ASIAN DEVELOPMENT BANK

PPA: PRC 21197

PROJECT PERFORMANCE AUDIT REPORT

ON THE

SHANGHAI INVESTMENT AND TRUST CORPORATION PROJECT (Loan 933-PRC, LOE 7031, and TA 1086-PRC)

IN THE

PEOPLES REPUBLIC OF CHINA

December 2000

CURRENCY EQUIVALENTS Currency Unit Yuan (Y) At Appraisal (October 1988) $0.2687 Y3.7221 At Project Completion (October 1995) $0.1183 Y8.4518 At Operations Evaluation (September 2000) $0.1208 Y8.2773

Y1.00 $1.00

= =

ABBREVIATIONS ADB EA ERPS IDC ITIC LOC LOE MIS MOF NBFI OEM PCR PPAR PRC SITEN SITICO SMG SMZ SOE TA Asian Development Bank Executing Agency exchange risk pooling system interest during construction international trust and investment company line of credit line of equity management information system Ministry of Finance nonbank financial institution Operations Evaluation Mission project completion report project performance audit report Peoples Republic of China Shanghai SITICO Enterprise Company Limited Shanghai International Trust and Investment Corporation Shanghai Municipal Government Shanghai Municipal Zone state-owned enterprise technical assistance

NOTES (i) (ii) The fiscal year (FY) of the Government ends on 31 December. In this report, $ refers to US dollars. Operations Evaluation Office, PE-561

CONTENTS Page BASIC DATA EXECUTIVE SUMMARY I. BACKGROUND A. B. C. D. E. F. II. Rationale Formulation Purpose and Outputs Cost, Financing, and Executing Arrangements Completion and Self-Evaluation Operations Evaluation ii iii 1 1 1 2 2 3 4 4 4 6 7 7 7 8 8 9 12 13 13 13 13 14 15 15 15 15 15 16 16 16 17 17 17 18 20

PLANNING AND IMPLEMENTATION PERFORMANCE A. B. C. D. E. Formulation and Design Achievement of Outputs Cost and Scheduling Procurement and Construction Organization and Management

III.

ACHIEVEMENT OF PROJECT PURPOSE A. B. C. D. Performance of Subprojects Performance of the Operating Entity Technical Assistance Sustainability

IV.

ACHIEVEMENT OF OTHER DEVELOPMENT IMPACTS A. B. C. Socioeconomic Impact Environmental Impact Impact on Institutions and Policy

V.

OVERALL ASSESSMENT A. B. C. D. E. F. G. Relevance Efficacy Efficiency Sustainability Institutional Development and Other Impacts Overall Project Rating Assessment of ADB and Client Performance

VI.

ISSUES, LESSONS, AND FOLLOW-UP ACTIONS A. B. C. Key Issues for the Future Lessons Identified Follow-Up Actions

APPENDIXES

BASIC DATA Shanghai Investment and Trust Corporation Project1 (Loan 933-PRC) Project Preparation/Institution Building TA No. TA Name 1086-PRC Institutional Support to SITCO Type A&O PersonMonths 36 Amount ($) 450,000 Approval Date 13 Dec 1988 Actual 87.20 87.20 12.80 55.10 0.00 Actual 18 Aug-3 Sep 1988 16-17 Nov 1988 13 Dec 1988 28 Aug 1989 27 Nov 1989 27 May 1994 24 Oct 1997 54

Key Project Data ($ million) Total Project Cost ADB Loan Amount/Utilization ADB Loan Amount/Cancellation ADB Loan Prepayment Line of Equity Key Dates Appraisal Loan Negotiations Board Approval Loan Agreement Loan Effectiveness Loan Closing Loan Repayment Months (effectiveness to completion) Loan Borrower Executing Agency Line of Equity Administering Institution Mission Data Type of Mission Fact-Finding Appraisal Project Administration Review Project Completion Operations Evaluation

As per ADB Loan Documents 100.00 100.00

3.00 Expected

13 Dec 1988 27 Nov 1989 27 Nov 1993 15 Sep 2003 48

Government of the Peoples Republic of China Shanghai Investment and Trust Corporation

Shanghai SITICO Enterprises Company, Limited

No. of Missions 1 1 1 1 1

No. of Person-Days 42 85 14 24 24

A&O = advisory and operational, ADB = Asian Development Bank, SITICO = Shanghai International Trust and Investment Corporation, TA = technical assistance. 1 At the time of establishment, its name was Shanghai Investment and Trust Corporation. However, in 1993, its name was changed to Shanghai International Trust and Investment Corporation (SITICO). The name SITICO is used in this report.

EXECUTIVE SUMMARY In December 1988, in line with its interim operational strategy on the Peoples Republic of China (PRC), the Asian Development Bank (ADB) approved a $100 million line of credit (LOC) to the PRC. It was relent to Shanghai International Trust and Investment Corporation (SITICO), the Executing Agency, for onlending to industrial enterprises in Shanghai Municipal Zone for technology upgrading and rehabilitation of obsolete and inefficient plant and machinery. A line of equity (LOE) of $3 million was also approved for Shanghai SITICO Enterprise Company Limited (SITEN), a subsidiary of SITICO, to make investments in majority privately owned enterprises in industry or service sectors to support the Governments efforts in encouraging foreign direct investment and technology transfer. A technical assistance (TA) grant of $450,000 was provided under the Japan Special Fund to help build institutional capacity. The objectives of the Project were to (i) help finance technology upgrading of viable enterprises, (ii) strengthen the role of the SITICO group as a major source of equity financing through SITEN, and (iii) guide and contribute to further development of SITICO and SITEN. The loan, to be drawn in various currencies equivalent to $100 million based on ADBs foreign exchange risk pooling system, was funded from ordinary capital resources and attracted a variable interest rate. The loan had a term of 15 years including a grace period of three years. SITICO was expected to add a minimum spread of 1 percent and pass on interest rate and exchange rate risks to the subborrowers. The loan utilization period was four years, and the maximum size of the subloans was $10 million. The subproject sponsors were required to contribute 15 percent of the total subproject cost for existing projects and 20 percent for new projects. Expenditure incurred by subborrowers up to 90 days prior to receipt of subloan documents by ADB was eligible for financing under the LOC. The project completion report (PCR), although fairly candid and objective, did not specify an overall performance rating for the Project, but stated that loan utilization and subproject performance were generally satisfactory. With the benefit of hindsight, it indicated that the covenants should have been designed to cater to the specific needs of nonbank financial institutions in the PRC. In particular, the PCR illustrated that covenants should have insisted on institutional independence of SITICO, clearly defined reserves for doubtful debts, and specified more realistic financial ratios for SITICO given its rapid expansion. The Operations Evaluation Mission generally agrees with the PCR, but believes that it could have better analyzed the information available at the time to draw more meaningful lessons for future projects. This evaluation focuses on (i) effectiveness of project design, (ii) achievement of objectives, (iii) capacity building, (iv) monitoring and supervision, (v) performance of SITICO, (vi) performance of subprojects, and (vii) development impacts and sustainability. The project design incorporated flexibility on retroactive financing and subloan size limits that were responsive to potential demand. However, the design had some weaknesses as well. It followed the traditional LOC approach without adaptation suited to an economy in transition. Also, it was inappropriate to pass on the foreign exchange risk of a long-term loan to subborrowers without access to any risk mitigation mechanism. Market conditions at the time made utilization of the LOE under ADBs guidelines impractical. Finally, the Project concentrated only on the credit needs of the enterprises and did not ensure that they would operate in an appropriate enabling environment to sustain their transition to a market economy. All 23 subprojects financed under the LOC were sponsored by state-owned enterprises in various industry sectors. To a large extent, the subprojects were successful in upgrading their equipment and surviving the transition to a market economy. The timing of the financing for the Project was opportune, as the LOC became effective when some other sources of foreign

iv currency loans had virtually dried up. In the absence of the loan, these state-owned enterprises would have faced difficulty in maintaining efficient production given the obsolete state of their machinery and technology. During implementation, however, several subloans had to be restructured due to severe financial problems caused by exchange rate adjustments. The TA provided consultancy services for a total of 12 months to SITICO and SITEN for project appraisal, monitoring, and supervision, as well as financial planning and liabilities management. It also provided overseas training for 13 middle managers in project appraisal and supervision, which appears to have been successful. Some of the staff members who received the overseas training are now in key management positions. The first computer hardware and software system for financial management was also set up as a result of the TA. SITICOs operations witnessed significant growth in the 1990s in its various lines of business. Since 1997, SITICO has been proactive in its asset management, focusing on quality by tightening risk management, reclassifying assets, adjusting its credit structure, and improving its portfolio quality and return on capital. It streamlined its operations, diversified investments, strengthened institutional capacity, and improved operational strategies and practices in several areas, including project appraisal and management information systems. Given normal circumstances, it is likely that SITICO will be able to survive competition and invest prudently in the PRCs changing environment. The overall Project is rated successful. However, the overall assessment is at the lower end of what constitutes successful due to the weaknesses in design that affected the efficacy of the Project. With ADBs interim operational strategy, its objectives were appropriate at the time it was formulated. A majority of the subprojects that benefited from the financing are operating normally. Some subprojects faced difficulties and SITICO has helped them survive. SITICO, as an institution, has fared relatively well and has gained prominence in certain areas such as investment banking, aided by project inputs. In addition, the TA was helpful in building institutional capacity of SITICO through the management information system and financial management upgrades and human resource development through training. The LOE was premature and was not utilized. ADB projects of a similar nature in transition economies should move away from the traditional LOC design, carefully consider the constraints and needs of enterprises in a transition economy including their ability to cope with reforms, and provide for associated risk factors. They should also ensure, through policy dialogue, project design, or donor coordination that not only are enterprises credit needs met but also that they have an enabling environment to sustain their transition to operating in a market economy. Several enterprises operating in the Shanghai Municipal Zone lack operational autonomy and commercial viability. The Government needs to undertake restructuring of these, encourage more autonomy in management, and ensure that they have appropriate links within and outside the PRC to respond to technological changes and market conditions. Current procedures followed by international trust and investment companies promote unhealthy and distorted delays in portfolio cleanup. The Government, in addition to reviewing its Bankruptcy Law, should require international trust and investment companies to reclassify their assets according to standard international accounting practices and allow them the freedom to allocate sufficient provisions before profit to depict an accurate picture of their financial position. SITICO has taken significant steps to reorganize its structure so as to achieve its market potential and is further automating its business processes using the latest technology to become competitive in its business niche. To continue its focus on prudent and efficient operations, it should (i) strive to use staff with specialization in handling problem accounts and managing nonperforming loans, (ii) increase the level of loan-loss provisions, and (iii) effectively carry out

v loan and investment monitoring through the use of a risk-rating system capable of providing early warning signals and of segregating problem assets at an early stage.

I.

BACKGROUND

A.

Rationale

1. The early years of the operations of the Asian Development Bank (ADB) in the Peoples Republic of China (PRC) were guided by an interim operational strategy developed in 1987.1 To maximize the level of ADBs effectiveness, the strategy required operations to focus on the heavily populated eastern region and three high-priority sectorsindustry, energy, and infrastructure. As such, Shanghai Municipal Zone (SMZ) was among the first recipients of ADB loans. The Shanghai Investment and Trust Corporation2 Project was intended to modernize and rehabilitate obsolete and inefficient plant and machinery of the enterprises located in SMZ. Despite its long history as PRCs economic center, the growth and performance of SMZ had lagged behind other provinces during 1982-1986. The loan was to help redress SMZs industrial decline by providing foreign exchange resources to finance the cost of imported equipment needed by small and medium-sized industrial enterprises. 2. The Shanghai International Trust and Investment Corporation (SITICO) was established in 1979 under the ownership and supervision of the Shanghai Municipal Government (SMG). SITICO is a leading international trust and investment company (ITIC) in Shanghai, and has played an important role in fostering the economic development of SMZ by providing long-term loans mainly to state-owned enterprises (SOEs) and PRC-foreign joint ventures. Its main operational activities includedbesides providing long-term (foreign or local currency) loans making equity investments in domestic and foreign joint ventures, providing consultancy services, assisting in the procurement of machinery and technology from abroad, and helping to set up joint ventures in SMZ. To undertake these activities, SITICOs articles of association3 allowed a variety of activities, including lending and investment, consulting and advisory services, accepting savings and trust deposits, issuing bonds, international settlement of letters of credit, and dealing in spot and forward currencies. B. Formulation

3. Subsequent to preliminary discussions with ADB staff in 1987, the Government requested a credit line from ADB during the Country Programming Mission in March 1988 to meet a part of SITICOs foreign exchange requirements for providing assistance to state-owned, collectively owned, and privately owned industrial enterprises, including joint venture enterprises located in SMZ. A project preparatory technical assistance (TA) was not considered necessary, and a Fact-Finding Mission was mounted in June 1988. The Appraisal Mission of August 1988 confirmed that the Project had been given high priority by the Government, and that SITICO was a suitable channel for ADB financing (described below).

The PRC became a member of ADB in March 1986. The first country operational strategy study for the PRC was prepared in 1991. At the time of establishment, its name was Shanghai Investment and Trust Corporation, which was changed to Shanghai International Trust and Investment Corporation (SITICO) in 1993. The name SITICO is used in this report. See Appendix 1 of the project completion report.

2 4. In December 1988, ADB approved a $100 million line of credit (LOC) to the PRC for relending to SITICO, and a line of equity (LOE) of $3 million to Shanghai SITICO Enterprise Co. Limited (SITEN), a subsidiary of SITICO, to support the Governments efforts to encourage foreign direct investment and technology transfer. In addition, a TA grant of $450,000 was provided under the Japan Special Fund for institutional capacity building of SITICO and SITEN. At the time of project approval, ADB was the only multilateral agency assisting SITICO improve the performance of the industry sector.4 The objectives of the Project were to (i) help the PRC foster technology upgrading and modernization of the industry sector by financing equipment investments of viable enterprises in SMZ, (ii) strengthen the role of the SITICO group as a major source of equity financing through SITEN, and (iii) guide and contribute to institutional development of SITICO and SITEN. 5. At the time of project appraisal, the PRCs foreign exchange reserves were not as abundant as it is today and nonstate sector was still developing. Therefore, ADB played an active role in arranging a cofinancing loan of $50 million from the Export-Import Bank of Japan. But this was never finalized.5 Instead, SITICO has secured a number of long-term foreign exchange loans from other sources since the launch of the ADB Project.6 The Project was expected to mobilize $200 million in incremental capital, generate annual foreign exchange earnings of $100 million, and create 5,000 jobs. Although the loan was geared to enhance productivity and improve product quality in established production facilities, it was also available for establishing new projects that would facilitate technology transfer. C. Purpose and Outputs

6. The basic purpose of the Project was to redress the industrial decline in SMZ by enhancing industrial productivity and strengthening SITICO and SITEN in aspects such as project evaluation and debt or equity financing. The expected outputs were sustainable subprojects financed by the LOC and SITENs equity investments, and the enhanced capacity of these institutions to evaluate and supervise such subprojects. The TA was expected to provide (i) services of three consultants for a total of 12 months to SITICO and SITEN in project appraisal, monitoring, and supervision, as well as financial planning and liabilities management capabilities; (ii) overseas training for about 15 middle managers in project appraisal and supervision; (iii) equipment and training f acilities to implement the above training; and (iv) two-month consultancy services to study accounting and management information system (MIS) computerization. The savings from the TA components were utilized to purchase SITICOs first mini-computer and set up an information division in the corporation.7 Since this was the first ADB loan to SITICO and considering its project appraisal capabilities, the free limit for SITICOs approval was set at $1 million. This was raised during implementation to $2.5 million, demonstrating ADBs confidence in SITICOs project appraisal capability.

5 6

Although SITICO was an eligible participating financial institution under the $150 million industrial development project loan to SMG approved by the World Bank in January 1991, it did not utilize this facility. The terms of the cofinancing were not acceptable to SITICO. Since 1990, SITICO has raised two overseas bonds in the amounts of Y35 billion and $70 million. It has also borrowed Y9.15 billion and $145 million on the international markets since 1990. Project documents indicate that the computerization study was carried out with SITICO funds by local consultants. ADB found SITICOs request to use savings of TA components amounting to $150,000 to set up the information division justified.

3 D. Cost, Financing, and Executing Arrangements

7. The loan amount was equivalent in various currencies to $100 million funded from the ordinary capital resources under ADBs foreign exchange risk pooling system (ERPS),8 and attracted a variable interest rate and a commitment charge of 0.75 percent per annum. The loan was to be effective after SITICOs Policy Statement and Development Strategy Statement had been submitted to ADB. The Government was to relend the loan at the same rate to SITICO, the Executing Agency (EA). The loan had a term of 15 years (up to 2003) including a grace period of three years. SITICO was expected to add a minimum spread of 1 percent for onlending to subborrowers and pass on exchange and interest rate risks to them. SITICO would also make arrangements to protect itself from foreign exchange risk from the time of recovery of subloans and repayment to ADB by maintaining and relending these funds in foreign currency. The loan utilization period was four years and the subloan applications were to be submitted within two years of loan effectiveness. The maximum size of the subloan was $10 million. The subproject sponsors were required to contribute at least 15 percent of subproject costs for existing enterprises and 20 percent for new subprojects. Advance purchases made up to 90 days prior to receipt of subloan documents by ADB were reimbursable under the subloan. 8. The LOE of $3 million was to be administered by SITEN, established in 1987 to promote venture capital investments. To be eligible for ADB equity investment under the LOE, enterprises had to be (i) incorporated in the PRC in the industry or service sectors, (ii) be majority privately owned, and (iii) enjoy considerable management autonomy and freedom to determine pricing for their products. The main beneficiaries were expected to be PRC-foreign joint ventures. The minimum and maximum investment limits were $100,000 and $1 million, respectively, and ADBs participation was generally limited to 25 percent of the share capital of the investee enterprise. SITEN was required to make at least a matching investment. In addition, a minimum of 20 percent of the investment cost had to be provided by the sponsors. All appraisals of investment proposals had to be submitted for ADB review within the loan utilization period of two years. 9. The $450,000 TA grant was divided into four components to be implemented according to the terms of reference indicated in the project documents. First was $180,000 to finance the services of three consultants to strengthen project evaluation, project supervision, and financial planning and liabilities management. Second, $170,000 was allocated for overseas training of about 15 middle managers for a duration of 3-6 months. The third and fourth components were provided respectively for a two-month study on computerization of SITICO ($30,000) and provision of office equipment and training facilities ($70,000). The reports of the consultants were to be reviewed by SITICO and ADB, and consultants recommendations were to be implemented with the agreement of both parties.9 10. As part of its restructuring efforts (para. 38), SITICO prepaid the ADB loan in October 1997, six years ahead of schedule. ADB waived the prepayment premium. The prepayment occurred three years after completion, and about two years after the preparation of the project completion report (PCR). SITICOs reason for requesting prepayment was the high cost of servicing the loan, since SITICO had by then gained access to cheaper sources of external funds.
8

At the time of appraisal, the ordinary capital resources rate was 6.53 percent. ERPS was a means ADB had adopted to allocate the foreign exchange risk on loans among its borrowers. Unfortunately, full recommendations of the consultants were not available for the Operations Evaluation Mission review as final reports of three TA components could not be found at either ADB or SITICO, except for one of the parts (financial planning and liabilities management) of the first TA component.

E.

Completion and Self-Evaluation

11. The loan was closed in May 1994 after one extension, six months later than the original schedule with 87 percent utilization. ADB prepared the PCR in January 1996, following the Project Completion Review Mission of June 1995. The PCR attributed the underutilization of the loan to the noncompetitive variable interest rate charges of ADB. However, it did not analyze the repercussion of the foreign exchange risk borne by the subborrowers. Though fairly candid and objective, the PCR did not specify an overall performance rating for the Project. However, it concluded that loan utilization and subproject performance were generally satisfactory. With the benefit of hindsight, it indicated that the covenants should have been designed to cater to the specific needs of nonbank financial institutions (NBFIs) of the PRC. In particular, it noted that (i) special covenants should have been included for SITICO to become more institutionally independent of SMG, (ii) reserves for doubtful debts should have been defined more clearly, and (iii) financial ratios to be maintained by SITICO should have been more realistic given its phase of rapid expansion at the time. It recommended SITICO to (i) establish accounting and MIS procedures to monitor loan and equity portfolio performance; (ii) develop operational rules and regulations to manage problematic loans; and (iii) institute appropriate career development programs for its staff, particularly on securities and derivatives instruments. The Operations Evaluation Mission (OEM) generally agrees with the PCR, but believes that it could have better analyzed the information available at the time to draw useful lessons for future projects. The PCR did not evaluate the consultants performance or present any lessons learned from the design and implementation of the Project and the actual performance of subprojects. F. Operations Evaluation

12. This project performance audit report (PPAR) is based on a review of the appraisal report, the PCR, other documents in ADB files, and records, as well as discussions with staff members of ADB and those met during the OEM. The OEM visited Shanghai in September 2000 and its members met with staff from SITICO, SMG, and the Peoples Bank of China (Shanghai Branch) and visited the sites of five of the 23 subprojects financed by the loan (Appendix 1). SITICO staff were cooperative in discussing many aspects of the Project and provided mainly its publicly available financial data to the OEM. It also helped the OEM obtain responses from six subprojects to the basic questionnaire (in Mandarin) that was forwarded prior to the OEM.10 In Beijing, the OEM visited the ADB office, and met with staff at the World Bank resident mission, as well as the Ministry of Finance (MOF). The major points examined by the OEM included (i) effectiveness of design, (ii) achievement of objectives, (iii) capacity building, (iv) monitoring and supervision, (v) performance of SITICO, (vi) performance of subprojects, and (vii) development impacts and sustainability. 13. Subproject analysis is based partly on the results of a survey completed by six subborrowers. The OEM found it difficult to obtain survey data from some of the subprojects, particularly those that had repaid their loans. The OEM aimed to visit at least one third of the total subprojects, representing several industry categories, and asset and loan sizes. The actual site visits depended on the availability and willingness of subproject owners to meet with the
10

General information on the subprojects was provided in aggregate form by SITICO, but specific details of restructuring, amounts written off, and outstanding balances for each subproject, were not made available to the OEM.

5 OEM and the arrangements made by SITICO. The views of ADBs concerned departments and offices and those of the Government and EA have been considered in preparing the PPAR. II. PLANNING AND IMPLEMENTATION PERFORMANCE

A.

Formulation and Design

14. In general, the LOC served the purpose it was intended for. It provided enough flexibility to cover new and existing demand for upgrading and modernizing industrial enterprises in SMZ (Appendix 2). It also allowed for advance purchase of equipment, 90 days prior to effectiveness. Subloan limits were specified to cater to the potential demand that existed. However, the project design had some fundamental weaknesses. First, it adopted a traditional approach to development finance investments and was not geared toward an economy in transition. As the focus of the Project was on SMZ with many existing SOEs undergoing reforms and restructuring, employment generation as a major development impact was unrealistic. The loan was for the introduction of new technology which, generally in the subprojects financed, helped automate manual and archaic processes thereby leading to reduced employment in SOEs that already had excess employment. 15. Second, it was inappropriate to pass on the foreign exchange risk of a long-term loan to subprojects without their ability to mitigate the risk.11 The subborrowers were all SOEs that were accustomed to operating in a command economy with relatively limited experience of, and exposure to, foreign exchange risks. Foreign currency earned by the subprojects could not be retained and was converted immediately as required under the prevailing foreign exchange regulations. SITICO, as the loan conditions stipulated, took the necessary steps to protect itself against foreign exchange risks between recovering the loan proceeds from the subborrowers and repayments to ADB, by undertaking short-term foreign currency transactions. But it was unable to hedge the risk of its customers.12 16. Third, the LOE was never utilized; it was subsequently cancelled. Market conditions existing at the time made utilization of the LOE under ADBs guidelines impractical. Although the LOE was intended for strengthening SITENs role in equity financing, the eligibility criteria catered more to the establishment of private enterprises. ADB had specified that the investments were to be made in majority privately owned companies, preferably joint ventures, with considerable autonomy in managing their affairs.13 Given the nature of SITICOs mandate and business, the majority of SITICOs existing and potential clients were SOEs or collective enterprises operating under the direction of local governments. In addition, privately owned
11

During project preparation, SITICO expressed concern over ERPS, but was informed by ADB that all public development finance investments were subject to ERPS at the time. 12 Under ERPS, loans were disbursed to clients in various currencies available in the ADB currency pool at the time and were debited to their accounts in equivalent dollar terms. The repayment of the dollar equivalent was carried out in the original currencies borrowed at the prevailing exchange rate, which resulted in the borrowers sharing the foreign exchange risk of the ADB currency pool. Since borrowers had no means to manage the pool of currencies they borrowed, they could not hedge the exchange rate risk. ADB stopped lending under ERPS in 1994, and adopted a single currency ($) lending facility. A proposal for adopting the London interbank offered rate plus margin to determine the interest rate is currently under consideration. 13 Although SITICO requested permission to include ADB financing to meet the minimum private shareholding requirement, ADB did not agree as ADB was a multinational financial institution owned by governments of member countries.

6 companies had just started emerging, and those that had been established could access funds from other investors. Finally, the stock market was in its infancy and other secondary markets were not well developed. Nevertheless, SITICO continued to make direct equity investments from its own sources, which currently stand at approximately $508 million.14 17. Fourth, the Project concentrated only on the credit needs of the enterprises and did not ensure that other factors like appropriate marketing channels, entrepreneurship training, management techniques, and enterprise autonomy were available to the enterprises to compete in a fast reforming environment. In the absence of a project preparatory TA, there was neither an analysis of the basic requirements for the loan to achieve its objectives nor a policy dialogue to ensure an enabling environment for the subprojects to prosper. To maximize the effectiveness of ADB lending, the project design should have incorporated mechanisms to ensure that subprojects had access, besides long-term finance, to the above factors, which are required for efficient industrial development. 18. Fifth, the OEM agrees with the PCR that the covenants were more designed for a typical development financial institution, and paid little attention to the unique mandate and diversity of SITICOs businesses. Special covenants should have been included for SITICO to become more institutionally independent of SMG. Clearer and well-defined provisioning requirements for bad and doubtful debts should also have been specified. 19. The design of the TA, including the terms of reference, was appropriate and provided long-lasting benefits to SITICO. The OEM was advised that SITICOs project appraisal greatly benefited from the consultancy and overseas training. SITICO continued to make further investments in computer acquisitions and enhancements to office automation and MIS. B. Achievement of Outputs

20. The selection of subprojects for financing under the LOC was consistent with the main project objectives to modernize and expand the industry sector in SMZ. The subborrowers were all SOEs or collectively owned enterprises. In all, 25 projects were submitted for approval and $98 million (98 percent of the loan funds) had been committed by May 1992. The loan request, review, and approval process flowed smoothly and effectively with an average turnaround time of two months. Minor delays that occurred were attributed to incomplete financial information submitted by the subprojects to SITICO at the time of application. Two subloans were cancelled prior to disbursement because the borrowing entities were restructured and merged with others. 21. Although most of the LOC was committed two years prior to loan closing in May 1994, actual disbursements including the commitment fees and capitalization of subloan interest during construction (IDC)15 amounted to $87.2 million. The underutilization of the committed amount was due to (i) liberal provision by subborrowers for cost overruns,16 (ii) lower than anticipated equipment costs after commercial negotiations with suppliers, and (iii) the cancellation of two projects. Thirteen subprojects were completed on schedule and 10 had delays in completion ranging from two to 27 months.

14 15

Market conditions have developed since then and a second board stock market is being considered. At loan negotiations, the Government had requested financing of IDC out of loan proceeds. As the ADB policy on financing IDC under LOCs was under consideration at the time, the decision to allow such financing was postponed until after the approval of the policy change in January 1992. 16 The total cost of the subprojects was 38.5 percent less than the original total estimate of Y1,148 million.

7 22. All 23 subprojects (Appendix 3) were located within SMZ and represented a balanced distribution of the loan across industry sectors with the textile industry representing 22 percent; light industry (17 percent); machinery manufacturing (12 percent); metallurgy (9 percent); and the balance representing telecommunications, harbor operations, electronics, and chemicals. All subloans were used for technology upgrades through modernization (10) and expansion (13). No new enterprise was financed under the LOC. The subloans varied in size from about $1 million to $10 million, with about half between $2 million and $5 million, and five loans over $5 million. All subprojects were submitted for ADB review and approval as none fell within SITICOs delegated authority despite an increase in the free limit in April 1991 to $2.5 million. Approved subloan maturities ranged from less than 3 years to 10 years with six subloans having medium-term maturities of 2-5 years, and 17 subprojects with long-term maturities of 5-10 years, all well within the loan tenor of 15 years. 23. An indirect goal of the Project was to promote exports and generate foreign exchange. The Project was expected to generate annual foreign exchange earnings in excess of $100 million.17 Neither ADB nor SITICO monitored the export performance of subborrowers during the life of the loan, nor did the PCR analyze it. Given the passage of time and lack of enthusiasm of most of the subborrowers to meet with the OEM, the PPAR is unable to present the necessary data and evaluate the achievement of this target. The PCR noted that initially, nine subborrowers were geared for export. Of the five subprojects visited by the OEM (Appendix 4), four were still exporting a share of 25 to 75 percent of their production. Similarly, it was not possible to analyze the employment generation objective given the lack of monitoring data and substantial layoffs that had been carried out in SOEs during the project implementation period. Some SOEs found peripheral employment (in cafeterias, shops, etc.) for their employees who were made redundant as a result of technology upgrading implemented to achieve productivity gains. C. Cost and Scheduling

24. The Project was approved on 13 December 1988, within nine months of its inclusion in the proposed projects list of the country programming mission, and within six months of the factfinding mission. However, it did not become effective for almost another year pending compliance with loan effectiveness conditions.18 ADB staff evaluated the subloan applications during the period between loan approval and effectiveness, thus minimizing the impact of the delay on project implementation. SITICO utilized 87.2 percent of the LOC amount (para. 19). Cumulative utilization at the original closing date of 27 November 1993 stood at $85.6 million. The closing date was extended by six months to commit the remaining $1.6 million. On 27 May 1994, SITICO requested that the balance of $12.8 million in undisbursed funds be cancelled. The LOE of $3 million also had to be cancelled because SITEN could not find any qualified subprojects (i.e., majority privately owned). About 99 percent of the TA grant was utilized with the savings in the cost of consultancy services being diverted to purchase a mini-computer and to establish an information division in SITICO. D. Procurement and Construction

17

Exporters at the time could not retain the foreign exchange and had to convert it to local currency at the official exchange rate. 18 The project agreement and the loan agreements were signed respectively on 12 and 18 November 1989.

8 25. As anticipated, the subloans were used to import state-of-the-art technology and equipment from about 16 countries with over 50 percent in value coming from Hong Kong, China; Italy; and Japan. The PCR reports that the procurement was made according to ADBs Guidelines for Procurement, mostly using the international shopping method. SITICO or the subprojects that OEM visited did not highlight any procurement-related problems. Since the loan was used to upgrade technology within the existing facilities of subborrowers, construction was not among the activities financed under the LOC. E. Organization and Management

26. Monitoring. During project implementation, monitoring and supervision was to be done at two levels: SITICO operations were to be monitored by ADB and the subprojects were to be monitored by SITICO. ADBs monitoring of SITICO was done through submission of appraisal reports of subprojects and periodic financial reports of SITICO. Only one review mission was fielded during the entire implementation period, from 25 to 31 January 1991, over two years after project approval. The Project Completion Review Mission and the OEM were carried out after loan closing. The OEM agrees with the PCR that more frequent review missions were called for, and would have improved the performance of the Project, helped address some of the difficulties the subprojects were undergoing during implementation, and facilitated benefit monitoring and evaluation. 27. SITICO staff monitored subprojects by evaluating their repayment patterns, analyzing periodic reports on their financial performance, and making periodic site visits. The focus of SITICOs monitoring was the repayment capabilities of the subprojects. Therefore, SITICO did not gather information on development impacts of the Project, presumably because ADB did not emphasize this at the time. It restructured several subloans based on the expected operational and financial performance of the subprojects. After fully repaying the ADB loan, SITICO converted subloans into local currency loans to help its clients avoid exchange risk. 28. Consultant Performance. According to OEM discussions with SITICO, the performance of consultants was good once they had an understanding of the characteristics of PRCs transition economy. According to SITICO, consultant evaluation of SITICO operations and the training activities that they conducted enabled substantial technology transfer. The OEM is unable to independently evaluate consultant performance due to the lack of documentation and the unavailability of four out of the five TA final reports that were to be prepared. SITICO staff were trained to better evaluate projects and undertake prudent lending. Subsequent to the consultant recommendations, changes were made to project approval procedures with the establishment of a project appraisal committee to assess and manage risks. Monitoring systems were adopted for loans, returns-on-equity, interest rates, etc., and SITICO staff were trained in standard funds-flow forecasting techniques. 29. Covenants. SITICO generally complied with the covenants (Appendix 5) stipulated in the Loan Agreement, with exceptions in some cases in meeting the minimum contributions to the total project cost by subproject sponsors and delays in the timely submission of quarterly reports and audited financial statements to ADB. The covenants were designed to assist ADB in monitoring the financial and organizational performance of SITICO. The long-term debt-equity ratio and total debt-equity ratio of 5:1 and 10:1, respectively, were maintained throughout the life of the loan and even after repayment. Debt service coverage of not less than 1.25:1 was also maintained.

9 30. Covenants requiring SITICO to maintain adequate provisions for bad and doubtful loans and investments were not clearly defined. SITICO had set aside reserves for loan and investment losses in excess of what was permitted at the time under MOF regulations (para. 66) by making additional provisions on an after-tax basis. However, such provisions were inadequate to cover potential losses given the quality of the portfolio. Nine of the 23 subprojects19 did not meet the stipulated minimum contribution by sponsors of subprojects. III. ACHIEVEMENT OF PROJECT PURPOSE

A.

Performance of Subprojects

31. To a large extent, subprojects under the loan facility fared well. Of the 25 projects originally approved by ADB and SITICO, two were cancelled (para. 20). Fourteen borrowers representing 53 percent of the loan amount fully repaid the subloans. Two subborrowers, one in the textile industry and the other in electronics, went bankrupt. Of the remaining seven, representing 25.2 percent of the total loan amount, four continue to repay SITICO according to long loan maturities originally granted under the LOE, while the other three are facing serious difficulties. Many subloans required restructuring due to the severe problems caused by the foreign exchange adjustment burden (Figure 1). Partial interest has been forgiven by SITICO on the troubled loans and a reduction of the interest rate granted on a number of subloans (following repayment of the ADB loan). In general, most subprojects were successful in upgrading their equipment and surviving the transition to a market economy. Based on site visits and information reviewed, and given the ownership structure of the borrowers, overall performance has been positive in the face of reforms and the challenging environment.

19

However, two had contributions from SITICO to meet the 15 percent contribution by sponsors.

10

Figure 1 : Ave ra ge Ex c ha nge Ra te of Yua n Aga ins t US Dolla r (1 9 8 8 -1 9 9 9 )

10 9 8 7

Yuan/US$

6 5 4 3 2 1 0 1 988 1 989 1 990 1 991 1 992 1 993 1 994 1 995 1 996 1 997 1 998 1 999

Ye a r
32. Financing the subprojects under the loan facility came at a very opportune time when many other sources of foreign currency loans were held up as a result of negative political developments.20 A majority of the SOEs that benefited from the loan facility would have had difficulty in maintaining efficient production given the obsolete state of their machinery. Some subprojects were able to export their products (para. 23). 33. Only one of the five subprojects that the OEM visited could be categorized as an outright failure. The subproject (producing plastic products) was conceived with poor planning and limited market knowledge. Production was hampered by existing equipment that could not match the capacity of the highly sophisticated equipment acquired through ADBs financing. In addition, given the lack of market knowledge, the product mix could not be changed to cater to client preferences. Finally, management decision making was constrained by other influences. The subproject has remained relatively idle for the past three years, and SITICO will incur losses as a result.21 The four other projects visited vary in their degree of success, but overall are doing well. One of them, a rubber and tire company, has grown and is said to have become a world player ranking 15th (worldwide) in the tire industry. A light manufacturing company producing industrial blades attracted a foreign partner due to its strong market position helped by the ADB loan. Two other textile companies remain in business and are performing relatively well despite the difficulties encountered in textile manufacturing and fierce external competition. ADBs financing helped them modernize to remain viable and competitive, while many of their counterparts had to shut down.

20

The loan was approved a few months prior to the 1989 Tiananmen events, which virtually halted all foreign investments to the PRC. ADB continued disbursement under the approved loans but stopped new loan approvals for about a year. 21 Due to stringent regulations, SITICO has not been allowed to write off this loan as yet.

11 B. Performance of the Operating Entity

34. Operational Performance of SITICO. In 1992, the Government reduced its direct involvement in the management of the SITICO group and established new entities to hold its share ownership in different enterprises. The Shanghai International Group holds SITICOs share on behalf of the Government. The current shareholding of SITICO consists of 14 shareholders, all of which are SOEs, with SMG representing 66 percent. After years of reliance on lending activities as the predominant source of revenue, SITICO has refocused its operations in response to the evolution of the finance sector. 35. SITICOs operations witnessed tremendous growth in the 1990s in its different lines of business (Appendix 6). Total revenues grew from Y246.5 million in 1988 to Y2,792.8 million in 1997 at an average annual rate of 27.4 percent (Figure 2). With the ADB loan and SITICOs focus on commercial lending, revenue from financing operations increased steadily from 69 percent of total revenues in 1988 to 93 percent in 1990. As SITICOs operations strengthened, the company began to diversify into other areas for its revenue stream, and income from investment and other operations began to gain importance. From 1992 onward, revenue from commercial lending activities dropped to an average of 75 percent of total revenues. Figure 2: SITICO Total Revenue and Profits

3,000 2,500 2,000

Y million

1,500 1,000 500 0 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1999

Income

Profit Before Tax

36. With its rapid expansion beginning in 1992, SITICO understood the need for a review of its operational strategy. In 1995, it set up new businesses such as the investment banking division responsible for financial advisory services, asset management, mergers and acquisitions, an international division, a legal division, and the Shainvest Company.22 This resulted in a rapid increase in income from investment, fiduciary, and real estate operations. The traditional focus on commercial banking was downplayed for eventual phasing out. To meet its capital needs, SITICO increased its registered capital from Y1.5 billion to Y2 billion at the end of 1995.

22

Incorporated in Hong Kong, China, Shainvest is responsible for developing business in Southeast Asia.

12 37. By 1997, the financial market in the PRC began to exhibit strain from the fast growth experienced earlier in the decade. Borrowers and financial institutions alike suffered as a result of excessive lending, speculative investments, and real estate construction in excess of demand. In response, from 1997, SITICO focused on enhancing asset quality by tightening its risk management, adjusting its credit structure, and improving its portfolio quality and return on capital. Operations were further streamlined through elimination of redundant layers. With the investment banking operations strengthened, SITICO has remained one of the active members of the Shanghai Stock Exchange in recent years.23 Equity investments continued in joint venture and domestic companies, representing a rough mix of 40 percent and 60 percent, respectively. The securities business became the mainstay of the corporation with total transaction volume exceeding $2 billion annually. 38. The restructuring of the SOE and industry sector created the impetus for SITICO to establish a new trust division in 1998. SITICO saw the opportunity to become involved in this activity to further enhance its consulting and investment banking activities. The trust division was further expanded in 1999, in preparation for the new trust law. It sought opportunities in underwriting and managing clients funds including securities, industrial, high technology, and venture funds. SITICOs operations in terms of growth and profitability peaked at the end of 1997 (Figure 2). Since then, SITICO has further cut back on commercial banking activities, which brought gross income down by 46 percent and 58.2 percent for 1998 and 1999, respectively. 39. The need to restructure, rationalize, and further consolidate took on real urgency. With the adverse effect created by the collapse of Guangdong International Trust and Investment Corporation, raising foreign debt became difficult. International credit ratings of SITICO were allowed to lapse. In 1998, it achieved a noteworthy milestone by paying back all its foreign denominated debt, totaling $139 million.
Financial Performance of SITICO. Consolidated financial statements for all its 40. subsidiaries are prepared by SITICO and are audited by Shanghai certified public accountants in accordance with the Accounting Standard of Enterprises issued by MOF, which has issued unqualified reports since the start of the Project (Appendixes 7-10).24

41. SITICO shows a sharp rise in revenue growth between 1991 and 1994 (Appendix 8) as a result of new loans approved and other income from investment and real estate activities.25 However, income growth declined steadily since 1994 as a result of the reining in of activities, consolidation efforts, and restructuring. Despite the steep decline in revenue that began in 1997, average annual revenue growth for 1989-1999 remained at 20.8 percent. During the same period, SITICOs net profit as a percentage of total revenue averaged 15.8 percent, indicating its long-term profitability. Net profit, which stood at Y33.6 million in 1989, reached a high of Y605.5 million in 1997, and then declined to Y147.8 million by the end of 1999. Following the shift of its business focus to investment and trust operations, income in these areas began to play a more significant role as it climbed from 20.8 percent in 1995 to 34 percent in 1999. During this period (1995-1999), SITICO gained importance as a major player in
23

The failure of Guangdong International Trust and Investment Corporation in 1998 created a negative impact on the ITICs international ratings. At the request of SITICO, ratings have been allowed to lapse and subsequently withdrawn. 24 Audited financial statements (although in line with current practices in the PRC) made available to the OEM do not reveal as much detail as current international practice regarding charge-off and recoveries, or any other details on specific provisions. 25 Compared to the projections made in the report and recommendation of the President, SITICO attained the targets for net profit/average equity and earnings spread with a lag of 3-4 years.

13 consulting and advisory services, and as a lead manager to large projects in SMZ. On the other hand, real estate operations, general administration, and loan loss provisions as a component of total expenses rose dramatically from 14.3 percent in 1995 to 37 percent in 1999, reflecting mainly the deterioration of asset quality. The increase in unearned interest revenue further confirmed the deterioration of the loan portfolio.26 42. This prompted SITICO to assume an active role in managing the asset portfolio. Thus SITICO continued to reduce its exposure to commercial real estate while focusing on the residential sector, which had strong demand and promised better returns. In response to asset quality deterioration, the shareholders again increased the paid-in capital to Y2.5 billion in 1998, demonstrating their confidence in SITICOs consolidation efforts. Reflecting prudent practice, SITICO set aside additional reserves after tax for doubtful assets and loan losses for the period 1996 to 1999. Furthermore, SITICO Investment Management Company was reorganized in 1998 with its registered capital increasing from Y750 million to Y1 billion, and charged with consolidating and restructuring the nonperforming assets. Reserves for bad and doubtful debts were increased by Y211 million during 1999 and stood at Y516.3 million at the end of 1999. 43. SITICOs assets grew from Y4,642.5 million in 1989 to Y23,556.2 million in 1999 (Appendix 9), yielding an average annual growth rate of 36.2 percent until 1994, which then decelerated to 2.1 percent during 1995-1999. Gross medium- and long-term loans peaked in 1998 when they stood at Y6,982.5 million. The initial rapid growth was coupled with an increase in liabilities as SITICO increased its deposit mobilization and took on additional external borrowings to fund its activities. Current ratios were maintained at between 1 and 2 times and did not drop below this range during 1989-1999. Long-term debt to equity was at a reasonable level of 4 times in 1995, but improved to 2.2 times in 1999 following the capital increase. 44. CAMEL27 analysis shows (Appendix 10) a high leverage ratio of 8.3 times; this peaked in 1995, as a result of increased borrowings to meet loan and investment demands. It dropped to 5.1 in 1999 after SITICO in 1997 embarked on repayment of its external debt. This leverage level is acceptable for a development bank. Asset quality, as highlighted earlier in the analysis, shows a steady deterioration resulting from rapid growth and poor credit risk management. Other banks and NBFIs had similar experiences in the PRC during the same period. Loans in arrears (Appendix 11) as a percentage of gross loans began to increase sharply from 1.3 percent in 1994 to 22.8 percent in 1996 and 20.7 percent in 1997.28 Loan loss provision was also increased to 1.9 percent in 1999. It appears insufficient given the asset quality, but better than the guideline of 1 percent stipulated by MOF. A review of management performance indicates an aggressive growth posture and high earnings at the expense of asset quality. However, management should be commended for taking early action to diversify operations and make additional loan loss provisions on an after-tax basis, a practice not common in the PRC.
C. Technical Assistance

45. The TA is rated successful. It was useful in providing several capacity-building measures at SITICO. The first computer hardware (AS 400) and software system for financial management was set up as a result of the TA. Although not initially intended, savings from other components of the TA were utilized with the approval of ADB to purchase an advanced software and hardware system to automate SITICO business processes. The integrated financial
26 27

SITICO did not make available the risk rating classifications of the loan and investment portfolio to the OEM. Capital adequacy, Asset quality, Management effectiveness, Earnings, and Liquidity position. 28 SITICO did not share data for subsequent years with the OEM as the ADB loan was fully repaid in 1997 (para. 6).

14 accounting software program designed and installed in 1992 is still being used in combination with a network of 200 computers purchased later by SITICO. The hardware has been upgraded to keep up with technological advances. In August 2000, SITICO purchased new computer equipment to further automate its business processes and conduct paperless online transactions in preparation for its new predominant role as an investment and trust company. 46. Overseas training provided by the TA also appears to have been successful. Two batches of middle level staff totaling 15 people from SITICO and SITEN were trained in project appraisal and supervision techniques in Manila and Singapore; and in turn, they trained the remaining account officers to form a team to appraise and supervise projects. Some of the staff members who received overseas training are now in key management positions. Staff have been using the training manuals prepared (in English) by the consultants for several years.
D. Sustainability

47. The main development impact of the Project has been the ability of the SOEs to survive the past decade with the help of the subloans under the Project. The subloans were used to import modern technology and equipment from industrialized countries. It appears that most of the subprojects would not have survived the reforms had it not been for injection of funds to upgrade technology. The ADB loan was made available at a time when many foreign investors were reluctant to invest in the PRC. Following the ADB loan, SITICO was able to raise about $600 million from other sources for its operations. 48. When the technological advancement of a subproject was coupled with market emphasis and skill training, the subprojects generally prospered and the productivity of their employees increased. However, in some cases, despite the revamping of the enterprises, they were unable to find appropriate markets and did not have the experience, information, or agents to help them. Almost all subprojects faced fierce competition from both outside and inside the PRC, and several changed their product mix and improved productivity to face market challenges. However, given the burden of large pools of employees, some SOEs were unable to be competitive. Others, which received help by way of joint ventures or opening up sales windows abroad, were able to cut employment substantially. Enterprises in this category appear to be sustainable and are able to service the subloan or have already repaid it fully. At present, due to the rapid advances in technology in some sectors (e.g., telecommunications), even those enterprises that survived at the time now need to further upgrade their equipment. Only a few, reportedly, have their own funds for this purpose. The continued sustainability of such enterprises, therefore, lies in their ability to finance further upgrading of their equipment and rationalization of their labor costs.
IV. ACHIEVEMENT OF OTHER DEVELOPMENT IMPACTS

A.

Socioeconomic Impact

49. The Project had several positive multiplier effects in generating economic activity. Some subprojects that were visited provided indirect business opportunities to the employees who were laid off, in cafeterias and stores adjacent to the factory. Others that survived the onslaught

15 of the reforms and competition continued to provide employment not only to their employees, but also helped other enterprises in their group by absorbing the job losses of those enterprises that could not operate profitably. In addition, by upgrading technology, they provided backward and forward linkages to other enterprises in related industries. The Project did not target women, and there were no specific provisions to promote women and their development. But a number of subprojects, especially textile and light manufacturing enterprises, employ a substantial number of female workers.
B. Environmental Impact

50. As the Project was approved in the late 1980s, the project approval documents contained no environmental mitigation measures or related clauses. Because most of the subprojects financed were light assembly type, the environmental compliance required was generally good housekeeping practice and/or wastewater treatment facilities. However, the Project had no significant impact on the improvement of environmental performance. In some subprojects visited, wastewater treatment plants constructed in the 1970s are operating and the laboratories are in working condition. Some housekeeping was needed in most enterprises. Scrap materials from discarded equipment appear to be stored on factory premises for a long time prior to recycling. Environmental management in subprojects varied depending on the inbuilt facilities (e.g., bags to collect fibers from cloth) and the extent of management focus on environmental concerns. Some enterprises producing mainly for export were careful about disposal of waste material, but some others did not even have proper employee safety standards. Some enterprises generated high volumes of fiber during production, but did not provide protection masks for workers (mostly women). However, the workers wore caps to prevent their hair from getting caught in the machinery. Though the noise level in some production areas was extremely high, the workers were not provided with earplugs. 51. Even though environmental regulations are in place, it is often very difficult to enforce them in practice. Therefore, it is useful to consider alternative incentives and penalties to encourage environmental compliance. In other LOCs, compliance with environmental regulations is often attached as one of the conditions that financial intermediaries have to evaluate prior to approving or restructuring subloans. This requires training of financial intermediary staff to understand the basics of environmental management in the subproject, as well as an ADB review of how environmental compliance is being handled by the financial intermediaries and the subprojects.
C. Impact on Institutions and Policy

52. SITICOs operations have matured since the loan was granted by ADB, and so have its staff. It is evident that the initial training for project appraisal and the overseas training had an impact on SITICOs current practices. SITICO has become more cautious in selecting deals and is pursuing higher quality assets. Its advisory and investment services arm has a high profile and has succeeded in securing prestigious mandates. 53. Following the recommendations of the TA, SITICO has continued to emphasize staff training. SITICOs training functions are managed under the Human Resources Division. Selected staff members are sent by SITICO for external short-term training from time to time, and on their return, they generally impart their knowledge to fellow staff who work on similar

16 aspects. Ten staff members are, for example, currently attending Masters in Business Administration courses in universities. SITICO expects that for it to fulfill its future role, its staff will need further training, especially in risk management and structured finance. 54. Following the TA on financial planning, SITICO is pursuing new lines of business in its effort to consolidate its activities in line with the new trust law currently being drafted. Since 1995, SITICO has modified its organizational structure (Appendix 12) to match the changes in operations. Due to the indefinite status of the new trust law (Appendix 13), it remains unclear as to how much preparation and staff development need to be carried out to meet the requirements of the new law, as well as to respond to market developments. 55. Considering that SITICO is an arm of SMG, its commercial orientation and expertise in dealing more vigorously with problem assets remain underdeveloped. The same loan officers that have dealt with the account relationship during favorable times continue to do so as these assets have become nonperforming. Managing troubled debt requires the time and special expertise that the loan officers may not possess.

17

V.

OVERALL ASSESSMENT

A.

Relevance

56. The Project is rated relevant given the Projects goals and purpose. The objectives were in line with ADBs interim operational strategy at the time. Similarly, the TA was relevant given the institutional strengthening that was needed. However, the LOE was premature and its design did not correspond to the objectives of strengthening the role of equity financing that existed at the time of project formulation.
B. Efficacy

57. The LOC helped modernize and rehabilitate some of SMZs existing obsolete and inefficient plant and machinery. However, due to the absence of an appropriate enabling environment, some subprojects had difficulties in achieving this objective. The TA was helpful in providing the basis for several capacity-building measures to SITICO that resulted in systems upgrades and human resource development through training. The premature LOE did not achieve its purpose. Given the lack of adequate analysis and preparation for some of its components to achieve the intended output, the Project is rated less efficacious.
C. Efficiency

58. The Project had several components: the LOC, TA, LOE, and cofinancing arrangements that were envisaged. The LOC and TA were disbursed without undue delays and complications. Savings from the TA were diverted to strengthen the information division of SITICO. The consultancy services provided to strengthen SITICO enabled it to become a more efficient and capable financial institution. The benefits of the LOE and the cofinancing arrangements were not realized.29 The Project is rated efficient considering the use of the inputs that it provided. The lack of preparatory work that should have been done prior to project approval has already been considered under the efficacy rating.30
D. Sustainability

59. In the absence of detailed financial and other economic data, it is inappropriate to rate the sustainability of the subprojects. SITICO has, though, matured as a financial institution with enhanced capacity and improved operational strategies and practices in several areas, including project appraisal, MIS, consulting, and advisory services. Given normal
29

The LOE was never utilized as eligible investments could not be found, while the cofinancing agreement was not signed as SITICO did not agree to the terms and conditions. 30 The weaknesses in the ADB performance during the implementation of the Project are not considered in the overall project rating; they are considered separately in para. 62 and the section Lessons Identified.

18 circumstances, it is likely that SITICO will be able to survive the competition and operate successfully. Therefore, project sustainability is rated likely. However, with the current state of flux that the ITICs are going through and the anticipated regulatory changes about to take place under the new trust law and other pending securities laws, future sustainability of SITICO depends both on the mandate that it will receive and on the institutional capacity building that it needs in order to undertake that mandate.
E. Institutional Development and Other Impacts

60. The institutional development of SITICO is rated moderate. SITICO has developed the necessary skills to carry out its activities and is attempting to respond to anticipated changes. Not knowing what the future entity would look like, it is difficult to determine how SITICO is positioned as an institution to handle its new role. It has, in the past, shown its ability to adapt to a changing environment and displayed its maturity and prudent practices by reviewing its operational strategy, redirecting its investments, and improving asset quality. Given its experienced management, and its emphasis on staff training and information management, SITICO has the potential to adapt into a dynamic institution under the pending ITIC regulations.
F. Overall Project Rating

61. The Project is rated successful overall (Table 1). Given the project design and its objectives, it is considered to have been appropriate at the time. A majority of the subprojects that have benefited from ADB financing are operating normally, while some have faced difficulties and SITICO has over time helped them survive. As an institution, SITICO has fared relatively well and has gained prominence in certain areas such as investment banking, aided by the project inputs. The TA has been productive, but the premature LOE was not utilized.
Table 1: Overall Project Rating

Criterion
1. Relevance 2. Efficacy 3. Efficiency 4. Sustainability 5. Institutional Development Overall Rating

Assessment Relevant Less Efficacious Efficient Likely Moderate S

Rating (0-3) 2 1 2 2 2

Weight (%) 20 25 20 20 15 100

Weighted Rating 0.40 0.25 0.40 0.40 0.30 1.75

Assessment Ratings: Relevance: 3 = highly relevant; 2 = relevant; 1 = partly relevant; 0 = irrelevant. Efficacy: 3 = highly efficacious; 2 = efficacious; 1 = less efficacious; 0 = inefficacious. Efficiency: 3 = highly efficient; 2 = efficient; 1 = less efficient; 0 = inefficient. Sustainability: 3 = most likely; 2 = likely; 1 = less likely; 0 = unlikely. Institutional Development and Other Impacts: 3 = substantial; 2 = moderate; 1 = little; 0 = negligible. Overall Rating: HS = highly successful S = successful LS = less than successful U = unsuccessful 2.5 < HS 3.0 1.6 S 2.5 0.6 LS < 1.6 < 0.6

19
G. Assessment of ADB and Client Performance

ADB Performance. The loan was prepared fairly quickly without the benefit of a project 62. preparatory TA or previous experience in dealing with the client. The project design had several weaknesses (paras. 14-19), some of which stemmed from ADB lending policies at the time, as well as inadequate evaluation of the particular circumstances of the PRCs transition economy. Given the importance and size of the loan, ADB performance was clearly less than satisfactory in monitoring the Project closely through regular onsite visits and relied mostly on reporting requirements. More frequent field visits would have enabled ADB to recognize early on some of the drawbacks of the LOC and help correct the situation. Because this was one of the early loans to the PRC, and especially to a transition economy, it was imperative that ADB staff supervised the implementation of the Project more closely and encouraged SITICO to adopt best development finance practices.

63. Client Performance. As expected, SITICOs focus was on the repayment capacity of the subprojects; and in the absence of ADBs impetus, closer monitoring of the subprojects to obtain the necessary data on development impacts was not considered. With the exceptions noted in para. 29 regarding a few covenants that SITICO partially complied with, in general it abided by the Loan Agreement. As could be expected of a government-controlled financial institution, SITICO was flexible in restructuring the overdue loans and providing working capital to help some troubled enterprises get back on their feet. It prepaid the ADB loan and converted the remaining overdue subloans into local currency long-term loans. In the face of fast evolving financial markets, SITICO managed to respond effectively by streamlining its operations, enhancing its asset quality, and diversifying its portfolio. Therefore, the performance of SITICO is rated satisfactory.
VI. ISSUES, LESSONS, AND FOLLOW-UP ACTIONS

A.

Key Issues for the Future

64. The Government is currently drafting a new trust law, which will provide a legal basis for the trust concept.31 When designing the specific regulatory details to govern the ITICs, it should look into appropriate operational guidelines for NBFIs to encourage more autonomy, use proper loan classifications and provisions, and ensure that appropriate supervision measures are in place to obtain early warning signals of oncoming difficulties.32 For the ITICs that may be dissolved, social impact assessments and mitigation measures need to be prepared in addition to their restructuring strategies. 65. Several SOEs operating in SMZ still lack operational autonomy and commercial viability. It is evident from the evaluation (para. 17) that credit was only one of the inputs that were needed by the SOEs to operate in a market economy. Therefore, SMG needs to undertake restructuring of these enterprises. In particular, SMG should encourage more autonomy in management of enterprises through the establishment of joint ventures and private companies.
31 32

It is unlikely that the new trust law will provide the necessary details on governing ITICs. ADB financed a study of NBFI (TA 1941-PRC) in 1993. In addition, ADB is currently assisting the Government to draft the new trust law and review the insolvency law as part of ADBs law and policy reform program in the PRC (TA 3032-PRC).

20 It also has to ensure that viable enterprises have appropriate links within and outside the PRC to make sure timely responses to technological changes and market conditions are undertaken. Through the creation of appropriate social safety nets and pension funds, the pressure on the enterprises to carry an excessive employment burden can be eased.33 66. The current procedures specified by MOF make it very difficult for SOEs to declare bankruptcy and, as a result, for ITICs to write off bad debts. They promote unhealthy and distorted delays in portfolio cleanup. This prevents the ITICs from making adequate provisions for loan losses and misrepresents the profits before taxes. In addition to reviewing its Bankruptcy Law, the Government should require the ITICs to classify their assets according to standard international accounting practices and allow them the freedom to allocate sufficient provisions before profits to depict an accurate picture of their financial position.
B. Lessons Identified

67. ADB projects of a similar nature in transition economies should move away from the traditional LOC design, carefully consider the constraints and needs of enterprises in a transition economy and their ability to cope with reforms, and provide for associated risk factors. Specifically, ADB should address the following points: (i) ADB should ensure, through policy dialogue, project design, or donor coordination, that not only are enterprises credit needs met but also that they operate in an appropriate enabling environment (e.g., appropriate government policies and streamlined bureaucratic procedures, technical skill enhancement, marketing information, adequate infrastructure facilities) to sustain the transition to a market economy. If not, the LOC will not be truly effective. When the foreign exchange risk is passed on to subborrowers, ADB should make arrangements to increase subborrower awareness of the risk involved. It should discuss with the Government and the EA possibilities for minimizing the risk (i.e., hedging the risks or retaining the subborrowers foreign exchange earnings, if any, to service the loan). In establishing the covenants for the financial intermediaries, ADB should carefully consider the mandate and the diversity of the institution, and specify special covenants to ensure its prudent lending practices and independence as an institution. Project documents for LOCs need to include environmental covenants to require subprojects to comply with the environmental regulations governing their enterprises.

(ii)

(iii)

(iv)

68. Financial institutions such as SITICO need to examine the projected cash flows of subprojects to determine realistic maturity periods and monitor subborrowers operations carefully. They should also use staff with specialization in problem accounts and collection to work together with the account officers when loans remain in arrears beyond a certain period. In addition, they should effectively carry out loan and investment monitoring through the use of a

33

ADB is currently assisting the PRC in social security reforms (TA 3148-PRC).

21 risk-rating system that will help in identifying early warning signs and in segregating problem assets at an early stage.
C. Follow-Up Actions

69. SITICO has taken significant steps in reorganizing its structure to cater to its market potential and is further automating its business processes using the latest technology to become competitive in its business niche. To continue its focus on prudent and efficient operations, SITICO needs to make the following adjustments as indicated in Table 2.
Table 2: Recommendations and Follow-Up Actions Entity Entity Responsible Recommendations and Follow-Up Actions Responsible for for Action Monitoring

Timing

1. Increase level of loan loss provisions based on the proper loan classification of SITICOs portfolio reflecting either the new Peoples Bank of China classification or the international accounting practice.a 2. Prepare a human resource development plan identifying skills, experiences, and competencies required for the various positions and incorporate a program for staff goal setting, assessment, training, recruitment, and personal compensation linked to the individual goals and SITICOs own targets. 3. Build flexibility in the investments for management information system upgrading to adapt to SITICOs future role.

SITICO

MOF

Within six months

SITICO

SMG

Within one year

SITICO

SMG

Immediate

MOF = Ministry of Finance, SITICO = Shanghai International Trust and Investment Corporation, SMG = Shanghai Municipal Government. a Current Peoples Bank of China guidelines for loan classification were not mandatory for SITICO at the time of the Operations Evaluation Mission. Once the loans are classified to different risk classifications, general loan loss provisions are calculated for inherent but unidentified losses existing in pools of homogenous loans. These reserve percentages are based on loss experience in the relevant categories. The general provisions may increase from 1 percent for unclassified loans to at least 20 percent for substandard loans and at least 50 percent for doubtful loans.

22

APPENDIXES

Number

Title

Page

Cited on (page, para.)

1 2 3 4 5 6 7 8 9 10 11 12 13

Overview of Subproject Financing Implementation Data Overview of Subprojects and Current Status Selection of Sample Subprojects Compliance with Loan Covenants SITICO: Key Performance Indicators SITICO: Consolidated Cash Flow Statements, 1995-1999 SITICO: Income Statements, 1988-1999 SITICO: Consolidated Balance Sheets, 1988-1999 SITICO: Camel Analysis SITICO: Loans in Arrear, 1989-1997 SITICO: Organizational Charts International Trust and Investment Companies

21 22 23 24 25 26 27 28 29 30 31 32 34

4, 12 4, 14 6, 22 7, 23 8, 29 10, 35 11, 40 11, 40 11, 40 11, 40 12, 44 14, 54 14, 54

OVERVIEW OF SUBPROJECT FINANCING

Subloan No. Name of Subproject Total Project Cost (Y000) ADB Loan Amount ($000) Borrowers Contribution (Y000) Percentage Contribution to Total Cost by Subborrower (%)
9.5 35.0 9.0 18.9 25.0 17.2 76.4 10.2 36.7 15.6 38.7 11.6 29.2 11.6 64.9 12.7 42.9 11.2 7.8 0.0 30.2 52.6 35.6

Remarks

001 002 003 004 005 006 007 008 009 010 011 012 013 014 015 016 017 018 019 020 021 023 A01 A02

Shanghai Cutting Tool Works Shanghai Long Distance Telecom Office Shanghai No. 6 Weaving Mill Shanghai No. 3 Worsted Mill Shanghai No. 1 Plastic Products Factory Shanghai Tsen Tire Rubber Factory Pengpu Machine Building Plant Shanghai No. 2 Textile Machinery Works Shanghai Long Distance Telecom Office Shanghai Huang Pu Radio Components Factory Shanghai No. 2 Dyeing and Printing Mill Shanghai No. 1 Silk Weaving Mill Shanghai Machinery Blades Factory Shanghai No. 1 Silk Printing and Dyeing Factory Shanghai Local Telephone Bureau Shanghai Magnetic Wire Factory Shanghai No. 19 Radio Factory Shanghai Harbor Towing Corporation Shanghai Suburb-County Post Telecom Bureau Shanghai Harbor Bureau Shanghai Harbor Jungonglu Container Handling Corp. Shanghai Household Chemical Product Factory Shanghai Tire and Rubber Corporation Shanghai First Refrigeration Machinery Works

14,455 28,000 32,562 12,687 45,495 40,808 69,506 14,879 20,927 10,957 40,763 18,590 11,990 34,003 20,218 Cancelled 16,418 22,000 18,676 51,400 52,864 7,296 361,305 44,983

3,515 4,900 4,675 2,180 7,223 6,725 3,468 2,823 2,800 1,772 5,290 4,148 1,626 5,783 1,500 3,035 2,400 3,128 8,943 9,974 980 5,000 5,367

1,380 9,772 3,000 2,397 11,403 7,000 53,137 1,525 7,683 1,706 15,794 2,156 3,500 3,930 13,123 2,093 9,448 2,100 4,000 2,200 190,000 16,000

$2,784,500 from SITICO

21 Appendix 1

$31,490,000 from others

ADB = Asian Development Bank, SITICO = Shanghai International Trust and Investment Corporation.

22
Appendix 2

IMPLEMENTATION DATA
1. Number of Subloans Made 2. Sectoral Distribution of Subloans No. of Subloans 3 5 1 4 3 1 7 Actual Loan Utilization Amount ($'000) 14.605 19.345 1.308 10.580 8.182 1.501 29.333 2.335 8.322 7.065 4.721 6.889 2.348 87.202 24
a

a. b. c. d. e. f. g.

Light Industry Textiles Chemicals Machinery Manufacturing Metallurgy Electronics Others i. Towing Services ii. Harbor Operations iii. Containerization iv. Communication Services v. Telecommunications h. Interest During Construction (IDC) Total

0 24

% 17.0 22.0 2.0 12.0 9.0 2.0 34.0 3.0 10.0 8.0 5.0 8.0 3.0 101.0

3. Size of Subloans a. Less than $100,000 b. Over $100,000 to $500,000 c. Over $500,000 to $1 million d. Over $1 million to $2 million e. Over $2 million to $5 million f. Over $5 million g. IDC Total 4. Other Breakdown of Subloans By Geographical Distribution a. Within Shanghai Municipality b. Outside Shanghai Municipality c. IDC Total By Purpose a. New b. Expansion c. Balancing, Modernization, and Replacement d. IDC Total By Maturity of Loans a Up to 2 years b. Over 2 to 5 years c. Over 5 years Total 5. Line of Equity

1 0 0 5 13 5 24

0.009 0.000 0.000 7.520 42.833 34.492 2.348 87.202

0.0 0.0 0.0 9.0 49.0 39.0 3.0 100.0

24 0 0 24 0 14 10 0 24 0 6 18 24

84.854 0.000 2.348 87.202 0.000 55.208 29.646 2.348 87.202 0.000 18.504 66.350 84.854

97.0 0.0 3.0 100.0 0.0 63.3 34.0 2.7 100.0 0.0 21.8 78.2 100.0

Shanghai SITCO Enterprises Co., Ltd. (SITEN)

a b

Date of Approval 28 Aug 1989

Amount Approved $3 millionc

This includes loan approved to Shanghai No. 1 Magnetic Wire Factory which was later cancelled. While $87.202 includes interest during construction, $84.854 is based on actual disbursements. c Not utilized. Source: Project completion report.

OVERVIEW OF SUBPROJECTS AND CURRENT STATUS

Subloan No. Type of Industry Actual Completion Date Actual Capacity Utilization (%) in 1995 (PCR Completion) 100 85 90 100 24 ADB Loan Amount ($000)

Name of Subproject

Current Status

001 002 003 004 005 006 007 008 009 010 011 012 013 014 015 016 017 018 019 020 021 023 A01 A02

Shanghai Cutting Tool Works Shanghai Long Distance Telecom Office Shanghai No. 6 Weaving Mill Shanghai No. 3 Worsted Mill Shanghai No. 1 Plastic Products Factory Shanghai Tsen Tire Rubber Factory Pengpu Machine Building Plant Shanghai No. 2 Textile Machinery Works Shanghai Long Distance Telecom Office Shanghai Huang Pu Radio Components Factory Shanghai No. 2 Dyeing and Printing Mill Shanghai No. 1 Silk Weaving Mill Shanghai Machinery Blades Factory Shanghai No. 1 Silk Printing and Dyeing Factory Shanghai Local Telephone Bureau Shanghai Magnetic Wire Factory Shanghai No. 19 Radio Factory Shanghai Harbor Towing Corporation Shanghai Suburb-County Post Telecom Bureau Shanghai Harbor Bureau Shanghai Harbor Jungonglu Container Handling Corporation Shanghai Household Chemical Product Factory Shanghai Tire and Rubber Corporation Shanghai First Refrigeration Machinery Works

Machinery Telecom Textile Textile Light Industry Chemical Machinery Machinery Telecom Electronics Textile Textile Machinery Textile Telecom Cancelled Electrical Transport Telecom Transport Transport Light Industry Chemical Industry Machinery

Dec 89 Mar 91 Nov 91 Nov 91 Dec 93

3,515 4,900 4,675 2,180 7,223 6,725 3,468 2,823 2,800 1,772 5,290 4,148 1,626 5,783 1,500 3,035 2,400 3,128 8,943 9,974 980 5,000 5,367

Jun 93 Jun 93 Jul 91 Dec 92 Nov 93 May 93 Dec 93 Dec 92 Dec 92

80 100 85 67 85 100 100 100 85

Loan restructuredFacing difficultiesPossible losses Repaid in fullRecently closedOutdated equipment. Loan maturity extendedNo expected loss Repaid in fullIn operation Loan restructuredRunning at minimum capacity Potential loss Maturity extendedNo expected loss Repaid in fullIn operation Loan restructuredFacing difficultiesPossible loss Repaid in fullIn operation Repaid in fullIn operation Loan maturity extendedNo expected loss BankruptTotal write-offStrong competition Repaid in fullForeign joint venture Repaid in fullIn operation Repaid in fullIn operation Bankrupt2/3 of principal recoveredStrong competition Repaid in fullIn operation Repaid in fullIn operation Repaid in fullIn operation Loan maturity extendedEquipment outdatedIn operation Repaid in fullIn operation Repaid in fullRanks #15 worldwide Repaid in fullIn operation

23

Jun 93 Jun 92 Jun 93 Jun 93 Jun 93 Dec 93 Dec 93

100 85 100 100 100 100 100

Appendix 3

ADB = Asian Development Bank. Source: Project completion report and Operations Evaluation Mission data.

24 Appendix 4 SELECTION OF SAMPLE SUBPROJECTS 1. The Operations Evaluation Mission requested the Shanghai International Trust and Investment Corporation (SITICO) to select the sample of subprojects for site visits based on the following criteria: (i) (ii) (iii) eight subprojects which are representative of project financing; asset size to include two large, two small, with the others falling in between; loan size to include borrowers ranging from small ($2 million) to large (over $5 million); industries representing textiles, machinery manufacturing, metallurgy, and other; at least three subprojects that are exporting; and financial and operational performance ranging from good to poor.

(iv) (v) (vi)

2. The final selection depended on SITICO making the arrangements in identifying the subprojects and subprojects willingness to meet with the Operations Evaluation Mission. Loan No. 003 005 Subproject Industry Loan Amount ($000) 4,675 7,223 Purpose

Shanghai No. 6 Weaving Mill Shanghai No. 1 Plastic Products Factory Shanghai No. 2 Dyeing and Printing Mill Shanghai Machinery Blades Factory Shanghai Tire and Rubber Corporation

Textile Light Industry

Modernization Expansion

011

Textile

5,290

Expansion

013

Machinery

1,626

Modernization

A01

Chemical

5,000

Expansion

25 Appendix 5 COMPLIANCE WITH LOAN COVENANTS

Covenant A. 1. Policy, Management, Organization The Borrower will ensure that SITICO, prior to the effective date, submits to ADB a Policy Statement and a Development Strategy Statement, in form and substance acceptable to ADB and duly approved by its Board of Directors. SITICO will seek ADBs consent on any substantial amendments to its Articles of Association, Policy Statement, and Development Strategy. SITICO will carry out a major review of the organizational structure and functions of its Financing Department with a view to streamlining its operations, including reassigning some of these functions and strengthening its staffing position, and submit to ADB the results of the review by 31 July 1989. Reporting SITICO will furnish to ADB quarterly reports on the execution of the Project and on the operation and management two months after the end of each quarter. SITICO will have its accounts and financial statements audited annually by an independent external auditor acceptable to ADB and furnish ADB certified copies of such audited accounts and financial statements six months after each fiscal year. The long form audit report will include comments on a) the quality and collectibility of SITICOs loan portfolio b) the adequacy of SITICOs provisions for bad and doubtful loans and investments c) the adequacy of SITICOs accounting and internal control procedures C. 6. Financial Covenants The Borrower and SITICO will, as and when necessary at mutually convenient time, exchange views with ADB concerning the interest rates to be charged by SITICO, taking into consideration SITICOs cost of funds, and profitability and interest rates charged by other financial institutions and banks in the Peoples Republic of China. SITICO will ensure that sponsors will contribute from their own resources at least 15 percent of the total project cost. SITICO shall maintain at all times a consolidated long-term debtequity ratio of not higher than 5:1 and total debt-equity ratio of 10.0:1. SITICO shall maintain at all times a debt service coverage ratio of not less than 1.25:1. LA Schedule 4, para. 5 Partially complied with. PA Section 3.05(b) PA Section 3.06(a) Complied with. LA Section 6.01(b) Schedule 4, para. 2 LA Schedule 4, para. 4 PA Schedule, para. 10 Complied with. Reference to Loan Documents Remarks

2.

Complied with.

3.

Complied with.

B. 4.

5.

Complied with.

PA Section 3.06(b) do do

Complied with. Partially complied with. Partially complied with.

7. 8.

PA Section 2.05(ii) PA Section 3.06(b) do

Partially complied with. Complied with.

9.

Complied with.

ADB = Asian Development Bank, LA = Loan Agreement, PA = Project Agreement, SITICO = Shanghai International Trust and Investment Corporation.

Income Profit Before Tax

1988 246.50 73.60

1989 357.50 89.90

1990 408.50 95.80

1991 396.80 102.50

1992 579.70 158.40

1993 920.30 276.70

1994 1728.00 433.10

1995 2270.40 557.60

1996 2712.80 643.20

1997 2792.80 686.50

1999 1742.90 370.70

Figure 2: SITICO Total Revenue and Profits

3,000 2,500 2,000 Y million 1,500 1,000 500 0 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1999

Income

Profit Before Tax

SITICO: KEY PERFORMANCE INDICATORS (Y million)

Item 1 Current Assets 2 Long-Term Assets Investment 3 Current Liabilities Overseas Loans Trust Deposit 4 Long-Term Liabilities Overseas Bonds Overseas Loans a 5 Equity Capital 6 Income 7 Income from Financial Operations 8 Expenses 9 Financial Expenses 10 Profit Before Tax Ratios Liquidity Ratio Long-Term Debt-Equity Ratio Return on Total Assets Return on Equity Capital-Asset Ratio 1988 1,362.90 2,235.20 433.50 826.70 311.70 261.90 1,939.10 1,184.70 684.50 832.30 246.50 170.90 172.90 166.60 73.60 1989 1,906.60 2,735.90 202.20 892.10 607.70 302.10 2,947.80 1,379.70 681.30 802.60 357.50 304.50 267.60 252.80 89.90 1990 2,326.50 3,128.80 257.60 1,240.70 471.40 461.10 3,358.40 1,584.90 935.90 856.20 408.50 379.30 312.70 293.70 95.80 1991 3,911.00 3,868.50 443.60 1,962.10 560.50 706.30 4,500.60 1,720.90 1,460.80 1,316.80 396.80 366.20 294.30 268.80 102.50 1992 5,842.50 6,771.30 1,863.70 3,953.70 864.90 1,867.50 6,801.90 3,331.50 1,552.30 1,857.70 579.70 430.30 421.30 363.20 158.40 1993 1994 1995 1996 1997 1998 1999

5,567.10 11,684.70 12,785.70 15,199.30 14,011.00 12,188.30 12,317.20 7,863.60 9,768.60 10,590.60 10,427.40 9,951.60 11,668.10 11,239.00 2,556.90 3,789.00 3,994.90 4,242.00 4,243.90 4,263.20 4,326.00 5,153.60 11,658.00 10,706.60 12,065.60 10,532.00 11,320.30 10,968.50 368.70 828.40 810.90 1,650.40 1,576.20 474.30 284.20 3,386.30 3,772.50 4,244.30 2,495.90 2,250.60 5,406.20 4,531.00 6,184.40 7,397.00 10,150.70 10,270.20 9,869.20 8,563.70 8,698.50 2,913.90 4,265.30 1,548.50 1,545.00 579.60 0.00 0.00 1,983.60 3,142.20 3,257.80 2,042.40 1,181.10 1,166.30 827.90 2,092.60 2,401.30 2,518.90 3,290.90 3,561.40 3,972.30 3,889.20 920.30 1,728.00 2,270.40 2,712.80 2,792.80 1,742.90 1,115.30 677.60 1,268.00 1,796.80 2,097.00 2,095.90 1,221.00 735.00 643.50 1,295.30 1,712.80 2,069.70 2,106.30 1,372.20 960.40 508.90 1,032.10 1,467.70 1,622.70 1,756.50 999.30 604.70 276.70 433.10 557.60 643.20 686.50 370.70 155.00

26

1.6 2.3 2.0 8.8 23.1

2.1 3.7 1.9 11.2 17.3

1.9 3.9 1.8 11.2 15.7

2.0 3.4 1.3 7.8 16.9

1.5 3.7 1.3 8.5 14.7

1.1 3.0 2.1 13.2 15.6

1.0 3.1 2.0 18.0 11.2

1.2 4.0 2.4 22.1 10.8

1.3 3.1 2.5 19.5 12.8

1.3 2.8 2.9 19.3 14.9

1.1 2.2 1.6 9.3 16.7

1.1 2.2 0.7 4.0 16.5

SITICO = Shanghai International Trust and Investment Corporation. a Overseas loans excludes a loan from the Asian Development Bank. Source: Calculated by the Operations Evaluation Mission based on SITICO's financial statements.

Appendix 6

SITICO: INCOME STATEMENTS, 1988-1999 (Y million) Year Ending 31 December REVENUE Income from Financing Operations Income from Investment Operations Income from Fiduciary and Other Ops. Total Revenue EXPENSES Financial Expenses Administrative and Other Expenses Provisions for Doubtful Loans and Inv. Total Expenses Gross Profit Before Tax Provision for Income tax Net Profit After Tax Financial Indicators (%) Growth in Income from Financing Growth in Income from Investment Growth in Fiduciary and Other Ops. Growth in Revenue Financial Expense/Revenue Administrative Expense/Revenue Provision for Loan Loss/Revenue Net Operating Margin Net Profit Margin Admin. Expense/Average Total Assets Net Oper. Profit/Average Total Assets Net Profit/Average Total Assets Net Income/Average Equity Earnings Spread 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

170.9 62.2 13.4 246.5

304.5

29.0 24.0 357.5

379.3 17.3 11.9 408.5

366.2 13.3 17.3 396.8

430.3 111.1 38.4 579.8

677.6 1,268.5 1,796.8 2,097.0 2,095.9 1,221.0 118.2 223.7 335.6 350.1 510.4 362.2 124.5 236.2 138.0 265.7 186.4 159.7

735.0 269.6 110.7

920.3 1,728.4 2,270.4 2,712.8 2,792.7 1,742.9 1,115.3

165.7 6.0 1.2 172.9 73.6 46.1 27.5

252.8 11.5 3.3 267.6 89.9 56.3 33.6

293.7 13.2 5.8 312.7 95.8 59.5 36.3

268.8 19.1 6.4 294.3 102.5 64.2 38.3

363.2 40.5 17.6 421.3 158.5 96.8 61.6

508.9 1,032.2 1,467.7 1,622.7 1,756.5 106.1 194.2 159.2 350.7 257.3 28.5 69.1 85.9 96.2 92.5

999.3 214.6 158.3

604.7 186.3 169.4 960.4 154.9 7.1 28 147.8

643.5 1,295.5 1,712.8 2,069.6 2,106.3 1,372.2 276.8 81.1 195.6 432.9 68.2 364.9 557.6 99.0 458.6 643.2 110.9 532.3 686.4 81.0 605.5 370.7 46.7 324.0

67.2 2.4 0.5 29.9 11.2 0.2

3.3 2.3

78.2 (53.4) 79.1 45.0 70.7 3.2 0.9 25.1 9.4 0.3 2.2 0.8 4.2 2.4

24.6 (67.6) (50.4) 14.3 71.9 3.2 1.4 23.5 8.9 0.4 1.9 0.7 4.2 2.3

(3.5) (30.1) 45.4 (2.9) 67.7 4.8 1.6 25.8 9.7 0.4 1.6 0.6 2.9 2.1

17.5 735.3 122.0 46.1 62.6 7.0 3.0 27.3 10.6 0.5 1.6 0.6 3.5 2.0

57.5 6.4 224.2 58.7 55.3 11.5 3.1 30.1 21.3 1.0 2.1 1.5 9.4 3.1

87.2 89.3 89.7 87.8 59.7 11.2 4.0 25.0 21.1 1.2 2.5 2.1 16.2 3.4

41.6 50.0 (41.6) 31.4 64.6 7.0 3.8 24.6 20.2 0.9 2.5 2.1 18.6 3.6

16.7 4.3 92.5 19.5 59.8 12.9 3.5 23.7 19.6 1.8 2.6 2.2 18.3 4.5

(0.1) 45.8 (29.8) 2.9 62.9 9.2 3.3 24.6 21.7 1.4 2.8 2.4 17.7 4.2

(41.7) (40.9) (14.3) (37.6) 57.3 12.3 9.1 21.3 18.6 1.6 1.6 1.4 8.6 3.1

(39.8) (34.3) (30.7) (36.0) 54.2 16.7 15.2 13.9 13.3 1.5 0.7 0.6 3.8 1.1

Appendix 8

SITICO = Shanghai International Trust and Investment Corporation. Source: Calculated by the Operations Evaluation Mission based on SITICO's financial statements.

SITICO: CONSOLIDATED BALANCE SHEETS, 1988-1999 (Y million) Year Ending 31 December Assets Cash and Due from Banks Marketable Securities Current Maturities Other Current Assets and Short-Term Loans Subtotal (Current Assets) Medium and Long-Term Loans Less Provisions for Doubtful Loans Net Loan Portfolio Lease Payments Receivable Equity Investments-Net Fixed Assets Less Depreciation Net Fixed Assets Other Assets Subtotal (Long-Term Assets) Total Assets Liabilities and Stockholders' Equity Short-Term Deposits Short-Term Borrowings Current Maturities Other Current Liabilities Subtotal (Current Liabilities) Long-Term Borrowings Debenture Issues Less Current Maturities Other Long-Term Liabilities (including Long-Term Deposits) Subtotal (Long-Term Liabilities) Total Liabilities Paid-In Capital Reserves and Retained Earnings Less Tax, Transfers, and Other Subtotal (Equity) Total Liabilities and Equity Financial Indicators Growth in Loans and Leases (%) Current Ratio (times) Long-Term Debt/Equity (times) Total Debt/Equity (times) 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

622.0 354.4 350.4 600.0 279.4 279.4 421.3 1,030.5 296.6 105.7 187.9 62.0 164.9 1,167.1 1,366.9 2,218.5 1,362.9 1,906.6 2,326.5 3,911.0 1,478.5 (1.2) 1,477.3 34.6 433.5 6.5 (0.6) 5.9 283.9 2,235.2 3,598.1 2,139.6 (3.3) 2,136.3 104.2 202.2 10.2 (1.5) 8.7 284.5 2,735.9 4,642.5 2,331.0 (5.8) 2,325.2 105.3 257.6 15.3 (2.1) 13.2 427.5 3,128.8 5,455.3

1,937.0 1,251.1 174.0 2,479.9 5,842.0

1,627.0 1,517.1 1,871.4 3,986.2 4,743.2 3,118.2 3,048.0 663.2 1,417.5 1,477.8 1,738.8 1,463.8 872.0 751.8 258.9 237.0 261.3 275.3 294.7 478.6 508.0 3,017.9 8,513.1 9,175.2 9,199.0 7,509.3 7,719.5 8,009.4 5,567.0 11,684.7 12,785.7 15,199.3 14,011.0 12,188.3 12,317.2

2,215.0 3,445.9 4,805.9 5,143.4 5,767.6 5,433.9 5,081.2 6,982.5 6,530.8 (6.3) (17.6) (28.0) (52.6) (56.0) (87.5) (79.2) (120.5) (123.2) 2,208.7 3,428.3 4,777.9 5,090.8 5,711.6 5,346.4 5,002.0 6,862.0 6,407.6 95.7 134.8 387.1 554.1 347.0 210.4 120.1 61.2 55.9 443.6 1,863.7 2,556.9 3,789.0 3,994.9 4,242.0 4,243.9 4,263.2 4,326.0 86.4 90.5 107.9 120.9 233.5 248.3 251.5 269.0 293.0 (2.9) (3.6) (6.0) (9.7) (19.7) (31.8) (51.3) (58.8) (66.2) 83.5 86.9 101.9 111.2 213.8 216.5 200.2 210.2 226.8 1,037.0 1,257.6 39.8 223.5 323.3 412.1 385.4 271.5 222.7 3,868.5 6,771.3 7,863.6 9,768.6 10,590.6 10,427.4 9,951.6 11,668.1 11,239.0 7,779.5 12,613.3 13,430.6 21,453.3 23,376.3 25,626.7 23,962.6 23,856.4 23,556.2

132.5 607.3 1,103.1 607.7 471.4 560.5 138.0 143.5 280.0 13.9 18.5 18.5 826.7 892.1 1,240.7 1,962.1 684.5 681.3 935.9 1,460.8 1,184.7 1,379.7 1,584.9 1,720.9 (19.3) (107.9) 69.9 886.8 856.9 1,426.8

457.1 311.7 57.9

2,834.9 864.9 138.6 115.3 3,953.7 1,552.3 3,331.5 (115.3) 2,033.4

4,588.4 7,516.0 9,218.3 8,594.9 7,385.1 9,640.6 9,211.6 368.7 828.4 810.9 1,650.4 1,576.2 474.3 284.2 194.6 2,940.1 670.9 1,801.4 1,542.1 1,182.1 1,418.5 1.9 373.5 6.5 18.9 28.6 23.3 54.2 5,153.6 11,658.0 10,706.6 12,065.6 10,532.0 11,320.3 10,968.5 1,983.6 3,143.2 3,257.8 2,042.3 1,181.1 1,166.3 827.9 2,913.9 4,265.3 1,548.5 1,545.0 579.6 0.0 0.0 (2,692.8) (954.3) (579.6) 1,286.9 2,678.3 5,344.4 7,637.2 8,688.1 7,397.4 7,870.6

29

1,939.1 2,947.8 3,358.4 4,500.6 6,801.9 6,184.4 7,394.0 10,150.7 10,270.2 9,869.2 8,563.7 8,698.5 2,765.8 3,839.9 4,599.1 6,462.7 10,755.6 11,338.0 19,052.0 20,857.3 22,335.8 20,401.2 19,884.0 19,667.0 730.3 775.2 809.7 1,200.0 1,500.0 1,500.0 1,500.0 1,500.0 2,000.0 2,000.0 2,500.0 2,500.0 102.0 27.4 46.5 116.8 357.7 592.6 901.3 1,018.9 1,290.9 1,561.4 1,472.3 1,389.2 832.3 802.6 856.2 1,316.8 1,857.7 2,092.6 2,401.3 2,518.9 3,290.9 3,561.4 3,972.3 3,889.2

3,598.1 4,642.5 5,455.3 7,779.5 12,613.3 13,430.6 21,453.3 23,376.2 25,626.7 23,962.6 23,856.3 23,556.2

1.6 2.3 3.3

48.3 2.1 3.7 4.8

8.6 1.9 3.9 5.4

(5.2) 2.0 3.4 4.9

55.0 1.5 3.7 5.8

45.0 1.1 3.0 5.4

9.7 1.0 3.1 7.9

7.3 1.2 4.0 8.3

(7.7) 1.3 3.1 6.8

(7.8) 1.3 2.8 5.7

35.4 1.1 2.2 5.0

(6.5) 1.1 2.2 5.1

Appendix 9

SITICO = Shanghai International Trust and Investment Corporation. Source: Calculated by the Operations Evaluation Mission based on SITICO's financial statements.

SITICO: CONSOLIDATED CASH FLOW STATEMENTS, 1995-1999 (Y million)

Year Ending 31 December Cash Flow from Operating Activities Net Profit Add: Depreciation Provision for Loan Loss Other Noncash Charges (Credits) Funds from Operation Operating Sources (Uses) (Increase) Decrease Marketable Securities (Increase) Decrease Short-Term Loans and Advances Increase (Decrease) Short-Term Deposits Increase (Decrease) Accounts Payable and Acc. Expenses Net Cash Provided by Operating Activities Cash Flows from Investing Activities (Increase) Decrease Medium and Long-Term Loans (Increase) Decrease Investment Equity (Increase) Decrease Fixed Assets (Increase) Decrease Other Assets Net Cash Flow from Investment Activities Cash Flow from Financing Activities Increase (Decrease) Long-Term Borrowings Increase (Decrease) Long-Term Deposits Increase (Decrease) Special and Deferred Credits Increase ( Decrease) Short-Term Borrowings Increase (Decrease) Equity Capital Cash Dividend Paid Adjustment, Reserves, and Others Net Cash Flow from Financing Activities Increase (Decrease) in Cash 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

557.6 10.9 85.9 3.4 657.8 (60.3) (488.3) 1,702.3 424.1

532.3 14.1 96.2 4.1 646.7 (260.1) 71.4 (623.4) 188.6

605.5 22.3 97.5 6.0 731.3 275.0 1,755.4 (1,209.8) 125.2

324.0 9.8 158.3 4.9 497.0 591.9 647.4 2,255.5 214.3

147.8 7.3 169.4 8.1 332.6 120.1 382.8 (429.0) 267.3

2,235.6

23.2

1,677.1

4,206.1

673.8

(417.2) (252.1) 112.5 (99.8) (656.6)

470.3 (248.6) 14.9 (88.8) 147.8

443.0 (6.7) 3.1 26.7 466.4

(1,822) (20.2) 17.6 113.9 1,711.1

437.0 71.4 23.9 48.8 1,418.2

27

114.6 2,675.6 28.2 (17.4) 117.6

(1,215.4) 2,293.7 36.2 839.5 771.9

(861.3) 993.6 30.2 (74.2) 270.5

(14.8) (1,253.9) (86.0) (1,101.8) 410.9

(338.4) 249.0 (1.3) (190.1) (83.1)

2,812.6

2,726.1

358.8

2,045.6

(363.9)

Appendix 7

Cash Balance, Beginning Change in the Year Cash Balance, End Debt Service Coverage Ratio

292.1 292.1 125.0

292.1 212.6 504.7

504.7 390.4 895.1 6.0

895.1 1,225.6 2,120.6 4.3

2,120.6 1,167.0 3,287.6 2.6

3,287.6 424.5 3,712.1 2.4

3,712.1 418.3 4,130.4 2.9

SITICO = Shanghai International Trust and Investment Corporation. Source: Calculated by the Operations Evaluation Mission based on SITICO's financial statements.

SITICO: CAMEL ANALYSIS

Year Ending 31 December Capital Adequacy Long-Term Debt-Equity (times) Total Liabilities-Equity (times) Equity-Total Assets (%) Asset Quality Loan Provision Expense as % of Medium and Long-Term Gross Loan Investment Provision Expense as % of Equity Investment Arrears as a Percentage of Gross Loans Profitability Profit before Tax-Equity (ROE) (%) Profit before Tax-Total Assets (ROA) (%) Liquidity Current Ratio (times) Current Assets-Total Assets (%) 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

2.3 3.3 23.1

3.7 4.9 17.3

3.9 5.4 15.7

3.4 4.9 16.9

3.7 5.8 14.7

3.0 5.4 15.6

3.1 7.9 11.2

4.0 8.3 10.8

3.1 6.8 12.8

2.8 5.7 14.9

2.2 5.0 16.7

2.2 5.1 16.5

0.1

0.2

0.2

0.3

0.5

0.6 0.3

1.0 0.4 1.3

1.0 0.7 7.5

1.6 0.7 22.8

1.6 0.8 20.7

1.7 0.8

1.9

30

1.1

1.3

1.4

1.5

1.1

8.8 2.1

11.2 2.1

11.2 1.9

7.8 1.5

8.5 1.4

13.2 2.1

22.1 2.0

19.5 2.4

19.3 2.5

19.3 2.9

9.3 1.6

4.0 0.7

1.7 37.9

2.1 41.1

1.9 42.7

2.0 50.3

1.5 46.3

1.1 41.5

1.0 54.5

1.2 54.7

1.3 59.3

1.3 58.5

1.1 51.1

1.1 52.3

Appendix 10

CAMEL = Capital adequacy, Asset quality, Management effectiveness, Earnings, and Liquidity position; ROA = return on equity; ROE = return on assets; SITICO = Shanghai International Trust and Investment Corporation. Source: Calculated by the Operations Evaluation Mission based on SITICO's financial statements.

Income Profit Before Tax

1988 246.50 73.6

1989 357.50 89.9

1990 408.50 95.8

1991 396.80 102.50

1992 579.70 158.40

1993 920.30 276.70

1994 1,728.00 433.10

1995 2,270.40 557.60

1996 2,712.80 643.20

1997 2,792.80 686.50

1998 1,742.90 370.70

1999 1,115.30 155.00

Chart 2: SITICO Total Revenue and Profits

3000 2500 2000
Y million

Income

Profit Before Tax

1500 1000 500

Year

00 20 99 19 98 19 97 19 96 19 95 19 94 19 93 19 92 19 91 19 90 19 89 19 88 19 87 19

31

Appendix 11

SITICO: LOANS IN ARREARS 1989-1997 (Y000) Year 1989 1990 1991 1992 1993 1994 1995 1996 1997 Amount of Loans 3,236,355 3,482,754 3,963,599 4,670,296 6,027,710 8,790,872 15,620,000 13,792,000 8,476,000 Amount in Arrears 34,406 43,632 55,087 67,534 63,295 113,872 1,171,291 3,140,610 1,757,864 Loans in Arrears % 1.06 1.25 1.39 1.45 1.05 1.30 7.50 22.80 20.70

SITICO = Shanghai International Trust and Investment Corporation.

SITICO: ORGANIZATIONAL CHARTS Figure A12.1: 1994

General Office (33)

Shanghai SITICO Pudong Branch (45) Shanghai SITICO Enterprises Co., Ltd. (17) Shanghai SITICO International Consulting Co. (18) Shanghai SITICO Tendering Co. (7) Shanghai SITICO Real Estate Co. (103) Shanghai SITICO International Trading Co. (79) Shanghai SITICO Investment and Management Co. (13)

Planning Division (5) Accounting Division (10)

Human Resources Division (7)

Public Relations Division (6) Chief Economist (1) Board of Governors Chief Accountant (1) Mr. Bao Youde President (1) Executive Vice Presidents (4) Supervisory Committee (3)

Auditing and Supervisory Division (4)

Research Division (4)

Computer Center (6)

Finance Division I (38)

Advisors (2) Consultants (2) Senior Assistant

Finance Division II (28)

San Francisco Delegate Office (2) Hamburg Delegate Office (4) Tokyo Delegate Office (3) Yokohama Delegate Sub-Office

Securities Division (68) Fund Investment and Management Division (12) Securities Investment and Management Division (14) Banking Operation Division (26)

SITICO = Shanghai International Trust and Investment Corporation. Note: Figures in parentheses denote number of staff.

Investment Banking Division (5)

Figure A12.2: 1999

Board of Directors Supervisory Committee
Finance Division I (24) Finance Division II (19)

President
General Office (36) Human Resources Division (8) Planning Division (5) Accounting Division (11) Auditing and Supervisory Division (5) Research Division (2) Legal Division (3) Computer Center (3) Financial Operations (68) Trust Operations (29)

Banking Operation Division (25) Trust Division I (6) Trust Division II (2) Trust Division III (7) Securities Investment and Trust Division (14) Securities Division (64) Investment Banking Division I (6) Investment Banking Division II (6) Shanghai SITICO Real Estate Co. (74) Shanghai SITICO Enterprises Co. Ltd. (31) East China Enterprises Co. Ltd. Shanghai SITICO Investment and Management Co. (24) Securities Operations (64) Shanghai SITICO International Trading Co. (57) Investment Banking Operations (12) Investment Operations (129) Trade Operations (70) Overseas Operations (7) Shanghai SITICO Pudong Branch (39) Shanghai SITICO Tendering Co. (8) Shanghai SITICO International Consulting Co. (5) SPP San Francisco, U.S.A. (2) AIT Hamburg, Germany (1) ATS Tokyo, Japan (2) Shainvest Co. Ltd. (2)

SITICO = Shanghai International Trust and Investment Corporation. Note: Figures in parentheses denote number of staff.

34

Appendix 13, page 1

INTERNATIONAL TRUST AND INVESTMENT COMPANIES 1. The 1998 collapse of Guangdong International Trust and Investment Corporation (GITIC) exposed the fundamental structural flaw with the international trust and investment companies (ITICs) in the Peoples Republic of China (PRC). The bankruptcy of GITIC ended the high-flying days of trust and investment companies and forced the central Government to face reality and institute reforms to address the weakest link in the financial sector. 2. ITICs were first set up in the early 1980s to promote the development of the PRCs local economies by bringing in much-needed foreign capital, foreign technology, and management expertise. By their functional design as an extension of the local or provincial governments, ITICs were inherently incapable of acting independently. At the request of the supervising bodies, the ITICs financed locally important, but poorly performing, state-owned enterprises and projects that were in no position to service their debt. The articles of incorporation allowed the ITICs to carry out myriad activities that ranged from lending and deposit gathering, to real estate development, trading, and speculative investments. As they sought to expand fast in search of high profits, many of their activities proved to be detrimental to their existence because of the lack of proper controls, autonomy, and adequate checks and balances. They borrowed substantial amounts of money from foreign lenders, often with significant maturities and currency mismatches. This was aided by lenders who were careless and did not perform any detailed financial analysis, but rather blindly lent on a name basis. As the Asian crisis took its toll on the region, the day of reckoning for the ITICs approached. A number of ITICs have defaulted on their loans, some have gone bankrupt and shut down, while others are currently preparing restructuring plans for approval by the central Government. The failures of the ITICs have presented the Government with an opportunity to draft a new trust law, based on the lessons learned over the last two decades. 3. The Governments initial reaction to the crisis was to completely shut down most of the weaker ITICs. However, as this action would have left a void in the financial sector that could not be immediately filled, the reform plans have changed. Although the Government has not yet indicated the specifics of the plan, financial market news suggests the following: (i) The number of ITICs will be substantially reduced from about 240 to 50 or less.1 Each province may keep one in operation, while a few may operate on a national level. Minimum capital requirements for relicensing will be about Y300 million after writing off bad debts and investments. Shareholders and senior managers will be vetted by the Peoples Bank of China. Clear and well-defined organizational structures including duties, responsibilities, and management systems, should be in place. The banking and securities business will be separated from the trust business and the ITICs will no longer be permitted to engage in the former, but will be allowed to hold an ownership interest (even a majority) in securities companies. The business scope will be limited to managing entrusted money and assets.

(ii)

(iii)

This is an unofficial estimate made in the media reporting of the financial sector and is not confirmed by the authorities.

35 Appendix 13, page 2

(iv)

Viable ITICs that do not meet the requirements will be transformed into securities firms, finance companies, property developers, or local commercial banks. Nonviable ITICs may be dissolved and liquidated, which in turn may cause a ripple in the financial markets as well as social problems.

4.

Many questions remain unanswered with regard to the new plan, such as: (i) (ii) How and when will the insolvencies be ultimately resolved? How will the restructuring of the ITICS affect their ability and extent to which they can divest their viable subsidiaries and lines of business? How will the divested lines of business be developed and regulated? How will corporate governance, accounting standards, and regulatory reporting be enforced? How will the municipal and provincial governments be able to finance their economic plans?

(iii) (iv)

(v)

5. Although these reforms are a step forward, it remains unclear how the Government will deal with the fundamental flaw or root problem in the ITICs, i.e., lack of independence resulting from the ownership structure. Failure to separate government from business, at a local and national level, and to hold all parties accountable for their actions will result in a repeat of the same mistakes. This certainly deviates from other reforms currently undertaken in state-owned enterprises. For the surviving ITICs, it will be a period of uncertainty and instability as they proceed to sort out their plans, separate their viable businesses from the unproductive ones, and face the tremendous challenges and fierce competition that lie ahead.