Urban Poverty - Finance-Based Program Examples

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. MDFs do not provide credits exclusively for poverty-alleviation programs. However, they are included in this menu as 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. Example Tamil Nadu Municipal Development Funds (see box below).

Two types of MDFs: 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.

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.

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.

Tamil Nadu Municipal Development Fund, India

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 will be managed by an asset management company, a joint venture between the TN government and private investment companies. The new arrangement is expected to bring 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. It is expected that government's share would be reduced eventually through sale to interested investors and that on-lending interest rates would be made to conform to market rates. A separate grant window for poverty-oriented investments, such as slum upgrading and cost of resettlement, would also be handled by the asset management company and would provide technical assistance to municipalities in preparing such investments and improving their own financial management.

Social funds and AGETIPs are non-governmental entities that select and finance projects where the formal government institutions are weak, for example, in countries emerging from a period of civil or economic crises. Political independence can be a primary advantage of these entities. Social funds are intermediaries that channel grant resources to small-scale projects for poor and vulnerable groups, based on proposals prepared and implemented by a variety of organizations such as CBOs and NGOs. AGETIPs are delegated contract managers for public works; they prepare and implement subprojects, usually for municipal governments, which take charge of the works upon completion. For a quick reference, see table below on Social Funds and AGETIPs.

Microfinance schemes target low-income and moderate-income households that do not qualify for formal/traditional credit. NGOs are generally the key actors in packaging small loans and mobilizing private savings. Government funding and small savings of households, coupled with foreign donor assistance, are the typical sources of funding. Loans can be given to communities or individuals for a variety of specific purposes. Loans for housing/home improvement can have multiple benefits because the poor often work out of their homes and rent out extra space as a source of income. For a quick reference, see the table below.

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Finance-Based Program Examples