team of six professionals qualified and experienced in various disciplines; and finance, corporate affairs, marketing, recoveries, and legal departments, each headed by a senior manager.

13. LOLC operated six branches and had a staff of 86 professionals and 84 nonexecutives. Promotions were mainly based on performance, qualifications, length of service, and commitment; and employees needed to be nominated or recommended by their superiors. Salaries were performance oriented. LOLC stressed training and development programs to develop competent staff to meet the challenges of the changing market. LOLC organized in- Appendix 8 75 house and external training programs based on needs analysis identifying weaknesses, and areas for improvement. Staff training was provided specifically for new products.

2. Financial Performance and Position

14. LOLC’s income statements from 1996 to 2001 are in Table A8.2. Total revenue increased by 43.0% from SLRs613.9 million in 1996 to SLRs880.5 million in 1999, and then by 13.5% to SLRs998.2 million in 2001. Net profit increased 21% from SLRs119.6 million in 1996 to SLRs144.2 million in 1999. Although it dropped in 2000 to SLRs118.2 million, it increased 53.3% to SLRs181.2 million in 2001. The return on average equity (after tax), which was 18.9% in 1998, dropped to 13.7% in 1999 and 10.0% in 2000. The return on average equity, however, increased considerably in 2001 to 15.6%. The return on average assets dropped from 4.5% in 1997 to 2.17% in 2000, but improved to 3.2% in 2001. Both these profit indicators were satisfactory. The interest rate spread dropped from 9.21 percentage points in 2000 to 7.60 in 2001, reflecting the high borrowing costs, but improved to 9.30 in the first quarter of 2002 based on a slight drop in the borrowing rates.

15. The balance sheets from 1996 to 2001 are in Table A8.3, showing a 48% increase in total assets from SLRs3.21 billion in 1996 to SLRs4.75 billion in 1998, and a 19% increase to SLRs5.64 billion in 1999. Total assets remained around that level in 2000 and 2001. Equity also increased because of increases in share capital and building up of reserves through retained earnings. Equity increased 67% from SLRs0.73 billion in 1996 to SLRs1.21 billion in 2000. Total equity, however, declined by 8.4% in 2001 to SLRs1.11 billion due reduced retained earnings.

16. The balance sheet ratios were satisfactory. The debt-equity ratio of 3.5 times and a debt service coverage ratio of 1.4 in 2001 were favorable and in excess of the Asian Development Bank (ADB) stipulated covenants.

3. Operational Performance and Portfolio Quality

17. The value of leasing contracts increased only slightly from SLRs3.48 billion in 2000 to SLRs3.50 billion in 2001, reflecting the adverse economic environment and drop in demand for new leases. LOLC’s portfolio quality has been satisfactory (Table A8.4). The cash collection ratio has remained well over 80% from 1996 to 2000, stood at 94.3% in 2001, and dropped slightly to 87.7% in 2002. The portfolio infection ratio remained well below 20% over that 5-year period, stood at 10.2% in 2001, and 10.5% in 2002. Both ratios deteriorated slightly in 2002, compared to 2001, due to the bleak economic environment and increase in nonperforming leases. The marketing, recoveries, and legal departments together addressed the problem of increased overdue loans. A comprehensive plan was devised in 2000 to improve collection and infection ratios and was being implemented.

D. Compliance with Loan Covenants

18. LOLC has fully complied with ADB’s financial covenants as follows: (i) a minimum annual collection ratio for the total portfolio of 80 percent; (ii) a maximum portfolio infection ratio of 20%; (iii) a minimum return on average assets (after tax) of 2%; (iv) a minimum debt service cover of 1.25 times; (v) a maximum debt-equity ratio of 6:1; (vi) single borrower group leasing limit of not more than 10% of total assets; (vii) single economic sector leasing limit of not more than 30% of total loan portfolio; and (viii) submission of reports and annual audited accounts to ADB on time. 76 Appendix 8

Table A8.1: Characteristics of Subprojects

Amount Item Number % ($ million) % A. Purpose 1. New 0 0.0 0.00 0.0 2. Expansion 6 50.0 0.16 20.5 3. Balancing, Modernization, and Replacement 6 50.0 0.62 79.5 Total 12 100.0 0.78 100.0

B. Size 1. Up to $50,000 10 83.4 0.27 34.6 2. $50,001–$100,000 1 8.3 0.05 6.4 3. $100,001–$300,000 0 0.0 0.00 0.0 4. $300,001–$500,000 1 8.3 0.46 59.0 5. $500,001–$1,000,000 0 0.0 0.00 0.0 6. over $1,000,000 0 0.0 0.00 0.0 Total 12 100.0 0.78 100.0

C. Maturity 1. Up to 5 years 12 100.0 0.78 100.0 2. Over 5–10 years 0 0.0 0.00 0.0 3. Over 10–15 years 0 0.0 0.00 0.0 Total 12 100.0 0.78 100.0

D. Region 1. Western (including Colombo) 10 83.4 0.73 93.6 2. Central 0 0.0 0.00 0.0 3. Northwestern 1 8.3 0.02 2.6 4. Southern 0 0.0 0.00 0.0 5. Sabaragamuwa 1 8.3 0.03 3.8 6. Uva 0 0.0 0.00 0.0 Total 12 100.0 0.78 100.0

E. Industry Sector 1. Agriculture, Forestry, and Fishing 1 8.3 0.03 3.8 2. Food and Beverages 2 16.7 0.06 7.7 3. Textiles, Wearing Apparel, and Leather 7 58.3 0.64 82.1 4. Wood and Wood Products 0 0.0 0.00 0.0 5. Paper, Printing, and Publications 0 0.0 0.00 0.0 6. Chemicals, Petroleum, Coal, Rubber, and Plastics 0 0.0 0.00 0.0 7. Basic Metals 0 0.0 0.00 0.0 8. Nonmetallic Minerals 0 0.0 0.00 0.0 9. Fabricated Metals, Machinery, and Equipment 0 0.0 0.00 0.0 10. Construction 0 0.0 0.00 0.0 11. Wholesale, Retail, Restaurants, and Hotels 0 0.0 0.00 0.0 12. Transport, Storage, and Communication 0 0.0 0.00 0.0 13. Financing and Business Services 0 0.0 0.00 0.0 14. Community, Social, and Personal Services 0 0.0 0.00 0.0 15. Other Industries 2 16.7 0.05 6.4 Total 12 100.0 0.78 100.0 Appendix 8 77

Amount Item Number % ($ million) % F. Procurement Procedures 1. Reasonable Competition 12 100.0 0.78 100.0 2. International Shopping 0 0.0 0.00 0.0 3. Proprietary Basis 0 0.0 0.00 0.0 Total 12 100.0 0.78 100.0

G. Procurement by Country 1. Japan 0.48 61.5 2. Singapore 0.06 7.7 3. Sri Lanka 0.19 24.4 4. United Kingdom 0.02 2.6 5. United States 0.03 3.8 Total 0.78 100.0 Source: Lanka Orix Leasing Company Ltd. Table A8.2: Income Statements 78 (SLRs million)

A ppendix 8 Year Ending 31 March1996 1997 1998 1999 2000 2001 Projected Actual Actual Revenue Lease Income 477.9 602.7 674.9 721.4 820.1 832.3 887.10 Other Expenses 33.2 11.2 56.3 89.1 60.4 35.9 111.10 Total Revenue 511.1 613.9 731.2 810.5 880.5 868.2 998.2

Operating Expenses Interest Expenses 206.9 370.3 419.2 451.9 562.7 529.1 562.20 Staff Costs 24.2 28.4 31.6 41.1 44.1 54.9 67.40 General & Administrative Expenses 15.8 29.5 33.7 44.1 52.5 57.8 66.70 Operating & Marketing 0.0 18.0 24.4 25.1 26.8 31.5 38.10 Others 73.1 48.1 62.1 77.7 50.1 76.7 82.60 Total Operating Expenses 320.0 494.3 571.0 640.0 736.3 750.0 817.0

Profit Before tax 191.1 119.6 160.2 170.5 144.2 118.2 181.2 Income Tax 4.5 0.0 0.0 0.0 0.0 0.0 0.0a Profit After Tax 186.6 119.6 160.2 170.5 144.2 118.2 181.2

Ratios Return on Average Equity (%) 22.3 16.5 20.4 18.9 13.7 10.0 15.6 Return on Average Assets (%) 6.2 3.7 4.5 3.9 2.8 2.1 3.2 a Tax not payable due to the claim of capital allowances on leased assets. Source: Lanka Orix Leasing Co. Ltd. Table A8.3: Balance Sheets (SLRs million)

Year Ending 31 March1996 1997 1998 1999 2000 2001 Porjected Actual Actual Assets Current Assets Cash and Bank Deposits 6.7 44.6 292.2 50.0 94.8 17.0 21.7 Lease Receivables-Current Maturities 1,116.0 972.4 1,218.2 1,317.7 1,408.5 1543.7 1,669.3 Debtors & Prepayments 86.4 0.0 0.0 0.0 0.0 0.0 0.0 Other Current Assets 8.8 445.3 786.8 1,165.5 1,790.5 1,182.7 1,374.5 Total Current Assets 1,217.9 1,462.3 2,297.3 2,533.2 3,293.8 2,743.4 3,065.5 Long-Term Lease Receivables-Net 1,711.5 1,440.2 1,282.5 1,739.6 1,914.4 1,935.2 1,833.9 Fixed Assets 68.8 70.9 82.5 110.4 194.9 253.3 359.3 Investments 24.2 232.9 256.1 371.3 238.9 655.8 336.1 Total Assets 3,022.4 3,206.4 3,918.4 4,754.6 5,642.1 5,587.7 5,594.8

Liabilities and Equity Current Liabilities Short-term Borrowings 402.0 1,671.2 1,645.6 1,759.0 2,498.1 2,255.6 1,886.9 Creditors & Accrued Expenses 77.5 78.4 25.1 208.0 287.9 208.2 369.4 Dividends Payable 22.5 6.0 2.6 25.4 28.2 1.6 31.1 Other Current Liabilities 603.6 11.2 103.3 21.6 389.2 21.2 0.0 Total Current Liabilities 1,105.6 1,766.8 1,776.6 2,014.1 3,203.4 2,486.6 2,287.4 Long-Term Borrowings 1,005.4 588.7 1,154.8 1,610.0 1,112.1 1,683.0 1,991.1 Reserve for Future Taxation 75.0 125.0 145.0 165.0 185.0 205.0 205.0 Total Liabilities 2,186.0 2,480.5 3,076.4 3,789.1 4,500.6 4,374.6 4,483.5 Equity Paid-In Capital 90.0 90.0 90.0 108.0 108.0 118.8 237.6 Reserves (Premium) 252.0 135.0 135.0 117.0 117.0 106.2 106.2 Retained Earnings 494.4 500.8 617.0 740.5 916.5 988.1 767.5 Total Equity 836.4 725.8 842.0 965.5 1,141.5 1,213.1 1,111.3 Total Liabilities and Equity 3,022.4 3,206.4 3,918.4 4,754.5 5,642.1 5,587.7 5,594.8 A Ratios ppendix 8 Current Ratio (times) 1.1 0.8 1.3 1.3 1.0 1.1 1.3 Debt-Equity Ratio (times) 2.6 3.1 3.3 3.5 3.2 3.3 3.5 Debt-Service Coverage Ratio (times) 1.9 1.3 1.4 1.4 1.3 1.2 1.4

Source: Lanka Orix Leasing Co. Ltd. 79

80 Appendix 8

Table A8.4: Analysis of Loan Portfolio Quality (SLRs million)

As of 31 March Infection Ratio (%) Collection Ratio (%) 1996 1.36 84.95 1997 9.20 91.43 1998 8.89 88.46 1999 6.04 88.91 2000 11.50 89.81 2001 10.16 94.32 2002 10.47 87.66 Source: Lanka Orix Leasing Company Ltd. Appendix 9 81

MERCANTILE LEASING LTD.

A. Background

1. History and Ownership

1. Mercantile Leasing Ltd. (MLL) was incorporated in January 1982 and commenced leasing operations in September 1983. It applied for registration under the new finance leasing law by the deadline of 31 July 2002. The shareholding pattern has changed since appraisal: National Development Bank of Sri Lanka took over 43% of share ownership; Capital Development and Investment Company, 23%; and the public, 34%. On 11 May 2002, MLL (par value of SLRs10.00 per share) was trading on the Colombo Stock Exchange at SLRs13.00 per share.

2. Activities, Policies, and Procedures

2. MLL’s major activity continued to be the provision of lease finance for various industrial, commercial, services, and agricultural enterprises to purchase machinery and equipment. MLL’s other activities were factoring, insurance broking, and property management. A well- documented policy statement has been issued specifying guidelines for prudential financial management of MLL in terms of debt-equity ratio, capital adequacy, and asset and liability management. Guidelines were also laid down for leasing operations in terms of exposure limits and assessment of leasing business on expected risk-return basis. Procedures have also been established to ensure compliance with appraising and rating of clients, and approval of leasing facilities adhering to exposure limits. To provide more efficient service, lease authorization limits have been established, giving a degree of responsibility to lower-level management. The accounts were audited, on time, by a reputable firm of auditors. An internal audit committee of three board directors was responsible for ensuring that operations followed guidelines laid down in the policy statement, and that other supervision and controls were in place.

B. Loan Utilization

1. Characteristics of Leases

3. MLL utilized $1.94 million from the Fourth Development Finance Loan Project for 12 leases (Table A9.1); 52% of the amount of leases were given for balancing, modernization, and replacement subprojects while the rest was equally spread between new and expansion subprojects. Most leases (54%) were $100,000–$300,000, and 35% were $500,000–$1 million. The lease terms were 5–10 years (79%) and less than 5 years (21%). Almost all the leases (99%) were in the western region (including Colombo). Most (35%) were in the textile, apparel, and leather subsector; followed by transport (17%), construction (9%), and information technology development (8%). The lease equipment was procured mainly through the international-shopping (46%) and proprietary (43%) methods, and mainly from Italy, Germany, Sri Lanka, Singapore, and India.

2. Implementation Status of Leases

4. Of the 12 leases, 8 were implemented without delay; the others were delayed 16–39 months due to late arrival of imported equipment, abandonment of the subproject, infrastructure problems; and poor marketing. The abandoned subproject was transferred to a new client and the loan was rescheduled. The subproject with the marketing problem was placed under new 82 Appendix 9 management. The leases of the four subprojects that suffered delay were rescheduled and since then, payments were made on time. Cost overruns occurred only for one lease, for SLRs29 million, which encountered marketing problems.

3. Financial Status of Leases

5. The financial performance of the leases has generally been satisfactory: four (33.33%) have been fully repaid; two (17%) were being repaid on schedule; and five (42%) were rescheduled and being repaid on time. Legal action for recovery has been initiated for one.

4. Economic Impact of Leases

6. Four subprojects resulted in incremental exports of SLRs836.5 million ($8.8 million). Eight created 559 jobs. All the subprojects contributed to capital formation of SLRs236.85 million ($ 2.5 million).

C. Institutional Performance

1. Organization, Management, and Personnel

7. Overall supervision, control, and policy direction rested with the board of seven directors, chaired by A.N.U. Jayawardena and assisted by subcommittees for audit and remuneration. MLL was competently managed by Asoka Sirimanne, a qualified chartered accountant. Business activities were under the divisions of leasing and asset finance, and business finance. MLL had divisions for lease portfolio management, finance and information technology, treasury, administration, property management, and insurance broking. To provide efficient service, operations have been decentralized to four branches (none at appraisal). The organizational structure was considered satisfactory. As of 31 March 2001, staff comprised 147 executives and 17 nonexecutives, compared to a total of 51 at appraisal. Staff members were trained mainly through in-house programs, and outside programs where appropriate. The subcommittee on remuneration ensured that staff compensation would be commensurate with effort, competence, and quality of output.

2. Financial Performance and Position

8. MLL’s income statements from 1996 to 2001 are in Table A9.2. Total revenue increased 35% from SLRs231 million in 1998 to SLRs311 million in 1999. Total revenue increased 52% in 2000, and 35% in 2001 to SLRs637 million. Net profit, however, increased only 5% in 1999 and 31% in 2000, and decreased 45% in 2001 due to the narrowing of interest rate spreads and increasing provisions for nonperforming leases and other business activities. As a result of those adverse developments, the return on average equity (after tax) dropped from 26.0% in 1996 to 21.0% in 2000, and to 8.6% in 2001. The return on average assets (after tax) dropped from 4.6% in 1996 to 2.0% in 2000, and further to 0.8% in 2001. As a result of increases in the borrowing interest rates, the interest rate spread dropped from 4.64 percentage points in 2000 to 4.27 in 2001, but increased to 9.47 in the first quarter of 2002 due to a drop in the borrowing interest rates.

9. The balance sheets from 1996 to 2001 are in Table A9.3. Total assets increased 53% from SLRs1.41 billion in 1998 to SLRs2.17 billion in 1999; 49% from SLRs2.17 billion to SLRs3.23 billion in 2000; and 29% in 2001 to record total assets of SLRs4.17 billion, which were financed by liabilities of SLRs3.75 billion and equity of SLRs0.43 billion. The debt-equity Appendix 9 83 ratio, which deteriorated in 1999 and 2000, improved slightly to 6:0 in 2001. The debt-service coverage ratio has been satisfactory and stood at 2.5 times in 2001.

3. Operational Performance and Portfolio Quality

10. The lease portfolio (SLRs2,163 million) comprised 67% of the total assets (SLRs3.23 billion) in 2000 but dropped to 57% in 2001, reflecting a reduced demand for new leases in the adverse economic environment. Portfolio quality, however, has remained satisfactory (Table A9.4). The cash collection ratio was over 80% in 1996–2001, and stood at 87.4% in 2001. The portfolio infection ratio remained below 20% and stood at 6.2% in 2001. Both ratios deteriorated slightly in 2001 compared to 2000, reflecting the adverse economic environment and increase in nonperforming leases.

D. Compliance with Loan Covenants

11. MLL has complied with the following Asian Development Bank (ADB) financial covenants: (i) a minimum annual collection ratio for the total portfolio of 80%; (ii) a maximum portfolio infection ratio of 20%; (iii) a minimum debt service cover of 1.25 times; (iv) a maximum debt-equity ratio of 6:1; (v) single borrower group limit of not more than 10% of total assets; (vi) loans to a single economic sector not more than 30% of total loan portfolio; and (vii) submission of reports and annual audited accounts to ADB on time. MLL, however, has not met the covenanted minimum return on average assets (after tax) of 2.0% in 2001 (0.8%) due to a drop in investor confidence and decrease in the demand for leases, increase in provisions for nonperforming loans, and narrowing interest rate spreads. However, based on improved profitability in the first quarter of 2002, the situation was expected to improve, with the ratio reaching the covenanted minimum of 2.0% at the end of the year. ADB should closely monitor this development. 84 Appendix 9

Table A9.1: Characteristics of Subprojects

Amount Item Number % ($ million) % A. Purpose 1. New 3 25.0 0.49 25.2 2. Expansion 6 50.0 0.44 22.7 3. Balancing, Modernization, and Replacement 3 25.0 1.01 52.1 Total 12 100.0 1.94 100.0

B. Size 1. Up to $50,000 3 25.0 0.11 5.7 2. $50,001–$100,000 2 16.7 0.12 6.2 3. $100,001–$300,000 6 50.0 1.04 53.6 4. $300,001–$500,000 0 0.0 0.00 0.0 5. $500,001–$1,000,000 1 8.3 0.67 34.5 6. over $1,000,000 0 0.0 0.00 0.0 Total 12 100.0 1.94 100.0

C. Maturity 1. Up to 5 years 5 41.7 0.41 21.1 2. Over 5–10 years 7 58.3 1.53 78.9 3. Over 10–15 years 0 0.0 0.00 0.0 Total 12 100.0 1.94 100.0

D. Region 1. Western (including Colombo) 11 91.7 1.92 99.0 2. Central 0 0.0 0.00 0.0 3. Northwestern 1 8.3 0.02 1.0 4. Southern 0 0.0 0.00 0.0 5. Sabaragamuwa 0 0.0 0.00 0.0 6. Uva 0 0.0 0.00 0.0 Total 12 100.0 1.94 100.0

E. Industry Sector 1. Agriculture, Forestry, and Fishing 0 0.0 0.00 0.0 2. Food and Beverages 3 25.0 0.49 25.3 3. Textiles, Wearing Apparel, and Leather 1 8.3 0.68 35.0 4. Wood and Wood Products 0 0.0 0.00 0.0 5. Paper, Printing, and Publications 1 8.3 0.02 1.0 6. Chemicals, Petroleum, Coal, Rubber, and Plastics 2 16.7 0.10 5.2 7. Basic Metals 0 0.0 0.00 0.0 8. Nonmetallic Minerals 0 0.0 0.00 0.0 9. Fabricated Metals, Machinery, and Equipment 0 0.0 0.00 0.0 10. Construction 2 16.7 0.18 9.3 11. Wholesale, Retail, Restaurants, and Hotels 0 0.0 0.00 0.0 12. Transport, Storage, and Communication 2 16.7 0.32 16.5 13. Financing and Business Services 0 0.0 0.00 0.0 14. Community, Social, and Personal Services 0 0.0 0.00 0.0 15. Other Industries 1 8.3 0.15 7.7 Total 12 100.0 1.94 100.0 Appendix 9 85

Item No. % Amount % ($ million) F. Procurement Procedures 1. Reasonable Competition 3 25.0 0.23 11.8 2. International Shopping 3 25.0 0.88 45.4 3. Proprietary Basis 6 50.0 0.83 42.8 Total 12 100.0 1.94 100.0

G. Procurement by Country 1. Germany 0.47 24.2 2. India 0.15 7.7 3. Italy 0.67 34.5 4. Japan 0.05 2.6 5. Singapore 0.19 9.8 6. Spain 0.06 3.1 7. Sri Lanka 0.31 16.0 8. United Kingdom 0.04 2.1 Total 1.94 100.0 Source: Mercantile Leasing Ltd. Table A9.2: Income Statements 86 (SLRs million) Appendix9

Year Ending 31 March1996 1997 1998 1999 2000 2001 Projected Actual Actual Revenue Lease Income — 215 225 209 262 388 470 Other Expenses — 15 16 22 49 84 167 Total Revenue — 230 241 231 311 472 637

Operating Expenses Interest Expenses — 118 121 118 178 320 461 Staff Costs — 10 16 18 21 31 41 General & Administrative Expenses — 51 74 55 70 65 104 Total Operating Expenses — 179 211 191 269 417 607

Profit Before tax — 51 30 40 42 55 30 Income Tax — 0 00000 Profit After Tax — 51 30 40 42 55 30

Ratios Return on Average Equity (%) — 27.6 15.4 18.6 17.9 21.3 8.6 Return on Average Assets (%) — 4.9 2.7 3.1 2.3 2.0 0.8

— = not available. Source : Mercantile Leasing Ltd. Table A9.3: Balance Sheets (SLRs million)

Year Ending 31 March 1996 1997 1998 1999 2000 2001 Assets Current Assets Cash and Bank Deposits 1 2 3 15 76 98 Lease Receivables-Current Maturities 305 387 441 575 856 1072 Debtors and Prepayments 53 45 113 199 485 1043 Other Current Assets 60 160 216 212 220 256 Total Current Assets 419 594 773 1,001 1,637 2,469 Long-term Lease Receivables 565 528 499 967 1307 1302 Fixed Assets 3 8 32 44 50 46 Investments 53 58 109 156 237 357 Total Assets 1,040 1,188 1,413 2,168 3,231 4,174

Liabilities and Equity Current Liabilities 452 516 637 920 330 508 Long-Term Borrowings 327 391 457 906 2528 3140 Reserve for Future Expansion 76 76 93 100 100 100 Total Liabilities 855 983 1,187 1,926 2,958 3,748 Equity Paid-In Capital 108 108 108 108 108 204 Reserves (Premium) 76 97 118 134 164 222 Retained Earnings 100010 Total Equity 185 205 226 242 273 426

Total Liabilities and Equity 1,040 1,188 1,413 2,168 3,231 4,174 A ppendix 9

Ratios Current Ratio (times) 0.9 1.2 1.2 1.1 1.1 1.3

Debt-Equity Ratio (times) 3.9 4.1 4.4 6.9 6.8 6.0 87 Debt-Service Coverage Ratio (times) 3.2 3.5 4.4 5.4 4.4 2.5 Source : Mercantile Leasing Ltd. 88 Appendix 9

Table A9.4: Analysis of Loan Portfolio Quality (SLRs million)

As of 31 March Infection Ratio (%) Collection Ratio (%) 1996 4.8 88.1 1997 11.0 83.4 1998 14.8 80.2 1999 4.8 85.8 2000 4.8 89.0 2001 6.2 87.4 Source: Mercantile Leasing Ltd. Appendix 10 89

TECHNICAL ASSISTANCE COMPLETION REPORT Division: SAGF

TA No. and Name Amount Approved: $713,000 TA 2111-SRI: Institutional Strengthening of National Savings Revised Amount: Not applicable Bank Executing Agency: Source of Funding: JSF TA Amount Undisbursed TA Amount Utilized National Savings Bank $32,588.02 $680,411.98 Date Closing Date Approval Signing Fielding of Consultants Original Actual 28 June 1994 17 August 1994 24 April 1995 June 1996 August 1996 Description

NSB was the premier savings institution in a country that had a shortage of domestic savings to assist economic development, particularly through the private sector.

Objectives and Scope

The objective of the technical assistance (TA) was to help transform the Government-owned National Savings Bank (NSB) into an autonomous and commercial institution to mobilize and invest savings efficiently. As Sri Lanka was dependent on external resources for development, the TA aimed to help mobilize domestic resources and invest them in various instruments, thereby promoting capital market development. The TA had three components: (i) establishment of an investment department, (ii) human resource development (HRD), and (iii) development of an information technology (IT) master plan.

Evaluation of Inputs

The TA was to be implemented through the help of three international consultants for 22 person-months at a total cost of $713,000: an investment management consultant for 12 person-months; an HRD consultant for 6 person- months; and an IT consultant for 4 person-months. The consultants were supported by local counterpart staff and provided with transport facilities. Counterpart support was costed at about SLRs8 million ($163,000 at the time).

Evaluation of Outputs a. Establishment of an Investment Department

The Investment Department was established in May 1997 with a defined role, organization, statement of policies and procedures, manual of operations, and 14 staff (7 professionals). Staff members were trained in various aspects of securities, investment, asset management, and treasury management through 12 local and 4 overseas training programs. Total investments by the department (in loans, government securities, private sector debentures, and unit trust) increased from SLRs74 billion in 1997 to SLRs112 billion in 2001. Total deposits of NSB increased from SLRs77 billion in 1997 to SLRs119 billion in 2001. b. Human Resource Development

TA recommendations that were implemented related to (i) establishing a separate division for training; (ii) improving training facilities; (iii) introducing structured training programs for customer service for branch managers; and (iv) dealing with issues such as staff planning, recruitment and selection, performance evaluation, and promotions. Staff were trained through in-house programs, courses conducted by local institutions, and external training programs. A training-of-trainers program was also instituted. The HRD consultant carried out the following training programs: (i) six 3-day programs on customer service for about 100 branch managers, (ii) two 4-day programs to train trainers for about 15 staff, and (iii) two half-day workshops for executives on performance evaluation. NSB continued to conduct these training programs; 192 were held in 2001, and 144 up to April 2002. HRD has improved considerably as a result of the TA.

90 Appendix 10

c. Development of an Information Technology Master Plan

The IT consultant prepared the IT Master Plan. It incorporated, among other things, management information systems (MIS) for the head office, online branch network, postal banking, special savings schemes, an automated teller machine network, and monthly management reporting by the branches. Implementation was carried out in phases. It was delayed due to lack of clear specifications for equipment to be purchased, detailed compliance procedures, and unforeseen changes in the business environment. These problems have been largely overcome. Consequently, the master plan was adjusted, and implementation proceeded to achieve the overall objective of the plan. NSB expected the MIS to provide updated information to support quick decision making and enable NSB to provide more efficient customer service and become more commercial.

TA Overall Assessment/Rating

The TA is rated as highly successful. The consultants have achieved all the objectives specified in the terms of reference, and all activities in the workplan were completed on schedule. The total expense was well within the TA budget with a savings of $32,588. Capacity building of NSB continued after completion of the TA. Staff training, HRD, and IT development made significant progress.

Major Lessons Learned

Purchase of equipment and software should be based on very clear specifications that should be stated in the request for proposal or tender document. Criteria for selection should also be made clear and explicit.

Recommendations and Follow-Up Actions

NSB should seek an active role in the development of the capital markets in Sri Lanka to develop expertise, shape trends, and raise its profile; and it should actively manage its liabilities as well as its assets to increase profitability.

Prepared by Virgilio T. Velasco Designation Sr. Financial Economist

Appendix 11 91

TECHNICAL ASSISTANCE COMPLETION REPORT Division: SAGF

TA No. and Name Amount Approved: $198,000 TA 2112-SRI: Development of an Institutional and Regulatory Revised Amount: Not applicable Framework for the Leasing Industry in Sri Lanka Executing Agency: Source of Funding: TA Amount Undisbursed TA Amount Utilized Central Bank of Sri Lanka JSF $26,746.75 $171,253.25 Date Closing Date Approval Signing Fielding of Consultants Original Actual 28 June 1994 27 September1994 12 June 1995 June 1996 April 1998 Description

The rationale was that the private sector, particularly small and medium-sized enterprises, required an alternative to bank financing, such as leases, which are quickly processed and disbursed, and based on cash flow rather than collateral. Leasing has become efficient, and therefore a competitive alternative to banking.

Objectives and Scope

The objectives of the technical assistance (TA) were to (i) develop an institutional and regulatory framework for the leasing industry to deepen and diversify the financial sector; and (ii) provide an alternative to collateral-based bank lending, especially to strengthen the operations of the leasing industry and thereby help deepen and diversify the financial sector. The TA’s three components were (i) preparation of a finance leasing law, (ii) training for the Central Bank of Sri Lanka supervisory departments in supervision and monitoring of leasing companies and the leasing activities of banks and other financial intermediaries, and (iii) establishment of a computerized lease registry.

Evaluation of Inputs

The TA, accompanying Loan 1302-SRI: Fourth Development Finance Loan Project (DFL IV), was approved on 28 June 1994. The TA was implemented with the help of two international and two domestic consultants for 4.5 person- months at a total cost of $157,777. The consultants were engaged on 25 May 1995 and commenced fieldwork on 12 June 1995. They undertook off-site desk research to obtain a background on Sri Lanka’s legal and regulatory systems and general economy prior to the on-site work. Questionnaires covering leasing law, supervisory framework, and registry were sent to leasing industry participants in 11 Asian countries and 6 Sri Lankan companies. Field interviews were conducted during the approximately 1 month spent on-site by the two international consultants. Further research work and report preparation were undertaken off-site after the field assignment.

Evaluation of Outputs a. Introduction of a Finance Leasing Law

The initial draft of the finance leasing law was submitted by the legal international consultant at the end of 1995. Several revisions were made over a period of almost 5 years. The finance leasing law was enacted by Parliament on 18 August 2000. It came into operation by gazette notification on 1 August 2001. The law gave leasing companies until 31 July 2002 to seek registration. Three private leasing companies have submitted their registration applications to the Central Bank of Sri Lanka, which advised that the certificates to be issued shortly would be effective on 1 August 2002. The Leasing Association of Sri Lanka proposed two amendments to the law: (i) provision to assign a lease, other than to a registered leasing company, to facilitate securitization of leased assets; and (ii) reduction of “reasonable notice” to be given for recovery of a leased asset. The Government agreed to both proposals, and reasonable notice was reduced to a maximum of 21 days. The amendments were finalized by the Ministry of Finance and presented to Parliament for approval in July 2002. b. Establishment of a Supervisory Framework for the Leasing Industry

A supervisory framework was established under the Central Bank of Sri Lanka’s Supervision Department of Nonbank Financial Institutions. The law requires leasing companies to register themselves annually, have a minimum share capital of SLRs75 million, and pay an annual registration fee of SLRs5,000–25,000. Once the leasing companies are registered, their operations are monitored by the Supervision Department for Nonbank Financial Institutions. The TA consultant conducted a lease training workshop in June 1996 for officers of the supervision departments of nonbanks and banks. The consultant prepared a report, “Development of an Institutional and Regulatory Framework for the Leasing Industry in Sri Lanka,” which also deals with supervision of leasing companies.

92 Appendix 11

c. Establishment of a Computerized Leasing Registry

A computerized leasing registry was established under the Credit Information Bureau of Sri Lanka (CRIB) which operates with a staff of about 30 (including 3 professionals) and made a net profit of SLRs13 million in 2001 (SLRs6 million in 2000). Credit reports on leasing have been provided on the following basis: 1-hour service (SLRs200); 1-day service (SLRs70); and service by post (SLRs36). About 1,000 credit reports per day are being generated in 2002 compared with only about 200 per month in 1990. All the leasing operations are required to be registered under the finance leasing law (by 31 July 2002). Once data on leased assets from all leasing operations are captured in the registry, comprehensive information can be provided on request for a fee. CRIB registers only those leased assets with readily identifiable serial numbers or any other identification marks. Motor vehicles however continue to be registered by the Registrar of Motor Vehicles.

Overall Assessment and Rating

The TA is rated as successful. Its objectives were achieved, as the leasing industry was strengthened and leasing was promoted as an additional funding source for private entrepreneurs.

Major Lessons Learned

The DFL IV policy action that required gazette notification by 30 June 1995 was unrealistic, as the TA did not give the Government enough time to draft the law, study and format it as required, and go through the various procedures to have it approved by Parliament and gazetted. A more reasonable deadline for the gazette notification would have been the end of December 1996. However, despite the TA, the Government took 6 years past the original deadline to gazette the law. The long delay was abnormal.

Recommendations and Follow-Up Actions

The leasing industry in Sri Lanka is healthy, dynamic, and growing rapidly. It could benefit from a finance lease law governing financial leases and clarifying the rights of the parties in a finance lease transaction. The Central Bank will have to exercise adequate supervision within the regulatory framework to bolster marketplace stability and confidence. A lease registry that provides timely and accurate reports would increase confidence in the system and promote its greater use for credit evaluation. The Asian Development Bank should engage the authorities in policy dialogue to support and sustain these initiatives.

Prepared by Virgilio T. Velasco Designation Sr. Financial Economist

Appendix 12 93

IMPLEMENTATION STATUS OF POLICY REFORM MEASURES UNDER THE FOURTH DEVELOPMENT FINANCE LOAN PROJECT

Policy Measures Implementation Status

By 31 December 1994 (i) The Government will have issued a gazette The Attorney General confirmed that it was not notification of a bill to amend the Employees necessary to amend the EPF Act to allow EPF to Provident Fund (EPF) Act to the effect that invest in private sector securities. The Monetary EPF will be allowed to invest in listed private Board thus decided to allow it to invest in listed sector securities. private sector securities in December 1995.

(ii) The Government will have issued a gazette The bill to amend the Registered Stocks and notification of a bill to amend the Rupee Securities Ordinance was gazetted on 17 October Security Ordinance to allow for the issuance of 1995. The Registered Stocks and Securities Government securities with coupons and the (Amendment) Act 32 of 1995 was passed in auctioning thereof. Parliament on 26 October 1995.

(iii) At least 10% of the combined investment Twenty percent of the investment portfolio of portfolios of Sri Lanka Insurance Corporation SLIC, amounting to SLRs2 billion, was invested in and National Insurance Corporation will be private sector securities since mid-June 1995. invested in private sector securities. SLRs20 million of NIC’s investment portfolio (SLRs1 billion) was invested in private sector debentures.

By 30 June 1995 (i) At least 10% of the monthly contributions Ten percent of total investments by ETF, received by ETF will be invested in private amounting to SLRs12.5 billion, were held in sector securities. private sector entities as of 30 September 1995. Investment in shares far exceeded monthly contributions amounting to SLRs120 million.

(ii) The Government will have issued a gazette Implemented with an over 6-year delay. The notification of a finance leasing law. finance leasing law was enacted by Parliament on 18 August 2000. The law came into operation by gazette notification on 1 August 2001.

By 31 December 1995 (i) At least 5% of the monthly contributions EPF invested SLRs300 million (more than 5% of received by EPF will be invested in private monthly flows) in debentures of Development sector securities. Finance Corporation of Ceylon and National Development Bank of Sri Lanka on 28 December 1995. EPF invested up to SLRs1,200 million in Development Finance Corporation of Ceylon and National Development Bank of Sri Lanka debentures in 1996. On 3 March 1998, the Monetary Board approved EPF’s investing in Colombo Stock Exchange shares commencing 21 April 1998.

(ii) The Government will have established a Implemented with delay. A computerized lease monitorable computerized lease register. register was established within the Credit Information Bureau in 1997 and is operational.

94 Appendix 13

COMPLIANCE WITH PRINCIPAL LOAN COVENANTS: FOURTH DEVELOPMENT FINANCE LOAN PROJECT

Reference to Loan Nature of Covenants for Subloan and/or Lease Approvals Document Remarks A. Eligibility Criteria 1. Qualified enterprises (QEs) and qualified projects (QPs) a. Private enterprises in the manufacturing, service, Loan Agreement Complied with and tourism sectors. Subloans and/or leases can Section 1.01 be provided for new as well as expansion projects, and diversification and modernization of existing facilities. b. Long-term debt-equity ratio not exceeding 7:3 Loan Schedule 6, Complied with para. 3 (a) c. Debt service coverage ratio of not less than 1.25 Loan Agreement Complied with for QEs Schedule 6 para. 3 (b) d. Financial internal rate of return of at least 15% for Loan Agreement Complied with all QPs Schedule. 6 para. 3 (c) e. For subloans or leases of more than $1 million, Loan Agreement Complied with an economic internal rate of return of not less Schedule. 6 para. 3 than 10% (d) f. No adverse environmental impact Project Agreement Complied with Schedule, Section 5 (a)

B. Allocation of Loan Proceeds 1. Up to 20% of the loan will be available for tourism Report and Complied with projects (excluding hotel facilities in the Greater Recommendation of Colombo area), and up to 20% for financing the President, para. equipment leases, excluding vehicles. Private leasing 79 companies (PLCs) can use the loan proceeds only for financial leases for equipment, and access is limited to $5 million each.

C. Subloan and/or Lease Terms 1. Market-rate interest charged by participating financial Loan Agreement Complied with institutions (PFIs) for the subloan and/or lease Schedule 3 para. B (i) 2. Subloan or lease amortization not exceeding 15 Loan Agreement Complied with years, including a grace period, if any, of 3 years Schedule 3 para. B (ii) 3. Maximum subloan or lease size of $3 million Loan Agreement Complied with Schedule 3 para. B (iii) 4. Minimum subloan size of $50,000; minimum, $20,000 Loan Agreement Complied with Schedule 3 para. B (iv) 5. Contribution of QE to QP through subloans/leases of Loan Agreement Complied with 30% of total project cost as equity and internal cash Schedule 3 para. B generation (v)

Appendix 13 95

Reference to Loan Nature of Covenants for Subloan and/or Lease Approvals Document Remarks D. Procurement 1. Certification by PFIs to the Asian Development Bank Loan Agreement Complied with (ADB) that the goods to be financed by the subloans Schedule 5 para. 1 and/or leases are produced by and procured in ADB’s member countries

E. Particular Covenants 1. Criteria for PFIs’ Initial and Continued Participation a. Minimum annual collection ratio of 80% of the Loan Agreement Complied with, total portfolio, calculated every 6 months Schedule 6 para. 1 (i) except National Development Bank of Sri Lanka (NDBSL) in 2001 b. Maximum portfolio infection ratio of 20% Para. 1 (ii) Complied with c. Minimum return on average assets (after tax) for Para. 1 (iii) Complied with development finance institutions and PLCs of only by 2%; for private domestic commercial banks, 1% Development Finance Corporation of Ceylon (DFCC), Lanka Orix Leasing Co. Ltd. Commercial Bank of Ceylon Ltd. Not complied with by NDBSL in 2000 and 2001, and by Hatton National Bank Ltd., Sampath Bank Ltd., and Mercantile Leasing in 2001. Seylan Bank Ltd. did not comply from 1996 to 2001. d. Total exposure of each PFI to a single borrower Para. 1 (vi) Complied with or lessee, including related company, not exceeding 10% of the total assets of the PFI 96 Appendix 13

Reference to Loan Nature of Covenants for Subloan and/or Lease Approvals Document Remarks

e. Debt service coverage ratio of not less than 1.25 Para. 1 (iv) Complied with except by Commercial Leasing Co. Ltd. in 2000 and 2001, and Lanka Orix Leasing Co. Ltd. in 2000 f. Maximum ratio of long-term debt to equity of 8:1 Para. 1 (v) Complied with for DFIs; 6:1 for PLCs; and compliance with the ratio of capital risk to adjusted assets set by Central Bank of Sri Lanka in accordance with the Basle Guidelines for capital adequacy, for private domestic commercial banks g. Total amount of loans and leases of each PFI to Para. 1 (vii) Complied with a single economic sector not exceeding 30% of the PFI’s total loan/lease portfolio h. DFCC and NDBSL consultation with ADB prior to Para. 2 (a) Complied with appointing the general manager and making any amendment to their respective policy statements i. Informing ADB of any proposal to amend the Para. 5 Complied with DFCC and NDBSL acts

2. Reporting Requirements Each PFI will furnish ADB the following: a. a quarterly report within 45 days after the end of PA Article iii Largely each quarter; Section 3.05 (b) (i) complied with. Some PFIs did not regularly submit their quarterly reports. b. certified copy of audited financial statements, not PA Article iii Complied with later than 6 months after the close of each fiscal Section 3.06 (a) year; c. long-form audit report, (including a certification PA Article iii Partially relating to the compliance or noncompliance with Section 3.06 (a) complied with, financial covenants). with delays and lapses. Several PFIs did not submit auditor’s certification.

Appendix 14 97

ASSESSMENT OF PROJECT OVERALL PERFORMANCE

Details of Rating Rating Criterion Weight (%) Performance Assessment Description Value A. Project Outcome Assessment 1. Relevance 20 The Fourth Development Finance Relevant 2 Loan Project (DFL IV) was considered relevant to the objectives of Sri Lanka and the Asian Development Bank (ADB) to promote private sector-led economic growth and contribute to development of financial institutions. The objectives of DFL IV during the project completion review remained the same as at appraisal and were achieved satisfactorily. DFL IV assisted 262 private enterprises and yielded incremental exports, employment, and capital formation, thereby contributing to private sector-led economic growth. DFL IV promoted development of the nine participating financial institutions (PFIs) by requiring them to maintain financial discipline by adhering to financial covenants and having their accounts audited, on time, by reputable auditing firms. The two associated technical assistance (TAs) for institutional strengthening of the National Savings Bank (NSB) and strengthening of the operations of the leasing industry were implemented successfully. The policy reform measures were implemented, albeit with delays, and promoted capital market development.

2. Efficacy 25 DFL IV’s $75 million equivalent was Efficacious 2 almost fully utilized ($73.4 million). Cancellations effected on 3 August 1999 amounting to $2.8 million included PFIs’ overcommitments. The 262 private sector subprojects contributed to the socioeconomic development of the country. 98 Appendix 14

Details of Rating Rating Criterion Weight (%) Performance Assessment Description Value

Most subprojects were implemented satisfactorily and operating profitably, and their subloans or leases fully repaid or being repaid on schedule. The nine PFIs continued to be well organized and competently managed, profitable, and financially sound. The two attached TAs were implemented satisfactorily and on time. Implementation of the policy reform measures was delayed but eventually completed.

3. Efficiency 20 The objectives were achieved Partly 1 commensurate with the inputs of efficient the Government, executing agencies (the PFIs), and ADB. The only inefficiency was in respect of the extension, on two occasions, of the closing dates for commitment and disbursement of DFL IV. The first extension was due to delay in loan effectiveness, and the second to the suspension of subloan and lease commitments for financing from DFL IV as a result of delay in implementing some policy reform measures. Consequently, the closing date of the DFL IV was delayed by 3 months, from November 1998 to February 1999.

B. Sustainability 20 The various components of DFL IV Likely 2 were sustainable. Out of DFL IV’s 262 subprojects, 80 (31%) have fully repaid their subloans and/or leases, 141 (54%) were repaying their subloans and/or leases on schedule, while 17 (6%) were regular in their repayments after being rescheduled. The sustainability of 24 appeared questionable as they were either in arrears (21 or 8%) or in litigation or to be written off (3 or 1%). The satisfactory repayments of the subloans and leases allowed recycling of funds by the PFIs to promote private enterprises.

Appendix 14 99

Details of Rating Rating Criterion Weight (%) Performance Assessment Description Value

The financial health of the nine PFIs deteriorated to some extent in 2001 due to the adverse economic environment. They were, however, expected to regain their previous higher levels of financial performance beginning in 2002. Capacity building of NSB continued after completion of TA 2111. Staff training, human resource development, and information technology development made significant progress. Savings mobilized were invested in a range of securities, including private sector securities. Leasing companies would be registering under the finance leasing law, drafted under TA 2112, by 31 July 2002. Thereafter, the Central Bank of Sri Lanka Department of Supervision of Nonbank Financial Institutions would monitor the operations of the leasing companies using the supervision and regulatory framework put in place by the TA. The Credit Information Bureau would request the registered leasing companies to submit details of the leased assets to make the computerized lease register fully operational. Policy reform measures, introduced under DFL IV, continued to help the public insurance corporations (Sri Lanka Insurance Corporation [SLIC] and National Insurance Corporation [NIC]), Employees Provident Fund (EPF), and Employees Trust Fund (ETF) invest in private sector securities.

C. Institutional 15 DFL IV contributed positively to Moderate 1 Development and institutional development and other Other Impacts impacts. With some exceptions, the PFIs continued to adhere to ADB financial covenants. As a result, the PFIs were profitable and in sound financial health. Their annual accounts also continued to be audited by reputable firms as required by ADB. 100 Appendix 14

Details of Rating Rating Criterion Weight (%) Performance Assessment Description Value

Some PFIs did not comply with particular covenants, particularly in 2001, due to the adverse economic environment, but it is expected to improve in 2002. Implementation of TA 2111 for institutional strengthening of NSB was successful. TA 2112 helped strengthen the leasing industry. The 262 subprojects financed under DFL IV adhered to the country’s environmental regulations. The policy reforms under DFL IV to promote capital market development strengthened the capacity of NSB, SLIC, NIC, EPF, and ETF to invest in private sector securities.

D. Overall Assessment Successful 1.65