FINANCIAL MANAGEMENT IN WORLD BANK OPERATIONS OPERATING MODEL

Transcription

1 FINANCIAL MANAGEMENT IN WORLD BANK OPERATIONS OPERATING MODEL This paper describes in a single, brief document the proposed operating model for financial management work in World Bank operations. It reflects recent and proposed changes to operational policy (e.g., on auditing, sectorwide approaches, adjustment lending, and expenditure eligibility), and seeks to respond to institutional commitments to strengthen the performance of country institutions that manage public finances, harmonize with other donors, support higher impact in Bank operations, and simplify business processes. It has been prepared as a background document for financial management staff attending Fiduciary Forum It will be amended to reflect feedback received during the Forum, and the final form of policy proposals currently being considered by Executive Directors. Its final form will be supported by guidelines to staff, as listed in th e Annex. Financial Management Anchor Unit Operations Policy and Country Services March 3, 2004

2 FINANCIAL MANAGEMENT IN WORLD BANK OPERATIONS I. INTRODUCTION 1. World Bank operations are planned and implemented to support country-led development programs that seek to promote growth and reduce poverty. 1 They are underpinned by technical, economic, and financial analysis, and include measures to ensure that environmental and social impacts are adequately addressed and that Bank funds are used appropriately. The measures concerning the use of funds often described as the Bank s fiduciary work comprise financial management, procurement, and disbursements. This note describes the World Bank s financial management work in operations. It has been prepared by the Financial Management Sector Board primarily for financial management staff and other Bank staff members whose work requires a knowledge of financial management policies and practices. It is supplemented by more detailed guidelines to staff, listed in the Annex. 2. Financial Management Objectives. The Bank s financial management work has two main objectives: improved financial management performance in client countries, and acceptable assurance on the use of Bank loan proceeds. Country performance. Financial management is an integral part of the development process. In the public sector, it is necessary to ensure accountability and efficiency in the management of public resources which are critical to the achievement of public policy objectives, including poverty reduction. In the private sector, it is an essential underpinning for investment and growth. Use of Bank funds. The Bank is required to take measures to ensure that the funds it provides are used appropriately. This requirement, sometimes known as the Bank s fiduciary obligation, derives from the Articles of Agreement. It is also necessary to sustain confidence in the Bank by its shareholders, other stakeholders, and the public at large. The two objectives are closely linked the best assurance that the Bank can have on the use of its funds is that it provides them to countries whose institutions have good financial management arrangements. II. OPERATING ENVIRONMENT 3. The operating environment within which Bank financial management work is carried out has four broad dimensions the Bank s business model, the country context, global financial management practices, and partnerships within the Bank and with other organizations. 1 In this note, Bank includes IBRD and IDA, and loans includes grants and recipient-executed trust funds.

3 3 4. Bank Business Model. The Bank supports increasingly in partnership with others country-led development programs that seek to promote growth and reduce poverty. The Bank s business model is evolving to meet these objectives: it is leveraging its interventions to enhance impact, focusing more keenly on results, and developing better partnerships with other donors. The legal and policy environment governing financial management work is set out in the Bank s Articles of Agreement, its operating policies and procedures, its legal agreements with borrowers Country Context. The Bank s financial management work in each country is determined by the country s development priorities and institutional environment, and by the nature of the Bank s engagement in the country. Country priorities and institutions influence the size of the program, its sectoral mix, the objectives and design of individual operations, and the choice of lending instrument. The Bank acquires the necessary knowledge of the country s institutional framework through diagnostic studies done by the Bank or other donors, similar reports by competent country institutions, and experience with portfolio implementation. This knowledge helps identify risks to Banksupported programs and to the use of Bank funds. It also helps determine the extent to which the Bank may make use of country institutions or needs to require alternative project-specific institutional arrangements. 6. Global Practices. The Bank seeks to develop and apply financial management policies that are consistent with generally accepted standards and codes. While respecting the diverse legal and administrative traditions that lead to different financial management practices in each country, the Bank helps borrowers improve national practices to meet broadly accepted standards and codes. 3 It engages with the organizations that set these standards and codes to ensure that they take development issues and the views of developing countries into account. Through the global donor harmonization initiative, the Bank promotes common policies and practices between development partners on financial management issues. 7. Partnerships. Internally, financial management staff are members of integrated task teams for each lending operation. In addition to working with task team leaders and relevant sector staff, they have particularly close relationships with team members responsible for procurement, disbursements, and legal matters. When working on policy and institutional issues affecting the public sector, they work closely with staff from the Procurement and Public Sector and Governance groups, and with the Financial Sector and Private Sector Development groups in the private sector. They work closely with 2 3 Article III, Section 5 (b) of the IBRD Articles of Agreements states that The Bank shall make arrangements to ensure that the proceeds of any loan are used only for the purposes for which the loan was granted, with due attention to considerations of economy and efficiency and without regard to political or other non-economic influences or considerations. The IDA Articles of Agreement contain a similar provision. OP 10.02, Financial Management, sets out the financial management policies for all lending other than development policy lending, for which the policies will be set out in OP/BP 8.60, Development Support Lending (forthcoming). The principal global standard-setting organizations with which the Bank engages are the International Federation of Accountants and its associated bodies, the International Accounting Standards Board, and the International Organization of Supreme Audit Institutions.

4 4 other oversight groups within the Bank. 4 Externally, including as part of the global harmonization initiative, they work at the global, regional, and individual country levels with relevant organizations and other donors. III. THE FINANCIAL MANAGEMENT OPERATING MODEL 8. This section describes how the Bank plans its work at the country level, acquires the institutional knowledge it needs, and works to build improved institutional performance and provide assurance on use of Bank funds. A. Country Financial Management Strategy 9. A country financial management strategy is an internal Bank document that articulates and facilitates the Bank s financial management work in a country. The Bank uses this strategy to document the environment in which financial management work is to be carried out, summarize key financial management issues, plan priority tasks, set performance targets for a defined period, and allocate Bank financial management resources most effectively. By focusing the strategy at the country level, the Bank aims to support the scaling-up agenda and multisector programs. With this strategy, it seeks to make financial management work more responsive to institutional performance objectives while continuing to provide acceptable financial management coverage of individual projects. Preparation of the strategy helps to shape the agenda for dialogue with borrowers on financial management issues, and to identify opportunities for more effective partnerships and harmonization with other donors. Finally, it helps do financial management work more cost-effectively, allowing resources to be directed to highpriority or high-risk areas, informing inputs to the Country Assistance Strategy and Country Portfolio Performance Review, and offering country-specific off-the-shelf solutions for individual projects. 10. Preparation. The country financial management strategy is normally prepared by Bank financial management staff with inputs, as appropriate, from disbursement, procurement, and legal staff, and other country team members. The strategy normally covers a period of one to three years; it is typically prepared more frequently for larger borrowers or those whose operating environment or portfolio undergoes significant change. As appropriate, government or the representatives of other donors may be involved in its preparation. The country financial management strategy is informed by the findings of work to understand the country s financial management environment, discussed in the next section. B. Understanding the Country Financial Management Environment 11. Understanding each country s financial management environment helps the Bank develop a common understanding with the government and development partners; identify priorities for action; identify and manage risks to Bank-funded programs and the 4 These include the Internal Audit Department, the Institutional Integrity Department, the Operations Evaluation Department, the Quality Assurance Group, and the Trust Fund Compliance group.

5 5 use of Bank loan proceeds; and design and implement capacity-building programs. The Bank acquires its knowledge of country financial management performance from its own diagnostic reviews or those carried out by other donors or competent country institutions, and from its experience with portfolio implementation. The Bank plans the scope and conduct of its diagnostic work according to the knowledge needed to support the Bank program, and it applies the findings of this work to the design of the operations it funds in the country. 12. Bank Country-Level Diagnostic Work. The Bank s primary diagnostic tools in financial management are the Country Financial Accountability Assessment (CFAA), which focuses on public sector issues, and the Report on Observance of Standards and Codes Accounting and Auditing (ROSC-A&A) review, which looks at the private sector. Within the Bank, the CFAA is coordinated with Public Expenditure Reviews (PERs) and Country Procurement Assessment Reviews (CPARs), while the ROSC-A&A is coordinated with Financial Sector Assessment Program reviews and ROSC reviews on Corporate Governance and on Insolvency and Creditor Rights. Financial management staff also carry out or facilitate less formal but nevertheless structured views of other dimensions of financial management for example, reviews of the performance of public and private sector auditors to assist the Bank in determining the acceptability of auditors of Bank-financed operations. 13. Others Diagnostic Work. The Bank also draws on the public sector financial management diagnostic products of other donors for example, the IMF s Fiscal Transparency ROSC and central bank Safeguards Assessment, financial management and governance reviews by the African and Asian Development Banks, and audits by the European Commission. In addition, many borrower countries have institutions and processes that provide valuable insights on financial management performance. In the public sector, these include published government accounts, reports by supreme audit institutions, proceedings of parliamentary oversight bodies, and work done by research bodies; in the private sector, they include published audit reports and the work of market and financial institution regulators. 14. Harmonization. As part of the global financial management harmonization initiative, the Bank has committed to improve coordination of its diagnostic work with that of other donors and country institutions. 5 The Financial Management, Procurement, and PREM Public Sector and Governance groups in the Bank are working with several other donors, including the IMF, to redesign and strengthen the aggregate donor effort in public financial management. This is likely to lead to changes in how CFAAs are conducted. C. Improving Financial Management Performance 15. The Bank supports client countries in improving their financial management performance in its client countries by carrying out analytic and advisory work, aligning its financial management requirements with the country s own institutional arrangements 5 See

6 6 when circumstances permit, creating direct capacity-building initiatives, and working in partnership with other donors toward common approaches and project requirements in individual countries. 16. Analytic and Advisory Work. Besides the country- and project-level diagnostic work described in the preceding section, the Bank also provides analytic work at the request of borrowers, and informal advice through regular dialogue with country agencies and borrower personnel. 17. Alignment with Country Institutions. In accordance with prevailing practice in the development community, the Bank has traditionally met the financial management arrangements for individual operations through project-specific arrangements that are often outside normal country institutional processes. By agreeing to use the country s own institutional arrangements where it judges circumstances permit, the Bank s aligns its financial management requirements with the country s financial accountability objectives, making the Bank s lending program an important instrument for improved institutional performance. 18. Direct Capacity-Building Initiatives. The Bank directly supports capacity building in financial management as part of lending operations for specific institutions and through overall improvements of public expenditure management for example, through the program content of development policy (formerly known as adjustment) operations; self-standing technical assistance or other investment operations (or components of such operations); targeted smaller initiatives such as Institutional Development Fund grants or the use of trust funds to improve financial management; and client learning programs (often organized in collaboration with the World Bank Institute). through direct capacity building interventions 19. Partnerships. The Bank works with other donors to agree on common and coordinated approaches to diagnostic work, financial management requirements for individual projects, and capacity-building interventions in each country. D. Financial Management in Lending Operations 20. Financial management staff oversee the application of the Bank s financial management policies in lending operations. 21. Investment Operations. The Bank s policy with respect to financial management in investment operations (defined for this purpose as all operations except development support operations) is set out in OP 10.02, Financial Management (forthcoming). 6 6 The policy applies to all loans, credits, advances under the Project Preparation Facility (PPF), and grants financed from World Bank resources, including IDA grants, and IDF (Institutional Development Fund) and other DGF (Development Grant Facility) grants, with the exception of development policy (previously known as adjustment) loans. It also applies to recipient-executed grants financed from trust funds, unless, exceptionally, the terms of the agreement with the donor make provision for different requirements. Related policy statements include OP 11.00, Procurement, and OP 12.00, Disbursements (forthcoming).

7 7 Financial management in investment operations is directed to ensuring that Bank loan proceeds are use for eligible expenditures. 7 (a) (b) Financial management arrangements. During project preparation, financial management staff review the proposed financial management arrangements of the entity or entities to which Bank resources will be transferred. 8 The review may be based on country- and project-level diagnostic studies done by the Bank or other donors, or reports by competent country institutions. The scope of the review is adapted to the nature of each operation, and may therefore focus on national, subnational, sector, or individual entities. The review informs judgments on the risks to the use of loan proceeds, and the design of measures to mitigate these risks. These measures may include amendments to the project design, agreements with the borrower to take remedial action (some of which may be supported by the operation), and enhanced level of oversight by Bank staff. Staff seek to use the country s own financial management processes as far as possible, requiring separate arrangements only when country processes are found to be particularly weak and acceptable mitigation measures are not available. Financial reporting and auditing. The Bank requires borrowers to provide periodic financial reports that facilitate comparison of financial and physical progress in implementing individual lending operations, with format, content, periodicity, and due date acceptable to the Bank. It also requires borrowers to provide audited financial statements, normally annually, that reflect the activities of the operation supported by the loan. The financial statements should be prepared in accordance with accounting standards acceptable to the Bank, and the audit should be conducted in accordance with auditing standards, and by independent auditors, that are acceptable to the Bank. The scope of the audit must be acceptable to the Bank, and it may be adapted to country- or projectspecific risks identified by Bank staff. The Bank may exempt a borrower from normal annual auditing requirements where more cost-effective mechanisms are available that provide the Bank with equivalent assurance that loan proceeds have been used appropriately, but in all such cases the Bank retains the right to request an audit. To the extent possible, the Bank seeks to uses the country s own financial reporting and auditing processes, and to agree on common financial reporting and auditing arrangements with other donors active in the same country or cofinancing the same projects. 7 8 OP 6.00, Bank Financing (forthcoming), states that Bank loan proceeds finance expenditures necessary to meet the development objectives of operations supported by the loan. Financial management arrangements comprise the budgeting, funds flow, accounting, internal control, financial reporting, and auditing arrangements of the entity or entities responsible for implementing Bank supported operations.

8 8 (c) Supervision. During project implementation, staff check the adequacy of the continuing financial management arrangements, review and follow up on financial reports and audits, and, as appropriate in the light of updated risk assessments, test-check application of parts of the financial management systems or individual transactions financed by the Bank. 22. Development Policy Operations. The Bank s policy with respect to financial management in development policy operations is set out in OP 8.60, Development Policy Lending (forthcoming). 9 In development policy lending, Bank loan proceeds provide balance of payments and budget support to borrowing governments, and are not used to finance specific transactions or programs. The Bank therefore focuses on the borrower's overall use of foreign exchange and budget resources rather than on the specific use of Bank funds. (a) (b) Disbursements. The Bank disburses the loan proceeds into an account that forms part of the country s official foreign exchange reserves (normally held by the central bank), and an amount equivalent to the loan proceeds is credited to an account of the government available to finance budgeted expenditures. Staff confirm these arrangements during project preparation and implementation. Foreign exchange and budget management. With respect to foreign exchange arrangements, Bank staff review, and discuss with IMF staff as appropriate, the IMF s most recent safeguards assessment of the borrower s central bank. When the assessment shows that the control environment of the central bank is satisfactory, or reveals issues for which the borrower has agreed to remedial actions that are monitored by the IMF, the Bank takes no further action. With respect to budget resources, the Bank reviews the country's public financial management arrangements through its diagnostic work and other sources, as discussed above. These reviews inform the Bank s decisions on the amounts of development policy loans, tranching, program content, conditionality, and risk mitigation measures. These results should be disclosed, as appropriate, in the Country Assistance Strategy or development policy operation documentation. When these reviews identify significant weaknesses, the Bank seeks a credible and monitorable government action program to address them. Some elements of this program may be included in the operation as part of the program content and conditionality. When the Bank has inadequate knowledge of the borrower s central bank control environment or budget management system, or an acceptable action plan to deal with identified weaknesses is not in place, the Bank may apply additional fiduciary 9 Pending the Executive Directors approval of the proposed changes to development policy lending, current policy is summarized in the Operational Memorandum Clarification of Current Bank Policy on Adjustment Lending, June 5, 2000.

9 9 requirements for example, it may require dedicated accounts for loan proceeds or counterpart funds, or may secure the right to request an audit on the dedicated accounts. The Bank may also agree with the government on the purposes for which the loan proceeds or counterpart funds may or may not be used. During implementation, financial management staff monitor compliance with any agreements of this nature. None of these measures can, or is intended to, provide assurance on the ultimate use of Bank loan proceeds. (c) Negative list. The Bank requires the borrower not to use the proceeds of development policy loan for ineligible purposes listed in the loan agreement (the standard negative list). 10 When the Bank requires dedicated accounts for loan proceeds, it may receive audit confirmation that the payments from this account were not used for items on the negative list; however, it is normally not possible for the Bank to obtain assurance on the ultimate use of loan proceeds. IV. GLOBAL AND REGIONAL PROGRAMS 23. The Bank participates in a range of global and regional programs and initiatives concerning financial management. Examples include work on standard-setting and regulatory issues with respect to accounting and auditing in both the public and private sectors, harmonization with other donors, and capacity-building initiatives. Through the Development Grant Facility, the Bank currently provides financial support to organizations that deal with international private sector and public sector accounting standards, harmonization of auditing standards on financial reporting between the public and private sectors, and for public interest oversight of the auditing profession. Bank staff participate actively in the work of many of these organizations. Through its engagement in these programs, the Bank seeks to ensure that development issues are fully taken into account, and that the Bank s own policies and capacity building initiatives are informed by recommended global and regional practices. 10 Draft OP 8.60, Development Policy Lending, proposes to eliminate expenditures incurred in the currency of the borrower from the negative list.

10 ANNEX FINANCIAL MANAGEMENT IN WORLD BANK OPERATIONS GUIDELINES TO STAFF I II III IV V Country Financial Management Strategy Diagnostic Work Investment Lending Development Support Lending Capacity Building