Municipal Development Funds
Municipal Development Funds (MDFs) are parastatal institutions that lend to local governments for infrastructure investments. MDFs usually start as an intergovernmental approach to municipal credit supply, structured as parastatal organizations, but then evolve to become financial intermediaries focusing on municipal credit. They are essentially financial intermediaries that provide credit to local governments and to other institutions investing in local infrastructure and are typically envisioned as transitional instruments in this effort intended to prepare the way for self-sustaining municipal credit systems that can tap domestic and international capital markets for financing. MDFs allocate loan capital to local government investment projects following procedures very similar to those that the World Bank and regional development banks employ in international lending, while reaching far more local authorities and smaller investment projects than it would be efficient for international institutions to try to finance directly. MDFs do not provide credits exclusively for poverty-alleviation programs. However, they are a financing tool since they can be used for poverty reduction objectives, like basic infrastructure investments in low-income areas and development of marketplaces, schools, and clinics for poor residents. In some cases, MDFs can have special windows for poverty alleviation projects e.g. provision of services for the urban poor. MDF Models
1. The first type of MDF, currently more common in the developing world, operates primarily as a substitute for government capital grants to local authorities. These programs supply capital through MDFs at below-market rates, often combining subsidized loans with grants. Typically MDFs of this type have a monopoly in lending to the municipal sector. Such MDFs exploit the favorable terms of their loans to impose stricter standards of project preparation on localities and to incorporate central or state government investment priorities in determining which projects should be funded. Credit Local de France and several other MDFs in Western Europe have evolved through financial deregulation from closed-circuit lending institutions, which obtained capital at below-market rates (from state grants) and lent to municipalities at below market rates, to institutions that compete freely with private-sector lenders. 2. The second type of MDF is intended to serve as a bridge to the private credit market. They prepare the municipal and financial sectors for private lending to municipalities. MDFs of this type lend at market rates of interest, allocate capital through arm's-length decisions of commercial banks or other private-sector lenders, require that private lenders assume the credit risk of municipal loans, and try to establish a track record of municipal creditworthiness. One such market-oriented MDF was developed in the Czech Republic. There, the MDF borrows funds from abroad, with a national government guarantee, then on-lends the funds to domestic commercial banks, which in turn lends to municipalities. The municipalities do all project selection and preparation. The commercial banks perform all credit analysis and accept all repayment risk. The parastatal MDF merely confirms the creditworthiness of the commercial banks to which it on-lends and makes capital available to nine banks participating in the system, so as to strengthen competition. The two models of MDFs need not be strict alternatives to each other. MDFs of the first kind normally have been introduced in environments where there is virtually no private lending to local governments and where public authorities believe that private credit markets cannot be developed in the short and medium term. MDF Examples § FINDETER : in Colombia, for example, is a market-oriented MDF. It operates as a rediscount facility for commercial bank lending to the municipal sector. FINDETER supplements the banks' project appraisal capacity and thus improves the technical quality of their lending, but the banks take the commercial risk. Unlike some other MDFs, FINDETER has a poverty alleviation mandate that it has tried to fulfill by giving particular attention to institutionally weak small towns and by favoring investments in essential services -- mainly water and sanitation. § TNUDF : The World Bank-financed Tamil Nadu Urban Development Project, which included slum upgrading of 72,000 households among other components, set up a loan and grant program as the Municipal Urban Development Fund (MUDF). By October 1996, the government-owned MUDF had financed over 500 subprojects in 90 out of 110 municipalities in Tamil Nadu. Building on that success, in 1996 the MUDF was converted into a new financially and legally autonomous financial intermediary with participation of private capital and management -- the Tamil Nadu Urban Development Fund (TNUDF). Restructuring suggests a direction in which existing municipal funds in some other projects may evolve to draw the private sector into small-scale urban investments. TNUDF is now managed by an asset management company, a joint venture between the TN government and private investment companies. The new arrangement has brought private-sector management expertise to the selection and financing of subprojects sponsored by either public or private agencies and to facilitate access to creditworthy municipalities to the private capital market. The government's share is to be reduced eventually through sale to interested investors and on-lending interest rates will gradually be made to conform to market rates. A separate grant window for poverty-oriented investments, such as slum upgrading and cost of resettlement, is also being handled by the asset management company and provides technical assistance to municipalities in preparing such investments and improving their own financial management. |
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