Implementation of local governments’ investment projects depends on their ability to raise necessary funds from a combination of own resources and external financing. Debt financing enables municipalities to carry out more infrastructure projects in a shorter time period as compared to the financing from own funds. However, the risks associated to borrowing have to be well understood and documented in terms of their potential impact on local budget in the future.
This website is an e-learning tool covering the topic of local government borrowing tailored for the needs of the local authorities in South East Europe. The website is based on a Guide prepared under the NALAS Task Force on Fiscal Decentralization, which can also be downloaded as an electronic book, or purchased as a book.
Please use the links on the left to learn about local government borrowing. If you are new to the subject, then going sequentially over each link will give you a thorough explanation. However, if you are coming with a specific issue, or question, then please visit the forum, where you can ask questions, or read previous discussion. A team of experts involved with the project monitor the forum and should be able to respond to your requests.
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Implementation of local governments’ investment projects depends on their ability to raise the necessary funds from a combination of own resources and external financing. Debt financing enables municipalities to carry out more infrastructure projects in a shorter time period as compared to the financing from own funds. However, the risks associated to borrowing have to be well understood and documented in terms of their potential impact on local budget in the future. Thus, before borrowing is undertaken, it is recommended that each local government has in place a debt management strategy and a written debt policy. The debt management strategy should ensure that the local government maintains at all times an adequate level of indebtedness which (i) would not impair its financial stability and (ii) would enable it to implement the investment objectives.
The financial framework of local governments plays a key role in the sustainable development of local credit markets. The design of intergovernmental fiscal structure together with the accounting system and reporting procedures are important factors that are taken into consideration by financial institutions when assessing the opportunity to finance local governments
here are two major types of debt instruments available to finance municipal capital expenditures: (i) loans and (ii) bonds. Loans are granted by a financial institution (e.g. commercial bank) directly to the local government. Applying for a loan is less complex than the procedures required for bond issuance. From this point of view, loans are more advantageous to small and medium size municipalities seeking external financing. Many international financial institutions have dedicated programs aimed at supporting and financing local governments' infrastructure projects, especially in the emerging markets.
Prior to establishing the terms and conditions of a financing agreement (be it loans or bonds), investors evaluate local governments' creditworthiness. The creditworthiness of a local government measures both quantitatively and qualitatively its ability to repay debt.
Adequate, accurate and timely financial information on local governments' operations benefits both investors and local governments. A uniform financial reporting format, which suites both local/ central governments' and investors' requirements, should be a top priority for national regulators, as a precondition for improved financial management performance.
Depending on which type of debt instrument (loans or bonds) a local government wants to issue, there are different specialized financial institutions which should be approached. Local government loans are originated by: (i) municipal banks, (ii) commercial banks, (iii) international financial institutions and (iv) municipal development funds. Bonds are intermediated by commercial/ investment banks or brokerage houses. The existence and availability of these financial institutions to finance local governments depends on the architecture (bank lending model or bond model) and development of the local credit market. Central and local authorities should promote specific measures aimed at supporting the development of sustainable credit markets by minimizing the risk of market failures.
Local governments can tap external resources using a wide range of borrowing instruments. However, each instrument is suited to finance only certain types of activities. Short term financing instruments include: (i) working capital credit line – local government draws funds from the credit line, on which they pay interest, to finance temporary revenue shortages; principal is usually rolled over, (ii) bridge loans are a special type of short term loan where financing for a capital investment project is provided for a transitory period until the main (long term) financing is obtained. Medium and long-term borrowing should be pursued by local governments when financing capital investment projects. Long-term borrowing to cover current expenditures is usually prohibited by law and must be avoided anyway.
8. How local government associations can help improve the local debt legislation and credit market 21.12.2010
Local government associations are voluntary membership organizations, which comprise local governments from within a country or region, acting as an effective and authoritative advocate on members’ behalf in relation to central government, the parliament, potential investors and other stakeholders.
Accrual Accounting System Cash Basis Accounting System Modified Accrual Basis Accounting Credit Enhancement Municipal Credit Market Due Diligence Debt Limitation Debt Policy Debt Restructuring Debt Service Capacity Escrow . . .