Venture capital fund supports SMEs in the Baltic states

Transcription

1 Equity Fund Central Europe Partly Successful Venture capital fund supports SMEs in the Baltic states The EBRD made an equity investment in a venture capital fund intended to finance small and medium-sized companies in Estonia, Latvia and Lithuania. In addition, the Bank made a subsequent investment in a second venture capital fund serving the same market. At the time of evaluation, the expected return on the EBRD s investment was expected to be below expectations. The fund had achieved excellent returns on a few investments but the performance of others had either been, or was expected to be, negative. The disappointing results at the time of evaluation reflected the immaturity of some portfolio companies; the reliance on trade sales for most portfolio companies due to their size: the limited scope for stock market sales, and competition with other venture capital funds (both with and without EBRD involvement), which pushed up entry prices. The returns on venture capital fund investments depend heavily on a small number of investee companies. Without a local stock market permitting initial public offerings at high price/earnings multiples, or strong interest from strategic investors, prospects for adequate returns on venture capital funds are constrained. Competition for attractive deals pushes up entry prices and, thus, reduces the likelihood of satisfactory returns.

2 Equity fund Central Asia Partly Successful EBRD supports start-up local bank in central Asia The EBRD made an equity investment in a start-up bank in central Asia. Half of the share capital was provided by a strategic foreign partner, with a state-owned local bank providing a significant minority and the EBRD and another international financial institution taking smaller stakes. The bank got off to a slow start in developing its business, in part due to the difficult macroeconomic and foreign investment climate of the country. It took longer than expected to eliminate loss from its start up costs. Much of the bank s past profits came from revaluation gains under hyper-inflation. The bank has preserved its equity base by maintaining the foreign equity subscription proceeds in offshore deposits. Also, the local shareholder could not pay its second equity tranche in US dollars, as planned, due to local currency regulations. In addition, the local partner has been more interested in developing its own business than the business of the new bank. The foreign main investor provided managerial support and helped to ensure transparent operations and adherence to good corporate governance standards. Direct minority shareholdings in local banks can be risky investments, both financially and in terms of prospects to affect reform, when the investment environment is distorted and financial sector regulation is weak. The presence of a strong strategic investor from the banking industry can help mitigate the inherent risks in investing in fledgling private banks in early transition countries. When a domestic financial group participates in a joint venture bank that is to operate in its home market, the other investors must recognise that this kind of local owner can have an inherent conflict of interest. Transition impact from direct equity investments in local banks can be difficult to achieve in terms of improved corporate governance standards and transparency, if the local partners include financial/industrial groups.

3 Equity fund Central Europe Successful EBRD supports small businesses in central Europe through venture capital fund The EBRD made an equity investment in a small venture capital fund set up to invest in exportoriented small businesses in central Europe. The management company was controlled by a European financial institution. Because of the small size of the fund (less than 10 million), the fund manager was based in a neighbouring country. At the time of evaluation, the fund had made commitments for ten ventures, accounting for roughly half the fund s capital and had a relatively strong pipeline of likely projects. It had written off two small investments, but had earned enough on the sale other interests to more than offset the losses. Overall, however, it was too early to assess the fund s results. Still, it had become clear that, because of the small size of the fund, the fund manager could not establish a local presence and, hence, its ability to identify, select and add value to investee companies and its ability to develop local capabilities would be limited. Small venture capital funds operate under a severe handicap.

4 Equity fund Central Europe Partly Successful EBRD supports central European private sector through private equity fund The EBRD made an equity investment in a US$ 20 million fund established to make equity and quasi-equity investments in existing private firms in central Europe. A European fund management company manages the fund. The fund fully invested its resources in eleven companies, taking stakes ranging between 1-30 per cent. All of the investee companies have been profitable and the fund to date has made two profitable exits. At the time of evaluation, the EBRD expected mediocre returns on its investment due to several factors. The small size of the market limited the fund s choice of potential deals and limited divestment prospects. In addition, the local stock market was small and not very active, and government regulations discouraged foreign portfolio investment. As a result, stock prices were too low to yield attractive capital gains on exits. In taking small equity positions in investee companies, the fund limited its ability to influence and add value to investee companies. And the individuals assigned to the fund management team, despite good industrial experience, had insufficient experience in managing a private equity fund. As a result, they failed to pay adequate attention to exit prospects and mechanisms in making investments. Prospects for good returns from a private equity fund in a small country are limited. Regional funds may be more appropriate for such markets. A large, active stock market that values stocks at good price/earnings multiples is typically a key element needed for the success of a private equity fund. A venture capital fund that takes small stakes in publicly traded companies is giving up the prospects of benefiting from its potential competitive advantage. In private equity funds, an exit strategy must be considered before making each investment. Regardless of the experience of the fund management company, the individuals managing a venture capital fund must have substantial experience in private equity management.

5 Equity fund Russia Partly Successful EBRD investment supports small businesses in Russia The EBRD provided a credit line to a privately owned commercial bank in Russia. The loan was intended for on-lending to private sector small and medium-sized enterprises (SMEs). The intermediary was well placed to handle this credit line because of its strong retail orientation and extensive branch network. The intermediary utilised the full EBRD loan and added a further 65 per cent of its own funds to finance the EBRD sub-projects. Although small loans accounted for a smaller than expected portion of the amounts advanced, they nonetheless accounted for 60 per cent of the number of subloans. The sub-loans and the intermediary performed well until the Russian banking crisis undermined the ability of some sub-borrowers to repay their loans and the intermediary s ability to service its debts. A twinning programme might have led to more conservative policies before the banking crisis, but the intermediary was not interested in this assistance. Banks with a strong retail orientation and extensive branch network are likely to be more effective than others in using credit lines designed to assist SMEs. Top management commitment is key to building a successful bank servicing SMEs.

6 Bank equity Russia Unsuccessful EBRD invests in project finance bank The EBRD invested in the equity of a newly established financial institution in Russia. This institution was expected to start as a project finance advisory services boutique and to evolve into a project finance lending and investment institution over a period of three years. During the first three years, the institution was to develop its staff skills, based on extensive technical assistance. It was also expected to accumulate sufficient earnings and to attract sufficient new capital to provide the basis for its proposed lending and investment activities, which were to be directed primarily at small and medium-sized enterprises (SMEs). The EBRD provided 51 per cent of the equity, including 16 per cent held in trust to support management stock option plans. The balance of the equity came from local companies and financial institutions, none of which held more than 11 per cent. At the time of evaluation, prospects for the expected evolution into a lending and investing institution were poor. The institution building efforts had yielded some benefits but not as much as envisaged. The institution had generated significant fee income but experienced delays in receiving payment from clients. Efforts to attract a strong strategic partner did not bring desired results. Meanwhile, foreign-owned operators had entered the financial advisory services market and were providing significant competition. Prospects for the institution s survival were unclear. Learned: Reliance on forecast earnings as the basis for financing the core element of an operation is not prudent. Expectations that sophisticated technologies can be transferred to a new financial institution based on technical assistance programmes in the absence of a strategic partner are unrealistic, especially when the technologies are to be transferred over only three years. The likelihood of rapid changes in the economic and political environment in the early stages of transition calls for flexibility in the range of services offered, especially in a fee-based financial institution.

7 Equity fund Commonwealth of Independent States Unsuccessful EBRD provides debt and equity investment in CIS commercial bank The EBRD made an equity investment and provided a loan to a commercial bank in the CIS. The bank suffered from the 1998 Russian crisis when the government defaulted on its short-term local currency debt (which accounted for a substantial part of the bank s assets) and counter-party banks refused to honor their obligations under forward contracts. The bank also suffered from an inadequate customer base and sharp competition from a government-owned bank. A Western bank was to have supplied technical assistance under a twinning programme, but abandoned this contract without much assistance having been provided. The EBRD itself had no significant influence on the bank s operations. Domestic local currency government debt in transition countries cannot be considered as risk free. In calculating capital adequacy ratios, an appropriate risk weight should be assigned to holdings of government debt instruments. When investing in a financial institution, it is imperative to ensure at the outset that the institution has appropriate policies and procedures to control counter-party risks and then to monitor these risks on a continuing basis.

8 Bank lending South-eastern Europe Successful EBRD supports small and medium-sized business in south-eastern Europe The EBRD provided a credit line to a state-owned bank in south-eastern Europe to finance small and medium sized enterprises (SMEs). Plans to finance energy conservation projects and to engage a credit adviser were dropped due to lack of grant funding. The client bank drew down and on lent nearly 90 per cent of the EBRD line of credit. All the subborrowers fully repaid their loans, with virtually no arrears during the period that the loan was outstanding. The good credit performance, despite the plans for a credit adviser not materialising, may be attributable to the bank s ability to pick relatively safe, strong firms in a market with little access to term finance and the contributions of the EBRD s loan conditions and monitoring, or a combination of both factors. A credit line via a state-owned bank can reach SMEs and have a good impact on economic transition, if well structured and monitored. Credit lines with split components for differing target groups of borrowers and types of projects may be overly complex to implement. When term finance is scarce, a lender may be able to make good loans, even in difficult conditions, by limiting itself to the safest, strongest borrowers in the market. To some extent, imposition and monitoring of sub-project selection criteria may substitute for the lack of an external credit adviser.

9 Equity fund Central Europe Partly Successful Private-equity fund supports development of medium-sized companies in central Europe The EBRD made an equity investment in a venture capital fund set up to invest in a central European country. The fund was managed by a Western investment management company. At the time of evaluation, 70 per cent of the fund was invested in almost a dozen companies. The fund had targeted medium-sized companies, as envisaged at the outset, but had not invested in more specific categories of companies (in the context of certain privatisation programmes), as originally intended. The fund had also taken equity shares in excess of 50 per cent in one third of the companies, all of which were making losses at the time of evaluation. No exits by sale of the holdings or initial public offerings on the local stock exchange had yet taken place, with manager estimates remaining optimistic, suggesting moderate to good overall return prospects. Two years later, the fund's assets had been written down by about 75 per cent and had achieved only one exit sale at a price significantly below cost. In addition, four of eleven investments had been fully written off. This poor performance forced the investors to terminate the management contract and bring in a new manager. The initial partner's falling interest led to further reduced efforts as the prospects looked poor for any profit sharing under the carry provisions. The transition impact of a private equity fund may be lost if it cannot establish a record of profitable investee companies which received active owner support from the fund manager. Post-evaluation of private equity funds cannot assess performance with any certainty until the fund has established an investment and exit record. Private equity funds as wholesale vehicles for minority investments in the share capital of non-listed private companies need competent dedicated managers. They also need senior investment professionals "on the ground" rather than "fly-in" expertise, otherwise the quality of selection and monitoring of investee companies will suffer, as will professional local staff development. Venture capital fund managers should respect agreed principles limiting the size of their stakes in individual companies.

10 Equity fund Central Europe Successful EBRD supports medium-sized central European companies through private equity fund In 1992 the EBRD made equity investments in two private equity funds in central Europe. The funds were set up to invest primarily in medium-sized, unquoted private enterprises and were managed by one of the largest and most experienced private equity teams operating in the region. The members of the team have a blend of local and Western talent, have worked together for many years and have developed a solid reputation in the local market. The funds invested in 35 investee companies. At the time of evaluation, although still too early to forecast the overall returns, the two funds had achieved 2.5 times the investment on their exits from 65 per cent of these companies. Good experience in managing private equity funds and good knowledge of the local market are key elements for a successful private equity fund.

11 Bank lending South-eastern Europe Partly Successful EBRD supports lending to micro and small enterprises in south-eastern Europe The EBRD channeled financing for on-lending to micro-enterprises, via several participating banks, in south-eastern Europe. Technical cooperation funds financed resident credit advisers in micro and small enterprise (MSME) lending. After a few years, the banks had made loans equivalent to 160 per cent of the amount provided by the EBRD. The participant banks have continued their local currency lending to micro and small enterprises. Their overall volume for this market segment has actually increased. Contrary to expectations, however, the EBRD s funds went essentially into small and medium-sized enterprises (SMEs), rather than informal micro-enterprises. The participating local banks lacked the tradition, willingness and capability to adopt micro-lending techniques. These would have called for greater emphasis on cash-flow and character due diligence than the retained emphasis on collateral. The banks might have changed their approach more easily if they had established specialised microlending units, but the funding provided to the individual banks and by the banks themselves was too small to justify the universal set up of such units. Repayment arrears over 30 days peaked at 30 per cent (better than the banks overall portfolios). The repayment problems were caused by the 1998 Russian crisis, high shares of loans to start-up enterprises and overall poor repayment discipline in the country. Some of the banks relied heavily on formal guarantees and collateral, rather than cash flow and other best-practice micro-financing lending techniques. The arrears situation improved a few years later, however, as the impact of the Russian crisis wore off. The transition impact generated from financing small and micro enterprise lending schemes can be high. The schemes can have a good outreach to numerous entrepreneurs and firms with little or no alternative credit access. Enduring impact requires, however, that the participating banks stay engaged with the new target group of clients for the longer term. Local banks may be reluctant to serve these market segments because of the specialised nature of lending to micro and small enterprises (MSEs). If they are willing, they may fail to adopt the appropriate lending techniques unless they receive enduring advisory support and incentives. The credit advisers must be professionals with good communication skills and an understanding of local conditions. The amount lent to a bank for on-lending to micro and small entrepreneurs should be big enough to encourage its change of culture and have capabilities for effective lending operations to this group. Lending schemes for micro enterprises or SMEs call for assessing the seriousness of the participating banks commitment to serving the targeted market. Micro and small enterprises that do not export will find it difficult to bear foreign exchange risks. Hedging facilities or domestic currency funding should be aggressively explored as an alternative. Exposing non-exporting borrowers to the full foreign exchange risk can be counterproductive for lending schemes.

12 Bank equity and bank lending South-eastern Europe Successful EBRD provides minority share and loan investment for spin-off bank in southeastern Europe The EBRD made an equity investment and provided a convertible loan to a south-eastern European commercial bank that had been spun off several years earlier from a state-owned bank. After the EBRD s subscription, most of the bank's shares were owned by private sector companies and investors, about a quarter by mixed enterprises. The state retained just under 10 per cent and the EBRD took a slightly smaller stake. The EBRD also made arrangements for a technical assistance programme. The operation helped the bank improve its governance, technical skills and launch its term lending. Management s willingness to introduce modern, efficient banking techniques and the introduction of technical cooperation all contributed to its success. Nevertheless, these efforts fell short of expectations. Management carried over old ways of thinking and kept stressing the bank s social role more than its profitability. The technical assistance had less of an impact than expected because responsibility for it was assigned to a high level executive who did not have sufficient time to devote to the programme. Technical cooperation programmes and board representation can improve financial institutions in transition economies, if management is receptive to adopting new ideas and methods. Even when a client bank is willing to adopt new ideas and methods at the technical level, it may not be motivated to maximise shareholder value in the absence of a strategic partner or competitive pressures. Technical assistance efficiency needs top management commitment but is more likely to have a significant effect when middle management is fully involved. Contacts and decisionmaking should not be centralised solely at the top management level.

13 Bank lending Central Asia Successful EBRD support strengthens privatised bank in central Asia The EBRD provided a convertible loan to a commercial bank established in the final years of the Soviet Union. Management held a controlling interest and foreign portfolio investors held a significant minority interest. The EBRD had dealt with the bank before and made the new loan through a trade facility credit line for small and medium-sized enterprises. The bank has developed well and seems set to become the strongest bank in its home country. Before the EBRD s loan, the bank had engaged in some financing transactions with related firms. Subsequently it has made significant progress in adopting Western reporting, transparency and management practices and in becoming an independent financial institution. A series of due diligence visits by the EBRD and an 18-month twinning arrangement with a western bank contributed significantly to the bank s institutional development. Focused due diligence visits by experienced staff can help clients in emerging markets and can encourage them to adopt the best international practices. At times, the bank s management considered the due diligence demands onerous, but has recognised the benefits from the procedures imposed. Twinning arrangements can contribute materially to institutional development, particularly when the programme addresses specific weaknesses and the needs of the client. The potential for a transition impact improves if a leading bank can be helped to set good standards in areas of transparency, reporting, efficient credit handling and forward looking management practices.

14 Bank lending Central Europe Successful EBRD finance supports privatisation of large state-owned bank in central Europe The EBRD provided a convertible loan to a major, state-owned commercial bank in central Europe and then converted it into shares of the client bank. This followed the partial privatisation of the client bank to a consortium of West European financial institutions. The EBRD terms had called for a step-up in the interest rate if the client bank was not partially privatised within a defined time frame. The client bank s operating results deteriorated significantly after the entry of the EBRD and the strategic Western sponsor banks. The poorer results reflected increased provisions on the bank s Russia-related loan portfolio and a sizeable portfolio of risky agricultural loans. Moreover, reduced interest margins followed increased competition. This emerged in parallel with a growth in nonearning assets and increased operating costs. The latter were attributable to severance payments, delays in rationalisation of the bank s branch network and mismanagement of IT programmes. The new strategic partners did not have a clear strategy when they entered. Their due diligence had been superficial and they had based their investment decision largely on their confidence in the existing management. No secondments of western banking expertise were, therefore, planned. The lead strategic partner was slow in reacting to the worsening profitability and also to the discovery of insider trading, lacking arms-length in some key transactions and other deficiencies in corporate governance. The new sponsors had not initially seen their role as bringing the investee bank to international standards in these respects. The lead strategic partner did thus not make any substantial changes in management until after increasing the strategic consortium's holding by buying the EBRD shares. A loan calling for a stepped-up interest rate if privatisation is not carried out by a specified date can create a strong incentive to move forward with privatisation. The participation of a strategic foreign partner does not guarantee a successful operation with a good transition impact, e.g. in terms of demonstrating timely management reform. A foreign partner must have a solid understanding of the issues and a clear strategy for addressing them, assigning enough expertise to ensure that necessary changes are carried out. An incoming foreign strategic partner s involvement and performance needs to be monitored when the Bank invests in a privatisation project. Insider trading or other controversial actions on the part of management may provide an early warning of broader management deficiencies. These need to be addressed without delay.

15 Bank equity and bank lending South-eastern Europe Successful A credit line for small and medium-sized enterprises in south- eastern Europe The EBRD provided an equity investment to strengthen the capital of an entrepreneurial, private sector commercial bank and a credit line to finance small and medium-sized enterprises. The bank had been founded after the onset of transition in eastern Europe. The EBRD subscribed for 20 per cent of the equity, two local sponsors and others invested 40 per cent and a passive foreign investment company, the rest. The EBRD subscribed for its shares based on net asset value, which looked expensive after the corrections to the Bank s accounts. It later emerged that the price the EBRD paid for the shares was rather high. The bank fully utilised the EBRD credit line to provide term loans to small clients previously served only by trade finance facilities. EBRD support allowed the bank to attract funding from other international sources and to expand its lending greatly. In contrast to other local banks, the bank consistently assisted local private enterprises. It became the leading start-up private bank in the country. Profitability, however, has been unstable, reflecting the volatile local economy and the bank s flexibility in adapting to changes in the environment. Despite these achievements, the bank s prospects are uncertain, because of weak capitalisation, internal controls and governance. Newly established private sector banks developed by local entrepreneurs are more likely to foster transition and private sector development than privatised banks, which continue to be influenced by their pre-privatisation culture, and foreign banks, which lack familiarity with local businessmen and conditions. Such banks, however, present financial and reputational risks from related party lending. Controlling such risks requires limits on loans to related parties, a higher than normal capital adequacy ratio, close monitoring and fostering good corporate governance. When subscribing for shares based on a company s net asset value, an investor needs to negotiate indemnification arrangements covering subsequent corrections in the subscription date net asset value.

16 Bank equity South-eastern Europe Partly Successful EBRD invests in new bank for micro-enterprise loans The EBRD has supported the establishment of a new bank in south-eastern Europe to finance micro and small enterprises. The EBRD and other international financial institutions provided the bulk of the initial equity, giving the bank a high degree of financial consolidation. One financier provided an interest-free loan for on-lending. Technical cooperation grants were secured to cover the initial years' cost of expatriate managers and staff training systems infrastructure. Independent evaluation in the late 1990s confirmed that the new bank had successfully introduced a proven methodology for lending to micro and small enterprises. The bank had developed a substantial portfolio of small loans (averaging about US$ 10,000). This was achieved with less than 1 per cent in repayment arrears beyond 30 days, despite the difficult local economic circumstances. The EBRD soon generated profits before adjustments for the technical assistance grants and the concession elements of its soft funding. Although the bank had this significant startup support and has not yet become an integral part of the domestic financial market, its operational and financial performance has still been impressive. The excellent performance can be attributed to strong management with extensive experience in micro-lending. The approach had a focus on less risky micro-enterprises and the ample startup funding helped the achievements. A well-managed institution with appropriate credit technology can provide micro-loans in a productive way with low credit losses. Micro-finance institutions that benefit from subsidies should structure their lending operations to avoid potential contamination of credit discipline by the subsidy elements. In the case of this project, an experienced manager successfully avoided these risks. The performance of micro-finance institutions should be monitored on two levels: with and without adjustment for subsidies (whether in the form of explicit grants or implicit in funding with concession elements). This approach helps the Bank and its development co-financiers to quantify progress beyond standard financial ratios. Transition impact via new micro-enterprise banks can be achieved on two levels. The first is to help demonstrate private entrepreneurship and successful micro-business to achieve various spread effects in the economy. The second level relates to becoming an efficient part of a maturing domestic financial system. Gradually increasing domestic funding and deposits can back continuous loans to the micro-enterprise target group. Another way is to demonstrate to other local banks that micro-loans can be profitable. However, these two institutional objectives can be difficult to meet as quickly as a good lending and repayment record. The overriding long-term objective should be to move the institution towards viability without explicit grants or implicit funding subsidies. Moreover, international development financiers may not aim to stay indefinitely as active shareholders. The design stage of micro-enterprise banks should, therefore, plan to gradually phase out as dominant shareholders. For the same reasons, localised management should be planned to contain cost and local sources of funding sought to reach domestic financial integration.

17 Bank equity South-eastern Europe Successful EBRD invests in south-eastern European commercial bank The EBRD made an equity investment in a four year old commercial bank in south-eastern Europe. The EBRD s stake was equivalent to 17 per cent of equity. Three foreign banks held stakes of per cent each. Before investing, the EBRD arranged technical cooperation funding for a financial audit, operational due diligence and an assessment of the bank s strategy and business plan. These efforts identified several weaknesses that needed to be addressed. To deal with these issues, the EBRD organised a two year twinning programme with a foreign bank. This programme was successful. The bank has been performing well above forecasts and its loan growth has been significant. The quality of its portfolio has also improved and is earning good profits. Twinning programmes can contribute materially to institution building.

18 Bank lending Commonwealth of Independent States Partly Successful EBRD finances SME credit line in CIS The EBRD provided an APEX (please define APEX) credit line to be channelled to several commercial banks in a CIS country. The funds were to be on-lent to small and medium-sized enterprises via selected privatising or privatised local banks. The operation was co-financed with a bilateral institution and benefited from direct technical cooperation as well as technical assistance from the financial sector. The participating banks drew from the facility more slowly than envisaged and had not fully utilised the available funds at the time of evaluation. Moreover, credit quality was poor, with 33 per cent of the amounts outstanding in arrears for over 60 days. The disappointing performance was attributable mainly to the difficult political and economic conditions in the country. Moreover, there was a serious adverse indirect impact from the Russian financial crisis in The business climate discouraged private investment and the macro-economic conditions discouraged small businesses from taking foreign currency risks. SME-lending programmes have the potential to foster economic transition by supporting private entrepreneurship and small business while the country's reform programmes progress. There can also be institutional reform benefits by helping improve techniques for lending to SMEs in the participant banks. Lagging overall economic reform or excessive government intervention delaying market reform may call for a temporary hold on loans via a central APEX structure. Alternatively credit lines could be provided to carefully selected private banks to increase transition impact potential. But they can also present higher financial risk to the EBRD if there is no government backing. Small businesses generally find it difficult to bear foreign exchange risks. Where possible, a foreign lender should explore the possibility of mobilising local resources with the foreign lender s guarantee.

19 Bank equity Commonwealth of Independent States Partly Successful EBRD invests in leading private bank, supporting private sector The EBRD took a 27 per cent equity stake in a leading private bank in the Commonwealth of Independent States. The EBRD sought to increase the bank s capital base and expand its lending to private sector enterprises and help attract private sector investors. The bank has a strong balance sheet and has been profitable. Its loan portfolio, however, has been decreasing because of the worsening domestic economic environment. The bank has been unable to resist political pressure to increase lending to high risk agribusiness ventures. The bank s largest borrowers continue to be state-owned enterprises. The macroeconomic environment, the regulatory framework and the behaviour of the authorities substantially affect the performance of local banks and can keep them from following sound banking practices. Prospects for a successful investment in a bank in an inappropriate environment are poor.

20 Bank equity and bank lending Central Asia Partly Successful EBRD invests in leasing company in central Asia The EBRD made an equity investment and provided a loan to a new leasing company in Central Asia to develop the financial sector and provide services to small and medium-sized enterprises (SMEs). The predominant local commercial bank was to provide 35 per cent of the equity, a foreign strategic partner 35 per cent, and the EBRD and another international financial institution the balance. The leasing company s performance has been disappointing. Disbursed leases are far below expectations, and the company has lost 30 per cent of its paid-in capital. Several factors have contributed to the disappointing results. First, the local shareholder has been unable to provide its share of the equity and the loan financing in hard currency due to restrictive foreign exchange regulations. Therefore, the company has had inadequate resources to fund leases. In addition, the local shareholder is not committed to the success of the venture, which would compete with its commercial banking operations. Second, the foreign strategic partner has done a reasonable job to build the foundation of the company, but, due to problems of its own, has not provided the extra effort needed to address the new leasing company s problems. It has provided its share of the equity but is recovering a substantial portion of its investment through management fees. Third, and perhaps most importantly, macroeconomic conditions and the regulatory environment have deteriorated, rather than improved. Foreign exchange controls and conversion delays interfere with the leasing company s ability to provide foreign currency leasing. And, the poor economic conditions are discouraging private sector growth and, hence, the demand for equipment leasing. A financial institution cannot succeed unless it has sufficient resources to develop a portfolio large enough to cover its costs and yield some profit. Shareholder commitment is essential. The seriousness of the sponsors commitments must be carefully assessed at the outset and monitored subsequently. Should the commitment of one or more of the sponsors wane, consideration should be given to replacing the partner(s) that have lost interest. When a strategic partner is to receive management fees that are significant in relation to its equity investment, it may be less interested in the success of the venture than the purely financial investors. Poor macroeconomic conditions and a poor regulatory environment are likely to undermine the prospects for developing a successful financial institution.