Guidelines on Local Government Borrowing and Recent Developments in South East Europe
5. Improving Financial Management Performance

5.1. Sound Financial Management for Improving Creditworthiness

Both local government officials and investors need adequate, accurate and timely financial information to be able to take optimal decisions.

Financial analysis assists officials to better understand the local government's fiscal situation and identify emerging trends of which they may be unaware. Financial analysis can also be used to present the local government's strengths and weaknesses to the local council, citizens, central government and investors. This promotes budget transparency and enhances the local government's ability to borrow. Moreover, financial analysis guides the financial planning and fiscal policy.

Investors need relevant and reliable financial information in their credit risk assessment analyses. The financial reports that local governments prepare rarely present financial information in the form that credit market participants need. A uniform financial reporting format, which suites both local/ central governments' and investors' requirements, should be a top priority for national regulators.

Local governments' annual reports should include at least an administrative report, a balance-sheet and income statement as well as a cash-flow analysis (if accounting system is accrual based). In some countries, the local governments are required to consolidate their financial statements with those of the subordinated local public institutions.

Steps to Improve Systemic Creditworthiness
1. Standardize the financial reporting format of local governments to include information that is important to credit markets
2. Public disclosure of local governments' financial reports should be mandatory
3. Periodic independent audits
4. Central government should monitor local debt service and financial ratios to ensure financial stability
1. Standardize the financial reporting format of local governments to include information that is important to credit markets
2. Public disclosure of local governments' financial reports should be mandatory
3. Periodic independent audits
4. Central government should monitor local debt service and financial ratios to ensure financial stability
Table 9: Using Financial Data To Improve Creditworthiness

Besides the steps aimed at improving the quality of financial reporting, additional actions should be taken in the areas presented in Table 10.



Steps to be taken for improvement of local government creditworthiness
Area Actions
Fiscal System

1.Intergovernmental
Transfers

2. Local Revenues
1a. Establish clear legislative or constitutional basis for revenue sharing and grants
1b. Maintain stable revenue-sharing formulas
2a. Provide for local control over local tax rates on some significant revenue sources
Municipal Development Funds

1. Problem Loans

2. Credit Assessment

3. Loan Policy
1a. Set explicit targets for maximum acceptable problem loan rates; monitor actual experience
2a. Assign explicit risk rating to each municipal loan
2b. Separate department or external credit-rating institution performs risk assessment.
2c. Compare ex post default or problem-loan experience with ex ante credit ratings; revise risk assessment methodology if necessary
3a. No new loans to borrowers who have problem loans outstanding
3b. No capital grants by Government to borrowers with problem loans outstandingy
Legal System

1. Default Procedures; Collateral Foreclosure
1a. Establish clear legal rules governing default procedures that are followed in practice, and enforceable by courts
Loan Defaults

1. Local Budget Intervention
1a. Establish automatic procedures for local budget intervention by Government at time of default
1b. Give intervention team power to restore budgetary balance by mandatory spending cuts and/or tax increases
Table 10: Steps to be taken for improvement of local government creditworthiness


 

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