Municipal sector review

Iller Bank Reform

5.24 The focus of Iller Bank reform should be to transform the bank into an agent for efficient transfer of public funds to the municipalities. The aim would be to improve the quality of local investments by rationalizing the process by which budgetary and other funds are transferred to local governments. Turkey’s Eighth Five Year Plan also supports the continuation of Iller Bank as a development and investment bank, carrying out important functions for the municipalities. Some of the main actions would be:

1. 
   Independent day-to-day operations: The bank should be governed by an independent board and not be linked to any particular ministry. Government regulations to ensure sound banking practices to protect shareholders and creditors, banking laws and control mechanisms for other financial organizations would apply. Since public funds would be used to finance the investments, the projects should be monitored through the Public Investment Program but simplified decision procedures should be in place for their approval.
   

2. 
   Separate financing and transfer functions: The transfer of central government transfers to municipalities should be separated from the financing of investments function. Local authorities would be expected to pay for infrastructure investments through the user fees and other cost recovery mechanisms. Withholding the transfers should not be the standard method of paying debt service.
   

3. 
   Achieve self-financing to sustain operations: The bank would set interest rates and lending terms to recover capital and sustain operations, thereby reducing its dependence on support from central and local governments. Iller Bank’s funding should increasingly consist of debt liabilities sourced from public agencies, international financial institutions, and private institutions. The need for annual contributions for central government and shareholders would be gradually eliminated. Any subsidies used would be budgeted up-front and transparent criteria for their use would be established.
   

4. 
   Separate project finance and technical assistance responsibilities: The bank would confine its role to the finance of local investments. The local authorities would be responsible for preparing, tendering and implementing the financed works. The technical assistance staff could be involved in the planning and execution of the projects, particularly when local authorities’ capacities are weak. This is justified when the cost of these services are reflected in the lending rates, and when the bank supports rather than assumes project execution. Further, in the long run, the technical assistance section of the bank should compete with other private firms that may be able to provide a similar service.
   

5. 
   Simplified decision-making: Today’s practice of reviewing every municipal project proposed for Iller Bank funding through the PIP process could be replaced with a speedier decision process. First, the intermediary would have to make projections on the medium term (less than 5 years) availability of funds. Second, the municipalities would have to submit feasibility studies taking economic, technical, institutional, financial, social, and environmental issues into account. The municipalities should have an option of using either a private firm or Iller Bank’s technical assistance section. In either case, the municipalities should pay for the service. Third, based on the feasibility study and objective criteria, projects would be selected for financing by the independent board of the bank. The financing would be for the entire duration of the project completion period to reduce the number of unfinished projects.
   

6. 
   Support credit culture enhancement: Iller Bank would contribute towards increasing the creditworthiness of municipalities. As Iller Bank’s resources would have, increasingly, to be passed on to municipalities as loans with no government subsidies or guarantees, changes would be needed to help rationalize the borrowing practices at the local level and improve the quality of local investment programs. This might involve assistance to municipalities in enforcing improved budgeting, financial control, auditing and disclosure standards and which would also provide other prospective lenders with reliable information that could allow meaningful credit assessment of local borrowers, and help municipalities build transparent credit records.
   

Iller Bank Reform - Long Run

5.25 Athough it is currently premature to discuss access to private and commercial funding by Turkey’s municipalities, the reforms should eventually allow private funding in municipalities. In the long run, Iller Bank could play a role in this matter by acting as a financial intermediary. A number of countries have established financial intermediaries or municipal development institutions as a channel to provide municipal credit. Given the ‘public good’ nature of municipal operations, it is common to find private capital backed by public support in the financial intermediaries. The involvement of private capital leads to loans being made to the creditworthy cities, which in turn creates an incentive for cities to improve their financial performance.

5.26 In some cases, financial intermediaries administer pools of funds from government sources. Others have sought, and some managed, to serve as a bridge in raising funds on credit markets for on-lending to local governments. The institutional arrangements adopted vary greatly between countries and are tailored to the specific national political and economic objectives, and local conditions (Table 5.8 and Annex 3).
5.27 The role, operating strategy and financial structure of a financial intermediary often evolves through the following stages: (i) fund local government investments along specific criteria applicable to loans or grants. In this phase the process of resource transfers from central to local governments is rationalized and the quality of local project finance enhanced; (ii) assist in local institutional development and help to build a local credit culture. This seeks to rationalize borrowing practices since indebted municipalities must service their loans out of the economic benefits of their investments, which in turn is an incentive to improve the quality of investments; and (iii) mobilize private resources from financial markets through a market-based pooling mechanism. Municipalities and other entities, such as utility corporations serving local constituencies, can cover their long-term financing needs through this pooling mechanism.
5.28 The need for financial intermediation often grows as decentralization and urbanization increase the need to provide and finance public services. In a tight fiscal environment, competing claims for scarce budget resources typically result in funding gaps for local infrastructure projects. The capability of municipalities to shoulder the expanded responsibilities and, in particular, mobilize the required resources is still largely lacking especially in a context where the regulatory framework promoting prudent behavior from municipalities is inadequate. Municipalities typically differ markedly in terms of resource base and economic size. These differences influence the choice of funding schemes for infrastructure investments. Larger, better endowed cities and metropolitan centers with good financial standing may be able to tap the credit markets, but smaller municipalities often need to rely on pooling capabilities of financial institutions to mobilize long-term credit. Some small municipal entities may not be able to access credit in any form. Hence, the establishment of a specialized local government financial intermediary would help facilitate access to credit by small and medium size municipalities.

Table 5.8 Examples of Financial Intermediaries
Country: Institution	Structure	Sources	Assistance	Lending US$	Staff
Belgium: Credit Communal Belgique (CCB) (later Dexia)	Limited Company	Private savings, municipal deposits, bonds	Loans	2.25 bln (1990)	4,000
Denmark: Danish Credit Inst for Local Authorities (DCLA)	Cooperative Credit Institution	Bonds	Loans	345 mln (1990)	18
Colombia: Urban Development Fund (UDF) (later FINDETER)	Rediscount facility owned by Gov’t and municipalities	Pension fund deposits, external borrowing, Gov’t loans and bonds	Rediscounts commercial bank loans	300 mln (1983-86)	90
France: Credit Local (CLF) (later Dexia)	Independent subsidiary of central deposit bank (Caisse des Depots – CDD)	Bonds, CDD loans, external borrowing	Loans	5.8 bln (1988)	1,000
UK: Public Works Loan Board (PWLB)	Independent commission reporting to Parliament	Bonds	Loans	11.3 bln (1987-88)	23

5.29 Local government financial intermediaries have also been set up to foster local economic development in industrialized countries (Belgium, Finland, France, Spain and Sweden). In Canada, municipal finance corporations are mostly provincial agencies operating at the provincial level, while in the USA, municipal “bond banks” are state instruments. A “State Revolving Fund” is an example of a bond bank with an element of public support where lending is mostly accomplished in leveraging federal and state capital grants through bond issuance in the credit markets.

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