1 N T E R N A T ~ O N A LB A N K FOR R E C O N S T R U C T I O N A N D DEVELOPMENT MANAGEMENT'S DISCUSSION AND ANALYSIS J U N E 30, 2 0 0 6 Section 1: Overview 3 Section 2: Basis of Reporting 5 Section 3: Development Activities 10 Loans 10 Guarantees 15 Other Activities 16 Section 4: Liquidity Management 16 Section 5: Funding Resources 18 Equity 18 Borrowings 21 Section 6: Financial Risk Management 22 GovernanceStructure 22 Managing Risk-Bearing Capacity 24 Credit Risk 25 Market Risk 28 Liquidity Risk 32 Operational Risk 32 Section 7: Critical AccountingPolicies 32 Section 8: Results of Operations 34 Section 9: Governance 37 Section 10: Reconciliation of Prior Year Current Value FinancialStatements to Reported Basis 39 Glossary of Terms 41 Boxes Selected Financial Data Hedging Strategy and Use of Derivatives Lending Operations Principles Treatment of Overdue Payments Tables Condensed Current Value Balance Sheets Condensed Current Value Statements of lncome Summary of Current Value Adjustments Impact of Currency Translation Adjustment Lending Status Contractual Terms of Currently Available Products Contractual Terms of Previously Available Products Loan Charge Waivers Guarantee Exposure Liquid Asset Portfolio Returns and Average Balances Contractual Cash Obligations Equity Capital Capital Subscriptions of DAC Members of OECD Countries Funding Operations Indicators Accumulated provision for Losses on Loans by Portfolio Credit Exposure, Net of Collateral Held, by Counterparty Rating Financial Instrument Portfolios Net lncome Net Noninterest Expense Condensed Current Value Balance Sheet at June 30, 2005 Condensed Current Value Statement of lncome for the year ended June 30, 2005 Figures Impact on Retained Earnings and Other Equity: FAS 133 vs. Current Value Adjustments 6 Commitments including Guarantee Facilities by Region 11 IBRD Lending Commitments 12 Loan Portfolio by Loan Product 15 Liquid Asset Portfolio Composition 18 Equity-to-Loans Ratio 19 New Medium- and Long-term Funding Excluding Swaps by Currency 22 Effect of Swaps on Interest Rate Structures 23 Effect of Swaps on Currency Composition 23 Top Eight Country Exposures 25 Relative Currency Composition of Significant Balance Sheet Components-Current Value Basis 31 Six-Month LlBOR Interest Rates U.S. Dollar 34 IBRD's U.S. Dollar Funding Curve 37 Throughout Management's Discussion and Analysis, terms in boldface type are defined in the Glossaryof Terms on page 41. The Management Discussion and Analysis contains forward looking statements which may be identified by such terms as "anticipates","believes","expects'', "intends" or words of similar meaning. Such state- ments involve a number of assumptions and estimates that are based on current expectations, which are subject to risks and uncertainties beyond IBRD's control. Consequently, actual future results could differ materially from those currently anticipated. 1. OVERVIEW Lending commitments to member countries in FY 2006 were$14.1 billion, reflectingan increase of $0.5 The International Bank for Reconstruction and billion from the FY 2005 level of $13.6 billion. Development (IBRD) is an international organization established in 1945 and is owned by its For the purposes of this document Operating member countries. IBRD'smain goalsare promoting Income refers to net income before Board of sustainable economic development and reducing Governors-approved transfers and the effect of net poverty in its developing member countries. It unrealized gains (losses)on non-trading derivative pursues these goals primarily by providing loans, instruments, as required by FAS 133. FY 2006 guarantees and related technical assistance for Operating Income was $1,740 million, $420 million projects and for programs for economic reform. more than that for FY 2005. This had the effect of IBRD'sability to intermediate funds from increasing IBRD'sreturn on equitya from 3.90% in international capital markets for lending to its FY 2005 to 5.05% in FY 2006 (see Boxl). developing member countries is an important During FY 2006, provisioning requirements for element in achieving its development goals. IBRD's probable losses on loans and guarantees were financial objectiveis not to maximize profit, but to reduced by $724 million due to the combined impact earn adequate net income to ensure its financial of changes in the creditworthiness of the loans strength and to sustain its development activities. portfolio, the annual update of the expected default Box 1presents selected financial data for the last five frequencies (probability of default to IBRD), fiscal years. developments in the nonaccrual portfolio and the The financial strength of IBRD is based on the reduction in the volume of the loans portfolio. support it receives from its shareholders and on its In the context of assessing changes in IBRD's array of financial policies and practices. Shareholder operating environment, it is management's practice support for IBRD is reflectedin the capital backing it to recommend each year the allocation of net income has received from its members and in the record of to augment reserves, waivers of loan charges to its borrowing members in meeting their debt-service benefit eligibleborrowers, and allocation of net obligations to it. IBRD'sfinancial policies and income to support developmental activities. practices have led it to build reserves, to diversify its funding sources, to hold a large portfolio of liquid On August 7,2006, the Executive Directors approved investments, and to limit a variety of risks, including the following allocations from FY 2006 net income: credit, market and liquidity risks. $1,036 million to the General Reserve and $64 million to the Pension Reserve. In addition, the IBRD's principal assets are its loans to member Executive Directors recommended to IBRD's Board countries. The majority of IBRD'soutstanding loans of Governors the following transfers from are priced on a cost pass-through basis. (SeeTables 5 unallocated net income: $140 million to Surplus, and and 6 for loan pricing details). $500 million to the International Development To raise funds, IBRD issues debt securities in a Association (IDA) as well as the transfer of $300 variety of currencies to both institutional and retail million to IDA out of Surplus. investors. These borrowings, together with IBRD's The Executive Directors also approved a 100 basis equity, are used to fund its lending and investment point waiver of the front-end fee on all loans (other activities, as well as general operations. than special development policy loans) presented to IBRD holds its assets and liabilities primarily in U.S. the Executive Directors between August 7,2006 and dollars, euro and Japanese yen. IBRD mitigates its the date on which the Board approves a front-end fee exposure to exchange rate risks by matching the waiver for FY 2008. The Executive Directors also currencies of its liabilitiesand equity with those of its approved that (i)interest charge waivers will be assets. However, the reported levels of its assets, maintained at 5 basis points for old loans and 25 liabilities, income and expensesin the financial basis points for new loans, respectively,to eligible statements are affected by exchange rate movements borrowers for payment periods commencing during in all the currencies in which IBRD transacts FY 2007 and (ii) waivers of 50 basis points on compared to IBRD's reporting currency, the U.S. commitment charges for FY 2007will be maintained dollar. Since IBRD matches the currencies of its for all loans. equity with those of its loans, the fluctuations captured in the cumulative translation adjustment for purposes of financial statement reporting do not a. Before the effects of Board of Governors-approved trans- significantlyimpact IBRD'srisk-bearingcapacity. fers and FAS 133. IBRD MANAGEMENT'S DISCUSSION AND ANALYSIS: JUNE30, 2006 3 Box 1: Selected Financial Data As of or for the Years Ended June 30 In millions of U.S. dollars. exceot ratio and return data in oercentaaes Lending Comm~tmentsto member countrlesb Gross D~sbursernents' Net D~sbursernents' Reported Basis Loan lncome Release of Prov~s~onfor Losses on Loans and Guarantees Investment lncome Borrow~ngExpenses Net Non~nterestExpense Operat~nglncome Board of Governors-Approved Transfers Net unreal~zed(losses) galns on non-trad~ng derlvat~veInstruments, as requ~redby FAS 133 Net (Loss) lncome Net Return on Average Earn~ng~ s s e t s ~ after the effects Board of Governors- Approved Transfers and of FAS 133' Return on Equ~ty after the effects Board of Governors- Approved Transfers and of FAS 133 ' Equ~ty-to-Loans~ a t ~ o ~ Total Assets Loans Outstand~ng Accumulated Prov~s~onfor Loan Losses Borrow~ngsOutstand~ng Total Equ~ty Current Value Basis Net lncome of wh~chcurrent value adjustment Net Return on Average Earn~ngAssets Return on Equ~ty Equ~ty-to-LoansRatlo Unrestr~ctedCash and L~qu~dInvestments Loans Outstand~ng Borrow~ngsOutstandlnge Total Equ~ty a IBRD'sStatement of lncome has been adlusted for prioryears as a result of a change ln account~ngprlnclple retrospectively appl~ed(see Change ~nAccount~ngPrlnclple for Board of Governors-approved Transfers-Sect~on 7 andNotes to F~nanc~al Statements-Note P) b Effectlve FY2005 comm~tments~ncludeguarantee comm~tmentsandguarantee facllltles c Amounts ~ncludetransactions wlth IFCand cap~tal~zedfront-end fees d Before the effects of Board o f Governors-approved transfers and FAS133 e Borrow~ngsoutstanding, exclud~ngswaps, net of prem~umld~scount Table 1: Condensed Current Value Balance Sheets at June 30,2006 and 2005 In millions o f U.5. dollars June 30, 2006 June 30, 2005 Reversal o f Current Current Reported FA5 133 Value Value Current Value Basis Effects Adjustments Basis Basis Due from Banks $ 758 $ 758 $ 1,177 Investments 25,826 25,826 27,444 Loans Outstanding 103,004 $881 103,885 107,549 Less Accumulated Provision for Loan Losses and Deferred Loan Income (2,783) (2,783) (3,491) Swaps Receivable Investments 7,525 7,525 9,735 Loans 87 $ 2 * 89 90 Borrowings 70,036 24 (24) 70,036 75,187 Other AsseVLiability 835 (94) 94 835 878 Other Assets 7,038 (344) 6,694 6,188 Total Assets $212,326 $ (68) $607 $212,865 $224,757 Borrowings $ 95,835 $41,033) $456 $95,258 $105,691 Swaps Payable Investments 7,960 7,960 11,215 Loans 84 * 84 89 Borrowings 65,819 (252) 252 65,819 65,404 Other AsseVLiability 1,014 (145) 145 1,014 1,034 Other Liabilities 5,140 5,140 4,381 Total Liabilities 175,852 (1,430) 853 175,275 187,814 Paid in Capital Stock 11,483 11,483 11,483 Retained Earnings and Other Equity 24,991 1,362 (246) 26,107 25,460 Total Equity 36,474 1,362 (246) 37,590 36,943 Total Liabilities and Equity $212,326 $ (68) $607 $212,865 $224,757 * Ind~catesamounts less than $0.5 m1111on. Investment Portfolio Market data include exchange rates and reference Under both the reported and current value basis, the n~arketinterest rates. The Currentvalue for the investment securities and related financial borrowings portfolio includes current value instruments held in IBRD'strading portfolio are adjustments for borrowings, swaps payable, swaps carried and reported at fair values. Therefore, for the receivableand the reduction in other assets due to investment portfolio, no additional adjustment is unamortized issuance costs. necessary. Fair value is based on market quotations. At June 30, 2006 the million ($2,793million- Instruments for which market quotations are not June30,2005) increase in IBRD'sborrowings readily available have been valued using market-based portfolio from the reported basis to the current value methodologies and market information. basis as shown in Table 3 reflects the averagecost of Borrowings Portfolio the borrowings portfolio being higher than the rate at The borrowings portfolio on a current value basis which IBRD could obtain funding at the reporting includes debt securities and associated financial date. The $1,717 million decrease from June30,2005 derivatives, and represents the present value of in the current value adjustment was due primarily to expected cash flows on these instruments discounted the decreasein the mark-to-market adjustment on the by the cost at which IBRD would obtain funding at U.S. dollar denominated debt consistent with the rise the reporting date. The valuation model incorporates in the reference market yield curve for the U.S. dollar availablemarket data in determining the expected during this period (see Figure12). cash flow and discount rates for each instrument. IBRD MANAGEMENT'S DISCUSSIONAND ANALYSIS: JUNE30, 2006 7 Table 2: Condensed Current Value Statements of lncome for the years ended June 30,2006 and 2005 In millions o f U.S. dollars FY2005 As Adjustedd Adjustments Current Value Current Value to Current Comprehensive Comprehensive Reported Basis Value Basis Basis lncome from Loans $ 4,864 $4,864 $4,155 lncome from Investments, net 1,057 $ (4) 1,053 624 Other lncome 267 267 271 Total lncome 6,188 (4) 6,184 5,050 Borrowing Expenses Administrative Expenses including contributions to Special Programs Release of Provision for Losses on Loans and Guarantees Other Expenses Total Expenses Operating lncome Board of Governors-Approved Transfers Current Value Adjustments Release of Provision for Losses on Loans and Guarantees-Current Value Net unrealized (losses) gains on non- trading derivative instruments, as required by FA5 133 Net (Loss) lncome a IBRD'sStatement of lncome has been adusted for prior years as a result of a change ~naccount~ngpr~nc~pleretrospect~vely applled (see Change ln Account~ngPrlnclplefor Board of Governors-approved Transfers-Sectlon 7 and Notes to F~nanc~al Statements-Note PI Table 3: Summary of Current Value Adjustments In millions o f U.S. dollars Total lncome Statement Balance Sheet Effects as o f June 30, 2006 Effect Less Prior Other Years' Loans Borrowings AssetlLiability Effects FY2006 FY2005 Current Value Adjustments on Balance Sheet due to Interest Rates $881 $(1,076)a $451) ~ ( 3 4 2 ) ~ $(588) $4227) Unrealized Gains on InvestmentsC 4 3 Currency Translation ~ d j u s t m e n t ~ 347 (216) 7 138 (49) Total Current Value Adjustments $4446) $4273) a Amount a net of the current value adustments for swaps, and unamortized ~ssuancecosts b Includes $1 16 m1111onrepresent~nga one-tlme cumulat~veeffect of recording the adoption, on July 1, 2000, of the current value bas15of account~ng c Unreal~zedgalns on the ~nvestmentportfolio have been moved from Operating lncome under the reported bas15and ~ncludedas part of current value adustments for current value reporting partly offset by a reduction in the average portfolio euro and the Japaneseyen accounted for size. approximately 16% and 4% of the total loan portfolio, and 97% of total non-U.S. dollar Administrative Expenses (IncludingContributions to Special Programs) denominatedloans at June30,2006. The borrowings portfolio accounted for a negative $216 million. The Administrative expenses increased by $34 million euro and the Japaneseyen accounted for during FY 2006 compared to FY 2005. Costs related approximately 12% and 3% of the total borrowing to pension and postretirement benefits accounted for portfolio, and 98% of total non-U.S. dollar $28 million of this increase. (seeTable 19). denominated borrowings at June 30,2006. Current ValueAdjustments Table 4: Impact of CurrencyTranslation Adjustment As part of its risk management strategy, IBRD closely aligns the duration (interest rate sensitivity) and the In m~ll~onsof U.S.dollars currency composition of its equity to that of its loan 2006 2005 portfolio in order to minimize the impact of any Loans $347 $(84) Borrowings (216) 52 interest rate and currency exchange rate movements Other Asset/L~ablllty 7 (17) on its risk bearing capacity.Therefore, on a current Total $ 138 $(49) value basiswhile there will be some mark-to-market effect on equity, such an impact will not significantly affect IBRD'srisk bearing capacity.Consistent with In comparison, during FY 2005 the impact of the positive duration of IBRD's equity, in a rising exchange rate changes on IBRD'snet assets resulted interest rate environment, the current value in a negative translation adjustment of $49 million adjustment decreased net income in FY 2006 by $446 due to the slight depreciation of both the euro million (decrease of $273 million in FY 2005) as (1.6%) and the Japaneseyen (0.5%) against the U.S. shown in Table 3. dollar. Impact of changes due to interest rates Given IBRD's risk management strategy, the stability of the current value equity-to-loansratio is The current value effect on the Income Statement of considered more significant than fluctuations in the negative$588 million, due to interest rate changes net current value adjustments. during FY 2006, was primarily due to the higher U.S. dollar reference market yield curve (see Figure12). The negative$588 million adjustment was due to the 3. DEVELOPMENT ACTIVITIES decrease in the current value mark on the loans portfolio of $2,267 million partially offset by the IBRD offersloans, related derivative products, and decrease in the current value mark on the guarantees to its borrowing member countries to borrowings portfolio of $1,717 million. These help meet their development needs. It also provides adjustments have been explained under the Current technical assistance and other advisory services to Value Balance Sheet Section. Similarly during FY support poverty reduction in these countries. 2005, IBRD'snet income on a current value basis Loans included a negative adjustment of $227 million, From its establishment through June30,2006, IBRD primarily reflecting the negativeeffects resulting had approved loans, net of cancellations, totaling from the upward movements in the discount curves $367,002 million to borrowers in 130 countries. A for the major referencecurrencies with the exception summary of cumulative lending is contained in Table of the euro. These losseswere partially offset by net 5. gains on the euro loans and borrowings portfolio, reflectingthe significant decrease in the euro interest At June 30,2006, the total volume of outstanding rate curve. loans was $103,004 million, $1,397 million lower than the $104,401 million of outstanding loans at Impact of changes due to currency translation June 30,2005. This decrease was due primarily to The current value adjustment from currency negative net disbursementsof $1,741 million, translation adjustments of positive $138 million was including $2,068 million of prepayments. primarily due to the appreciation of the euro (3.8%) Undisbursed balances at June 30,2006 totaled offset by the depreciation of the Japaneseyen (5.5%) $34,938 million, reflectingan increase of $1,194 against the U.S. dollar during FY 2006. Table 4 million from June30,2005. This change was due to provides a breakdown of this adjustment by the loans new commitments and positive currency translation and borrowings portfolios. The loans portfolio adjustments, partially offset by cancellations and contributed $347 million towards this increase. The disbursements of loans. Repayment terms for fmed-spread loans are more Derivative Products flexible than for variable-spread loans, subject to Along with the approval of the introduction of the certain constraints on the average repayment fixed-spread loan product with its various risk maturity and final maturity on a country basis. management features such as rate fixing and Within these constraints, borrowers have flexibility currency conversion, IBRD also offers derivative to configure grace periods and maturity profiles in a products to borrowers. These products respond to manner consistent with the purpose of the loan. borrowers' needs for access to better risk Repayment profiles may be level repayment of management tools in connection with existing IBRD principal, an annuity type schedule, a single lump- loans. These derivative products include currency sum repayment, or a customized schedule. and interestrate swaps, and interest rate caps and Repayment profiles cannot be changed after a loan is collars. signed. IBRD will pass through its market cost of the At June30,2006,71% (63%-June30,2005) of loans instrument to the borrower, and will charge a outstanding were made on currently availableterms. transaction fee comparable to the fee charged on the fixed-spread loan conversion features. These Local Currency Lending instruments may be executed either under a master IBRD offersits borrowers products to convert or derivativesagreement, which substantially conforms swap their IBRD loans into their domestic currencies to industry standards, or in individually negotiated to reduce their foreign currency exposure that do not transactions. The first currency swap transaction was generate foreign currency revenues. These local executed in FY 2004 between IBRD and one of its currency loans have Fixed Spread Loan terms. The borrowers under a Master DerivativesAgreement. balance of such loans outstanding at June 30,2006 Further details are provided in the Notes to Financial was $50 million. Statements-Note D-Loans, Guarantees and As part of the initiative taken during FY 2005 by the Derivatives for Borrowers. Board of Executive Directors to increase the usability Contractual Terms of PreviouslyAvailable Products of local currency paid-in capital, IBRD entered into a Local Currency Loan FacilityAgreement with IFC In previous years, IBRD offered loans with a variety which is capped at $300 million. Under this of other contractual terms including: multicurrency agreement, IBRD would lend local currencies of its pool loans and fmed-rate single currency loans. member countries, funded from paid-in capital, to Table 7 summarizes the contractual terms for IFC. These currencies would subsequently be used by variable-rate multicurrency and single-currency pool IFC to finance projects in those member countries. loans, and fixed-rate single-currency loans. Loan commitments under this facilityare subject to In 1980, IBRD established the currency pool system, consents of the respectiveIBRD member countries funded primarily with fmed rate medium-to-long whose currency is involved. At June 30,2006, loans term borrowings. In 1982, IBRD mitigated its outstanding equivalent to $50 million had been interest rate risk by moving from offering a fixed rate made under this facility. to a variable rate on these loans. Loans with a Deferred Drawdown Option The currency composition of multicurrency pool A Deferred Drawdown Option (DDO) for use with loans is determined on the basis of a pool, which IBRD development policy loans gives IBRD provides a currency composition that is the same for borrowers the option of deferring the loan's all loans in the pool. Pursuant to a policy established disbursement for up to three years. Loans with a by the Executive Directors, and subject to their DDO are subject to a commitment fee of 100 basis periodic review, at least 90% of the U.S. dollar points, which is 25 basis points higher than that for equivalent value of the pool is in a fmed ratio of one standard IBRDloans. Also, the front-end fee which is U.S. dollar to 125 Japaneseyen to one euro. The normally payable at the time a loan becomes lending rate formulation for loans with single effective,is only payablefor a DDO loan at the time currency pool terms is the same as that for it is disbursed. multicurrency pool loans. Single-currency pool loans are held in U.S. dollars, Japaneseyen, and euro. IBRD MANAGEMENT'S DISCUSSIONAND ANALYSIS: JU NE30, 2006 13 Table 7: ContractualTerms of Previously Available Products Varlablerate mult~currency Vanable rate slngle Flxedrate slngle pool loans currencypoolloansd currency ~ o a n s ~ (1982-2001) (1996-1998) (1995-1999) Welghted average cost of Welghted average Cost Base allocated debt cost of allocated debt LIBOR Spread Contractual Lendlng Spread 75 (new loans) 50 75 (new loans) 50 (oldloans) 50 (oldloans) Market Rlsk Premlum - - 0-10 Fundlng Cost Margln - - IBRD's fundlng slsread to LlBOR Charges Commltment charge on undlsbursed balances 75 75 75 Front-end fee on effective loans 100 (new loans) - 100 (new loans) 0 (oldloans) - 0 (oldloans) Ellglblefor WalversC Interest Yes Yes Yes Commitment Yes Yes Yes Final Matur~ty 15-20 years based on orlglnal 12-20 years loan agreement Grace perlod 3-5 years based on orlglnal 3 years loan agreement a. Converted from vanabie-rate muillcurrency pooi loans. b. Cost base and spread are fixed on rate-fix~ngdate for amounts d~sburseddunng the preced~ngSIX months c. Waiversof a portlon of charges and ~nterestare determ~nedannuaiiy, see Table 8 for detalis. During FY 2006 the Executive Directors approved At June 30,2006,29% (37%-June30,2005) of loans the revision of variable rate multi-currency pool and outstanding carried these previously available variable rate U.S. dollar pool lending rates to contractual terms. composite LIBOR + 100 basis points or the fmed rate Figure 4 presents a breakdown of IBRD'sloan equivalent thereof (at the borrower's choice) for portfolio by loan product. For more information,see borrowers that agree to certain amendments to their the Notes to Financial Statements-Note D-Loans, loan agreements. This revision has been approved in Guarantees and Derivativesfor Borrowers. order to adjust the pool lending rates, which are rising above market rates as these products are Waivers phased out, in a manner that was not envisioned at Waiversof a portion of charges and interest owed by the time that borrowers signed their loan all eligible borrowers are determined annually and agreements. These revised loan terms will be offered have been in effect since FY 1992. Eligibilityfor the from July2006, and will apply on interest rate reset partial waiver of interest is limited to borrowers that dates that occur on or after January1,2007. have made full payments of principal, interest and Any fmed-rate multicurrency pool loans that were other charges within 30 calendar days of the due converted to singlecurrency pools continued to carry dates during the preceding six months, on all their their fmed rate. loans. Waivers of a portion of the commitment charge owed on the undisbursed portion of loans are Fixed-rate single currency loans carry lending rates also determined annually and have been in effect fmed on semi-annual rate fixing dates for amounts since FY1990. All borrowers receivethe commitment disbursed during the preceding six months. For the charge waiver on their eligibleloans. Table 8 presents interim period from the date each disbursement is a breakdown of IBRD'sloan charge waivers. Further made until its rate fixing date, interest accrues at the details are provided in the Notes to Financial rate applicable to variable-spread loans. Statements-Note D-Loans, Guarantees and Derivativesfor Borrowers. IBRD generallyprovides the following types of countries in devising coordinated development guarantees: programs, appraising projects suitable for investment and assisting member countries in improving their Partial risk guarantees: These cover debt-service asset and liability management techniques. defaults on a loan that result from non-performance of government obligations. Research and Training:To assist its developing member countries, IBRD-through the World Bank Partial credit guarantees: These are used for public Institute and its partners-provides courses and other sector projects when there is a need to extend loan training activities related to economic policy maturities and guarantee specifiedinterest or development and administration for governments principal payments on loans to the government or its and organizations that work closely with IBRD. agencies. Trust Fund Administration: IBRD, alone or jointly Policy-basedguarantees: When partial credit with IDA, administers on behalf of donors, funds guarantees are used in support of agreed structural, restricted for specific uses. These funds are held in institutional and social policiesand reforms, they are trust and are not included in the assets of IBRD. See considered policy-based guarantees. Eligibilityfor the Notes to Financial Statements-Note J- IBRD development policy lending is a necessary Management of External Funds. condition for eligibilityfor policy-based guarantees. Investment Management: IBRD offers investment Enclave guarantees: These partial risk guarantees are management servicesto several types of external offered in exceptional cases for loans for foreign- institutions, including central banks of member exchangegenerating projects in a member country countries. One objective of providing the servicesto usuallyeligible only for credits from IDA. Fees central banks is to assist them in developing portfolio charged for enclave guarantees are higher than those management skills. These managed funds are not charged for non-enclave guarantees. The annual included in the assets of IBRD.See the Notes to commitment of enclave guarantees is limited to an Financial Statements-Note J-Management of aggregateguaranteed amount of $300 million. As of External Funds. June30,2006 commitments made under enclave guarantees were $30 million. 4. LIQUIDITY MANAGEMENT IBRD'sexposure at June 30,2006 on its guarantees IBRD'sliquid assets are held principally in highly- (measured by discounting each guaranteed amount rated fixed income securities. These securities from its first call date) is detailed in Table9. For include obligations of governments and other official additional information see the Notes to Financial entities, time depositsand other unconditional Statements-Note D-Loans, Guarantees and obligations of banks and financial institutions, Derivativesfor Borrowers. currencyand interestrate swaps (including currency Table 9: Guarantee Exposure forward contracts), asset-backed (including mortgage-backed) securities, and futures and In m~ll~onsof U.5. dollars options contracts. FY 2006 FY 2005 FY 2004 --- Part~alr~sk $248 $ 413 $ 418 Liquidity risk arises in the general funding of IBRD's Part~alcred~t 523 523 561 activities and in the management of its financial Pollcy based 154 156 157 -- - positions. It includes the risk of being unable to fund Total ---itsportfolioofassetsatappropriatematuritiesand $925 $1,092 $1,136 --- rates and the risk of being unable to liquidate a Other Activities position in a timely manner at a reasonable price. The objective of liquidity management is to ensure Consultation:In addition to its financial operations, the availabilityof sufficient cash flows to meet all of IBRD provides technical assistance to its member IBRD'sfinancial commitments. countries, both in connection with, and independently of, lending operations. There is a As one component of liquidity management, IBRD growing demand from borrowersfor strategic advice, maintained a $500 million line of credit as of June30, knowledge transfer, and capacity building. Such 2006, with an independent financial institution." assistanceincludes assigning qualified professionals This facilitywas used to cover any overnight to survey developmental opportunities in member countries, analyzing their fiscal, economic and a This 11neof credlt a heldlo~ntlywlth the lnternat~onal developmental environment, assisting member DevelopmentAssoc~at~on(IDA), an affillated organlzatlon overdrafts that may have occurred due to failed liquidity, which is set at the beginning of each fiscal trades. For further details about this facility, see the year. Investment of up to 20% of the stable portfolio Notes to Financial Statements-Note E-Borrowings. may be contracted out to external managers. Separate investment guidelines which conform to The primary objective for IBRD in the management IBRD'soverall Investment Guidelines are provided of liquid assetsis to protect the principal amount of to each external manager. these investments. In addition, IBRDseeks to achieve a reasonable return on the liquid asset portfolio The operational portfolio provides working capital using prudent asset and risk management for IBRD'sday-to-day cash flow requirements. techniques. The General Investment Authorization The discretionary portfolio, when used, provides for IBRD approved by the Executive Directors flexibilityfor the execution of IBRD'sborrowing provides the basic authority under which the liquid program and can be used to take advantage of assets of IBRD can be invested. Further, all attractive market opportunities. During FY 2005, investment activities are conducted in accordance this portfolio was liquidated, however, in FY 2006, it with a more detailed set of Investment Guidelines. was replenished by funds that were available above The Investment Guidelines are approved bythe Chief the requirements of the stable and oper56+ational Financial Officer and implemented by the Treasurer. portfolios. These Investment Guidelines set out detailed trading and operational rules including providing criteria for Figure 5 represents IBRD'sliquid asset portfolio size eligibleinstruments for investment, establishing risk and structure at the end of FY 2006 and FY 2005, parameters relative to benchmarks, such as an overall excluding investment assets associated with certain stop-loss limit and duration deviation, specifying other postemployment benefits. At the end of FY concentration limits on counterparties and 2006, the aggregatesize of the IBRD liquid asset instrument classes,as well as establishing clear lines portfolio was $24,655million, reflectinga decrease of responsibility for risk monitoring and compliance. of $l,515million from FY 2005. Of this amount, $1,443 million ($1,383million in FY 2005) in the Under IBRD'sliquidity management guidelines, stable portfolio was managed by external firms. aggregateliquid asset holdings are kept at or above a IBRD'sliquid asset portfolio is largelycomposed of specified prudential minimum in order to safeguard assets denominated in U.S. dollars with net exposure against cash flow interruptions. That minimum is to short-term interest rates. The debt funding these equal to the highest consecutive six months of liquid assets also shares similar currency and expected debt service obligations for the fiscal year, duration profiles. This is a direct consequence of plus one-half of net approved loan disbursements as IBRD'sexchange rate and interest rate risk projected for the fiscal year. The FY 2007 prudential management policies (seeSection 6-Financial Risk minimum liquiditylevel has been set at $15.5 billion, Management), combined with appropriate a decrease of $2.5 billion from that set for FY 2006. investment benchmarks. In addition to monitoring IBRD also holds liquid assets over the specified gross investment returns compared to their minimum to provide flexibilityin timing its benchmarks, IBRD also monitors overallinvestment borrowing transactions and to meet working capital earnings net of funding costs (seeSection 8-Results needs. of Operations). Liquid assets may be held in three distinct sub- The returns and average balances of the liquid asset portfolios: stable; operational; and discretionary, portfolio in FY 2006 compared to FY 2005 are each with different risk profiles and performance presented in Table 10. These returns exclude benchmarks. investment assets funding certain other The stable portfolio is principally an investment postemployment benefits. portfolio holhng the prudential minimum level of IBRD MANAGEMENT'S DISCUSSIONAND ANALYSIS: JU NE30, 2006 17 Table 12: Equity Capital June 30,2006 June 30, 2005 Usable Capital Paid-in Capital Restricted Paid-in Capital Net Payable for Maintenance of Value Total Usable Capital Special Reserve General Reserve, including allocation of FY 2006lFY 2005 net income Cumulative Translation Adjustmenta Equity used in Equity-to-Loans Ratio-Reported Basis Current Value Adjustments Equity used in Equity-to-Loans Ratio-Current Value Basis Loans and GuaranteesOutstanding, net of Accumulated Provision for Losses on Loans and Guaranteesand Deferred Loan Income $101,140 $101,990 Current Value Loans and GuaranteesOutstanding, net of Accumulated Provision for Losses on Loans and Guaranteesand Deferred Loan Income $102,021 $105,138 Equity-to-LoansRatio-Reported Basis Equity-to-LoansRatio-Current Value Basis a. Exclud~ngcumulat~vetranslation amounts assoc~atedwlth the FAS 133 adjustment (iii) $118million of IBRD'scapital was converted to $26,461million of IBRD'scapital is to be called U.S. dollars from the currency of the subscribing only when required to meet obligations of IBRD members by providing U.S. dollar denominated for funds borrowed or on loans guaranteed by it, nonnegotiable, non-interest bearing demand pursuant to resolutions of IBRD'sBoard of Gov- notes, encashable in the currency of the sub- ernors (though such conditions are not required scribing member. This amount may, under the by the Articles). Of this amount, 10% would be terms of the note, be encashed for administrative payablein gold or U.S. dollars and 90% in the expenses or, after all subscribed capital has been national currencies of the subscribing members. called, IBRD will have the right to encash the While these resolutions are not legally binding note to meet its obligations. on future Boards of Governors, they do record an understanding among members that this CallableCapital amount will not be called for use by IBRD in its (iv) $151,774million of IBRD'scapital may, under lending activities or for administrative pur- the Articles,be called only when required to poses.No call has ever been made on IBRD's meet obligations of IBRD for funds borrowed or callablecapital. Any calls on unpaid subscrip- on loans guaranteed by it. This amount is thus tions are required to be uniform, but the obliga- not availablefor use by IBRD in making loans. tions of the members of IBRD to make payment Payment on any such call may be made, at the on such calls are independent of each other. If option of the particular member, either in gold, the amount received on a call is insufficient to in U.S. dollars or in the currency required to dis- meet the obligations of IBRD for which the call charge the obligations of IBRD for which the call is made, IBRD has the right and is bound to is made. make further calls until the amounts receivedare IBRD, without any requirement of further sufficient to meet such obligations. However, no congressional action. The balance of the uncalled member may be required on any such call or portion of the U.S. subscription, $22,303million, has calls to pay more than the unpaid balance of its been authorized by the U.S. Congress but not capital subscription. appropriated. Further action by the U.S. Congress At June 30,2006, $103,604 million (58.1%) of the would be required to enable the Secretary of the uncalled capital was callable from the member Treasury to pay any portion of this balance. The countries of IBRD that are also members of the General Counsel of the U.S. Treasury has rendered an Development Assistance Committee (DAC)of the opinion that the entire uncalled portion of the U.S. Organization for Economic Cooperation and subscription is an obligation backed by the full faith Development (OECD).This amount exceeded and credit of the United States, notwithstanding that IBRD'soutstanding borrowings including swaps at congressional appropriations have not been obtained June 30,2006. Table 13 sets out the capital with respect to certain portions of the subscription. subscriptions of those countries and the callable For a further discussion of capital stock, restricted amounts. currencies, maintenanceof value and membership refer to the Notes to Financial Statements-Note A- Table 13: Capital Subscriptionsof DAC Members of Summary of Significant Accounting and Related OECD Countries Policies and Note B-Capital Stock, Restricted In millions of U.5. dollars Currencies, Maintenance of Value and Membership. Total Capital Uncalled Portion Borrowings Member Countrp Subscription of Subscription Source of Funding Un~tedStates $ 31,965 $ 29,966 IBRD diversifies its sources of funding by offering its Japan 15,321 14,377 securities to institutional and retail investors around Germany 8,734 8,191 the world, both through global offerings and by way France 8,372 7,851 of bond issues designed to meet the needs of specific Un~tedK~ngdom 8,372 7,832 markets or types of investors. Under its Articles, Canada 5,404 5,069 Italy 5,404 5,069 IBRD may borrow only with the approval of the Netherlands 4,283 4,018 member in whose markets the funds are raised and Belg~um 3,496 3,281 the member in whose currency the borrowing is Spa~n 3,377 3,171 denominated, and only if each such member agrees Sw~tzerland 3,2 10 3,012 that the proceeds may be exchanged for the currency Australla 2,951 2,770 of any other member without restriction. Sweden 1,806 1,696 Denmark 1,623 1,525 New medium- and long-term funding excluding Austr~a 1,335 1,254 swaps by currency for FY 2006, as compared to FY Norway 1,204 1,132 2005, is shown in Figure 7. F~nland 1,033 971 New Zealand 873 821 Funding Operations Portugal 659 620 In FY 2006, medium- and long-term debt raised Ireland 636 599 directly in financial markets by IBRD amounted to Greece 203 189 $10,233 million compared to $12,723 million in FY Luxembourg 199 190 2005. Table14 summarizes IBRD'sfunding Total $110,460 $103,604 operations for FY 2006 and FY2005. Table 14: Funding Operations Indicators a See details regarding the capital subscriptionsof all members of IBRD at June 30, 2006 in Financial State- ments-Statementof Subscriptions to Capital Stock and Voting Power Total Med~um-and Long-term Borrowlngsa (USD m~ll~on) $10,233 $12,723 The United States is IBRD'slargest shareholder. Average ~ a t u r(years) ~ ~ t ~ 3.7 5.2 Under the Bretton Woods Agreements Act, the Par Number of Transact~ons 259 283 Value Modification Act and other U.S. legislation, the Number of Currenc~es 11 13 Secretary of the U.S. Treasury is permitted to pay up a. Includes one-year notes and representsnet proceeds on to $7,663 million of the uncalled portion of the a settlement date basis. subscription of the United States, if it were called by b. Average maturity to first call date. IBRD MANAGEMENT'S DISCUSSION AND ANALYSIS: J UN E30, 2006 21 foundation of initial identification and measurement measured in terms of both probable and unexpected of risks by each of the business units. Under the losses from protracted payments arrears. Probable direction of the Finance Committee, policies and losses are covered by IBRD's accumulated provision procedures for measuring and managing such risks for losses on loans and guarantees, and unexpected are formulated, approved and communicated lossesare covered by income-generating capacityand throughout IBRD. Senior managers represented on equity. the Committee are responsible for maintaining The framework of stress testing provides a basis for sound credit assessments,addressing transaction and evaluating whether IBRD has sufficient financial product risk issues, providing an independent review capacityto be able to (i)absorb the income loss due function and monitoring the loans, investments and to a credit shock," and (ii) generate sufficientincome borrowings portfolios. to support loan growth in the followingyears. The The primary responsibility for the management of first requirement on the degreeof shock absorption is operational risk in IBRD's financial operations designed to reduce the probability of having to rely resides with each of IBRD's managers. These on additional shareholder support (in terms of individuals are responsible for identifying additional paid-in capital or a call on callablecapital). operational risks and establishing, maintaining and This is intended both to protect shareholders and to monitoring appropriate internal controls in their support IBRD's credit standing, which reduces respective areas using an operational risk borrowing costs and correspondingly, lending rates management framework. for borrowers. The second requirement on loan growth reflects the view that as a development This framework requires each business unit to institution, IBRD needs to play a positive role in a document operational risks and controls, assess the crisisby maintaining the capacityto continue lending likelihood and impact of operational risks and to assist recovery in borrowing member countries. evaluatethe design and operating effectivenessof One of the credit shock events used in the stress existingcontrols using guidelinesestablished by testing framework is an estimate of the amount of the IBRD. An independent operational risk control unit loan portfolio that could enter nonaccrual status supports this processby undertaking periodic (payment arrears in excess of six months) in the next reviews, performing quality assurance testing and three years at an appropriate confidencelevel. reporting exceptions. IBRD's equity supports its risk-bearingcapacity for The processes and procedures by which IBRD its lending operations. IBRD strives to immunize its manages its risk profile continually evolve as its risk-bearingcapacity from fluctuations in interest activitieschange in response to market, credit, and exchange rates. Therefore, IBRD uses the equity- product, operational and other developments. The to-loansratio (ona current valuebasis) as one tool to ExecutiveDirectors, particularly the Audit monitor the sensitivityof its risk-bearingcapacity to Committee members, periodically review trends in movements in interest and exchange rates. One of IBRD's risk profiles and performance, as well as any IBRD'sfinancial risk management objectives is to significantdevelopments in riskmanagement policies seek to protect the equity-to-loansratio from and controls. movements arising from market risks. Managing Risk-Bearing Capacity The sensitivityof IBRD's operatingincome to interest The risk bearing capacityof IBRD is the adequacy of rate movements arises primarily from the sensitivity its capital to absorb credit shocks and still be able to of the "contribution of equity" (the income earned lend for development purposes without the need for from that portion of IBRD's assets funded with additional shareholder support. The Board of equity rather than with debt).Thesensitivityof ExecutiveDirectors assesses IBRD'srisk-bearing IBRD's operating income to changesin market capacity based on a variety of metrics, including a interest rates has been increasing as borrowers have framework of stress testing and simpler measures chosen to borrow from IBRD primarily on floating such as the equity-to-loansratio, to assess capital rate terms since the introduction of LIBOR-based adequacy. The riskthat a significant portion of its loan portfolio a, Income loss ames from borrowers ~nnonaccrual status no longer may go into extended arrears is the most significant pay~ng~ntereston the~rloans. In add~t~on,an ~ncreasem the loan loss prov~s~ontyp~caliywarranted as a result of the nonaccrual event Th~s n risk faced by IBRD, and almost all of IBRD's equity ~ncreasem the prov~aonmust be recogn~zedas an expense, wh~chfur- capital is held against this risk. Credit risk is ther reduces net ~ncomem the year of the shock, and through that, ~mpactsthe equ~ty-to-loansratlo. Box 4: Treatment of Overdue Payments Where the borrower is the member country, no new loans to the member country, or to any other borrower in the country, will be presented to the Board of Executive Directors for approval, nor will any previously approved loan be signed, until payments for all amounts 30 days overdue or longer have been received. Where the borrower is not the member country, no new loans to that borrower will be signed or approved. In either case, the borrower will lose its eligibility for any waiver of interest charges in effect at that time. In addition to the provisions cited above for payments overdue by 30 days, to avoid proceeding further on the notification process leading to suspension of disbursements, the country as borrower or guarantor and all borrowers in the country must pay not only all payments overdue by 30 days or more, but also all payments due regardless of the number of days since they have fallen due. Where the borrower is not the member country, no new loans to, or guaranteed by, the member country, will be signed or approved. In addition to the suspension of approval for new loans and signing of previously approved loans, disbursements on all loans to or guaranteed by the member country are suspended until all overdue amounts have been paid. This policy applies even when the borrower is not the member country. Overdue by more than six All loans made to or guaranteed by a member of IBRD are placed in nonaccrual status, unless IBRD determines that the overdue amount will be months collected in the immediate future. Unpaid interest and other charges not yet paid on loans outstanding are deducted from the income of the current period. To the extent that these payments are received, they are included in income. At the time of arrears clearance, a decision is made on the restoration of accrual status on a case by case basis; in certain cases that decision may be deferred until after a suitable period of payment performance has passed. See Notes to Financial Statements-Note D-Loans, provision. In addition, the Audit Committee is Guarantees and Derivativesfor Borrowers for a apprised by management at least twice a year on the summary of countries with loans or guarantees in accumulated provision for losses on loans and nonaccrual status at June 30,2006. guarantees. Accumulated Provision for Losses on Loans and The accumulated provision for losses on both the Guarantees accrual and nonaccrual loans portfolio decreased by IBRD maintains an accumulated provision for losses $713 million (Table15).This decrease comprises a on loans and guarantees to recognize the probable release of provision for losses on loans (excluding losses inherent in both the accrual and nonaccrual guarantees) of $722 million and a negative portfolios. The methodology for determining the translation adjustment of $9 million during FY accumulated provision for losses on loans and 2006). This decrease was primarily due to the guarantees is discussed in Section 7, Critical combined impact of changes in the creditworthiness Accounting Policies. of the loans portfolio, changes in the volume and distribution of loans and guarantees outstanding and IBRD'sprovision for losses on loans and guarantees the annual update of the expected default frequencies covers probable credit losses from protracted arrears. (probabilityof default to IBRD)and developments in The Credit Risk Subcommittee reviewsthe allowance the nonaccrual portfolio. for losses on loans and guarantees at least quarterly and, if necessary, adjustments are made to the Table 15: Accumulated provision for Losses on Loans by Portfolio as a Percentage of Total Loans Outstanding In rn~ii~onsof U.8, doiiars 2005 Accurnuiated Accurnuiated Prov~s~onas a Prov~s~onas a Loans Accurnuiated Percentageof Total Loans Accurnuiated Percentageof Totai outstandmg Prov~aon Loans Outstand~ng outstandmg Prov~s~on Loans Outstand~ng Accrual Portfolio $101,966 $1,480 1.4% $100,858 $1,578 1.5% Nonaccrual Portfolio 1,038 816 0.8% 3,543 1,431 1.4% Total Loans Outstand~ng $103,004 $2,296 2.2% $104,401 $3,009 2.9% Treatment of Protracted Arrears borrowing activities and to meet the financial needs In 1991, the Executive Directors adopted a policy to of its borrowers, to generate income through its assist members with protracted arrears to IBRD to investment activities and to manage its exposure to mobilize sufficient resources to clear their arrears fluctuations in interest and currency rates. and to support a sustainable growth-oriented The effectivemanagement of credit risk is vital to the adjustment program over the medium term. This success of IBRD'sfunding, investment and asset1 policy is conditional on members agreeing to liability management activities.The monitoring and implement certain requirements including an managing of these risks is a continuous process due acceptable structural adjustment program, adopting to changing market environments. a financing plan to clear all arrears to IBRD and other multilateral creditors, and continuing to IBRD controls the counterparty credit risk arising service their obligations to IBRD and other from investments, derivativesand foreign exchange multilateral creditors on time. transactions through its credit approval process, the use of collateral agreements and risk limits, and It is IBRD's practice not to reschedule interest or monitoring procedures. The credit approval process principal payments on its loans or participate in debt involves evaluating counterparty creditworthiness, rescheduling agreements with respect to its loans. assigning credit limits and determining the risk During FY 1996 and FY 2002, exceptions were made profile of specifictransactions. Credit limits are to that practice with regard to Bosnia and calculated and monitored on the basis of potential Herzegovina (BiH) and Serbia and Montenegro exposures taking into consideration current market (SAM),formerly the Federal Republic of Yugoslavia, values, estimates of potential future movements in based on criteria approved by the ExecutiveDirectors those values and collateral agreements with in connection with the financial assistance package counterparties. If there is a collateral agreement with for Bosnia and Herzegovina in 1996. See the Notes to the counterparty to reduce credit risk, then the Financial Statements-Note A-Summary of amount of collateral obtained is based on the credit Significant Accounting and Related Policies, for rating of the counterparty. Collateral held includes additional information. cash and government securities. Commercial Credit Risk For foreign exchange and derivative products IBRD Commercial credit risk is the risk of loss due to a treats the credit risk exposure as the replacement counterparty not honoring its contractual cost. This is also referred to as replacement risk or the obligations. mark-to-market exposure amount. While contractual principal amount is the most commonly IBRD'scommercial credit risk is concentrated in used volume measure in the derivative and foreign investments in debt instruments issued by sovereign exchange markets, it is not a measure of credit or governments, agencies,banks and corporate entities. market risk. The majority of these investments are in AAA and AA rated instruments. Mark-to-market exposure is a measure, at a point in time, of the value of a derivative or foreign exchange In the normal course of its business, IBRD utilizes contract in the open market. When the mark-to- various derivativesand foreign exchange financial market is positive, it indicates the counterparty owes instruments to reduce funding costs through its IBRD and, therefore, creates an exposure for IBRD. IBRD MANAGEMENT'S DISCUSSION AND ANALYSIS: JU NE30, 2006 27 When the mark-to-market is negative, IBRD owes Market Risk the counterparty and does not have replacement risk. IBRD faces risks which result from market When IBRD has more than one transaction movements, primarily changes in interest and outstanding with a counterparty, and the parties exchange rates. In comparison to country credit risk, have entered into a master derivativesagreement IBRD'sexposure to market risks is small. IBRD has which contains legally enforceable close-out netting an integrated assetlliability management framework provisions, the "net" mark-to-market exposure to flexibly assess and hedge market risks associated represents the netting of the positive and negative with the characteristics of the products in IBRD's exposures with the same counterparty. If this net portfolios. - . mark-to-market is negative,then IBRD'Sexposure to Asset/Liabi/ityManagement the counterparty is considered to be zero. For the The objectiveof assetlliability management for IBRD contractual value, notional amounts and related is to ensure adequate funding for each loan product credit risk exposure amounts by instrument, see the and liquid asset at the most attractive available cost, Notes to Financial Statements-Note G-Credit Risk. and to manage the currency composition, maturity Table 16 provides details of IBRD'sestimated credit profile and interest rate sensitivity characteristics of exposure on its investments (excluding externally- the portfolio of liabilities supporting each lending managed assets-$1,443million at June 30,2006, product and liquid asset in accordance with the $1,383 million at June 30,2005) and swaps particular requirements for that product or liquid (excludingthosewith borrowing member countries), asset and within prescribed risk parameters. The net of collateral held, by counterparty rating current valueinformationis used in the assetlliability category. management process. The decrease in the proportion of AAA-rated Use of Derivatives investments and the corresponding increase in AA- As part of its assetlliability management process, and A-rated investments reflect (i) a reduction in IBRD employs derivatives to manage and align the investments in obligations of European agenciesand characteristics of its assets and liabilities. IBRD uses official entities, including the German Landesbanks, derivative instruments to adjust the interest rate (ii)some continued investments in short-term repricing characteristics of specificbalance sheet deposits with German Landesbanks after their assets and liabilities,or groups of assets and liabilities downgrade as a result of the expiration of state with similar repricing characteristics, and to modify guarantees and (iii) an increase in investments in the currency composition of net assets and liabilities. Japanese government securities. After the effects of netting arrangements, the credit exposure from Table 17 details the current value information of swapsdecreased from $8,167million at June30,2005 each loan product, the liquid asset portfolio, and the to $4,375 million at June30,2006. The swap credit debt allocated to fund these assets. exposure of $4,375 million is offset by collateral of $3,239 million which results in a total net swap exposure of $1,136 million. Table 16: Credit Exposure, Net of Collateral Held, by Counterparty Rating In m~ll~onsof U.5. dollars At June 30, 2006 At June 30, 2005 At June 30, 2004 lnvestments Agencies, Net Total Exposure Total Exposure Total Exposure Counterparty Banks & Swap on Investments % of on lnvestments % of on lnvestments % of Ratlng Soverelgns Corporate5 Exposure and Swaps Total and Swaps Total and Swaps Total AAA $ 340 $ 6,693 $ 288 $ 7,321 29 $11,208 42 $12,266 40 AA 31 13,132 848 14,011 55 12,831 49 15,975 51 A 1,771 2,220 - 3,991 16 Total $2.142 $22,045 $1,136 $25,323 100 Table 17: Financial Instrument Portfolios In m~ll~onsof U.5. dollars A t June 30, 2006 A t June 30, 2005 Current Current Value Value Carrying Contractual Adjust- Carrying Contractual Adjust- Value Yield ments Value Yield ments Loansa Variable-Rate Multicurrency Pool Loans Single Currency Pool Loans Variable-Spread Loans Fixed-Rate Single Currency Loans Special Development Policy LoansC Fixed-Spread Loans Other Fixed Rate Loans Liquid Asset ~ o r t f o l i o ~ Borrowings Allocation (including swaps)e Variable-Rate Multicurrency Pools Single Currency Pools Variable-Spread Fixed-Rate Single Currency Special Development Policy Fixed-Spread Other ~ e b t ~ a. Contractual y~eldn presented before the appl~cat~onof lnterest walvers. b, lncludes fixed-rate slngle currency loans for whlch the rate had not yet been fixed at fiscal year-end. c, lncludes loans w ~ t non-standard terms as descr~bed~nContractual Terms of Loans. h d. The 11qu1dasset portfol~on camed and reporied at market value and excludes ~nvestmentassets assoc~atedw ~ t hcerialn other postemployment benefits.The y~eld~nformat~onrepresents the welghted average markety~eldto matunty e. Carrv~naarnounts and contractual v~eldsare on a bas18whlch lncludes accrued lnterest and anv unamori~zedarnounts. but does not lnclude the effetts>f app/y~ngFA8 133. lncludes arnounts not yet allocated at June 30, 2006 and June 30, 2005. Ind~catesamounts less than $0.5 m1111on. Interest Rate Risk The borrowing cost pass-through formulation There are two main sources of potential interest rate incorporated in the lending rates charged on most of risk to IBRD. The first is the interest rate sensitivity IBRD'sexisting loans has traditionally helped limit associatedwith the net spread between the rate IBRD the interest rate sensitivity of the net spread earnings earns on its assets and the cost of borrowings, which on its loan portfolio. Such cost pass-through loans fund those assets. The second is the interest rate currently account for 61% of the existing sensitivity of the income earned from funding a outstanding loan portfolio (65% at the end of FY portion of IBRD assets with equity. In general, lower 2005).All cost pass-through loans, including single nominal interest rates result in lower lending rates currency and multicurrency pool loans as well as which, in turn, reduce the nominal earnings on variable-spread loans, pose residual interest rate risk, IBRD'sequity. In addition, as the loan portfolio given the lag inherent in the lending rate calculation. shifts from pool loans to LIBOR based loans, the Another potential risk arises because the cost pass- sensitivity of IBRD'soperating income to changes in through currency pool products have traditionally market interest rates will increase. been funded with a large share of medium- and long- IBRD MANAGEMENT'S DISCUSSION AND ANALYSIS: JU NE30, 2006 29 term fixed-rate debt, to provide the borrowers with a The interest rate risk on IBRD'sliquid asset portfolio, reasonably stable interest basis. Given that the which includes the risk that the value of assets in the cumulative impact of interest rate changes over time liquid portfolio will fluctuate due to changes in has resulted in a decline in the level of interest rates, market interest rates, is managed within specified the cost of these historical fixed-rate borrowings in duration-mismatch limits and is further limited by the multicurrency pool and the singlecurrency pools stop-loss limits. is currently considerably higher than IBRD's new Interest rate risk also arises from a variety of other borrowing costs.The amount of debt allocated to the factors, including hfferences in the timing between multicurrency debt pool will exceed the balance of the contractual maturity or repricing of IBRD's the multicurrency loan pool from FY 2008. The debt assets, liabilitiesand derivativefinancial instruments. which funds these loans has maturities that extend On floating rate assets and liabilities, IBRD is beyond those of the loans. This debt overhang exposed to timing mismatches between the re-set presents a risk of loss to IBRD because the debt dates on its floating rate receivables and payables. To carries fmed interest rates. mitigate its exposure to these timing mismatches, Over-funding of the multicurrency loan pool will IBRD has executed some overlay interestrate swaps. reach a maximum of approximately $6.2 billion in ExchangeRate Risk FY 2016. Strategies for managing this risk include changing the interest rate characteristics of the over- In order to minimize exchange rate risk in a funded portion of the debt from fmed to floating multicurrency environment, IBRD matches its rates beyond FY 2008 through the use of forward- borrowing obligations in any one currency (after starting swaps. IBRD began executing these forward- swap activities) with assets in the same currency, as starting swapsin FY 2000 and the cost to date has prescribed by the Articles.In addition, IBRD'spolicy been approximately $708 million. The fair value of is to minimize the exchangerate sensitivity of its the debt overhang remaining to be hedged is equity-to-loansratio.It carries out this policy by approximately $2 million as of June 30,2006. The undertaking currency conversions periodically to cost of the overhang will vary with interest rates and align the currency composition of its equity to that of prepayments. its outstanding loans. This policy is designed to minimize the impact of exchangerate fluctuations on Interest rate risk on non-cost pass-through products, the equity-to-loansratio, thereby preserving IBRD's which currently account for 39% of the existing loan ability to better absorb unexpected lossesfrom portfolio (35%at the end of FY 2005),is managed by arrears of loan repayments regardlessof the market using interestrate swaps to closely align the rate environment. sensitivity characteristics of the loan portfolio with those of their underlying funding. As the portfolio of Figure 10 presents the currency composition of fmed-spread loans increases, the proportion of non- significant balance sheet components (net of swaps) cost pass-though products will grow. at the end of FY 2006 and FY 2005. Figure 10: Relative Currency Composition of SignificantBalance Sheet Components-Current Value Basis At June 30,2006 Others JPY EUR USD 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Assets Liabilities &Equity Loans 78% rn Borrowings&Other 72% rn Investments &Other 22% Equity 28% 100% 100% At June 30,2005 Others JPY EUR USD 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Assets Liabilities &Equity Loans 78% rn Borrowings&Other 73% rn Investmnts &Other 22% Equity 27% 100% 100% Liquidity Risk Key risks and control weaknesses are evalu- Liquidity risk arises from the general funding needs ated on an annual basis by an internal panel. of IBRD'sactivities and in the management of its The panel evaluates and categorizesthese to determine if they pose a threat to manage- assets and liabilities. For a discussion on how ment's ability to make a positive assertion liquidity is managed, refer to Section 4-Liquidity on the adequacy of internal controls sur- Management. rounding IBRD'sexternal financial report- Operational Risk ing. Operational risk is the potential for loss resulting The results of the work undertaken to evalu- from inadequate or failed internal processesor ate the effectivenessof internal controls over systems,human factors, or external events, and financial reporting are reported to the Audit includes business disruption and system failure, Committee through an annual report. transaction processing failures and failures in On a periodic basis, operational risks and execution of legal, fiduciary and agency controls are assessed and reviewedto moni- responsibilities. IBRD, like all financial institutions, is tor significant changes. exposed to many types of operational risks. Internal Control Over Financial Reporting IBRD attempts to mitigate operational risk by Management has carried out an evaluation of maintaining a system of internal control that is internal control over external financial reporting for designed to keep that risk at appropriate levels in the purpose of determining if there were any changes view of the financial strength of IBRD and the made in internal controls during the fiscal year characteristics of the activities and markets in which coveredby this report, that had materially affected,or IBRD operates. Since 1996, IBRD has used a COSO - would be reasonablylikelyto materially affect IBRD's based integrated internal control framework. internal control over external financial reporting. As During FY 2006, IBRD updated its framework for of June 30,2006 no such significant changes operational risk management for its finance, human occurred. resources, information technology and procurement Annually IBRD'smanagement has made an assertion activities.This framework was implemented in that, as of June 30 of each fiscal year since 1997, its conjunction with business units and involves the system of internal control over its external financial following core steps: reporting has met the criteria for effectiveinternal Key operational risks and mitigating con- control over external financial reporting as described trols (including risks and controls over in COSO. Since FY 1997, IBRD'sexternal auditors financial reporting) are identified and docu- have provided an attestation report that mented using a combination of tools management's assertion regarding the effectivenessof including business process maps and risk internal control over external financial reporting is and control self assessments. Tailored risk fairlystated in all material respects. and control categories are also applied con- sistently across business units. Disclosure Controls and Procedures Operational risks are quantified based on Disclosure controls and procedures are those likelihood of occurrence and the resulting processeswhich are designed to ensure that financial impact using probability and information required to be disclosed is accumulated severity parameters. The inherent risks of and communicated to management, as appropriate potential misstatements in financial report- to allow timely decisions regarding required ing are also assessed. disclosure by IBRD. Management has undertaken an The design and operating effectiveness of evaluation of the effectiveness of such controls and key controls over financial reporting are procedures. Based on that evaluation, the President evaluated using self assessment workshops, and the Chief Financial Officer have concluded that independent walk through tests of pro- these controls and procedures were effectiveas of cesses, independent compliance testing by June 30,2006. internal audit, quality assurance testing by management and annual internal represen- 7. CRITICAL ACCOUNTING POLICIES tation letters from business unit managers. The Notes to IBRD'sfinancial statements contain a Action plans are developed for issues identi- summary of IBRD'ssignificant accounting policies. fied and followed up on a periodic basis. The following is a description of those accounting policies and Note D-Loans, Guarantees and policies which involve significant management Derivativesfor Borrowers. judgments that are difficult, complex or subjective Fair Value of Financial Instruments and relate to matters that are inherently uncertain. Under the current value basis of reporting, IBRD Provision for Losses on Loans and carries all of its financial assets and liabilities at Guarantees estimated values. Under the reported basis, IBRD IBRD'saccumulated provision for losses on loans carries its investments and derivatives,as defined by and guarantees reflects the probable losses inherent FAS 133, on a fair value basis.These derivatives in its nonaccrual and accrual portfolios. There are include certain features in debt instruments that, for several steps required to determine the appropriate accounting purposes, are separately valued and level of provisions for each portfolio. First, the total accounted for as either assets or liabilities.When loan portfolio is segregated into the accrual and possible, fair value is determined by quoted market nonaccrual portfolios. In both portfolios, the prices. If quoted market pricesare not available, then exposure for each country (defined as loans fair value is based on discounted cash flow models outstanding plus the present value of guarantees) is using market estimates of cash flows and discount then assigned a credit risk rating. With respect to rates. loans in the accrual portfolio, these loans are grouped according to the assigned risk rating. Each All the financial models used for input to IBRD's risk rating is mapped to an expected default financial statements are subject to both internal and frequency using IBRD'scredit migration matrix. The external verification and review by qualified provision required is calculated by multiplying the personnel. These models use market sourced inputs, outstanding exposure, by the expected default such as interest rates, exchange rates and volatilities. frequency (probabilityof default to IBRD) and bythe Selection of these inputs may involvesome assumed severity of the loss given default. judgement. Imprecision in estimating these factors, and changes in assumptions, can impact net income The determination of a borrower's risk rating is and IBRD'sfinancial position as reported in the based on both quantitative and qualitative analyses of financial statements. various factors, which include political risk, external debt and liquidity, fiscal policy and public debt IBRD believes its estimates of fair value are burden, balance of payments risks, economic reasonable given its processesfor obtaining external structure and growth prospects, monetary and prices and parameters; ensuring that valuation exchange rate policy, financial sector risks and models are reviewed and validated both internally corporate sector debt and other vulnerabilities. IBRD and externally; and applying its approach periodically reviews such factors and reassesses the consistently from period to period. adequacy of the accumulated provision for losses on Pension and Other Postretirement Benefits loans and guarantees accordingly.Actual losses may IBRD participates along with IFC and MIGA in differ from expected losses due to unforeseen pension and postretirement benefit plans that cover changes in any of the factors that affect borrowers' substantially all of their staff members. All costs, creditworthiness. assets and liabilities associated with the plans are The accumulated provision for loan losses is allocated between IBRD, IFC and MIGA based upon separately reported in the balance sheet as a their employees' respectiveparticipation in the plans. deduction from IBRD'stotal loans. The accumulated Costs allocated to IBRD are subsequently shared provision for losses on guarantees is included in between IBRD and IDA based on an agreed cost other liabilities. Increases or decreasesin the sharing ratio. The underlying actuarial assumptions accumulated provision for losses on loans and used to determine the projected benefit obligations, guarantees are reported in the Statement of Income fair value of plan assets and funded status associated as provision for losses on loans and guarantees. with these plans are based on financial market interest rates, past experience, and management's Additional information on IBRD's provisioning best estimate of future benefit changes and economic policy and the status of nonaccrual loans can be conditions. For further details, please refer to Notes found in the Notes to Financial Statements-Note A- to Financial Statements-Note K-Pension and Other Summary of Significant Accounting and Related Postretirement Benefits. IBRD MANAGEMENT'S DISCUSSION AND ANALYSIS: JU NE30, 2006 33 Table 18: Net lncome In m~ll~onsof U.S.dollars As Adjusted Loan interest income, net of funding costs Debt funded Equity funded Net interest income Other loan income Release of Provision for losses on loans and guarantees Investment income, net of funding costs Net noninterest expense Operating lncome Board of Governors-Approved Transfers Net unrealized gains (losses) on non-trading derivative instruments, as required by FA5 133 Net (Loss) Income-Reported Basis A $72 million increase in investment in higher-yielding loan products, also contributed to income, net of funding costs, reflectingthe the decline in net interest income. The margins for improved performance of IBRD'sinvest- cost pass-through products in FY 2004 were high, in ment portfolio during FY 2005 largelydue part reflectingthe effect of favorable interest rate to the higher return performance against repricing lags in a falling interest rate environment. benchmark. The performance during FY 2004 was depressed in part reflectingthe Net Noninterest Expense poor performance of certain asset classesat The main components of net noninterest expense are the beginning of FY 2004 when the bond presented in Table 19. market suffered one of its worst months. The borrowings which fund the investment FY 2006 versus FY 2005 portfolio are not marked-to-market. Net noninterest expense increased by $37 million Net Interest lncome primarily due to a $28 million increase in pension FY 2006 versus FY 2005 and other postretirement benefits and a $10 million increase in other expenses. Loan interest income, net of funding costs, increased by $274 million largely due to higher returns on the FY 2005 versus FY 2004 equity funded component of loans resulting from the Net noninterest expense increased by $40 million rise in market rates. In FY 2005, loan interest primarily due to a $75 million increase in staff costs income net of funding costs were lower primarily and operational travel. This was offset by a $41 due to the negative impact of the re-pricing lag on million increase in servicefee revenues and other net pool loans. income. FY 2005 versus FY 2004 Loan interest income, net of funding costs, decreased by $270 million largely due to lower returns on the debt funded component of loans, as a result of the lower lending rates of the cost pass-through loan products. Lower average loan balances, particularly Table 19: Net Noninterest Expense In m~ll~onsof U.S.dollar5 Gross Administrative Expenses Staff Costs Operational Travel Consultant Fees Pension and other postretirement benefits Contributions to Special Programs Communications and IT Contractual Services Equipment and Buildings Other Expenses Total Gross Administrative Expenses Less: Contribution to Special Programs Total Net Administrative Expenses Contribution to Special Programs Service Fee Revenues Net Other Income Total Net Noninterest Expense Net Unrealized (Losses) Gains on Non-trad- based on U.S. dollar-Japanese yen exchange rates, in Derivative Instruments, as required by these swaps also resulted in mark-to-market losses. FA%133 IBRD marks to market all derivative instruments, as Currently most of IBRD'sinterest rate swaps are U.S. defined by FAS 133. To a large extent, IBRD uses dollar-based with IBRD being a net fixed rate interestrate and currencyswapsto modify fmed U.S. receiver and variable rate payer (six-month LIBOR). dollar and non-U.S. dollar borrowings to variable Higher U.S. dollar interest rates in FY 2006, (see U.S. dollar borrowings. IBRD borrows in currencies Figure12) have also resulted in mark-to-market that are not directly needed for lending, to take losses on the interest rate swap portfolio. Essentially, advantage of arbitrage opportunities, and then the higher interest rates at the end of FY 2006 immediatelyswaps the borrowings into variable-rate resulted in an increase in the present value of the U.S. dollars. Currencyswaps are financially variable-rate coupons that IBRD pays, and a decline equivalent to non-U.S. dollar fmed-rate assets. Thus in the present value of the fixed-rate coupons that with higher interest rates in euro, South African IBRD receives on these swaps. rands and Pounds Sterling, these currencyswaps The overall effect is a mark-to-market loss of $3,479 resulted in significant mark-to-market losses. Some million on the Statement of Income for FY 2006. In of IBRD'scurrency swaps particularlyin Japanese contrast in FY 2005, primarily as a result of yen have coupons linked to the U.S. dollar-Japanese- significant downward shifts in the applicable yen exchange rate. With U.S. dollar interest rates referencemarket interest rate curves, the effects of rising by more than Japaneseyen interest rates in FY applying FAS 133 resulted in a mark-to-market gain 2006, the U.S. dollar was at a larger discount to of $2,511 million. Japaneseyen in the forward market (beyond ten years). Since IBRD receives coupons that are partly reviewingthe performance and recommending to throughout the year to discuss financial and the Board the appointment of the external auditor, as accounting matters. Executive Directors have well as monitoring the independence of the external complete access to management. The Audit auditor and meeting with it in executive session. The Committee reviews and discusseswith management Audit Committee participates in oversight of the the quarterly and annual financial statements. The internal audit function, including reviewingthe Committee also reviewswith the external auditor the responsibilities, staffing and the effectiveness of financial statements prior to their publication and internal audit. The Committee also reviews the recommends them for approval to the Board of annual internal au&t plan and meets with the Executive Directors. Auditor General in executive session. In the The Audit Committee has the capacity, under execution of its role, the Committee discusseswith exceptional circumstances, to obtain advice and management, the external auditors, and the internal assistancefrom outside legal, accounting or other auditors, financial issues and policieswhich have a advisors as deemed appropriate. bearing on the institution's financial position and risk-bearing capacity. The Audit Committee Code of Ethics monitors the evolution of developments in corporate IBRD strives to foster and maintain a positivework governance and the role of audit committees on an environment that supports the ethical behavior of its ongoing basis and revisedits terms of referencein FY staff. To facilitate this effort, IBRD has in place a 2004. Code of Professional Ethics-Livingour Values. The Communications Code applies to all staff (including managers, consultants, and temporary employees) worldwide. The Audit Committee communicates regularlywith the full Board through distribution of the following: This Code is available in nine languages on IBRD's website,www.worldbank.org. Staff relations, The minutes of its meetings. conflictsof interest, and operational issues,including Reports of the Audit Committee prepared the accuracy of books and records, are key elements by the Chairman, which document discus- of the Code. sions held. These Reports are distributed to the Executive Directors, Alternates, World In addition to the Code, an essential element of Bank Group Senior Management and Vice appropriate conduct is compliance with the Presidents of IBRD. obligations embodied in the Principles of Staff Employment, Staff Rules, and Administrative Rules, "Statement(s) of the Chairman" and state- the violation of which may result in disciplinary ments issued by other members of the Committee. actions. In accordance with the Staff Rules, senior managers must complete a confidential financial The Annual Report to the Board of Execu- disclosure instrument with the Office of Ethics and tive Directors, which provides an overview Business Conduct. of the main issues addressed by the Com- mittee over the year. Guidance for staff is also provided through The Audit Committee's communications with the programs, training materials, and other resources. external auditor are described in the Auditor Managers are responsible for ensuring that internal Independence section. systems, policies, and procedures are consistently aligned with IBRD'sethical goals. In support of its Executive Sessions efforts on ethics, IBRD offers a variety of methods Members of the Committee may convene in for informing staff of these resources. Many of these executive session at any time, without management efforts are headed by the following groups: present. Under the Committee's terms of reference,it The Office of Ethics and Business Conduct meets separately in executive session with the provides leadership, management and over- external and internal auditors. sight for IBRD'sethics infrastructure Access to Resourcesand to Management including the Ethics HelpLine, a consoli- dated conflicts of interest disclosure/resolu- Throughout the year, the Audit Committee receivesa tion system, financial disclosure, ongoing large volume of information, which supports the training to both internal and external audi- preparation of the financial statements. The Audit ences, and communication resources. Committee meets both formally and informally The Department of Institutional Integrityis In FY 2004, IBRD'sexternal auditor, Deloitte and charged with investigating allegations of Touche, began a new five-year term and will have fraud and corruption in IBRD-funded served 11 years as auditor upon completion of that projects worldwide. The Department also term, pursuant to a one-time grandfathered investigatesallegations of misconduct by exemption from the above-referenced ten-year limit. IBRD staff, and trains and educates staff Even within a five-year term the service of the and clients in detecting and reporting fraud external auditors is subject to recommendation by and corruption in IBRD-funded projects. the Audit Committee for annual reappointment and The Department reports directly to the President and is composed of professionals approval of a resolution by the Board of Executive from a range of disciplines including finan- Directors. cial analysts, researchers,investigators, law- As a standard practice, the external auditor is present yers, prosecutors, forensic accountants, and as an observer at virtually all Audit Committee IBRD staff with operational experience. meetings and is frequently asked to present its IBRD has in place procedures for the receipt, perspective on issues. In addition, the Audit retention and treatment of complaints received Committee meets periodically with the external regarding accounting, internal control and auditing auditor in private session without management matters. present. Communication between the external IBRD offers both the Ethics HelpLine, as well as a auditor and the Audit Committee is ongoing, as Fraud and Corruption hotline run byan outside firm frequently as is deemed necessary by either party. staffed by trained specialists.This third-party service IBRD'sauditors follow the communication offers numerous methods of communication in requirements with audit committees set out under addition to a toll free hotline in countries where U.S. generallyaccepted auditing standards. In access to telecommunications may be limited. In keeping with these standards, significant formal addition there are other methods by which the communications include: Department of Institutional Integrity may receive Quarterly and annual financial statement allegations, including directly by email, reporting. anonymously, or through confidential submission Annual appointment of the external audi- through its website, as well as the postal service and tors. telephone. Presentation of the external audit plan. Auditor Independence Presentation of control recommendations In FY 2003, the Board of ExecutiveDirectors adopted and discussion of the COSO attestation and a set of principles applicable to the appointment of report. the external auditor for IBRD. Key features of those principles include: Presentation of a statement regarding inde- pendence. Prohibition of the external auditor from the provision of all non audit-related services. In addition to Committee meetings, individual members of the Audit Committee have independent All audit-related services must be pre- access to the external auditor. approved on a case-by-casebasis by the Board of Executive Directors, upon recom- 10. RECONCILIATION OF PRIOR YEAR mendation of the Audit Committee. CURRENTVALUE FINANCIALSTATEMENTS TO Mandatory rebidding of the external audit REPORTED BASIS contract every five years. IBRD's Condensed Current Value Balance Sheet at Prohibition of any firm serving as external June 30,2005 is presented, with a reconciliation to auditors for more than two consecutive five- the reported basis, in Table 20 below. Similarly, year terms. IBRD's Condensed Current Value Statement of Mandatory rotation of the senior partner Income for the year ended June30,2005 is presented, after five years. with a reconciliation to the reported basis, in Table An evaluation of the performance of the 21. external auditor at the mid-point of the five year term. IBRD MANAGEMENT'S DISCUSSION AND ANALYSIS: JU NE30, 2006 39 Table 20: Condensed Current Value Balance Sheet at June 30,2005 In m1111onsof U.S. dollars June 30, 2005 Reported Reversalo f FAS Current Value Current Bas15 133 Effects Adustments Value Bas15 Due from Banks lnvestments Loans Outstanding Less Accumulated Provlslonfor Loan Losses and Deferred Loan lncome Swaps Receivable lnvestments Loans Borrowlngs Other Asset/L~ab~l~ty Other Assets Total Assets Borrowlngs Swaps Payable lnvestments Loans Borrowlngs Other Asset/L~ab~l~ty Other Llabllltles Total Llabllltles Pald In Capltal Stock Retalned Earnlngsand Other Equlty Total Equlty Total Llabllltles and Equlty * Indicatesamounts less that $0.5 m~ll~on. Table 21: Condensed Current Value Statement of lncome for the year ended June 30,2005 In m1111onsof U.S. dollars FY2005 As Adlusted3 Reported Current Value Comprehenslve Adustments to Comprehenslve Bas15 Current Value Bas15 lncome from Loans $4,155 $4,155 lncome from Investments, net 627 $ (3) 624 Other lncome Total lncome Borrowing Expenses Admlnlstratlve Expenses Release of Provlslon for Losses on Loans and Guarantees Other Expenses Total Expenses Operating lncome Board of Governors-Approved Transfers Current Value Adjustments Release of Provlslon for Losses on Loans and Guarantees- Current Value Net unrealized galns (losses) on non-tradlng derlvatlve Instruments as requlred by FAS 133 Net lncome (Loss) a IBRD's Statement of lncome has been adusted for prloryears as a result o f a change ln accounting prlnclple retrospectively applled(see Change ln Accounting Pr~nc~plefor Board of Governors-approved Transfers-Sectlon 7 andNotes to Flnanclal Statements-Note P) GLOSSARY OF TERMS Asset-backedSecurities:Asset-backedsecurities are instru- scription, of certain restricted currencies. Additional pay- ments whose cash flow is based on the cash flows of a pool ments to (or from) IBRD are required in the event the par of underlying assets managed by a trust. value of the currency is reduced (or increased) to a signifi- cant extent, in the opinion of IBRD. COSO:Committee of Sponsoring Organizations of the TreadwayCommission. Net Disbursements:Loan disbursements net of repay- ments and prepayments. Currency Swaps (includingCurrency ForwardContracts): Currency swaps are agreements between two parties to NewLoans:Loansfor which the invitation to negotiate was exchangecash flows denominated in different currencies at issued on or after July31, 1998. one or more certain times in the future. The cash flows are Old Loans:Loansfor which the invitation to negotiate was based on a predetermined formula reflecting rates of inter- issued prior to July31, 1998. est and an exchangeof principal. Options:Options are contracts that allow the holder of the Duration:Duration provides an indication of the interest option the right, but not the obligation, to purchase or sell rate sensitivity of a fixed income security to changes in its a financial instrument at a specified price within a specified underlying yield. period of time from or to the seller of the option. The pur- Equity-to-LoansRatio:This ratio is the sum of usable cap- chaser of an option pays a premium at the outset to the ital plus the special and general reserves,cumulative trans- seller of the option, who then bears the risk of an unfavor- lation adjustment (excluding amounts associated with able change in the price of the financial instrument under- applying the provisions of FAS 133) and the proposed lying the option. transfer from unallocated net income to general reserves Repurchase and Resale Agreements and SecuritiesLoans: divided by the sum of loans outstanding, the present value Repurchase agreements are contracts under which a party of guarantees, net of the accumulated provision for losses sells securities and simultaneously agrees to repurchase the on loans and guarantees and deferred loan income. same securities at a specified future date at a fixed price. Failed Trades: Failed trades are securities transactions that The reverse of this transaction is called a resale agreement. do not settle on the contractual settlement date. A resale agreement involves the purchase of securities with a simultaneous agreement to sell back the same securities FAS 133: FAS133 refers collectively to the Statement of at a stated price on a stated date. Securities loans are con- Financial Accounting Standards No. 133, "Accountingfor tracts under which securities are lent for a specified period Derivative Instruments and Hedging Activities", as of time at a fixed price. amended. Returnon Equity:This return is computed as net income Forward Starting Swaps:A forward starting swap is an divided by the average equity balance during the year. agreement under which the cash flow exchanges of the underlying interest rate swaps would begin to take effect Risk-bearing Capacity:The ability to absorb risks in the from a specified future date. balance sheet while continuing normal operations without having to call on callablecapital. Futures:Futures are contracts for deliveryof securities or money market instruments in which the seller agrees to Short Sales:Short sales are sales of securities not held in make deliveryat a specified future date of a specified the seller's portfolio at the time of the sale. The seller must instrument at a specified price or yield. Futures contracts purchase the security at a later date and bears the risk that are traded on U.S. and international regulated exchanges. the market value of the security will move adversely between the time of the sale and the time the security must GovernmentandAgency Obligations:These obligations be delivered. include marketable bonds, notes and other obligations issued by governments. Statutory LendingLimit:Under IBRD's Articles of Agree- ment, as applied, the total amount outstanding of loans, Hedging:Hedging is a risk management technique of participations in loans, and callable guarantees may not entering into offsetting commitments to eliminate or mini- exceed the sum of subscribed capital, reserves and surplus. mize the impact of adverse movements in value or cash flow of the underlying. Time Deposits:Time deposits include certificatesof deposit, bankers' acceptances, and other obligations issued InterestRate Swaps:Interest rate swaps are agreements or unconditionally guaranteed by banks and other finan- involving the exchangeof periodic interest payments of dif- cial institutions. fering character, based on an underlying notional principal amount for a specified time. LIBOR:London interbank offered rate. Maintenanceof Value:Agreements with members provide for the maintenance of the value, from the time of sub- IBRD MANAGEMENT'S DISCUSSION AND ANALYSIS: JU NE30, 2006 41 ~ N T E R N A T ~ ~ NB A N K FOR R ECO N ST RU CT I O N L A N D D EVELOPM ENT F I N A N CI A L ~ T A T E M E N T SA N D 1 N T ERN A L C O N TRO L R EP O RT S J U N E 30, 2 0 0 6 Management's Report Regarding Effectiveness of lnternal Controls Over External Financial Reporting 44 Report of lndependent Accountants on Management's Assertion Regarding Effectiveness of lnternal Controls Over External FinancialReporting 46 Report of IndependentAccountants 47 Balance Sheet 48 Statement of Income 50 Statement of ComprehensiveIncome 51 Statement of Changes in Retained Earnings 51 Statement of Cash Flows 52 SummaryStatement of Loans 54 Statement of Subscriptionsto Capital Stock and Voting Power 57 Notes to FinancialStatements 61 The World Bank 1818 H street N.W (2021477-1234 INTERNATIONAL BANK FOR RECDNSTRUCTION AND DEVELOPMENT Washington, D.C. 20433 Cable Address: INTBAFKAD INTERNATIONAL DEVELOPMENTASSOCIATION U S.A. Cable Address, INDEVAS Management's Report Regarding Effectiveness of ll~temalControls Over External Financial Reporting The management of the International Bank for Reconstruction and Development (IBRD) is rcsponsihle for the prepamtion, integrity, and fair presentation of its published financial statements. The financial statements have bccn prepared in accordance with accnunting princ~plesgenerally accepted in the United States of Amcrica and, as such, include amounts based on ~nfomedjildgrnents and est~rnatesmade by ~nanagcrncnt. The financial statements have been audited by an independent accounting firnl, which was given unrestricted access to all financial records and related data, including minutes of all meetings of the Board of Executive Directors and committees of the Board. Management believes t h a ~all represen~ntiotlsmade to the independent auditors during Iheir audit were valid and appropriate. Thc independenl auditors' report accompanies the audited financial statements. Management is responsible for establishing and maintaining effective internal control over external financial reporting for financial presentations in conformity with accounting principles generally ar.cepted in Ihe United States of America. The system of internal control conlains monitoring mechanisms, and actions are taken to correct deficiencies idenlified. Management believes that internal controls for exlen~alfinancial reporting, which are subject to scrutiny by managcmznt and the intetnal auditors, and are revised as considered necessary. support ll~e integrity and reliability o f the external finailcia1statements. There are inherent limitations in the effectiveness of any internal conlrol, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal control c m provide o~llyreasonable assurance with rcspcct to financial statcmcnt preparation. Further, because of changes in conditions, the effectiveness of inrcrnal control may vary over tilme. IBRD assessed its internal control over external financial reporting for financial presentations in conformity with accounting principles generally accepted in the United States of America as of June -10, 2006. This assessme~ltwas based on the criteria for effective internal control over external financial reporting described in Infernal Control-Jrltegmled Framc~i-orkissued by the Committee of Sponsoring Organizations of the Treadway Commission. Based upon this assessmenr, management believes that IBRD maintained effective internal control over external financial reporting presented in confo~mitywith accounting principles generally acceptcd in the Unitcd States of America as of June 30, 2006. The indcpendent accounting firm that auditcd the financial statements has issued an attestation report on management's assessment of IBRD's internal control o\.er external ljnancial reporting. -2- August 7,2006 The Board of Executive Directors of IBRD has appointed an Audit Committee responsible for monitoring the accounting practices and internal controls of IBRD. The Audit Committee is comprised entirely of Executive Directors who are independent of IBRD's management. Thc Audit Committee is responsible for recommending to the Board of Executive Directors the selection of independent auditors. It meets periodically with management, the independent auditors, and the internal auditors to ensure that they are carrying out their responsibililies. The Audit Committee is responsible for performing an oversight rolc by reviewing and monitoring the financial, accounting and auditing procedures of IBRD in addition to reviewing IBRD's reports. The independent auditors and the internal auditors have full and free access to the Audit Cornmittce, with or without the presence of management, to discuss the adequacy of internal control over external financial reporting and any other matters which they bclieve should be brought to the attention of the Audit Committee. Vi~lcenzoLa Via Chief Financial Officer - - Fayezul H. Choudhury ~h&lesA. ~ c ~ o n o * Vice President and Controller Director, Accounting Department IBRD FINANCIAL STATEMENTS: JUNE 30, 200645 Deloillr & Touche LLP Su~te500 555 12th S t r e ~ tNW Wash~ngton.DC 200i)4~1207 U5 4 Tel: +1 202 879 5600 Fax + I 202 879 53119 www delo~tte.cu~~s INDEPENDENT ACCOUNTANTS' REPORT President and Board of Executive Dirrctors International Bank for Reconstruction and Development We have examined managetnet~t'sassertion, included in rhc accompanying h,fanagernenf's Report Regording Eflecriveness oj'lnrdrnul C'onrrulsover External Finiinciul Reporting, that the li~ier~iational Ba11korReconstructio~~ Dcvclopment (''IBRD") maintained cffictive internal and control over external financial reporting presented in conformity wit11accour~tingprinciples generally accepted in the United States of America as of June 30. 2006, based on the criteria established in "internal Control-Integrated Framework" issued by the Committee of Sponsoring Organization.; of the Treadway Commission ("theCOSO report"). Management is rcspotlsible for maintaining effective internal control over externalfinancial rcpurting. Our responsibility is to express an opinion on managemznt's assertion based on our examination. Our examination was conducted in accordance with attestation standards established by the American Institute of Certified Public Accoul\tants and, accordingly. included obtaining an understanding of internal control over financial reporting, ~esting,a~ldevaluating the design and operating effectiveness of the internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our cxaminalion provides a ressonable basis for our opinion. Because of the inherent limitations of internal control over external financial reporting, including the possibility of collusion or improper management override of controls, material missratzments due to error or fraud may occur and not be detccted. Also, projections of any evaluation of the effectrveness ot'bhe lnternat control over externai t7nanc1alreporting ro iuture periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assertion that IBRD maintained effective intcrnol control over cxternal financial reporting presented in conformity with accounting principles generally accepted in the United States of America as of June 30, 2006, is fairly slated, in all rnaterial respects, based on the criteria established in the COSO report. August 7,2006 Deloitte. Deloitte & Tuua he LLP Suite 500 555 12th Street tlW Washnginn. DC 20004-1207 USA Tel:+ 1 202 879 5600 Fax- + I 202a n 1309 www dclo~ttccorn INDEPENDENT AUDITORS' REPORT President and Board of Executive Directors International Bank for Reconstruction and Development We have audited the accompanying balance sheets of the lnternatioaal Bank for Reconstruction and Eevelopment ("IRRn") as of June 30, 2006 and 2005. including the summary statement of loans and the siatcinent of subscriptions to capital stock and voting power as of June 30, 2006, and the related statements of income, comprehensive income, changes in retained earnings. and cash flows for each of the three fiscal years in the period ended June 30. 7,006.These financial statements are the responsibility of IRRD's management. Our responsibili~yis ru cxprsss an opinion on these financial statements based on our audits. Wc conducted our audits in accordance with auditing standards generally acceptcd in the United States of America and Intctnational Standards on Auditing. Those standards require that we plan and perform the audit to obtain reasonable zsurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also iticludrs assessing the accounting principles used and significan~estimates made by management, as wcll a cvaliratirig the overall financial statement presentation. We believe that our a u d i ~ sprovide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of IUKD as o f June 30, 2006 and 2005, and the results of its operations and its cash flows for each of the three fiscal years in the period ended June 30, 2006 in conformity with accounting principles getisi.ally accepted in the United States of America. As discussed in Notes A and P to the financial statements. i l l thefourth quarter of the fiscal year ended June 30, 2006, IUKD changed its method of accounting f~>rcerlain Board of Governors-approved transfers. In connection with this change, IBRD early adopted Staterner~tof Financial Accou~itingStandards No. 154 and applied this change retrospcctively to the 2005 and 2004 financial statements. August 7,2006 Member of Delotte Touche Tohmatsu IBRD FI NANCIAL ST ATEMENTS: JU NE30, 2006 47 B A L A N C E S H E E T June 30, 2006 and June 30, 2005 Expressed in millions o f U.S. dollars Assets Due from Banks Unrestricted currencies Currencies subject to restrictions-Note B Investments-Trading-NotesCand G Securities Purchased Under Resale Agreements-Note C Nonnegotiable, Noninterest-bearing Demand Obligations on Account of Subscribed Capital Receivable from Currency and Interest Rate Swaps Investments-Notes C and G Member operations-Notes D and G Borrowings-Notes E and G Other AssetILiability-Notes F and G Receivable to Maintain Value of Currency Holdings on Account of Subscribed Capital Other Receivables Receivable from investment securities traded-Note C Accrued income on loans Loans Outstanding (see Summary Statement of Loans, Notes D and G) Total loans Less undisbursed balance Loans outstanding Less: Accumulated provision for loan losses Deferred loan income Net loans outstanding Other Assets Unamortized issuance costs of borrowings Prepaid pension cost-Note K Premises and equipment (net) Miscellaneous Total assets Liabilities Borrowings-Notes Eand G Short-term Medium- and long-term Payable for Currency and Interest Rate Swaps Investments-Notes C and G Member operations-Notes D and G Borrowings-Notes E and G Other AssetILiability-Notes F and G Payable to Maintain Value of Currency Holdings on Account of Subscribed Capital Other Liabilities Payable for investment securities purchased-Note C Accrued charges on borrowings Payable for Board of Governors-approved transfers-Note H Liabilities under other postretirement benefits plans-Note K Accounts payable and miscellaneous liabilities-Notes D and K Total liabilities Equity Capital Stock (see Statement of Subscriptions to Capital Stock and Voting Power, Note B) Authorized capital (1,581,724 shares-June 30, 2006, and June 30, 2005) Subscribed capital (1,572,661 shares-June 30, 2006, and June 30, 2005) Less uncalled portion of subscriptions Amounts to Maintain Value of Currency Holdings-Note B 52 46 Retained Earnings (see Statement of Changes in Retained Earnings, Note H) 24,782 27,171 Accumulated Other Comprehensive Income (Loss)-Note M Total equity Total liabilities and equity The Notes to Financial Statements are an integral part of these Statements. IBRD FINANCIALSTATEMENTS: JU NE30, 2006 49 S T A T E M E N T O F I N C O M E For the fiscal years ended June 30, 2006, June 30, 2005 and June 30, 2004 Expressed in millions of U.S. dollars 2005 2004 As adjusted As adjusted 2006 (Note P) (Note P) Income Loans-Note D lnterest Commitment charges Investments-Trading-Note C lnterest Net losses Other-Notes l and J Total income Expenses Borrowings-Note E lnterest Amortization of issuance and other borrowing costs Administrative-Notes I, J and K Contributions to special programs-Note I Release of provision for losses on loans and guarantees-Note D Other Total expenses Net income before Board of Governors-approved transfers and net unrealized (losses)gains on non-trading derivative instruments, as required by FAS 133 Board of Governors-approved transfers-NotesH and P (650) (642) (645) Net unrealized (losses) gains on non-trading derivative instruments, as required by FAS 133-Note N (3,479) 2,511 (4,100) Net (loss) income $ (2,389) $ 3,189 $ (3,049) The Notes to FinancialStatements are an integral part of these Statements. 50 THE WORLD BANKANNUAL RE PORT 2006 S T A T E M E N T O F C O M P R E H E N S I V E IN C O M E For the fiscal years ended June 30, 2006, June 30, 2005 and June 30, 2004 Expressed in millions of U.S.dollars 2005 2004 As Adjusted AsAdjusted 2006 (Note P) (Note P) Net (loss) income $42,389) $3,189 Other comprehensive income-Note M Reclassification of FAS 133 transition adjustment to net income (4) (44) Currency translation adjustments Total other comprehensive income (loss) Comprehensive (loss) income S T A T E M E N T O F C H A N G E S I N R E T A I N E D EA R N I N G S For the fiscal years ended June 30, 2006, June 30, 2005 and June 30, 2004 Expressed in millions of U.S.dollars 2005 2004 AsAdjusted As Adjusted 2006 (Note P) (Note P) Retained earnings at beginning of the fiscal year Net (loss)income for the fiscal year Retained earnings at end of the fiscal year The Notes to FinancialStatements are an integralpart of these Statements. IBRD FINANCIAL STATEMENTS: JUNE 30, 2006 51 S T A T E M E N T O F C A S H F L O W S For the fiscalyears endedJune 30, 2006, June 30, 2005 andJune 30, 2004 Expressed in millions o f U.S. dollars 2005 2004 As adjusted As adjusted 2006 (Note P) (Note P) Cash flows from investing activities Loans Disbursements Principal repayments Principal prepayments Loan origination fees received Net cash provided by investing activities Cash flows from financing activities Medium- and long-term borrowings New issues Retirements Net short-term borrowings Net currency and interest rate swaps-Borrowings New capital subscriptions Net maintenance of value settlements Net cash used in financing activities Cash flows from operating activities Net (loss) income Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities Net unrealized losses (gains) on non-trading derivative instru- ments, as required by FA5 133 Depreciation and amortization Release of provision for losses on loans and guarantees Changes in: Investments-Trading Net investment securities tradedlpurchased-Trading Net currency and interest rate swaps-Investments Net securities purchasedlsold under resalelrepurchase agree- ments and payable for cash collateral received Accrued income on loans Miscellaneous assets Payable for Board of Governors-approved transfers Accrued charges on borrowings Accounts payable and miscellaneous liabilities Net cash provided by (used in) operating activities Effect of exchange rate changes on unrestrictedcash Net decreasein unrestrictedcash Unrestricted cash at beginning of the fiscal year Unrestricted cash at end of the fiscal year 2005 2004 As adjusted As adjusted 2006 (Note P) (Note P) Supplemental disclosure Increase (decrease) in ending balances resulting from exchange rate fluctuations Loans outstanding Investments-Trading Borrowings Currency and interest rate swaps-Investments Currency and interest rate swaps-Borrowings Capitalized loan origination fees included in total loans The Notes to Financial Statements are an integral part of these Statements. IBRD FINANCIAL STATEMENTS: JUNE 30, 2006 53 PURPOSE AND AFFILIATED ORGANIZATIONS affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at The International Bank for Reconstruction and the date of the financial statements and the reported Development (IBRD) is an international organization amounts of income and expensesduring the reporting which commenced operations in 1946. The principal period. Actual results could differ from these purpose of IBRD is to promote sustainable economic estimates. Significant judgments havebeen used in the development and reduce poverty in its member valuation of certain financial instruments, the countries, primarily by providing loans, guarantees determination of the adequacy of the accumulated and related technical assistancefor specificprojects provision for losses on loans and guarantees, the and for programs of economic reform in developing determination of net periodic income from pension member countries. The activities of IBRD are and other postretirement benefits plans, and the complemented by those of three affiliated present value of benefit obligations. organizations, the International Development Association (IDA),the International Finance Certain reclassificationsof the prior years' Corporation (IFC),and the Multilateral Investment information have been made to conform with the Guarantee Agency (MIGA). Each of these current year's presentation. organizations is legally and financially independent On August 7,2006, the Executive Directors approved from IBRD, with separate assets and liabilities, and these financial statements for issue. IBRD is not liable for their respectiveobligations. Transactions with these affiliates are disclosed in the Translation of Currencies:IBRD's financial notes that follow. IDA'Smain goal is to reduce poverty statements are expressedin terms of U.S. dollars solely through promoting sustainable economic for the purpose of summarizing IBRD's financial development in the less developed areas of the world position and the results of its operations for the included in IDA'Smembership by providing a convenience of its members and other interested combination of grants and financing on parties. concessionary terms. IFC's purpose is to encourage IBRD is an international organization which conducts the growth of productive private enterprises in its its operations in the currencies of all of its members. member countries through loans and equity IBRD's resources are derived from its capital, investments in such enterprises without a member's borrowings, and accumulated earnings in those guarantee. MIGA was established to encourage the various currencies. IBRD has a number of general flow of investments for productive purposes between policies aimed at minimizing exchange rate risk in a member countries and, in particular, to developing multicurrency environment. IBRD matches its member countries by providing guarantees against borrowing obligations in any one currency (after noncommercial risks for foreign investment in its swaps) with assets in the same currency, as prescribed developing member countries. by its Articles of Agreement. In addition, IBRD periodically undertakes currency conversions to more NOTE A-SUMMARY OF SIGNIFICANT closely match the currencies underlying its Equity ACCOUNTING AND RELATED POLICIES with those of the net loans outstanding. IBRD's financial statements are prepared in Assetsand liabilities are translated at market exchange conformity with the accounting principles generally rates in effect at the end of the period. Income and acceptedin the UnitedStates ofAmerica (U.S.GAAP). expenses are translated at either the market exchange Effective July1,2005, IBRD ceased preparing rates in effect on the dates on which they are financial statements in accordance with International recognized or at an average of the market exchange Financial Reporting Standards (IFRS). This action rates in effect during each month. Translation was taken in order to allow IBRD to evaluate the adjustments are charged or credited to Accumulated Amendment to International Accounting Standard Other Comprehensive Income. No. 39, Financial Instruments: Recoanition and " Measurement, The Fair Value Option, issued in June Valuation of Capital Stock:In the Articles of 2005, and in particular, to examine whether Agreement, the capital stock of IBRD is expressed in refinements to its loan valuation model would permit terms of "U.S. dollars of the weight and fineness in application of the fair value option to such financial effect on July1, 1944" (1944 dollars). Followingthe assets. abolition of gold as a common denominator of the monetary system and the repeal of the provision of the The preparation of financial statements in conformity U.S. law defining the par value of the U.S. dollar in with generallyaccepted accounting principles requires terms of gold, the pre-existing basis for translating management to make estimates and assumptions that IBRD FINANCIALSTATEMENTS: JU NE30, 2006 61 1944 dollars into current dollars or into any other The Special Reserve consists of loan commissions set currency disappeared. The Executive Directors of aside pursuant to Article IV, Section 6 of the Articles IBRD have decided, until such time as the relevant of Agreement, which are to be held in liquid assets. provisions of the Articles of Agreement are amended, These assets may be used only for the purpose of that the words "U.S. dollars of the weight and fineness meeting liabilities of IBRD on its borrowings and in effect on July1, 1944" in Article 11,Section 2(a) of guarantees in the event of defaults on loans made, the Articles of Agreement of IBRD are interpreted to participated in, or guaranteed by IBRD.The Special mean the Special Drawing Right (SDR)introduced by Reserve assets are included under Investments- the International Monetary Fund, as valued in terms Trading, and comprise obligations of the United States of U.S. dollars immehately before the introduction of Government, its agencies,and other official entities. the basket method of valuing the SDR on July 1,1974, The allocation of such commissions to the Special such value being $1.20635 for one SDR (1974SDR). Reserve was discontinued in 1964 with respect to subsequent loans and no further additions are being Maintenance of Value: Article 11,Section 9 of the made to it. Articlesof Agreement provides for maintenance of the value (MOV),at the time of subscription, of restricted The General Reserve consists of earnings from prior currencies (see Note B). Maintenance of value fiscal yearswhich, in the judgment of the Executive amounts are determined by measuring the foreign Directors, should be retained in IBRD's operations. exchangevalue of a member's currency against the The Pension Reserveconsists of the difference standard of value of IBRD capital based on the 1974 between the cumulative actual funding of the Staff SDR. Members are required to make payments to Retirement Plan (SRP) and other postretirement IBRD if their currencies depreciate significantly benefits plans, and the cumulative accounting income relative to the standard of value. Furthermore, the or expense for these plans, from prior fiscalyears.This Executive Directors have adopted a policy of Pension Reserve is reduced when pension accounting reimbursing members whose currencies appreciate expenses exceed the actual funding of these plans. significantlyin terms of the standard of value. Surplus consists of earnings from prior fiscal years The net MOV amounts relating to restricted which are retained by IBRD until a further decision is currencies out on loan, invested, swapped, or loaned made on their disposition or the conditions of transfer to the member by IBRD or through IFC, and amounts for specified uses have been met. that have been reclassified from receivables for those countries that have been in arrears for two years or The Cumulative FAS 133 Adjustments consist of the more, are included as a component of equity under effects associated with the application of FAS 133" Amounts to Maintain Value of Currency Holdings. from prior years. At June 30,2006, this amount For restricted currencies used in IBRD's lending and includes the one-time cumulative effect of the investing operations, these MOV amounts are shown adoption of FAS 133 on July1,2000, the as a component of Equity since MOV becomes reclassificationand amortization of the transition effective only as such currencies are repaid to IBRD. adjustments for prior fiscal years, and the unrealized gains or losses on certain derivative instruments, as Transfers Approved by the Board of Governors: In defined by FAS 133, for prior fiscal years. accordance with IBRD's Articles of Agreement, the Board of Governors may exerciseits reservedpower to Unallocated Net Income (Loss)consists of the current approve transfers to other entities for development fiscal year's net income (loss) adjusted for Board of purposes. These transfers, referred to as "Board of Governors-approved transfers, and the equivalent Governors-approved transfers",are reported as amount for transfers funded from Surplus. expenses on the Statement of Income in the year of Loans:All of IBRD's loans are made to or guaranteed approval (SeeNote P). The transfers may be funded by members, except loans to IFC. The majority of from prior year's Unallocated Net Income or Surplus. IBRD's loans have repayment obligations based on If the transfer is funded from Surplus, there is a specific currencies. IBRD also holds multicurrency concurrent transfer from Surplus to the current year's loans which have repayment obligations in various Unallocated Net Income (Loss)within Retained currencies determined on the basis of a currency Earnings in an amount equivalent to the expense pooling system. recognized. Any loan origination fees incorporated in a loan's Retained Earnings: Retained Earnings consists of terms are deferred and recognized over the life of the allocated amounts (SpecialReserve, General Reserve, Pension Reserve, Surplus and Cumulative FAS 133 a. For the purpose of this document, FAS 133 refers to the State- ment of Financial Accounting Standards (FAS)No. 133, Account- Adjustments) and Unallocated Net Income. ing for Derivative Instruments and HedgingActivities,as amended. loan as an adjustment of yield. However, incremental any such loan are overdue by more than six months, direct costs associated with originating loans are unless IBRD management determines that the expensed as incurred as such amounts are considered overdue amount will be collected in the immediate insignificant. The unamortized balance of loan future. In addition, if development credits made by origination fees is included as a reduction of Loans IDA to a member government are placed in Outstanding on the balance sheet, and the loan nonaccrual status, all loans made to or guaranteed by origination fee amortization is included in Interest that member government will also be placed in under Income from Loans on the income statement. nonaccrual status by IBRD. On the date a member's loans are placed into nonaccrual status, unpaid It is IBRD's practice not to reschedule interest or interest and other charges accrued on loans principal payments on its loans or participate in debt outstanding to the member are deducted from the rescheduling agreements with respect to its loans. In income of the current period. Interest and other exceptional cases, however, such as when charges on nonaccruing loans are included in income implementation of a financed project has been onlyto the extent that payments have been received by delayed, the loan amortization schedule may be IBRD. If collectibility risk is considered to be modified to avoid substantial repayments prior to particularly high at the time of arrears clearance, the project completion. member's loans may not automatically emerge from In addition, during fiscal years 1996 and 2002, nonaccrual status, even though the member's exceptions were made to that practice with regard to eligibilityfor new loans may have been restored. In Bosnia and Herzegovina (BiH) and Serbia and such instances, a decision on the restoration of accrual Montenegro (SaM),formerly the Federal Republic of status is made on a case-by-case basis after a suitable Yugoslavia, respectively,in connection with their period of payment performance has passed from the succession to membership of the former Socialist time of arrears clearance. Federal Republic of Yugoslavia (SFRY). One Guarantees:IBRD generallyprovides guarantees of component of the financial assistance packages for loans undertaken for, or securities issued in support BiH and SaM was a plan for the clearance of arrears of, projects located within a member country eligible under all loans to the former SFRY for which they for IBRD loans, as well as loans undertaken or undertook responsibility. Under the arrears clearance securities issued by entities eligible for IBRD plans, the accumulated arrears on loans to the former development policy lending. These financial SFRY which were assumed by BiH and SaM were guarantees are commitments issued by IBRD to cleared through the issuance of new loans extended by guarantee payment performance by a borrower to a IBRD. IBRD's treatment of BiH and SaM was based third party. on criteria approved by the Executive Directors in connection with the financial assistance package for Guarantees are regarded as outstanding when the BiH in fiscal year 1996. These criteria limit eligibility underlying financial obligation of the borrower is for such treatment to a country: (a) that has emerged incurred, and called when a guaranteed party from a current or former member of IBRD; (b)that is demands payment under the guarantee. IBRD would assuming responsibility for a share of the debt of such be required to perform under its guarantees if the member; (c) that, because of a major armed conflict payments guaranteed were not made by the debtor in its territory involving extensive destruction of and the guaranteed party called the guarantee by physical assets, has limited creditworthiness for demanding payment from IBRD in accordance with servicing the debt it is assuming; and (d) for which the terms of the guarantee. In the event that a reschedulinglrefinancing would result in a significant guarantee is called, IBRD has the contractual right to improvement in its repayment capacity,if appropriate require payment from the member country that has supporting measures are taken. This treatment was provided the counter guarantee to IBRD on demand, based on a precedent established in 1975 after or as IBRD may otherwise direct. Bangladesh became independent from Pakistan. For guarantees issued or modified after December 31, IBRD does not believe that any other borrowers with 2002, in accordance with Financial Accounting loans in nonaccrual status currently meet these Standards Board (FASB) Interpretation No. 45 (FIN eligibilitycriteria. 45), Guarantor's Accounting and Disclosure It is the policy of IBRD to place in nonaccrual status Requirements for Guarantees, Including Indirect all loans made to or guaranteed by a member of IBRD Guarantees of Indebtedness to Others, IBRD records if principal, interest, or other charges with respect to IBRD FINANCIALSTATEMENTS: JU NE30, 2006 63 the fair value of the obligation to stand ready, and a Statement of Cash Flows: For the purpose of corresponding asset in the financial statements. IBRD'sStatement of Cash Flows, cash is defined as the amount of unrestricted currencies Due from Banks. Guarantee fee income received is deferred and amortized over the life of the guarantee. Investments:Investment securities are classified based on management's intention on the date of IBRD records a contingent liability for the probable purchase, their nature, and IBRD's policies governing losses related to guarantees outstanding. This the level and use of such investments. At June 30, provision, as well as the unamortized balance of the 2006 and June 30,2005, all investment securities were deferred guarantee fee income, and the unamortized held in a trading portfolio. Investment securities and balance of the obligation to stand ready, are included related financial instruments held in IBRD's trading in Accounts Payableand Miscellaneous Liabilities on portfolio are carried and reported at fair value. The the balance sheet. first-in first-out (FIFO) method is used to determine Accumulated Provision for Losses on Loans and the cost of securities sold in computing the realized Guarantees:Delaysin receivingloan payments result gains and losses on these instruments. Unrealized in present value losses to IBRD since it does not gains and losses for investment securities and related charge fees or additional interest on any overdue financial instruments held in the trading portfolio are interest or loan charges. These present value losses are included in income. Derivative instruments are used equal to the difference between the present value of in liquidity management to take advantage of payments of interest and charges made according to profitable trading opportunities. These derivativesare the related loan's contractual terms and the present carried at fair value. From time to time, IBRD enters value of its expected future cash flows. IBRD has not into forward contracts for the sale or purchase of written off any of its loans. investment securities; these transactions are recorded at the time of commitment. Management determines the appropriate level of accumulated provisions for losses on loans and Securities Purchased Under Resale Agreements guarantees. IBRD'saccumulated provision for losses and Securities Sold Under Repurchase on loans and guarantees reflects the probable losses Agreements and Payable for Cash Collateral inherent in its nonaccrual and accrual portfolios. Received:Securities purchased under resale There are several steps required to determine the agreements, securities lent under securities lending appropriate level of provisions for each portfolio. agreements, and securities sold under repurchase First, the total loan portfolio is segregated into the agreements are recorded at historical cost. IBRD accrual and nonaccrual portfolios. In both portfolios, receives securities purchased under resale agreements, the exposure for each country (defined as loans monitors the fair value of the securities and, if outstanding plus the present value of guarantees) is necessary, closes out transactions and enters into new then assigned a credit risk rating. With respect to repriced transactions. The securities transferred to countries with loans in the accrual portfolio, these IBRD under the repurchase and security lending loans are grouped according to the assigned borrower arrangements and the securities transferred to risk rating. Each risk rating is mapped to an expected counterparties under the resale agreements have not default frequency using IBRD'scredit migration met the accounting criteria for treatment as a sale. matrix. The provision required is calculated by Therefore, securities transferred under repurchase multiplying the outstandingexposure, bythe expected agreements and security lending arrangements are default frequency (probabilityof default to IBRD)and retained as assets on IBRD'sbalance sheet, and by the assumed severity of the loss given default. securities received under resale agreements are not recorded on IBRD'sbalance sheet. The determination of borrowers' ratings is based on both quantitative and qualitative analysesof various Nonnegotiable, Noninterest-bearing Demand factors. IBRD periodically reviews these factors and Obligations on Account of Subscribed Capital: reassessesthe adequacy of the accumulated provision Payments on these instruments are due to IBRD upon for losses on loans and guarantees accordingly. demand and are held in bank accounts which bear Adjustments to the accumulated provision are IBRD's name. Accordingly, these instruments are recorded as a charge or addition to income. carried and reported at face value as assets on the balance sheet. Premises and Equipment: Premisesand equipment, relationships. Rather, all derivative instruments, as including leasehold improvements, are carried at cost defined by FAS 133, have been marked to fair value less accumulated depreciation and amortization. and all changes in fair value have been recognized in IBRD computes depreciation and amortization using net income. While IBRD believes that its hedging the straight-line method over the estimated useful strategies achieve its objectives, the application of FAS lives of the owned assets, which range between two 133 qualifying hedge criteria would not make fully and fiftyyears. For leasehold improvements, evident the risk management strategies that IBRD depreciation and amortization is computed over the employs. lesser of the remaining term of the leased facilityor Valuation of Financial Instruments: Derivative the estimated economic life of the improvement. financial instruments and investment securities are Maintenance and repairs are charged to expense as recorded in IBRD's financial statements at fair value. incurred, while major improvements are capitalized Disclosures related to the fair value of these, and other and amortized over the estimated usefullife. financial instruments are included in Note 0. Fair value is based on market quotations when possible. Borrowings:To ensure funds are available for lending Financial instruments for which market quotations and liquidity purposes, IBRD borrows in the are not readily available have been valued based on worldwide capital markets offering its securities to discounted cash flow models using market estimates private and governmental buyers. IBRD issues short- of cash flows and discount rates. All the financial term and medium- and long-term debt instruments models used for valuing IBRD's financial instruments denominated in various currencies with both fixed are subject to both internal and periodic external and adjustable interest rates. Borrowings are carried verification and review. These models use market on the balance sheet at their par value (facevalue), sourced inputs such as interest rates, exchange rates, adjusted for any unamortized premiums or discounts, and volatilities. Selection of these inputs may involve and include adjustments for embedded derivatives some judgement, as does estimating prices when no and fair value hedges that existed at June 30,2000, as external parameters exist. required by FAS 133. Issuance costs associated with a bond offering are deferred and amortized over the Accounting for Grant Expenses: IBRD recognizes period during which the related indebtedness is an expense for grants, such as Contributions to outstanding. Amortization of discounts and Special Programs, and Board of Governors-approved premiums is included in Interest under Borrowing transfers, when the obligation has been incurred. In Expenseson the income statement. instances where the recipient organization is deemed, in accordance with generally accepted accounting IBRD uses derivativesin its borrowing and liability principles, to be controlled by IBRD, only those management activities. In the borrowing portfolio, amounts which have been expended by the recipient derivativesare used to take advantage of cost saving organization are recognized as an expense; any opportunities in non-target currencies in various remainder is deferred. capital markets. These derivativesare used to modify the interest rate andlor currency characteristics of the Accounting and Reporting Developments:In the borrowing portfolio, and are carried at fair value in fourth quarter of the fiscal year ended June30,2006, accordance with FAS 133. The interest component of IBRD adopted a voluntary change in accounting these derivativesis recognized as an adjustment to the principle for certain Board of Governors-approved borrowing cost over the life of the derivative contract transfers on the basis of preferability. At the same and included in Interest under Borrowing Expenses time, IBRD early adopted FAS No. 154, Accounting on the income statement. Changes and Error Corrections (FAS 154),and retrospectivelyapplied this change in accounting Accounting for Derivatives: IBRD complies with principle (SeeNote P). FAS 154 requires that, in the the derivative accounting requirements of FAS 133. absence of specifictransitional provisions applying to FAS 133 requires that derivative instruments, as a change in accounting policy (including adoption of defined by these standards, be recorded on the balance a new standard), any such change should be applied sheet at fair value. retrospectively. IBRD uses derivative instruments in its investments, On July1,2005, IBRD adopted Financial Accounting loans and borrowings portfolios and for assetlliability Standards Board (FASB) Interpretation No. 46 (R), management purposes. In applying FAS 133 for the Consolidation of Variable Interest Entities, a n purposes of financial statement reporting, IBRD has Interpretation of Accounting Research Bulletin No. 51 elected not to define any qualifying hedging IBRD FINANCIAL STATEMENTS: JUNE 30, 2006 65 (FIN 46(R)). The adoption of FIN 46(R),together the same terms as other MOV obligations only after with its related final FASB Staff Positions did not have such currencies are repaid to IBRD. The remaining a material impact on IBRD's financial statements. amount is a net MOV receivable of $125 million ($159 million-June30, 2005), representing receivables for In February 2006, the FASB issued FAS No. 155, countries that have amounts in arrears for two years Accounting for Certain Hybrid Financial Instruments. or more. IBRD still considers these MOV receivables This standard is effectivefor annual periods beginning in arrears as obligations due from the members on or after September 15,2006. IBRD is assessing the concerned. impact of this standard on its financial statements. Subsequent Event NOTE B-CAPITAL STOCK, RESTRICTED On July10,2006, IBRD received a joint CURRENCIES, MAINTENANCE OF VALUE, AND communication from both the Republic of Serbia and MEMBERSHIP the Republic of Montenegro stating that the two Capital Stock:At June30,2006, IBRD's capital republics had signed an agreement regarding the comprised 1,581,724authorized shares (1,581,724 regulation of membership in international financial shares-June30,2005), of which 1,572,661shares institutions and the allocation of financial assets and (1,572,661shares-June 30,2005) had been liabilities between the two republics. Under this subscribed. Each share has a par value of 0.1 million agreement, the Republic of Serbia will continue the 1974 SDRs,valued at the rate of $1.20635 per 1974 membership of SaM in IBRD, retaining SaM's present SDR. Of the subscribed capital, $11,483 million subscription and voting power, with all rights and ($11,483 million-June30,2005) has been paid in, obligations stemming from membership in IBRD. In and the remaining $178,235 million ($178,235 addition, the Bank has taken note of the agreement million-June30,2005) is subject to call only when between the two republics on their respectiveportions required to meet the obligations of IBRD created by of the financial obligations formerly undertaken by borrowing or guaranteeing loans. SaM with IBRD. Under IBRD's Articles of Agreement, in the event a IBRD has accepted the Republic of Serbia as the member withdraws from IBRD, the withdrawing continuation of its member SaM,with all the rights member is entitled to receive the value of its shares and obligations arising from SaM's membership, and payable to the extent the member does not have any with no change in capital subscriptions. On July17, outstanding obligations to IBRD. IBRD's Articles of 2006, the Government of the Republic of Montenegro Agreement also state that the former member has submitted its application for membership in IBRD. continuing obligations to IBRD after withdrawal. Specifically,the former member remains fullyliable NOTE C-INVESTMENTS for its entire capital subscription, including both the As part of its overall portfolio management strategy, previously paid-in portion and the callableportion, so IBRD invests in government and agency obligations, long as any part of the loans or guarantees contracted time deposits, corporate and asset-backed securities, before it ceased to be a member, are outstanding. repurchase agreements, securities loans, resale Currencies Subject to Restrictions:A portion of agreements and related financial derivativesincluding capital subscriptions paid in to IBRD has been paid in futures, currency swaps (including currency forward the local currencies of the members. These amounts, contracts), interest rate swaps and options. referred to as restricted currencies, are usableby IBRD For government and agency obligations, IBRD may in its lending and investing operations, only with the only invest in obligations issued or unconditionally consent of the respectivemembers, and for guaranteed by governments of countries with a administrative expenses. minimum credit rating of AA-; however, if such Maintenance of Value:As of June30,2006, IBRD obligations are denominated in the home currency of had positive $52 million (positive $46 million-June the issuer,no rating is required. IBRD may only invest 30,2005) of net MOV amounts classified as a in obligations issued by an agency or instrumentality component of equity. Of this amount, IBRD had a net of a government of a member country, a multilateral MOV payable of $177million ($205million-June30, organization or any other official entity other than the 2005) relating to restricted currencies out on loan, government of a member country, with a minimum invested, swapped, or loaned to the member by IBRD credit rating of AA-. For corporate and asset-backed or through IFC, which become payable by IBRD on securities, IBRD may only invest in securities with a As of June 30,2006 and June 30,2005 there were no AAA credit rating. short sales included in Payable for Investment Securities Purchased on the balance sheet. Time deposits include certificates of deposit, bankers' acceptances and other obligations issued or As of June 30,2006, IBRD had received $154 million unconditionally guaranteed by banks or other ($713 million-June30,2005) of securities under financial institutions. IBRD may only invest in time resale agreements. None of these securities had been deposits issued or guaranteed by financial institutions transferred under repurchase or security lending whose senior debt securities are rated at least A-. agreements as of June 30,2006 or June 30,2005. With respect to futures and options, IBRD generally For the fiscal year ended June 30,2006, IBRD had closes out most open positions prior to expiration. included $4 million of unrealized gains in income Futures are settled on a daily basis. For options, IBRD (unrealized gains of $3 million-June30, 2005 and only investsin exchange-traded options. IBRD does unrealized gains of $54 million-June30,2004). not write uncovered option contracts as part of its investment portfolio strategy. A summary of IBRD's trading portfolio at June30,2006 and June 30,2005, is as follows: In millions of U.5.dollars 2006 2005 Carrying Value Carrying Value Investments-Trading Government and agency obllgatlons Tlme deposlts Asset-backed securltles Total The following table summarizes the currency composition of IBRD's trading portfolio at June30,2006 and June 30, 2005: In millions of U.S.dollars equivalent 2006 2005 Average Average Carrying Average Repricing Carrying Average Repricing Currency Value Yield (%) @ears) Value Yield (%) @ears) Euro Japanese yen U.S. dollars Others Total a The averagerepricing representsthe remaining period to the contractual repricing or maturity date, whichever a earlier This indicates the average length of time for which interest rates are fixed IBRD FINA NCIA L STATEMENTS:J UN E 30, 2006 67 IBRD manages its investments on a net portfolio basis. The followingtable summarizes IBRD's net portfolio position as of June30,2006 and June30,2005: In millions of U.5. dollars Carrying Value 2006 2005 Investments-Trading Securitiespurchased under resale agreements Receivable from currency and interest rate swaps Currency forward contracts Currency swaps Interest rate swaps Total Payable for currency and interest rate swaps Currency forward contracts Currency swaps Interest rate swaps Total Cash held in investment portfolioa Receivable from investment securitiestraded Payable for investment securities traded Net Investment Portfolio a. This amount n included in UnrestrictedCurrencies under Due from Banks on the balancesheet. The following table summarizes the currency composition of IBRD's net investment portfolio at June30,2006 and June 30 2005: In millions of U.S.dollarsequivalent 2006 2005 Average Average Carrying Average Repricing Carrying Average Repricing Currency Value Yield (%) @ears) Value Yield (%) &ears) U.S. dollars $23,054 5.30 0.12 $25,040 3.37 0.17 Others 1,800 2.43 1.23 1,326 1.55 0.07 Total $24,854 5.09 0.20 $26,366 3.27 0.17 a The average repricing representsthe remaining period to the contractual repricing or maturity date, whichever a earlier This indicates the average length of time for which interest rates are fixed NOTE D-LOANS, GUARANTEES AND The reduction in net income for the fiscal years ended DERIVATIVES FOR BORROWERS June 30,2006, June 30,2005 and June 30,2004 result- ing from waivers of loan charges, is summarized IBRD's loan portfolio includes multicurrency loans, below: single currency pool loans, single currency loans and fmed spread loans. Single currency loans (variable In m~ll~onsof U.S.dollars spread loans and fmed-rate singlecurrencyloans), and fmed spread loans, include special development policy loans. At June30,2006 onlyvariable spread loans and fmed spread loans, including special development Interest walvers $138 $125 $112 policy loans, were available for new commitments. Comm~tment charge walvers 128 125 133 Waiversof Loan Charges Front-end fee * walvers 2 1 Waivers of a portion of interest on loans to all eligible Total $268 $251 $245 borrowers, a portion of the commitment charge on undisbursed balances on all eligible loans, and a por- tion of the front-end fee charged on all eligible loans, * Ind~catesamounts less than $0.5 m1111on are approved annually by the ExecutiveDirectors of IBRD. A summary of waivers of loan charges for the fiscal years ended June30,2006 (FY2006)and June30,2005 (FY2005),is as follows: S~nceFY FY2006 FY2005 -- Interest walvers Old loansa 1992 5 5 New loansb 1999 25 25 Comm~tmentcharge walvers 1990 50 50 Front-end fee walversC 2005 75d 50 a. Loans for wh~chthe mv~tat~onto negot~atewas ~ssued pr~orto July 31, 1998. b. Loans for wh~chthe mv~tat~onto negot~atewas ~ssuedon or after July 31, 1998. c. On all loans other than specla1development pol~cyloans. d. Appl~cableto loans presented to the Board between July 1, 2005 and the date on wh~chthe Board approvesa front end fee wa~verfor the fiscal year end~ngJune 30, 2007. IBRD FINA NCIA L STATEMENTS:J UN E30, 2006 69 A summary of IBRD's outstanding loans by currency and by interest rate characteristics (fmed or adjustable) at June 30,2006 and June30, 2005 follows: In m~ll~onso f U.S. dollars equ~valent Euro Japanese yen U S dollars Others Loans Outstanding Flxed Adlust Flxed Adlust Flxed Adlust Flxed Adlust Flxed Adlust Total Multlcurrency loansa Amount $ 40 $ 4,239 $ 32 $3,633 $ 87 $ 3,578 $ 105 $409 $ 264 $11,859 $ 12,123 Welghted average rate (%)b 9.25 5.16 7.89 5.16 9.32 5.16 6.16 5.16 7.88 5.16 5.22 Average Maturlty (years) 0.01 3.15 0.01 3.15 0.36 2.97 3.94 3.15 1.68 3.09 3.06 Slngle currency pools Amount $ - $1,446 $ - $ 12 $ - $ 7,876 $ - $ - $ - $ 9,334 $ 9,334 Welghted average rate (%)b - 2.90 - 0.27 - 5.30 - - - 4.92 4.92 Average Maturlty (years) - 2.18 - 1.42 - 2.49 - - - 2.44 2.44 Slngle currency loans Amount $ 487 $ 3,653 $ - $ 140 $ 8,142 $40,810 $ - $ 1 $ 8,629 $44,604 $ 53,233 Welghted average rate (%)b 5.28 3.17 - 0.27 6.15 5.37 - 1.56 6.10 5.17 5.32 Average Maturlty (years) 4.92 2.59 5.36 1.98 2.59 5.40 4.94 2.61 5.79 - - Flxed-spread loans Amount $2,818 $ 3,699 $ 4 $ 138 $ 5,575 $16,030 $ - $ 50 $ 8,397 $19,917 $ 28,314 Welghted average rate (%)b 5.44 3.45 2.16 0.85 5.09 5.68 - 8.43 5.21 5.24 5.23 Average maturlty (years) 7.95 8.06 7.78 7.86 10.87 8.49 9.95 13.44 6.64 7.56 - Loans Outstanding Amount $3,345 $13,037 $ 36 $3,923 $13,804 $68,294 $105 $460 $17,290 $85,714 $103,004 Welghted average rate (%)b 5.46 3.87 7.26 4.82 5.74 5.42 6.16 5.50 5.69 5.16 5.25 Average Maturlty (years) 9.53 5.30 I . I I 3.57 4.21 5.42 3.94 3.66 5.23 5.31 5.30 Loans Outstanding Less accumulated provlslon for loan losses and deferred loan Income Net loans outstanding Note: For footnotes see follow~ngpage. In m1111onsof U.S.dollars equivalent Euro Japanese yen U S dollars Others Loans Outstanding Flxed Adlust Flxed Adlust Flxed Adlust Flxed Adlust Flxed Adlust Total Multlcurrency loansa Amount $ 42 $5,128 $ 35 $4,821 $ 1 1 1 $ 4,406 $ 54 $ 451 $ 242 $14,806 $15,048 Welghted average rate (%)b 9.17 4.59 7.91 4.59 8.71 4.59 8.18 4.59 8.55 4.59 4.65 Average Maturlty (years) 0.07 3.50 0.04 3.50 0.69 3.36 0.04 3.50 0.34 3.46 3.41 Slngle currency pools Amount $ - $1,897 $ - $ 1 9 s - $10,780 $ - $ - $ - $12,696 $ 12,696 Welghted average rate (%)b 0.28 5.46 - 3.96 - - - - - 5.23 5.23 Average Maturlty (years) - 2.68 - 1.80 - 2.80 - - - 2.78 2.78 Slngle currency loans Amount $ 567 $ 3,438 $ - $ 155 $10,143 $41,058 $ - $ 2 $10,710 $44,653 $ 55,363 Welghted average rate (%)b 5.35 2.43 - 0.23 6.23 3.63 - 0.95 6.18 3.52 4.04 Average Maturlty (years) 2.97 6.00 - 5.58 2.94 5.54 - 2.47 2.94 5.58 5.07 Flxed-spread loans Amount $2,479 $ 3,Ol1 $ 4 $ 4 $ 4,720 $11,076 $ - $ - $ 7,203 $14,091 $ 21,294 Welghted average rate (%)b 5.66 2.69 2.17 0.56 5.06 3.87 - - 5.26 3.62 4.17 Average maturlty (years) 11.55 9.28 11.12 12.50 7.17 7.45 - - 8.68 7.84 8.13 Loans Outstanding Amount $3,088 $13,474 $ 39 $4,999 $14,974 $67,320 $ 54 $ 453 $18,155 $86,246 $104,401 Welghted average rate (%)b 5.65 3.53 7.42 4.44 5.87 4.02 8.18 4.58 5.85 3.97 4.30 Average Maturlty (years) 9.82 5.32 0.98 3.56 4.26 5.27 0.04 3.50 5.18 5.17 5.17 Loans Outstanding Less accumulated provlslon for loan losses and deferred loan Income Net loans outstanding a. Includes loans lssued prlor to 1980, and loans to IFC, ~naddltlon to mult~currencypool loans b. Excludes effects of any walversof loan Interest. The maturity structure of IBRD's loans at June30,2006 and June30, 2005 is as follows: In m~ll~onsof U.S.dollar5 July 1, 2006 July 1, 2007 July 1, 2011 through through through ProductlRate Type June 30,2007 June 30, 2011 June 30, 2016 Thereafter Total Multlcurrency loans Flxed $ 202 $ 12 $ 42 $ 8 $ 264 Adjustable 2,544 6,920 2,274 121 11,859 Slngle currency pools Flxed - - - - - Adjustable 2,701 5,438 1,193 2 9,334 Slngle currency loans Flxed 2,008 5,636 985 - 8,629 Adjustable 4,204 18,344 16,918 5,138 44,604 Flxed-spreadloans Flxed 175 2,391 3,797 2,034 8,397 Adjustable 377 4,785 9,462 5,293 19,917 All Loans Flxed 2,385 8,039 4,824 2,042 17,290 Adjustable 9,826 35,487 29,847 10,554 85,714 Total loans outstanding $12,211 $43,526 $34,671 $12,596 $103,004 July 1, 2005 July 1, 2006 July 1, 20 10 through through through ProductlRate Type June 30,2006 June 30, 2010 June 30, 2015 Thereafter Total Multlcurrency loans Flxed $ 209 $ 33 $ - $ - $ 242 Adjustable 2,763 8,306 3,533 204 14,806 Slngle currency pools Flxed - - - - - Adjustable 3,032 7,589 2,062 13 12,696 Slngle currency loans Flxed 2,049 6,857 1,804 - 10,710 Adjustable 4,001 17,676 17,288 5,688 44,653 Flxed-spreadloans Flxed 110 1,602 3,508 1,983 7,203 Adjustable 208 3,153 7,273 3,457 14,091 All Loans Flxed 2,368 8,492 5,312 1,983 18,155 Adjustable 10,004 36,724 30,156 9,362 86,246 Total loans outstanding $12,372 $45.216 $35,468 $11,345 $104,401 Guarantees IBRD loans, or in support of programs also financed IBRD has provided partial guarantees of loans by IBRD through regular loans. IBRD's partial syndicatedby other financialinstitutions for projects. guarantees of such securities are included in the In addition, IBRD has also provided partial guarantees amount mentioned below. guarantees of securities issued by an entity eligiblefor Guarantees of $995 million were outstanding at June During the fiscal year ended June 30,2006 and June 30,2006 ($1,157million-June30,2005). This 30,2005, no guarantees provided by IBRD were called. amount represents the maximum potential amount of Derivativesfor Borrowers undiscounted future payments that IBRD could be required to make under these guarantees, and are not These are transactions executed between IBRD and its included in the balance sheet. Most of these borrowers under master derivativesagreements. The guarantees have maturities ranging between 5 and 15 net interest income associated with these transactions years,and expire in decreasing amounts through 2015. is included in Loan Interest income on the Statement of Income. At June 30,2006, IBRD had one currency At June 30,2006, liabilities related to IBRD's swap with a borrower, which matures in 2017. The obligations under guarantees of $22 million ($22 balances relating to this swap are included in Member million-June 30,2005), have been included in Operations under Receivablefrom and Payable for Accounts Payableand Miscellaneous Liabilities on the Currency and Interest Rate Swaps on the balance balance sheet. These include the accumulated sheet. provision for guarantee losses of $11million ($13 million-June30,2005). OverdueAmounts At June 30,2006, there were no principal or interest amounts on loans in accrual status, which were overdue by more than three months. The following tables provide a summary of selected financial information related to loansin nonaccrual status as of and for the fiscal yearsended June30,2006,June30,2005 and June30,2004: In millionsof U.S. dollan Recorded investment in nonaccrual loansa Accumulated provision for loan losses on nonaccrual loans Average recorded investment in nonaccrual loans for the fiscal year Overdue amounts of nonaccrual loans: Principal lnterest and charges a. A loan loss provlslon has been recorded agalnst each of the loans ~nthe nonaccrual portfol~o. In millionsof U.S. dollan lnterest income recognized on loans in nonaccrual status at end of fiscal year 8 1 $118 $112 lnterest income not recognized as a result of loans being in nonaccrual status $51 $ 65 $ 37 IBRD FINANCIALSTATEMENTS: JU NE30, 2006 73 A summary of countries with loans or guarantees in nonaccrual status at June30,2006 follows: In m11110nsof U.S.dollars Pr~ncpal,Interest Pr~ncpal and Charges Nonaccrual Borrower outstand~ng overdue since CBte d'lvo~re $ 241 November 2004 L~ber~a 405 June 1987 Seychelles 1 August 2002 Z~mbabwe 353 October 2000 Total During the fiscal year ended June 30,2006, all loans previous years had these loans not been in nonaccrual outstanding to Serbia and Montenegro were restored status. to accrual status following management's Accumulated Provisionfor Losses on Loans and determination that a suitable period of policy and Guarantees payments performance had passed subsequent to the IBRD has always eventually collected all contractual clearance of all arrears to IBRD in January2002. Loan principal and interest on its loans. However, IBRD income for the fiscal year increased by $19 million, sufferslosses resulting from the differencebetween the representing income that would have been accrued in discounted present value of payments for interest and previous fiscal years had these loans not been in charges according to the related loan's contractual nonaccrual status. terms and the actual cash flows. Certain borrowers During the fiscal year ended June 30,2005, all loans have found it difficult to make timely payments for made to, or guaranteed by, CBte d'Ivoire were placed protracted periods, resulting in their loans being into nonaccrual status. Loan income for the fiscalyear placed in nonaccrual status. Several borrowers have ended June 30,2005 would have been higher by $32 emerged from nonaccrual status after a period of time million, had these loans not been in nonaccrual status. by bringing up-to-date all principal payments and all overdue service payments, including interest and During the fiscal year ended June30,2005, Iraq other charges. To recognize the probable losses cleared all of its outstanding loan principal, interest inherent in its loan and guarantee portfolio, IBRD and charges due to IBRD. As a result of this event, maintains an accumulated provision for losses on loan income for the year ended June30,2005 loans and guarantees. increased by $56 million, $51 million of which represents income that would have been earned in Changes to the accumulated provision for losses on loans and guarantees for the fiscalyears ended June 30,2006, June 30,2005 and June 30,2004 are summarized below: In m~ll~onsof U 5 dollars June30,2006 June 30,2005 June 30,2004 Accumulated provision for losses on loans and guarantees, beginning of the fiscal year $3,022 $3,520 Release of provlslon for losses on loans and guarantees (724) (502) Translat~onadjustment 9 4 Accumulated provision for losses on loans and guarantees, end of the fiscal year $2,307 $3,022 Composed of: Accumulated provlslon for loan losses $2,296 $3,009 Accumulated provlslon for guarantee losses 11 13 Total $2,307 $3,022 Reported as Follows BalanceSheet Statement of Income Allowance for Losses on: Loans Accumulated Prov~s~onfor Loan Losses Release of Prov~s~onfor Losses on Loans and Guarantees Guarantees Accounts Payable and M~scellaneousL~ab~l~t~esRelease of Prov~s~onfor Losses on Loans and Guarantees IBRD has endorsed a multilateral initiative for has taken the situation of these countries into addressing the debt problems of a group of countries, consideration, although IBRD has not entered into identified as heavily indebted poor countries (HIPC), any commitments to provide debt relief under these to ensure that the reform efforts of these countries will initiatives. not be put at risk by unsustainable external debt Local Currency Lending to IFC burdens. Under this initiative, creditors are to provide debt relief for those countries that have demonstrated During the fiscal year ended June 30,2005, IBRD good policy performance over an extended period to entered into a Local Currency Loan Facility bring their debt burdens to sustainable levels. In Agreement with IFC which is capped at $300 million. addition, on March 28,2006, the Executive Directors At June30,2006, the loan balance under this facility of IDA approved IDA'Sparticipation in the amounted to $50 million. This loan is at standard Multilateral Debt Relief Initiative (MDRI). In terms available to other borrowers but is not eligible determining the adequacy of the accumulated for interest waiver. provision for losses on loans and guarantees, IBRD IBRD FINANCIAL STATEMENTS: JU NE30, 2006 75 NOTE E-BORROWINGS Providing liquidity and minimizing the cost of funds are key objectivesto IBRD'soverallborrowing strategy. IBRD uses swaps in its borrowing strategy to lower the overall cost of its borrowings for those members who benefit from IBRD loans. IBRD initiates swap transactions with a list of authorized counterparties. Credit limits have been established for each counterparty. The following table summarizes IBRD's borrowing portfolio at June30,2006 and June 30,2005: In m~ll~onsof U.S.dollars Net Net Net Net Unamortized unreal~zed Unamortized unreal~zed Pr~nc~palat Premlum (gains) Pr~nc~palat Premlum (gams) Face Value (Discount) lossey Total Face Value (Dncount) lossey Total Short-Term Med~um-and Long-Term Currency Swap Agreements (Net) Interest Rate Swap Agregments (Net) .C a. Thlsrefers to "net unreal~zed(gams) losses on non-trad~ngder~vatlvemstruments, as requlred by FAS 133" b. The negat~ve$394 m1111onat June 30, 2006 (negat~ve$557 m~ll~on-June30, 2005) represents the net unamortlzed d~scount on zero coupon trades. c The net unamortlzed d~scountof $10 m1111onat June 30,2006 (net unamortlzed premlum of $379 m~ll~on-June30, 2005), represents the unamortlzed premlum (d~scount)on non zero coupon trades Thefollowingtablessummarize IBRD's borrowing portfoliobycurrencyand product at June30,2006andJune30,2005: Medium- and Long-term Borrowings and Swaps at June 30,2006 In millions of U.S.dollars Currency Interest rate Direct borrowings swap agreements swap agreement? Net currency obligations* Notional Average Amount Average amount Average Amount Average Currency1 WA@ maturity payable WA@ maturity payable WA@ maturity payable WA@ maturitfl Rate type Amount (%) @ears) (receivable) (%) @ears) (receivable) (%) @ears) (receivable) (%) @ears) Euro Flxed $ 7,134 6.29 6.56 $ 1,064 5.58 6.50 $ 2,131 5.32 11.44 $10,329 6.02 7.56 Adjustable 3,664 6.22 6.68 9,691 2.96 3.40 102 3.22 6.91 13,457 3.85 4.32 (4,266) 6.29 6.81 (2,131) 3.47 11.44 (6,397) 5.35 8.35 Japanese yen Flxed 2,917 4.16 5.11 189 4.51 11.72 2 1.77 16.81 3,108 4.18 5.52 Adjustable 10,760 4.39 24.34 1,567 0.01 0.51 931 (0.17) 2.00 13,258 3.55 19.95 (11,079) 4.17 23.14 (2) 0.16 16.81 (11,081) 4.17 23.14 U. 5. dollars Flxed 29,188 5.31 5.68 1,095 10.16 5.24 13,528 5.45 7.60 43,811 5.47 6.26 Adjustable 2,667 3.92 4.96 50,070 4.85 8.91 30,021 4.93 4.94 82,758 4.85 7.35 (12,726) 4.96 3.16 (15,423) 5.14 7.37 (28,149) 5.06 5.47 Others Flxed 32,024 5.80 5.03 2,473 5.97 5.98 - - - 34,496 5.81 5.10 Adjustable 397 5.16 13.46 50 7.53 17.00 176 5.37 1.44 622 5.41 10.33 Flxed 71,263 5.58 5.45 4,820 15,661 91,744 5.62 5.95 Adjustable 17,488 4.72 17.43 61,377 31,230 110,095 4.57 8.51 (28,601) (17,556) (46,157) 4.89 10.17 Principal at face value $ 88,751 5.41 7.81 $ (4,772) $ (394) $ 83,585 4.87 7.73 a Excludes forward-starting swaps of $8,319 million (mechannm for managing debt overhang in currency pool products) b WAC refers to weighted average cost c At June 30, 2006, the average repricing period of the net currency obligations for adlustablerate borrowings was three months d May differ from the sum of individual figuresdue to rounding Medium- and Long-term Borrowings and Swaps at June 30,2005 In millions of U.S. dollars equivalent Currency Interest ratea Direct borrowings swap agreements swap agreements Net currency obligations Notional Average Amount Average amount Average Amount Average Currency1 WA@ maturity payable WA@ maturity payable WA@ maturity payable WA@ maturityC Rate type Amount (%) @ears) (receivable) (%) @ears) (receivable) (%) (years) (receivable) %) years) Euro F~xed $ 7,821 6.01 6.63 $ 1,083 (7,227) Adjustable 3,720 6.54 7.45 9,481 (4,406) Japanese yen F~xed 3,437 4.31 5.56 272 (1,865) Adjustable 11,488 3.51 24.92 1,731 (11,989) U. 5. dollars F~xed 36,601 5.36 5.18 1,431 - Adjustable 2,422 3.69 6.82 49,423 (12,287) Others F~xed 32,503 5.70 5.79 2,042 (34,324) Adjustable 502 5.76 11.91 - (624) ~ o t a l ~ F~xed 80,363 5.51 5.58 4,828 (43,415) Adjustable 18,132 4.22 18.55 60,634 (29,306) Principal at face value $ 98,495 5.27 7.97 $ (7,259) a Excludes forward-starting swaps of $7,152 million (mechanam for managing debt overhang in currency pool products) b WACrefers to weighted averagecost c At June 30, 2005, the averagerepricing period of the net currency obligations for adlustable rate borrowings was three months d May differ from the sum of individual figures due to rounding Short-term Borrowings at June 30,2006 and June 30,2005 In m~ll~onsof U.5. dollars lnterest rate Swap Agreements Not~onal Currency1 Prlnclpal at WAC Rece~vable WA Cb Net WA Cb Rate type face valuea (%I (payable) (%) Obl~gat~on (%) U. 5. dollars Flxed Adjustable 659 4.96 Principal at face value $7,312 5.19 In m~ll~onsof U.5. dollars 2005 lnterestrateSwap Agreements Not~onal Currency1 Prlnclpal at w,$ Rece~vable WA Cb Net WA Cb Rate type face valuea (%I (payable) (%) Obl~gat~on (%I U. 5. dollars Flxed Adjustable 644 3.19 13 2.41 657 3.18 Principal at face value $3,220 3.10 $ - $3,220 3.10 a. At June 30, 2006, the average repr~c~ngperlod of the pr~nc~pal outstanding for short-term borrow~ngswas less than two months (less than two months -June 30, 2005). b. WAC refers to we~ghtedaverage cost. The maturity structure of IBRD's Medium-and Long-term borrowings outstanding at June30,2006 and June30, 2005 is as follows: In m~ll~onsof U.S.dollars In m~ll~onsof U.S.dollars Perlod 2006 Perlod 2005 July 1, 2006 through June 30, 2007 $14,676 July 1, 2005 through June 30, 2006 July 1, 2007 through June 30, 2008 16,144 July 1, 2006 through June 30, 2007 July 1, 2008 through June 30, 2009 11,604 July 1, 2007 through June 30, 2008 July 1, 2009 through June 30, 2010 6,849 July 1, 2008 through June 30, 2009 July 1, 2010 through June 30, 2011 2,029 July 1, 2009 through June 30, 2010 July 1, 2011 through June 30, 2016 13,370 July 1, 2010 through June 30, 2015 Thereafter 24,079 Thereafter 27,980 Total $88,751 Total $98,495 Line of credit: During the fiscal year ended June 30, exceed $500 million in aggregate. The line of credit is 2006, IBRD maintained a line of credit with an used to cover any overnight overdrafts that may occur independent financial institution. This facilitywas due to failed trades. At June 30,2006 and June 30, created for the benefit of both IBRD and IDA. The 2005, there were no amounts outstanding under this available line of credit to each institution is $500 facility. million, but usage from both institutions cannot NOTE F-OTHER ASSETILIABILITY SWAPS As part of assetlliabilitymanagement, IBRD has entered into currency and interest rate swap agreements to better align its currency composition and duration of Equity with that of Loans Outstanding. A summary of IBRD's other assetlliability swaps at June 30,2006 and June 30,2005 is presented below: In m1111onsof U.8,dollarsequ~valent Currency swap agreements lnterest rate swap agreements Net Denvatlve AssetlL~ab~l~ty Notlonal Amount We~ghted Average Amount We~ghted Average Amount We~ghted Average Rece~vable Average Matunty Rece~vable Average Mahinty Rece~vable Average Matun@ (payable) Cost (%) hears) (payable) Cost (%) (years) (payable) Cost (%) hears) U.S. dollars $726 5.13 0.72 $ 1,250 3.68 2.31 (14) - 3.42 (1,250) 5.27 2.31 Euro Japanese yen Other Total Rece~vable (Payable) Net unreal~zed galnsa Total a. Thlsrefers to "net unreal~zed(gains) losses on non-trad~ngder~vat~ve~nstruments,as requlred by FAS 133. In m1111onsof U.8,dollarsequ~valent Currency swap agreements Interest rate swap agreements Net Denvatlve AssetlL~ab~l~ty Notlonal Amount We~ghted Average Amount We~ghted Average Amount We~ghted Average Rece~vable Average Matunty Rece~vable Average Matunty Rece~vable Average Matunty (payable) Cost (%) hears) (payable) Cost (%) hears) (payable) Cost (%) hears) U.S. dollars $726 3.34 1.72 $1,250 3.68 3.31 $ 1,976 3.55 2.72 (14) - 4.42 (1,250) 3.41 3.31 (1,264) 3.37 3.32 Euro (381) 2.20 1.71 - - - (381) 2.20 1.71 Japanese yen Other Total Rece~vable (Payable) Net unreal~zed losses (ga~ns)~ Total a. Thlsrefers to "net unreal~zed(gams)losses on non-trad~ngder~vat~ve~nstruments,as requlred by FAS 133 NOTE G-CREDIT RISK Country Credit Risk:This risk includes potential application of eligibilitycriteria and volume limits for losses arising from protracted arrears on payments transactions with individual counterparties and from borrowers for loans, guarantees or related through the use of mark-to-market collateral derivatives. IBRD manages country credit risk arrangements for swap transactions. IBRD may through individual country exposure limits according require collateral in the form of cash or other to creditworthiness. These exposure limits are tied to approved liquid securities from individual performance on macroeconomic and structural counterparties in order to mitigate its credit exposure. policies. In addition, IBRD establishes absolute limits As of June30,2006, IBRD had received collateral of on the share of outstanhng loans to any individual $3,655 million ($7,278million-June30, 2005) in borrower. The country credit risk is further managed connection with swap agreements, of which $2,163 by financial incentives such as pricing loans using million ($4,181million-June30,2005) had been IBRD's own cost of borrowing and partial interest transferred under security lending agreements. charge waivers conditioned on timely payment that As the transfer of this collateral did not meet the give borrowers self-interest in IBRD's continued requirements of a sale, the collateral has not been strong intermediation capacity. Collectibility risk is included in the assets of IBRD. covered by the accumulated provision for losses on loans and guarantees. IBRD also uses a simulation IBRD has entered into master derivativesagreements model to assess the adequacy of its equity including which contain legally enforceable close-out netting reserves in case a major borrower, or group of provisions. These agreements may further reduce the borrowers, stops servicing its loans for an extended gross credit risk exposure related to the swaps shown period of time. below. Credit risk with financial assets subject to a master derivativesarrangement is further reduced Commercial Credit Risk:For the purpose of risk under these agreements to the extent that payments management, IBRD is party to a variety of financial and receipts with the counterparty are netted at instruments, certain of which involve elements of settlement. The reduction in exposure as a result of credit risk. Credit risk exposure represents the these netting provisions can vary as additional maximum potential loss due to possible transactions are entered into under these agreements. nonperformance by obligors and counterparties The extent of the reduction in exposure may therefore under the terms of the contracts. For all securities, change substantially within a short period of time IBRD limits trading to a list of authorized dealers and following the balance sheet date. counterparties. Credit risk is controlled through IBRD FINANCIAL STATEMENTS: JUNE 30, 2006 81 The contract value/notional amounts and credit risk exposure, as applicable, of these financial instruments at June 30,2006 and June 30,2005 (prior to taking into account any master derivatives or collateral arrangements that have been entered into) are given below: In m1111onsof U.S.dollars INVESTMENTS - TRADING PORTFOLIO Exchange traded Options and Futuresa Notional Long position Notional Short position Currency swaps (including currency forward contracts) Credit exposure lnterest rate swaps Notional principal Credit exposure BORROWING PORTFOLIO Currency swaps Credit exposure lnterest rate swaps Notional principal Credit exposure OTHER ASSETILIABILITY lnterest rate swaps Notional principal Currency swaps Credit exposure a Exchange-traded instruments are generally subject to dally margln requ~rementsand are deemed to have no materlal credlt rlsk All outstanding optlons and futures contracts as of June 30, 2006 and June 30, 2005, are ~nterestrate contracts NOTE H-RETAINED EARNINGS, ALLOCATIONS AND TRANSFERS The changes in the components of Retained Earnings for each of the fiscal periods from June 30,2003 to June30, 2006, are summarized below: In m~ll~onsof US dollars Unalloca- Cumulat~ve ted Net Specla1 General Penslon FAS133 Income Reserve Reserve Reserve Surplus Adjustments (Loss) Total As of June 30, 2003 $293 $19,132 $ 963 $100 $ 1,199 $ 5,344 $27,031 Net lncome allocatlona - 2,410 (29) 100 2,323 (4,804) - Board of Governors-approved transfers funded from surplusb - - - (105) - 105 - Net loss for the year As of June 30,2004 Net lncome allocatlona - 680 21 405 (4,100) 2,994 - Board of Governors-approved transfers funded from surplusb - - - (52) - 52 - Net lncome for the year As of June 30,2005 Net lncome allocatlona - 690 68 (48) 2,511 (3,221) - Board of Governors-approved transfers funded from surplusb - - - (40) - 40 - Net loss for the year - - - - - (2,389) (2,389) As of June 30,2006 $293 $22,912 $1,023 $360 $ 1,933 $(1,739) $24,782 a. Amounts reta~nedas Surplus from net lncome allocat~onare approved by the Board of Governors. b. A concurrent transfer a made from Surplus to UnallocatedNet lncome (Loss) for all transfers reported on the Statement of lncome and authorized to be funded from Surplus. IBRD makes net income allocation decisions on the On September 24, 2005, IBRD's Board of Governors basis of reported net income, after adjustment for the approved the transfers out of the net income earned in effects associated with the application of FAS 133 and the fiscal year ended June 30,2005, to IDA, the HIPC pension income or expense, as well as Board of Gover- Debt Initiative Trust Fund, and the amounts to be nors-approved transfers. retained as Surplus. As disccussed in Note A, Board of Governors-approved transfers are reported as On August 4, 2005, IBRD's Executive Directors expenses on the Statement of Income in the year of approved the allocation of the net income earned in approval (See Note P-Change in Accounting Princi- the fiscal year ended June 30, 2005 to the General ple for Certain Board of Governors-approved trans- Reserve and the Pension Reserve. fers for additional details). IBRD FINA NCIA L STATEMENTS:J UN E 30, 2006 83 Transfersapproved during the fiscalyearsended June30,2006, June30,2005 and June30,2004, and amounts payable for the transfers approved by the Board of Governors at June30,2006 and June30,2005, are included in the following table: In m~ll~onsof U.S.dollars Amount Payable Fiscal Years EndedJune 30, at June 30, Transfers funded from: 2006 2005 2004 2006 2005 Unallocated Net Income: lnternat~onalDevelopment Assoclatlon $400 $300 $300 $210 $740 Debt Reduction Faclllty for IDA-only Countries - 50 - 66 65 HeavllyIndebted Poor Countries Debt ln~t~at~veTrust Fund 2 10 -- 240 240 - - 610 -- 590 540 276 805 Surplus: Trust Fund for Gaza and West Bank - - 80 - - Trust Fund for Earthquake Recovery and Reconstruction In Paklstan 5 - - - - Low-Income Countrles Under Stress (LICUS) lmplementatlon Trust Fund 25 - 25 - - Trust Fund for Llber~a - 25 - - - Multl-Donor Trust Fund for Aceh and North Sumatra - 25 - - - Trust Fund for Tsunaml D~sasterRecovery ~nlndla - 2 - - - Natlonal Multl-Donor Trust Fund for Sudan 5 - - - - Multl-Donor Trust Fund for Southern Sudan Total $650 -- $642 $645 $276 $805 NOTE I- ADMINISTRATIVEEXPENSES, For the fiscal years ended June 30,2006, June 30,2005 CONTRIBUTIONS TO SPECIAL PROGRAMS, AND and June30,2004, the amount of fee revenue associated OTHER INCOME with administrative servicesis as follows: Administrative expenses for the fiscal year ended June In m~ll~onsofU.S.dollar5 30,2006 are net of the share of administrative expenses allocated to IDA of $954 million ($891 million-June 2006 2005 2004 30,2005, and $908 million-June30,2004). The Servlce fee revenue $243 $228 $207 allocation of expenses between IBRD and IDA is based Included In these on an agreed cost sharing formula that reflects the amounts are the following: administrative costs of service deliveryto countries that are eligible for lending from IBRD and IDA. Fees charged to IFC 43 45 34 Fees charged to Contributions to special programs represent grants for MlGA 8 8 6 agricultural research, and other developmental activities. Other income primarily consists of service fee revenue. IBRD recovers certain of its administrative expenses by billing third parties, including IFC, MIGA, and certain trust funds for services rendered. At June 30,2006 and June30,2005, IBRD had the following payables to (receivablesfrom) its affiliated organizations with regard to administrative services and pension and other postretirement benefits. In millions of U.S. dollars 2006 2005 Pension and Pension and Other Other Administrative Postretirement Administrative Postretirement Services Benefits Total Services Benefits Total IDA $064) $903 $539 $ 013) $820 $507 IFC (20) 2I I (25) 2I (4) MlGA (3) 1 (2) (4) 1 (3) $087) $925 $538 $042) $842 $500 The payables (receivables)balances to (from) these affiliated organizations are reported in the balance sheet as follows: Reported as: Receivable for Admlnlstratlve Servlces M~scellaneousAssets Payable for Penslon and Other Postretirement Beneflts Accounts Payable and M~scellaneousLlabllltles NOTE J-MANAGEMENT OF EXTERNALFUNDS assistancefor borrowers including feasibilitystudies and project preparation, globaland regional programs Trust Funds and research and training programs. These funds are IBRD, alone or jointly with IDA, administers on held in trust with IBRD andlor IDA, and are held in a behalf of donors, including members, their agencies investment portfolio which is not and other entities, funds restricted for specific uses commingled with IBRD's funds, nor are they included which include the cofinancing of IBRD lending in the assets of IBRD. projects, debt reduction operations, technical The trust fund assets by executing agent at June30,2006 and June 30,2005 are summarized below: Total fiduciary Number of Total fiduciary Number of assets trust fund assets trust fund (In millions of accounts (In millions of accounts U.S. dollars) (unaudited) U.S. dollars) (unaudited) IBRD executed Recipient executed Total The responsibilities of IBRD under these Investment ManagementServices arrangements vary and range from servicesnormally IBRD offersinvestment management servicesto one provided under its own lending projects to full project non-affiliated organization and one affiliated implementation including procurement of goods and organization. Under these arrangements, IBRD is services. During the fiscal year ended June 30,2006, responsible for managing investment account assets IBRD received $15 million ($17million-June30, on behalf of these institutions, and in return receives a 2005 and $14 million-June30,2004) as fees for quarterly fee based on the average value of the administering trust funds. These fees have been portfolios. recorded as Other Income. IBRD FINANCIAL STATEMENTS: JUNE 30, 2006 85 In addition, IBRD offers asset management and The SRP provides regular pension benefits and technical advisory servicesto central banks of member includes a cash balance plan. The RSBP provides countries, under the ReservesAdvisory and certain health and life insurance benefits to eligible Management Program, for capacity building and retirees. The PEBP provides certain pension benefits other development purposes and receives a fee for administered outside the SRP. these services. IBRD uses a June30 measurement date for its pension The fee income from all of these investment and other postretirement benefit plans. management activitiesis included in service fee The amounts presented below reflect IBRD's revenues described in Note I. respectiveshare of the costs,assetsand liabilitiesof the At June 30,2006, the assets managed under these plans. agreements had a value of $11,301 million ($9,180 All costs, assets and liabilities associated with these million-June30,2005). These funds are not plans are allocated between IBRD, IFC, and MIGA included in the assets of IBRD. based upon their employees' respectiveparticipation in the plans. Costs allocated to IBRD are then shared NOTE K-PENSION AND OTHER between IBRD and IDA based on an agreed cost POSTRETIREMENTBENEFITS sharing ratio. IDA, IFC and MIGA reimburse IBRD for their proportionate share of any contributions IBRD, IFC and MIGA participate in a defined benefit made to these plans by IBRD. contributions to these SRR a Retired StaffBenefitsPlan (RSBP) and a Post- plans are calculated as a percentage of salary. Employment Benefits Plan (PEBP)that cover substantially all of their staff members. The following table summarizes the benefit costs associated with the SRP, RSBP, and PEBP for IBRD and IDA for the fiscal years ended June 30,2006, June 30,2005, and June30,2004: In m~ll~oonsf U.S. dollars SRP RSBP PEBP 2006 2005 2004 2006 2005 2004 2006 2005 2004 Benefit Cost Serv~cecost Interest cost Expected return o n plan assets Amort~zat~onof prlor servlce cost Amort~zat~onof unrecog- n~zednet loss (ga~n) Net p e r ~ o d ~penslon c cost of w h ~ c h : IBRD's share IDA'S share * Less than $0.5 m ~ l l ~ o n IDA'Sshare of the net periodic pension incornelcost is The following table summarizes the projected benefit included as a payable tolreceivable from IDA in obligations, fair value of plan assets, and funded status Miscellaneous Assets and Accounts Payable and associated with the SRP, RSBP, and PEBP for IBRD Miscellaneous liabilities on the balance sheet. and IDA for the fiscal years ended June30,2006, June 30,2005, and June30,2004. Since the assets for the The expenses for the SRP, RSBP and PEBP are PEBP are not held in an irrevocable trust separate included in Administrative Expenses. from the assets of IBRD, they do not qualify for off- For the fiscalyearsended June30,2006, June30,2005, balance sheet accounting and are thereforeincluded in and June30,2004, expenses for these plans of $28 IBRD'sinvestment portfolio. The assets of the PEBP million, $16 million and $20 million, respectively, are invested in fmed income instruments. were allocated to IFC, and $2 million, $1 million and $1 million, respectively,were allocated to MIGA. In m~ll~onsof U.S. dollars SRP RSBP PEBP 2006 2005 2004 2006 2005 2004 2006 2005 2004 Projected Benefit Obligation Beg~nn~ngof year Serv~cecost Interest cost Employee contr~but~ons Benef~tspa~d Actuar~al(ga~n)loss End of year Fair value of plan assets Beg~nn~ngof year Employee contr~but~ons Actual return on assets Employer contr~but~ons Benef~tspa~d End of year Funded status Plan assets In excess of (less than) projected benef~tobll- gat~on Unrecogn~zednet loss (ga~n) from past experience d~ffer- ent from that assumed and from changes In assump- t~ons Unrecogn~zedprlor servlce cost Prepa~d(accrued) penslon cost Accumulated Benef~t Obl~gat~on The $1,925 million prepaid SRP cost at June 30,2006 The $158 million prepaid RSBP cost at June30,2006 ($1,779million-June30,2005) is included in ($152 million-June 30,2005), is included in Prepaid Prepaid Pension Cost on the balance sheet. Of this Pension Cost on the balance sheet. Of this amount amount $827 million was attributable to IDA ($748 $57 million was attributable to IDA ($54 million- million-June30,2005) and is included in Accounts June 30,2005) and is included in Accounts Payable Payable and Miscellaneous Liabilities on the balance and Miscellaneous Liabilities on the balance sheet. sheet. IBRD FINANCIAL STATEMENTS: JU NE30, 2006 87 Assumptions return for the RSBP is computed using procedures The actuarial assumptions used are based on financial similar to those used for the SRP. The discount rate market interest rates, past experience, and used in determining the benefit obligation is selected management's best estimate of future benefit changes by reference to the ~ear-end and corporate and economic conditions. Changes in these bonds. assumptions will impact future benefit costs and Actuarial gains and losses occur when actual results obligations. are different from expected results. Amortization of The expected long-term rate of return for the SRP these unrecognized gains and losses will be included assets is a weighted average of the expected long-term in income if, at the beginning of the fiscal year, they (10yearsor more) returns for the various asset classes, exceed 10 percent of the greater of the projected weighted by the portfolio allocation. Asset class benefit obligation or the market-related value of plan returns are developed using a forward-looking assets. If required, the unrecognized gains and losses building block approach and are not strictly based on are amortized over the expected average remaining historical returns. Equity returns are generally servicelives of the employee group. developed as the sum of expected inflation, expected The following tables present the weighted-average realearningsgrowth and expected long-term dividend assumptions used in determining the projected yield. Bond returns are generally developed as the benefit obligations and the net periodic pension costs sum of expected inflation, real bond yield, and risk for the fiscal years ended June30,2006, June30,2005, premiumlspread (as appropriate). Other asset class and June 30,2004: returns are derived from their relationship to equity and bond markets. The expected long-term rate of Weightedaverageassumptionsused to determineprojectedbenefit obligation In percent SRP RSBP PEBP Dlscount rate 6.50 5.25 6.25 6.50 5.25 6.25 6.50 5.25 6.25 Rate of compensat~onlncrease 6.80 5.90 6.40 Health care growth rates - a t end of flscal year Ultlmate health care growth rate Year In whlch ultlmate rate IS reached Weightedaverageassumptionsused to determinenet periodic pensioncost In percent SRP RSBP PEBP 2006 2005 2004 2006 2005 2004 2006 2005 2004 Dlscount rate 5.25 6.25 5.75 5.25 6.25 5.75 5.25 6.25 5.75 Expected return o n plan assets 7.75 7.75 7.75 8.25 8.25 7.75 Rate of compensat~onlncrease 5.90 6.40 5.40 Health care growth rates - a t end of flscal year 6.80 7.30 6.10 - t o year 2012 and thereafter 4.25 4.75 3.75 The medical cost trend rate can significantly affect the reported postretirement benefit income or costs and benefit obligations for the RSBP. The following table shows the effects of a one-percentage-point change in the assumed healthcare cost trend rate: In m1111onso f U.S. dollar5 One percentage polnt lncrease One percentage polnt decrease Effect on total servlce and lnterest cost $ 25 $ (20) Effect on postretirement beneflt obllgatlon 260 (216) Investment Strategy tions and future asset and liability balances. Plan The investment policy for the SRP and the RSBP is to assets are managed by external investment managers optimize the risk-return relationship as appropriate to and monitored by IBRD's pension investment depart- the respective plan's needs and goals, using a global ment. The pension plan assets are invested in diversi- diversified portfolio of various asset classes. Specifi- fied portfolios of public equity, fixed income, and cally, the long-term asset allocation is based on an alternative investments. The fmed-income and public analysisthat incorporates expected returns by asset equity asset classesare rebalanced on a monthly basis. classas well as volatilities and correlations across asset The following table presents the weighted-average classesand the liability profile of the respective plans. asset allocation at June30,2006 and June30,2005 and This analysis,referred to as an asset-liability analysis, the respectivetarget allocation by asset category for also provides estimates of potential future contribu- the SRP and RSRP: Inpercent SRP RSBP Target % o fPlanAssets Target % o fPlanAssets Allocat~on Allocat~on Asset Class 2006 2006 2005 2006 2006 2005 Flxed Income Publlc Equlty Alternatlve Investments Total Alternatlve Investments Include: Prlvate Equlty Real Estate Hedge Funds Estimated Future BenefitsPayments ExpectedContributions The following table shows the benefit payments IBRD's contribution to the SRP and RSBP varies from expected to be paid in each of the next five years and year to year, as determined by the Pension Finance subsequent five years. The expected benefit payments Committee, which bases its judgement on the results are based on the same assumptions used to measure of annual actuarial valuations of the assets and the benefit obligation at June 30,2006: liabilities of the SRP and RSBP. The best estimate of the amount of contributions expected to be paid to In m~ll~oonfsU.S. dollars the SRP and RSBP for IBRD and IDA during the fiscal SRP RSBP PEBP year beginning July1,2006 is $149 million and $67 million, respectively. July 1, 2006 -June 30, 2007 $ 390 $ 34 $ 16 July 1, 2007 -June 30, 2008 430 38 18 July 1, 2008 -June 30, 2009 469 42 19 July 1, 2009 -June 30, 2010 506 46 20 July 1, 2010 -June 30, 2011 541 51 21 July 1, 2011 -June 30, 2016 3,250 333 126 IBRD FINANCIAL STATEMENTS: JU NE30, 2006 89 NOTE L-SEGMENT REPORTING differentiate between the nature of the products or services provided, the preparation process, or the Based on an evaluation of IBRD's operations, method for providing the services among individual management has determined that IBRD has only one countries. reportable segment since IBRD does not manage its operations by allocating resources based on a For the fiscal year ended June 30,2006, loans to one determination of the contribution to net income from country generated in excess of 10 percent of loan individual borrowers. In addition, given the nature of income; this amounted to $502 million. Loan income IBRD, the risk and return profiles are sufficiently comprises interest, commitment fees, loan origination similar among borrowers that IBRD does not fees and prepayment premia, net of waivers. The followingtable presents IBRD's loan outstanding balances and associatedloan income, by geographic region, as of and for the fiscal years ended June 30,2006 and June30,2005: In m~ll~onsof U.S.dollars 2006 2005 Loan Income Loans Outstanding Loan Income Loans Outstanding Afr~ca $ 49 $ 1,934 East Asla and Pac~f~c 1,295 25,506 Europe and Central Asla 1,143 25,223 Lat~nAmer~caand the Car~bbean 1,734 36,273 M~ddleEast and North Afr~ca 289 6,089 South Asla 349 7,899 Othera 5 80 Total $4,864 $103,004 $4,155 $104,401 a. Represents loans to IFC, an affillated organlzatlon NOTE M-COMPREHENSIVE INCOME Comprehensive income consists of net income and effects of a change in accounting principle related to other gains and losses affectingequity that, under U.S. the implementation of FAS 133, currency translation GAAP, are excluded from net income. For IBRD, adjustments, and net income. These items are comprehensive income comprises the cumulative presented in the Statement of Comprehensive Income. The followingtables present the changes in Accumulated Other Comprehensive Income (Loss)for the fiscalyears ended June 30,2006, June 30,2005, and June 30,2004: In m11110nsof U.S.dollars Cumulative Total Effect of Accumulated Cumulative Change ln Other Translation Accounting Reclass~f~cat~on~ Comprehensive Adjustment Prlnclple Income Balance, beg~nn~ngof the f~scalyear Changes from per~odact~v~ty Balance, end of the f~scalyear a. Reclass~f~cat~onof Cumulatlveeffect of change ln accounting prlnclple to net ~ncome. In mlll~onsof U.S.dollars Cumulative Total Effect of Accumulated Cumulative Change ~n Other Translatlon Accountlng Reclass~f~cat~on~Comprehenslve Adustment Prlnclple Loss Balance, beglnnlng of the flscal year Changes from perlod actlvlty Balance, end of the flscal year In m1111onsof U.S.dollars Cumulative Total Effect of Accumulated Cumulative Change ln Other Translatlon Accountlng Reclass~f~cat~on~Comprehenslve Adustment Prlnclple Income Balance, beglnnlng of the flscal year $ (346) $500 $(414) $(260) Changes from perlod actlvlty Balance, end of the flscal year a. Reclass~f~cat~onof Cumulatlve effect of change ~naccounting prlnclple to net lncome NOTE N-NET UNREALIZEDGAINS (LOSSES) comprehensive income was based upon the hedging ON NON-TRADING DERIVATIVE relationships that existed under generallyaccepted INSTRUMENTS, AS REQUIRED BY FAS 133 accounting principles before the initial application of FAS 133. On July1,2000, IBRD adopted FAS 133. This standard requires that derivativeinstruments, as The $500 million difference between the carrying defined by FAS 133, be recorded on the balance sheet value and the fair value of those derivatives that were at fair value. IBRD has not defined any qualifying hedging a cash flow exposure prior to the initial hedging relationships under this standard. application of FAS 133, was included in Other Comprehensive Income at the time FAS 133 was Prior to the adoption of FAS 133, the derivative implemented. This amount is being reclassified into instruments in the borrowing portfolio were recorded earnings in the same period or periods in which the using synthetic accounting. The derivative hedged forecasted transactions affect earnings. instruments in the investment portfolio were, and continue to be, recorded at fair value in accordance Any gains or losses on those borrowings for which a with the requirements of Statement of Financial fair value exposure was being hedged prior to Accounting Standards No. 115, Accountingfor Certain adoption of FAS 133 were recorded in income at the Investments in Debt and Equity Securities. time of implementation, and were offset by the mark- to-market adjustments on the related derivative Upon adoption of FAS 133, IBRD's net income was instruments. The mark-to-market adjustments on the increased by $219 million, and an additional $500 bonds are being amortized over the remaining lives of million was reported in other comprehensive income. the related bonds. The allocation between net income and other IBRD FINA NCIA L STATEMENTS:J UN E30, 2006 91 The following table reflects the components of the effects of applying FAS 133 for the fiscal years ended June 30, 2006, June30,2005, and June 30,2004. Unrealized (losses) gainson non-trading derivative instruments, as defined by FAS 133 $(3,440) $2,527 $(4,052) Reclassification and amortization of transition adjustment Reclass~f~cat~onfrom Other Comprehensive Income-Cash Flow Hedges Amortlzatlon of mark-to-market on borrowings associated wlth falr value hedges (43) (60) (50) Net unrealized (losses) gains on non-trading derivative instruments, as required by FAS 133 $(3,479) $2,511 $(4,100) NOTE 0-ESTIMATED AND FAIR VALUE DISCLOSURES The Condensed Balance Sheets below present IBRD's estimates of fair value of its assets and liabilities along with their respectivecarrying amounts as of June30,2006 and June 30,2005. In m~ll~onso f U.5. dollars 2006 2005 Carrylng Carrylng Value Fair Value* Value Fair Value* Due from Banks lnvestments Loans Outstandlng Less Accumulated Provlslonfor Loan Losses and Deferred Loan Income (2,783) (2,783) (3,491) (3,491) Net Loans Outstandlng Swaps Receivable lnvestments Loans Borrowlngs Other Asset/L~ab~l~ty Other Assets Total Assets Borrowlngs Swaps Payable lnvestments Loans Borrowlngs Other Asset/L~ab~l~ty Other Llabllltles Total Llabllltles Pald In Capltal Stock Retalned Earnlngsand Other Equlty Total Equlty Total Llabllltles and Equlty * Except for loans, whlch are on an est~matedvalue (current value) basls. ValuationMethods and Assumptions value and fair value of other assetsis due to the Due from Banks carryingvalue of debt issuance costsbeing included in other assets while the fair value of these costs is The carrying amount of unrestricted and restricted included as part of the fair value of borrowings. currencies is considered a reasonable estimate of the fair value of these positions. Investments NOTE P-CHANGE IN ACCOUNTING PRINCIPLE FOR BOARD OF GOVERNORS-APPROVED IBRD's investment securities and related financial TRANSFERS instruments held in the trading portfolio are carried and reported at fair value. Therefore, for the In the fourth quarter of the fiscal year ended June30, investment portfolio, no additional adjustment is 2006, IBRD changed its accounting for Board of necessary. Fair value is based on market quotations. Governors-approved transfers. This change is Instruments for which market quotations are not described below. readily available have been valued using market-based Background methodologies and market information. (See Note A). IBRD is an international organization formed under its Articles of Agreement and not under the laws of Net Loans Outstanding any particular jurisdiction. Its legal form and All of IBRD's loans are made to or guaranteed by distribution policy is therefore governed by the countries that are members of IBRD, except for those Articles, related Amendments and By-Laws, and loans made to IFC. IBRD does not currently sell its Interpretations by the Board of Executive Directors. loans, nor does it believe there is a comparable market Generally accepted accounting principles, specifically for its loans. The current value of loans outstanding related to equity transactions, such as dividends or incorporates management's best estimate of the distributions to shareholders, are primarily based on probable expected cash flows of these instruments to the legal requirements prescribed by corporate law IBRD. applicable to the jurisdiction of incorporation of the The current value of loans, including associated reporting entity. financial derivatives,is based on a discounted cash IBRD'sdistribution policy is contained in Article V, flow method. The estimated cash flows from principal Section 14 (a) of the Articles of Agreement which repayments and interest are discounted using the rate states that "The Board of Governors shall determine at which IBRD would originate a similar loan at the annually what part of the Bank's net income, after reporting date. The cash flows of these instruments making provision for reserves, shall be allocated to are based on management's best estimates taking into surplus and what part, if any shall be distributed." account market exchange rates and interest rates. While the Executive Directors have been delegated the The current value of net loans outstanding also authority for the ordinary operations of IBRD, only includes IBRD's assessment of the appropriate credit the Board of Governors has the authority for declaring risk, considering its history of collections from distributions or making transfers out of retained borrowers. This is reflectedin the accumulated earnings under IBRD'sArticles ofAgreement. This is provision for loan losses. a reserved power which, under the Articles, may not be delegated. Swaps Receivableand Swaps Payable Certain derivatives,as defined by FAS 133, are Each year since 1964, IBRD's Board of Governors has recorded in the balance sheet at estimated fair value. considered and authorized, in lieu of distributions to The fair value is estimated using a discounted cash its shareholders, transfers to other organizations for flow method representing the estimated cost of purposes congruent with IBRD'smission (See Note replacing these contracts on that date. (See Note A). H). IBRD'sprevious accounting for Board of Governors-approved transfers placed emphasis on the Borrowings role of the Governors acting on behalf of shareholders The fair value of borrowings is predominantly based and was viewed as being constructively a transaction on discounted cash flow techniques using appropriate with owners. In effect, IBRD viewed these market yield curves. transactions as being equivalent to distributions, whereby theshareholders constructively receivedthese Other Assetsand Other Liabilities funds and simultaneously agreed to contribute them These amounts are generallyshort-term in nature. to the designated recipient. IBRD effected the Therefore, the carrying value is a reasonable estimate distributions via transfers to the designated recipients. of fair value. The difference between the carrying Therefore, in prior periods certain of these transfers, IBRD FINANCIALSTATEMENTS: JU NE 30, 2006 93 depending on their nature, were accounted for as accounting principle also provides greater consistency direct reductions in equity. This accounting reflected with the more traditional corporate legal form and the shareholders' view of the substance and intent of associated expense recognition policies presumed by these transfers and was applied consistently by IBRD generally accepted accounting principles. since 1964. Impact of the change in Principle Description of the changein Principle As described in Note A under Accounting and In light of the increasing frequency of these transfers Reporting Developments, IBRD also elected to early and varying nature of recipients, IBRD has re- adopt FAS 154, Accounting Changes and Error evaluated its accounting related to these types of Corrections, and therefore this change to a preferable transactions and determined that, effectiveJune 30, accounting principle has been applied retrospectively. 2006, all Board of Governors-approved transfers Retrospectiveapplication means applying the new would be reported as expenseswithin the Statement of accounting principle as if it had always been in effect. Income. For the reasons discussed in the following Accordingly, all amounts in the prior periods' paragraph, management believes that expensing these financial statements impacted by this change in transactions represents a change to a preferable accounting policy have been adjusted. In particular; accounting principle, although the past accounting the change in accounting policy has resulted in an principle was acceptable. increase in expenses for amounts that were previously reported as direct reductions in equity. Accordingly, The new accounting treatment provides greater amounts reported as Board of Governors-approved transparency in IBRD'sfinancial statements, by transfers on the Statement of Income are higher than reflecting all of these transactions in the Statement of the amounts previously reported, and the Statement Income as compared to the prior method of reflecting of Changes in Retained Earnings no longer presents certain of such transactions as direct chargesto equity. Board of Governors-approved transfers as direct In addition, while these transactions do not meet the reductions in retained earnings. Also, the presentation criteria used by IBRD to define its principal operating of Board of Governors-approved transfers previously activities, they are consistent with IBRD'soverall presented in the Statement of Cash Flows as mission. Therefore, the inclusion of these distributions and, therefore, a component of cash transactions within the Statement of Income provides flows from financing, are now reported as a greater transparency regarding the full extent of component of cash flows from operating activities. IBRD'soutflows in connection with its principal operating activities as well as those activities The effect of this change on net income previously separately authorized by the Board of Governors reported in fiscal years ended June 30,2005 and June outside of IBRD's regular operations. This change in 30,2004 is summarized in the table below: In m~ll~onsof US dollars F~scalYear Ended June 30, 2005 F~scalYear Ended June 30, 2004 As Adlusted As Reported As Adlusted As Reported Net Income (Loss) There is no impact on ending retained earnings, any other component of the balance sheet from this accumulated other comprehensive income (loss) or change in accounting principle. As this change in accounting principle was made in the fourth quarter of the fiscalyear ended June30,2006, the tables below provide supplemental information about the effect of the change on the results of interim periods previously reported for this fiscal year ended June 30,2006 as well as the comparative periods of fiscal year ended June 30,2005. Condensed Statementof Income for interim periods of the fiscal year ended June30,2006 In m~ll~onsof US dollars First Quarter SecondQuarter ThlrdQuarter As As As As As As Reported Adlusted Reported Adlusted Reported Adlusted Income Loans Investments-Tradlng Other Total income Expenses Borrow~ngs Admlnlstrat~ve Contr~but~onsto specla1programs 6 6 41 41 44 44 Board of Governors-approved specla1allocat~ongrants - - 5 - 25 - Release of provlslon for losses on loans and guarantees (98) (98) (317) (317) (52) (52) Other Total expenses Net income before Board of Governors-approved transfers and net unrealized (losses) gains on non-trading derivative instruments, as required by FAS 133 (previously reported as Operating Income) 412 412 592 597 270 295 Board of Governors-approved transfers - (610) - (5) - (35) Net unreal~zed(losses) galns on non-trad~ngder~vat~ve ~nstruments,as requlred by FAS 133 (921) (921) (13) (13) (1,045) (1,045) Net (loss) income Condensed Statementof Incomefor the interim periods of the fiscal year ended June30,2005 In m~ll~onsof US dollars First Quarter Second Quarter ThlrdQuarter Fourth Quarter Full Year As As As As As As As As As As Reported Adlusted Reported Adlusted Reported Adlusted Derlved3 Adlusted Reported Adlusted lncome Loans $ 931 $ 9 3 1 $1,105 $1,105 $1,020 $1,020 $1,099 $1,099 $4,155 $4,155 Investments-Tradlng 123 123 158 158 157 157 190 189 628 627 Other Total lncome Expenses Borrow~ngs 683 683 777 777 759 759 818 818 3,037 3,037 Admlnlstrat~ve 218 218 237 237 217 217 349 349 1,021 1,021 Contr~but~onsto specla1programs 20 20 64 64 38 38 51 51 173 173 Release of provlslon for losses on loans and guarantees (30) (30) (319) (319) (86) (86) (67) (67) (502) (502) Other 3 3 3 3 4 4 (5) (6) 5 4 Total expenses Net income before Board of Governors-approved transfers and net unrealized (losses)gains on non-trading derivative instruments, as required by FAS 133 (previously reported as Operating Income) 218 218 566 566 312 312 224 224 1,320 1,320 Board of Governors-approved transfers - - - - - - (615) - (27) (642) Net unreal~zed(losses) galns on non- tradlng derlvatlvemnstruments, as requlred by FAS 133 631 631 889 889 (801) (801) 1,792 1,792 2,511 2,511 Net (loss)income a. The fourth quarter results have been derlvedby calculat~ngthe differences between amounts reported for the thlrd quarter and the full year. Management's Report Regarding Effectiveness of Internal Controls Over External Financial Reporting 98 Report of lndependent Accountants on Management's Assertion Regarding Effectiveness of Internal Controls Over External Financial Reporting 100 Report of lndependent Accountants on Special Purpose Financial Statements 101 Statement of Sources and Applications of Development Resources 102 Statement of Income 104 Statement of ComprehensiveIncome 105 Statement of Changes in Accumulated Deficit 105 Statement of Cash Flows 106 Summary Statement of Development Credits 107 Statement of Voting Power and Subscriptions and Contributions 110 Notes to Special Purpose Financial Statements 114 The World Bank 1818 ti Street N W. (202)477-1234 INTERNATIONAL BANK FOR RECONSTRUCTIONAND DEVELOPMENT Wash~ngton.D.C. 20433 Cable Address INTBAFRAD INTERNATIONAL DEVELOPMENT ASSOCIATION U.S.A. Cable Address INDEVAS Management's Report Regarding Effectiveness of Internal Controls Over ExternaI Financial Reporting August 7,2006 The management of the International Development Association (IDA) is responsible for the preparation, intepity, and fair presentation of its published special purpose financial statements. The special purpose financial statements have been prepared in accordance with accounting principles described in Note A to IDA'S special purpose financial statements and, as such, include amounts based on informcd judgments and estimates made by management. The special purpose financial statements have been audited by an independent accounting firm, which was given unrestricted access to all financial records and rclaled data, including minutes of all meetings of the Board of Executive Directors and co~nmitteesof thc Board. Management believes that all representations made lo the independent auditors during their audit were valid and appropriate. The independent auditors' report accompanies the audited special purpose financial statements. Management is responsible for establishing and maintaining effective internal control over extcrnal financial reporting for financial presentations in conformity with accounting principles described in Note A 10 IDA'S special purpose financial statements. The system of internal control contains monitoring mechanisms, and actions are taken to correct deficiencies identified. Management beIieves that internal controls for external financial reporting, which are subject to scrutiny by management and the internal a~iditors,and are revised as considered necessary, support lhe integrity and reliability of the external financial statements. There are inhcrcnt limitations in the effectiveness of any internal control, including the possibility of human error and the circumvention or overriding of controts. Accordingly, even effective internal control can provide only reasonable assurance with rcspcct lo financial statement preparation. Further, because of changes in conditions, the effectivencss of internal control may vary over time. IDA assessed its intcrnal control over extemal financial reporting for financial presentations in conformity with accounting principles described in Note A to LDA's special purpose financial statements as of June 30, 2006. This assessment was based on thc crilena for effective internal control over extemal financial reporting described in I~iternalControl-lntegrcrted Framework issucd by the Com~nitteeof Sponsoring Organizations of the Treadway Commission. Based upon this assessment, management bclieves that IDA maintained effective internal control over extcrnal financial reporting presented in conformity with accounting principles described in Note A to IDA'S special purpose financial statemenls, as of June 30, 2006. The independent -2- August 7,2006 accounting firm that audited the special purpose financial statements has issued an attestation report on management's assessment of IDA'S internal control over external financial reporting. The Board of Executive Directors of IDA has appointed an Audit Committee responsible for mo~iitoringthe accounting practices and internal controls of IDA. The Audit Con~rnittccis comprised entirely of Executive Directors who are independent of IDA'S management. The Audit Committee is responsible for recommending to the Board of Executive Directors the selection of independent auditors. It meets periodically with management, the indepcndent auditors, and the intemal auditors to ensure that they are carrying out tlieir responsibilities. The Audit Committee is respoilsible for performing an oversight role by reviewing and monitoring the financial, accounting and auditing procedures of IDA in addition to reviewing IDA'S reports. The indepcndent auditors and the internal auditors have full and free acccss to the Audit Committee, with or without the presence of management, to discuss Ihe adequacy of internal control over external financial reporting and any other matters which they believe should be brought to the attention of the Audit Committee. Preside t t, i,LV, Vincenzo La Via Chief Financial Officer Fayexul H. Cho~ldhury 1 Charles A. ~ c ~ o n o $ h Vice President and Controller Director, Accounting ~cpartrnent IDA SPECIAL PURPOSE FINANCIAL STATEMENTS: JUNE 30, 2006 99 Deloitte. Deloitte & Tow-tre LC? Su~te500 555 12th Street NW Washington. CC 211M4-123: USA T?I, +1 202 879 5600 F a x + I?OL8795?09 m~ihwde101tte.con INDEPENDENT ACCOUNTANTS' REPORT President and Board of Executive Directors Interrlational Development Association We have esarnincd management'sassertion, inctuded in the accompanying mu nag em err^'.^ Report Reguyding .Etjcectivenes~of hternai C'ontrol~over External Fir~rrncialReporting, that the International Developrnsnt Association ("IDA-') inaintai~ledeiiectike internal control over external financial reporting presented in collformity with the accounting principles described in Note A to IDA'Sspecial PUrpoEe financial statementsas of Suilc 30, 2006, based on the criteria established in "Internal Control-Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission ("the COSO repon"). M a n a p l e n t is responsible for maintaining effective internal control over external financial reporting. Our responsibility is to express an opinior~or1 management's asseflion based on our cxarnination* Our examination was conducted in accordance with attestation standards established hy the American l~~stitureCertified Public Accountants and, accordingly. included obtaining an of undtirstancli~~g ir~ternatcontrol over financial reporting, testing, and evaluating the design and of operating effectiveness of the internal control, and performing such other procedures as we considered necessary in the circumstances. Wc believe that our examination provides a reasonable basis for our opiniim. Because of the inherent limitations of interndlcontrol over external financial reporting, including the possibility of collusion or improper managcment override of cuntruls, material misstatements due to error ar fraud may occur and not be detected. Also, prujectiuns of any evaluation of the effectivenrss of the internal control over external financial reporting 10 future periods are subject to the risk that controls may hecnme inadequate because of changes in conditions. or that the degree of conlpliancc with the policies or pr~ceduresmay deteriorate. In orrr opinion, management's assenion that IDA maintained rffrcti\lc internal control over external financial reporting presented in conformity wilh the accounting principles described in Note A to IDA'Sspecial purpose financial statements as uf June 30,2006.is fairly stated, in all material respects, based on the criteria established in the COSO report. August 7,2006 Deloitte. Delortte B. Touche LLP 5u1te500 555 12th Street NW Warhington. DC 20004 1207 U5A Tvl. +1202 879 5600 Fax. t 1 202 879 5309 www deloitte corn IXDEPENDENT AUDITORS' REPORT President and Board of Executive Directors International Development Association We have audited the accompanying special purpose statement of sources and applications of developnlent resources uf the International Development Association as of June 30, 2006 and 2005, including the summary statement of development credits and statement of voting power and subscriptions and contributions as of June 30, 2006 and the related special purpose statements of income, comprcl~ensiva incotne, changes in accumulated deficit, and cash flows for each of the three fiscal years in the period ended June 30. 2006. These special purpose financial statements are the responsibility of the International Development Association's management. O u r responsibility is to express an opinion on these special purpose financial statements based on our audits. We conducted our audits in accordance with aud~tingstandards generally accepted in the United States of America and international Standards on Auditing. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the special purpose financial statements are free of material misstatement. Arr audit includes csarnining, on a test basis, evidence supporting the amounts and disclosures in the special purpose financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall special purpose financial statement presentation. We believe thal our audits provide a reasonable basis for our opinion. The accompanying special purpose fnancial statements were prepared to reflect the sources and applications of development resources, operations, and cash flows o f the International Development Association to comply with Article V1. Section I 1 (a) of the Articles of Agreement of the International Development Association, as discussed in Note A to the special purpose financial statements, and are not intended to be a presentation in conformity with the accounting principles generally accepted in the United States of America ar lnrernaticnal Financial Reporting Standards. In our opinion, the special purpose financial statements referred to above present fairly. in all malerial respects, the sources and applications of development resources of the International Developnlent Association as of June 30, 2006 and 2005, and the results of its operations and its cash flows for each of the three fiscal years in the period ended June 30, 2006 in conformity with the accounting principles described in Note A to the special purpose financial statements. This report is intended solely Tor the informatior1 and use of the Board of Governors, management, and members of the Internationai Developmenr Association. However, under the International Dcvelopment Association's Articles of Agreement, this report is a matter of public record and its distribution is not limited. August 7,2006 Member of Deloine Touche Tohrnatsu IDA SPECIAL PURPOSE FINANCIAL STATEMENTS: JUNE 30, 2006 101 S T A T E M E N T O F S O U R C E S A N D A P P L I C A T I O N S O F D E V E L O P M E N T R E S O U R C E S June 30, 2006 andJune 30, 2005 Expressed in millions o f U.S. dollars Applications of Development Resources Net ResourcesAvailable for Development Activities Due from banks Unrestricted currencies Currencies subject to restriction Investments-Notes Band F Investments-Trading (including securities transferred under repurchase or security lending agreements of $9,601 million-June 30, 2006; $5,259 million-June 30, 2005) Net payable on investment securities transactions Nonnegotiable, noninterest-bearing demand obligations on account of member subscriptions and contributions Receivable from the International Bank for Reconstruction and Development-Note D Receivable from the HlPC Debt Initiative Trust Fund-Note E Payable for development grants-NoteI Other resources, net Total net resources available for development activities Resources Used for Development Credits (see Summary Statement of Development Credits, Notes E and F ) Total development credits Less undisbursed balance Development credits outstanding Less accumulated provision for debt relief Total resources used for development credits outstanding Total Applications of Development Resources Sources of Development Resources Member subscriptions and contributions (see Statement of Voting Power and Subscriptions and Contributions, and Note C) Unrestricted Restricted Subscriptions and contributionscommitted Less subscriptions and contributions receivable-Note C Less unamortized discounts on advance subscriptions and contributions Subscriptions and contributions paid in Deferred amounts receivable to maintain value of currency holdings Transfers-NoteD Accumulated other comprehensive income-Note J Accumulated deficit Total Sources of Development Resources The Notes to Special Purpose FinancialStatements are an integral part of these Statements. IDA SPECIAL PURPOSE FINANCIALSTATEMENTS: JU NE30, 2006 103 S T A T E M E N T O F I N C O M E For the fiscalyears endedJune 30, 2006, June 30, 2005 andJune 30, 2004 Expressed in millions o f U.S. dollars 2006 Income Development credits-Note E Service charges Commitment charges Investments, net-Note B Total income Expenses Development grants-Note I Administrative-Notes G and H Amortization of discount on advance subscriptions and contributions Total expenses Operating Loss Effect of exchange rate changes on accumulated income before HlPC Debt lnitiative and Multilateral Debt Relief lnitiative (MDRI) Net Loss before HIPC Debt lnitiative and MDRI HIPC Debt lnitiative and MDRI-Income (Expenses)- Note E Provision for debt relief Contribution from the HlPC Debt lnitiative Trust Fund Total net expenses for HlPC Debt Initiative and MDRl (32,784) Net Loss after HIPC Debt Initiative and MDRI 804,666) The Notes to Special Purpose Financial Statements are an integral part of these Statements. 104 THE WORLD BANK ANNUAL REPORT 2006 S T A T E M E N T O F C O M P R E H E N S I V E IN C O M E For the fiscalyears ended June 30, 2006, June 30, 2005 and June 30, 2004 Expressed in millions of U.S.dollars Net Loss after HlPCDebt Initiative and MDRl 804,666) $42,298) $41,687) Other comprehensive(loss) income-Note J Currency translation adjustment on development credits, payable for development grants and MDRl (357) (549) 4,212 Comprehensive (loss) income $435,023) $42,847) $2,525 S T A T E M E N T O F C H A N G E S I N A C C U M U L A T E D D E F I C I T For the fiscalyears ended June 30, 2006, June 30, 2005 and June 30, 2004 Expressed in millions of U.S.dollars Accumulateddeficit at beginning of the fiscal year $ (8,856) $46,558) $(4,871) Net loss after HlPC Debt Initiative and MDRl for the fiscal year (34,666) (2,298) (1,687) Accumulateddeficit at end of the fiscal year $443,522) $48,856) $46,558) The Notes to SpecialPurposeFinancialStatements are an integralpart of these Statements. IDA SPECIA LPURPOSE FINA NCIA LSTATEMENTS: J UN E30, 2006 105 For the fiscalyears endedJune 30, 2006, June 30, 2005 andJune 30, 2004 Expressed in millions o f U.S. dollars Cash Flows from development activities Development credits Disbursements Principal repayments Reimbursements received from the HlPC Debt lnitiative Trust Fund for principal repayments forgiven Net cash used in development credit activities Grant activities Development grant disbursements Net cash used in development activities Cash Flows from Member subscriptions and contributions Transfers from the International Bank for Reconstruction and Development Transfers from trust funds Cash Flows from operating activities Operating loss Adjustments to reconcile operating loss to net cash provided by operating activities Development grants Amortization of discount on subscription advances Net changes in other development resources Net cash provided by operating activities Effect of exchange rate changes on unrestricted cash and liquid investments Net Increase in unrestricted cash and liquid investments Unrestricted cash and liquid investments at beginning of the fiscal year Unrestricted cash and liquid investments at end of the fiscal year Composed of: Due from banks-Unrestricted currencies Investments $16,691 Supplemental Disclosure Increase/(Decrease) in ending balances of development credits outstanding, resulting from exchange rate fluctuations $ 577 Principal repayments forgiven under HlPC Debt Initiative (458) Development credits transferred from the Trust Fund for Bosnia and Herzegovina - The Notes to Special Purpose Financial Statements are an integral part of these Statements. 106 THE WORLD BANK ANNUAL REPORT 2006 June 30, 2006 Expressed in millions o f U.S. dollars Percentage of Total Undisbursed Development development development development credits credits Borrower or guarantor credits credits a outstanding outstanding Afghanistan Albania Angola Armenia Azerbaijan Bangladesh Benin Bhutan Bolivia Bosnia and Herzegovina Botswana Burkina Faso Burundi Cambodia Cameroon Cape Verde Central African Republic Chad Chile China Colombia Comoros Congo, Democratic Republic of Congo, Republic of Costa Rica CBte d'lvoire Djibouti Dominica Dominican Republic Ecuador Egypt, Arab Republic of El Salvador Equatorial Guinea Eritrea Ethiopia Gambia, The Georgia Ghana Grenada Guinea Guinea-Bissau Guyana Haiti Honduras India Indonesia IDA SPECIAL PURPOSE FINANCIALSTATEMENTS: JU NE30, 2006 107 ( c o n t i n u e d ) June 30, 2006 Expressedin millions o f U.5. dollars Percentage o f Total Undisbursed Development development development development credits credits Borrower or guarantor credits credits a outstanding outstanding Iraq $ Jordan Kenya Korea, Republic of Kyrgyz Republic Lao People's Democratic Republic Lesotho Liberia Macedonia, former Yugoslav Republic of Madagascar Malawi Maldives Mali Mauritania Mauritius Moldova Mongolia Morocco Mozambique Myanmar Nepal Nicaragua Niger Nigeria Pakistan Papua New Guinea Paraguay Philippines Rwanda St. Kitts and Nevis St. Lucia St. Vincent and the Grenadines Samoa 520 Tome and Principe Senegal Serbia and Montenegro ' Sierra Leone Solomon Islands Somalia Sri Lanka Sudan Swaziland Syrian Arab Republic Tajikistan Tanzania Thailand Togo Percentage of Total Undisbursed Development development development development credits credits Borrower or guarantor credits credits a outstanding outstanding Tonga Tunisia Turkey Uganda Uzbekistan Vanuatu Vietnam Yemen, Republic of Zambia Zimbabwe Subtotal members Bank of the States of Central Africa 17 8 Caribbean Development Bank 24 - West African Development Bank 156 98 Subtotal regional development banks 197 106 African Trade Insurance Agency 11 5 Other g 3 - Total-June 30, 2006 Total-June 30, 2005 * Ind~catesamounts less than $0.05 m1111onor less than 0.005 percent a. Of the undisbursed balance at June 30, 2006, IDA has entered into irrevocable commitments to disburse $239 million ($2 11million-June30, 2005). b. May differ from the sum of individual figures shown due to rounding. c. These development credits are for the benefit of Benin, Burkina Faso, C6te d'lvoire, Mali, N i g e ~Senegal and Togo. d. These development credits are for the benefit of Cameroon, Chad, Central African Republic, Republic of Congo, Gabon and Equatorial Guinea. e. These development credits are for the benefit of Grenada and territories of the United Kingdom (Associated States and Dependencies) in the Caribbean region. f. Represents development credit extended to the African Trade lnsurance Agency (ATI)as implementing agency for the benefit of Burundi, Kenya, Malawi, Rwanda, Tanzania, Uganda and Zambia. g. Represents development credits made at a time when the authorities on Taiwan represented China in IDA (prior to May 15, 1980). h. See note E - Subsequent Event. i. Montenegro declared independence from Serbia on June 3, 2006 (Note C) The Notes to Special Purpose Financial Statements are an integral part of these Statements. IDA SPECIA LPURPOSEFINA NCIA LSTATEMENTS: J UN E30, 2006 109 S T A T E M E N T O F V OT I N G PO W E R A N D SU B S C R I P T I O N S A N D C O N T R I B U T I O N S June 30, 2006 Expressed in millions o f U.S. dollars Subscriptions and Number o f Percentage o f contributions Member a votes total votes committed Part I Members Australia Austria Belgium Canada Denmark Finland France Germany Greece Iceland Ireland Italy Japan Kuwait Luxembourg Netherlands New Zealand Norway Portugal Russian Federation Slovenia South Africa Spain Sweden 5witzerlandb United Arab Emirates United Kingdom United States Subtotal Part I ~ e m b e r s ~ , ~ Part I1Members Afghanistan Albania Algeria Angola Argentina Armenia Azerbaijan Bangladesh Barbados Belize Benin Bhutan Bolivia Bosnia and Herzegovina Botswana Brazil Burkina Faso Subscriptions and Number o f Percentage o f contributions Member a votes total votes committed Burundi Cambodia Cameroon Cape Verde Central African Republic Chad Chile China Colombia Comoros Congo, Democratic Republic of Congo, Republic of Costa Rica CBte d'lvoire Croatia Cyprus Czech Republic Djibouti Dominica Dominican Republic Ecuador Egypt, Arab Republic of El Salvador Equatorial Guinea Eritrea Ethiopia Fiji Gabon Gambia, The Georgia Ghana Grenada Guatemala Guinea Guinea-Bissau Guyana Haiti Honduras Hungary India Indonesia Iran, Islamic Republic of Iraq Israel Jordan Kazakhstan Kenya Kiribati IDA SPECIAL PURPOSE FINANCIALSTATEMENTS: JU NE30, 2006 11 1 S T A T E M E N T O F V OT I N G P O W E R A N D SU B S C R I P T I O N S A N D C O N T R I B U T I O N S ( c o n t i n u e d ) June 30, 2006 Expressed in millions o f U.S. dollars Subscriptions and Number o f Percentage o f contributions Member a votes total votes committed Korea, Republic of Kyrgyz Republic Lao People's Democratic Republic Latvia Lebanon Lesotho Liberia Libya Macedonia, former Yugoslav Republic of Madagascar Malawi Malaysia Maldives Mali Marshall Islands Mauritania Mauritius Mexico Micronesia, Federated States of Moldova Mongolia Morocco Mozambique Myanmar Nepal Nicaragua Niger Nigeria Oman Pakistan Palau Panama Papua New Guinea Paraguay Peru Philippines Poland Rwanda St. Kitts and Nevis St. Lucia St. Vincent and the Grenadines Samoa 520 Tome and Principe Saudi Arabia Senegal Serbia and ~ o n t e n e ~ r o ~ Sierra Leone Singapore Slovak Republic Solomon Islands Somalia Subscriptions and Number of Percentage of contributions Member a votes total votes committed Sri Lanka Sudan Swaziland Syrian Arab Republic Tajikistan Tanzania Thailand Timor-Leste Togo Tonga Trinidad and Tobago Tunisia Turkey Uganda Ukraine Uzbekistan Vanuatu Vietnam Yemen, Republic of Zambia Zimbabwe Subtotal Part IIMembers Total-June 30, 2006 b,C Total-June 30, 2005 * Indicates amounts less than $0.05 million or less than 0.005 percent. a. See Notes to Special Purpose Financial Statements-Note A for an explanation of the two categories of membership. b. $512.3 million of Switzerland's subscription and contributions have not been included in the Statement of Sources and Applications of Development Resourcesat June 30, 2006 and June 30, 2005 since this represents the difference between the total cofinancing grants of $580.1 million provided by Switzerland directly to IDA borrowers as cofinancing grants between the fourth and the ninth replenishments of IDA resources, and the July 1992 contribution by Switzerland of $67.8 million. c. May differ from the sum of individual figures shown due to rounding. d. Montenegro declared independence from Serbia on June 3, 2006 (Note C) The Notes to Special Purpose Financial Statements are an integral part of these Statements. IDA SP ECIA LPURPOSEFINA NCIA LSTATEMENTS: J UN E30, 2006 113 NOTE A-ORGANIZATION, OPERATIONS AND and assumptions that affect the reported amounts of SIGNIFICANT ACCOUNTING AND RELATED assets and liabilities and disclosure of contingent POLICIES assets and liabilities at the date of the financial statements and the reported amounts of revenue and Purpose and Affiliated Organizations expenses during the reporting period. Actual results The International Development Association (IDA) is could differ from these estimates. Significant an international organization that was established on judgments have been used in the computation of September 24, 1960. IDA'Smain goal is reducing estimated fair values of development credits and poverty through promoting sustainable economic accumulated provision for the HeavilyIndebted Poor development in the less developed areas of the world Countries (HIPC) Debt Initiative and the Multilateral included in IDA'S membership, by extending Debt Relief Initiative (MDRI). concessionary financing in the form of grants, development credits and guarantees. IDA has three On August 7,2006 the Executive Directors approved affiliated organizations, the International Bank for these financial statements for issue. ~econstructionand Development (IBRD),the Reclassifications International Finance Corporation (IFC), and the Certain reclassificationsof the prior years' Multilateral Investment Guarantee Agency (MIGA). information have been made to conform to the Each of these other organizations is legally and current year's presentation. financially independent from IDA, with separate assets and liabilities, and IDA is not liable for their Basis of Accounting respectiveobligations. Transactions with these IDA's special purpose financial statements are affiliates are disclosed in the notes that follow. The prepared on the accrual basis of accounting. That is, principal purpose of IBRD is to promote sustainable the effects of transactions and other events are economic development and reduce poverty in its recognized when they occur (and not as cash or its member countries, primarily by providing loans, equivalent is received or paid) and are recorded in the guarantees and related technical assistancefor specific accounting records and reported in the financial projects and for programs of economic reform in statements of the periods to which they relate. developing member countries. IFC's purpose is to encourage the growth of productive private IDA follows a special basis of accounting for member enterprisesin its member countries through loans and subscriptions and contributions and for development equity investments in such enterprises without a credits as described under the discussion on member's guarantee. MIGA was established to significant accounting policies below. encourage the flow of investments for productive Translationof Currencies purposes between member countries and, in IDA's special purpose financial statements are particular, to developing member countries by expressed in terms of U.S. dollars solely for the providing guarantees against noncommercial risks for purpose of summarizing IDA'Sfinancial position and foreign investment in its developing member the results of its operations for the convenience of its countries. members and other interested parties. Summaryof SignificantAccountingand Related IDA is an international organization which conducts Policies its operations in Special Drawing Rights (SDRs)and Due to the nature and organization of IDA, these U.S. dollars. Applications of development resources financial statements have been prepared for the and sources of development resourcesare translated at specificpurpose of reflectingthe sources and market exchange rates in effect at the end of the applications of member subscriptions and accounting period, except Member Subscriptions and contributions and other development resources. Contributions which are translated in the manner These financial statements are not intended to be a described below. Income and expenses are translated presentation in accordance with accounting principles at either the market exchange rates in effect on the generallyaccepted in the United States of America or dates of income and expense recognition, or at an with International Financial Reporting Standards. average of the exchange rates in effect during each These special purpose financial statements have been month. Translation adjustments relating to the prepared to comply with Article VI, Section 11(a) of revaluation of development credits and development the Articles of Agreement of IDA, and are prepared in grants denominated in SDRs are charged or credited accordance with the accounting policies outlined to Accumulated Other Comprehensive Income. Other below. translation adjustments are shown in the Statement of The preparation of these special purpose financial Income. statements requires management to make estimates Member Subscriptions and Contributions Transfers to IDA from IBRD are recorded under Recognition Sources of Development Resources and are receivable upon approval by IBRD's Board of Governors. Member Subscriptions and Contributions committed for each IDA replenishment are recorded based upon For the purposes of its financial resources, the the full amount of Instruments of Commitment membership of IDA is divided into two categories: (1) received from members upon effectiveness of the Part I members, which make payments of relevant replenishment. Prior to effectiveness, only a subscriptions and contributions provided to IDA in portion of the Instruments of Commitment received convertible currencies which may be freely used or are recorded as Subscriptions and Contributions exchanged by IDA in its operations and (2) Part I1 committed. A replenishment becomes effective when members, which make payments of ten percent of IDA receivesInstruments of Commitment from their initial subscriptions in freely convertible members for subscriptions and contributions of a currencies, and the remaining 90 percent of their specified portion of the full replenishment. Amounts initial subscriptions, and all additional subscriptions not yet paid in, at the date of effectiveness, are and contributions in their own currencies or in freely recorded as Subscriptions and Contributions convertible currencies. Certain Part I1members Receivableand shown as a reduction of Subscriptions provide a portion of their subscriptions and and Contributions Committed. These receivables contributionsin the same manner as mentioned in (1) become due throughout the replenishment period above. IDA'SArticles of Agreement and subsequent (generallythree years) in accordance with an agreed replenishment agreements provide that the currency maturity schedule. The actual payment of receivables of any Part I1member paid in by it may not be used by when they become due from certain members is IDA for projects financed by IDA and located outside conditional upon the respectivemember's budgetary the territory of the member except by agreement appropriation processes. between the member and IDA. The local currency portion of subscriptions of Part I1members are The Subscriptions and Contributions Receivable are recorded as restricted under Member Subscriptions settled through payment of cash or deposit of and Contributions unless released under an nonnegotiable, noninterest-bearing demand notes. agreement between the member and IDA or used for The notes are encashed by IDA as provided in the administrative expenses. The cash paid and notes relevant replenishment resolution over the deposited in nonconvertible local currencies for the disbursement period of the credits committed under subscriptions of Part I1members are recorded either the replenishment. as currencies subject to restriction under Due from In certain replenishments, donors have had the option Banks, or as restricted notes included under of paying all of their subscription and contribution Nonnegotiable, noninterest-bearing demand amounts in cash before they become due, and thereby obligations on account of member subscriptions and receivingdiscounts. In addition, some replenishment contributions. arrangements have incorporated an accelerated Followingadoption by the Board of Governors on encashment schedule. In these cases, IDA and the April 21,2006 of a resolution authorizing additions to donor agree that IDA will invest the cash and retain IDA'S resources to finance the Multilateral Debt Relief the income. The related subscription and contribution Initiative (MDRI),any pledges received in the form of are recorded at the full undiscounted amount. The Instruments of Commitments will be recorded and discount is recorded as unamortized discount on accounted for in their entirety. Therefore, the full contributions (a reduction of Subscriptions and value of all Instruments of Commitments receivedwill Contributions Committed) and amortized over the be recorded as subscriptions and contributions upon projected encashment period. effectiveness of the replenishment. In addition, these Under the provisions governing replenishments, IDA Instruments of Commitments will also be recorded as must encash the notes or similar obligations of subscriptions and contributions receivable in the contributing members on an approximatelypro rata Statement of Sources and Application of Development basis. As discussed in the previous paragraph, donors Resources. sometimes contribute resources on an advanced or an Under IDA'SArticles of Agreement, a member may accelerated basis. IDA holds these resources until they withdraw from membership in IDA at any time. When become available for disbursement on a pro rata basis. a government ceases to be a member, it remains liable for all financial obligations undertaken by it to IDA, whether as a member, borrower, guarantor or IDA SPECIAL PURPOSE FINANCIAL STATEMENTS: JUNE 30, 2006 115 otherwise. The Articlesprovide that upon withdrawal, exchange rates in effect on dates of disbursement or IDA and the government shall proceed to a settlement conversion. Subscriptions and contributions not yet of accounts. If agreement is not reached within six available for disbursements are translated at market months, standard arrangements are provided. Under exchange rates in effect at the end of the accounting these arrangements, IDA would pay to the period. government the lower of the member's total paid-in Article IV, Section 2(a) and (b) of IDA'SArticles of subscriptions and contributions or the member's Agreement provides for maintenance of value proportionate share of IDA'Snet assets. These funds payments on account of the local currency portion of would be paid as a proportionate share of all principal the initial subscription whenever the par value of the repayments received by IDA on loans made during the member's currency or its foreign exchangevalue has, government's membership. in the opinion of IDA, depreciated or appreciated to a Valuation significant extent within the member's territories, so The subscriptions and contributions provided long as, and to the extent that, such currency shall not through the Third Replenishment are expressed in have been initially disbursed or exchanged for the terms of "U.S. dollars of the weight and fineness in currency of another member. The provisions of effect on January1, 1960" (1960 dollars). Following Article IV, Section 2(a) and (b) have by agreement the abolition of gold as a common denominator of the been extended to cover additional subscriptions and monetary system and the repeal of the provision of the contributions of IDA through the Third U.S. law defining the par value of the U.S. dollar in Replenishment, but are not applicable to those of the terms of gold, the pre-existing basis for translating Fourth and subsequent replenishments. 1960 dollars into current dollars or any other currency The ExecutiveDirectors decided on June 30, 1987 that disappeared. The Executive Directors of IDA decided, settlements of maintenance of value, which would with effect from that date and until such time as the result from the resolution of the valuation issue on the relevant provisions of the Articles of Agreement are basis of the 1974 SDR, would be deferred until the amended, that the words "U.S. dollars of the weight Executive Directors decide to resume such and finenessin effect on January1, 1960" in Article 11, settlements. These amounts are shown as Deferred Section 2(b) of the Articles of Agreement of IDA are Amounts Receivableto Maintain Value of Currency interpreted to mean the SDR introduced by the Holdings. International Monetary Fund as the SDR was valued in terms of U.S. dollars immediatelybefore the Development Credits introduction of the basket method of valuing the SDR All development credits are made to or guaranteed by on July1, 1974, such value being equal to $1.20635 for member governments or to the government of a one SDR (the 1974 SDR), and have also decided to territory of a member (exceptfor development credits apply the same standard of value to amounts which have been made to regional development expressedin 1960 dollars in the relevant resolutions of institutions for the benefit of members or territories the Board of Governors. of members of IDA).In order to qualifyfor lending on IDA terms, a country's per capita income must be The subscriptions and contributions provided below a certain level and the country may have only through the Third Replenishment are expressed on limited or no creditworthiness for IBRD lending. the basis of the 1974 SDR. Prior to the decision of the Development credits carry a service charge of 0.75 Executive Directors, IDA had valued these percent and generally have 35- or 40-year final subscriptions and contributions on the basis of the maturities and a 10-year grace period for principal SDR at the current market value of the SDR. payments. A new hard-term lending window was The subscriptions and contributions provided under established in the IDA Fourteenth Replenishment. the Fourth Replenishment and thereafter are Eligibilityfor this window is restricted to creditworthy expressed in members' currencies or SDRs and are IBRDIIDAblend countries with per capita incomes payablein members' currencies. Beginning July1, below the IDA operational cut-off and an active IBRD 1986, subscriptions and contributions made available lending program. Lending terms include a 35-year for hsbursement in cash to IDA are translated at maturity, including 10 years of grace, and an interest market exchange rates in effect on the dates they were charge in addition to standard IDA charges. The made available. Prior to that date, subscriptions and interest rate is set for each fiscal year and is derived contributions which had been disbursed or converted from the fmed-rate equivalent of IBRD's lending rate into other currencies were translated at market reduced by 200 basis points. Commitment charges on the undisbursed balances of Development Grants IDA credits are set annually by the Board of Executive IDA is authorized to provide a significant portion of Directors of IDA. Development credits are carried in financing beginning with the Thirteenth the Special Purpose Financial Statements at the full Replenishment as development grants.The annual net face amount of the borrowers' outstanding income transfers from IBRD for fiscal years 1997 obligations. through 2005also authorized the use of such funds for It is the practice of IDA to place in nonaccrual status IDA development grants. all development credits made to or guaranteed by a EffectiveJuly1,2005, development grants are charged member government or to the government of a to income upon approval by IDA'SExecutive territory of a member if principal or charges with Directors. In previous periods, development grants respect to any such development credit are overdue by were charged to income upon signing of the grant more than six months, unless IDA'Smanagement agreement by the recipient country. determines that the overdue amount will be collected in the immediate future. In addition, if loans by IBRD Commitment charges on the undisbursed balances of to a member government are placed in nonaccrual IDA grants are set annually by the Board of Executive Directors of IDA. status, all development credits to that member government will also be placedin nonaccrual status by Guarantees IDA. On the date a member's development credits are IDA provides guarantees for loans issued in support of placed in nonaccrual status, charges that had been projects located within a member country that are accrued on development credits outstanding to the undertaken by private entities. These financial member which remained unpaid are deducted from guarantees are commitments issued by IDA to the income from development credits of the current guarantee payment performance by a borrower to a period. Charges on nonaccruing development credits third party. are included in income only to the extent that payments have actually been received by IDA. If Guarantees are regarded as outstanding when the collectibility risk is considered to be particularly high underlying financial obligation of the borrower is at the time of arrears clearance, the member's credits incurred, and called when a guaranteed party maynot automatically emerge from nonaccrual status, demands payment under the guarantee. IDA would be even though the member's eligibilityfor new credits required to perform under its guarantees if the may have been restored. A decision on the restoration payments guaranteed are not made by the borrower of accrual status is made on a case-by-casebasis. and the guaranteed party called the guarantee by demanding payment from IDA in accordance with the In fulfillingits mission, IDA makes concessional loans terms of the guarantee. to the poorest countries. Therefore, there is significant credit risk in the portfolio of development credits. In the event that a guarantee is called, IDA has the Management continuallymonitors this credit risk. No contractual right to require payment from the provision for credit losses, other than accumulated member country that has provided the counter provision for the HIPC Debt Initiative and MDRI, has guarantee to IDA, on demand, or as IDA may been established. otherwise direct. The repayment obligations of IDA'Sdevelopment Guarantees fee income received is deferred and credits funded from resources through the Fifth amortized over the period of benefit. Replenishment are expressed in the development At inception of the guarantees, IDA records the fair credit agreements in terms of 1960 dollars. In June value of the obligation to stand ready. 1987, the Executive Directors decided to value those development credits at the rate of $1.20635 per 1960 The unamortized balance of the deferred guarantee dollar on a permanent basis. Development credits fee income and the unamortized balance of the funded from resources provided under the Sixth obligation to stand ready are included in Other Replenishment and thereafter are denominated in Resources,net on the Statement of Sources and SDRs;the principal amounts disbursed under such Applications of Development Resources. development credits are to be repaid in currency HeavilyIndebted Poor Countries (HIPC)Debt Initia- amounts currently equivalent to the SDRs hsbursed. tive The HIPC Debt Initiative was launched in 1996 as a joint effort by bilateral and multilateral creditors to IDA SPECIAL PURPOSE FINANCIAL STATEMENTS: JUNE 30, 2006 117 ensure that reform efforts of HIPCs would not be put donors under a resolution of IDA's Board of at risk by unsustainable external debt burdens. As Governors adopted on April 21,2006. Such resources part of this process, the HIPC Debt Initiative Trust will be added to IDA's resources and will be accounted Fund was established on November 7, 1996. It is for as subscriptions and contributions. administered by IDA and constituted by funds of The MDRI replenishment will become effectivewhen donors including the IBRD, to help beneficiaries IDA has received written commitments from donors reduce their overall debt, including IDA debt. whose aggregatecontributions amount to not less Under the Enhanced Framework of the Initiative, than SDR 10,434 million, of which not less than SDR which was approved by IDA'SExecutive Directors on 410 million are unqualified commitments for January27,2000, implementation mechanisms payments due in FY2007 and FY2008. include: (i) partial forgivenessof IDA debt serviceas it Upon approval of IDA's participation in the MDRI by comes due, to be reimbursed to IDA by the IBRDIIDA IDA'sExecutive Directors, IDA provided in full for the component of the HIPC Debt Initiative Trust Fund; expected write off of the principal component of debt and (ii)in the case of countries with a substantial relief to be delivered under the MDRI. The provision amount of outstanding IBRD debt, partial refinancing is recorded as a reduction of the disbursed and by IDA resources (excluding transfers from IBRD) of outstanding developments credits and as a charge to outstanding IBRD debt. income. Followingthe start of the MDRI Upon approval of debt relief for a country under the implementation by IDA on July1,2006, the applicable Enhanced HIPC Initiative by the Executive Directors development credits will be written off and the of IDA, the principal component of the estimated debt provision reduced accordmgly for the first group of relief costs is recorded as a reduction of the disbursed post-completion point HIPC countries that have been and outstanding development credits under the confirmed by the Executive Directors as eligible for accumulated provision for HIPC Debt Initiative, and MDRI relief, and subsequently upon reaching as a charge to income. completion point for the other HIPC countries. This estimate is subject to periodic revision. The Cash and Liquid Investments accumulated provision for HIPC Debt Initiative is IDA considers unrestricted cash as well as securities reduced when debt relief is provided by IDA. held in the investment portfolio, as an element of Upon signature by IDA of the country specificlegal liquidity in the Statement of Cash Flows, since they notification, immediately following the decision by are readily convertible to known amounts of cash. the ExecutiveDirectors of IDA to provide debt relief to IDA carries its investment securities and related the country (thedecision point), the country financial instruments at fair value, using trade date becomes eligible for debt relief up to the nominal accounting. The first-in-first-out (FIFO) method is value equivalent of one third of the net present value used to determine the cost of securities sold in of the principal component of the total debt relief computing the realized gains and losses on these committed to the specific country. Further, when the instruments. Both realized and unrealized gains and country reaches its completion point and the losses are included in income from Investments on the country's other creditors have confirmed their full Statement of Income. participation in the debt relief initiative to the satisfaction of IDA, the country becomes eligible for Securities Purchased Under Resale Agreements and the full amount of debt relief provided under this SecuritiesSold Under Repurchase Agreements initiative. Securities purchased under resale agreements and securities sold under repurchase agreements are The MultilateralDebt Relief Initiative (MDRI) recorded at historical cost. IDA receivessecurities On March 28,2006, the Executive Directors approved purchased under resale agreements, monitors the fair IDA's participation in the MDRI. The objectiveof the value of the securities and, if necessary, closes out MDRI is to provide additional support to HIPC transactions and enters into new repriced countries. transactions. Debt relief to be provided under the MDRI will be in The securities transferred to IDA under the addition to existing debt relief commitments by IDA repurchase and security lending arrangements and the and other creditors under the HIPC Debt Initiative. securities transferred to counterparties under the Additional resources for financing IDA'scosts of resale agreements have not met the accounting criteria providing debt relief under MDRI will be provided by for treatment as a sale. Therefore, securities Futures contracts generallyentail daily settlement of transferred under repurchase agreements and security the variation margin. lending arrangements are retained as assets on IDA's Government and Agency Obligations: Obligations Statement of Sources and Applications of issued or unconditionally guaranteed by governments Development Resources and securities received under of member countries require a minimum credit rating resale agreements are not recorded on IDA's of AA- if denominated in a currency other than the Statement of Sources and Applications of home currency of the issuer, otherwise no rating is Development Resources. required. NOTE B-INVESTMENTS Obligations issued by an agency or instrumentalityof a government of a member country, a multilateral As part of its portfolio management strategy, IDA organization or any other official entity other than the invests in the following financial instruments. government of a member country require a minimum Asset-backed Securities: IDA may only invest in asset- credit rating of AA-. backed securities with a AAA credit rating. Options: IDA investsonlyin exchange-traded options. Currency Swaps: IDA is authorized to enter into The initial price of an option contract is equal to the currency swaps including currency forward contracts. premium paid by the purchaser and is significantly less than the contract or notional amount. Futures: IDA generallycloses out most open positions in futures contracts prior to expiration. Therefore, Time Deposits: IDA may only invest in time deposits cash receipts or payments are mostly limited to the issued or guaranteed by financial institutions whose change in market value of the futures contracts. senior debt securities are rated at least A-. A summary of IDA'Sinvestments, by instrument, at June30,2006 and June 30,2005 is as follows: In m~ll~onsof U.S.dollars equ~valent Carrying Value Government and agency obligations Time deposits Asset-backed securities Gross investment holdings Securities purchased under resale agreements Repurchase agreements and securities loans Receivable from currency and interest rate swaps Payable for currency and interest rate swaps Investments-Trading Receivable from securities traded Payable for securities tradeda Net payable on investmentssecurities transactions Investments Cash held in lnvestment portfoliob Net lnvestment Portfolio a. As of June 30, 2006, IDA had $59 m1111on($228 m~ll~on-June30, 2005) of short sales ~ncludedln Payable for secur~t~estraded. b. Thlsamount a ~ncludedln Unrestricted Currenoesunder Due from Banks on the Statement of Sources and Appl~cat~onsof Development Resources. IDA SPECIAL PURPOSE FINANCIAL STATEMENTS: JU NE30, 2006 119 A summary of the currency composition of investments at June30,2006 and June 30,2005 is as follows: Gross investment holdings In m~ll~onsof U.S.dollars equ~valent 2006 2005 Average Average Carrying Average Yield Repricing Carrying Average Yield Repricing value (%j hears) value (%j hears) Euro $12,099 3.30 2.00 $ 8,337 2.43 3.49 Japanese yen 1,963 0.39 1.10 - - - Pounds sterling 1,607 4.70 2.00 3,410 4.52 3.82 U.S. dollars 9,888 5.37 2.19 7,047 3.74 3.52 Other 421 4.11 0.35 403 4.69 3.28 Total Net Investment Portfolio In m~ll~onsof U.S.dollars equ~valent 2006 2005 Average Average Carrying Average Yield Repricing Carrying Average Yield Repricing value (%j hears) value (%j hears) Euro $ 6,427 3.78 3.45 $ 7,290 2.38 3.74 Japanese yen 2,429 0.28 0.87 873 - - Pounds sterling 1,061 4.57 2.96 1,846 4.33 6.73 U.S. dollars 6,751 6.10 3.16 5,026 4.42 7.28 Other 1 2.34 t * t t Total * Ind~catesamounts less than $0.05 mlll~on. t Ind~catesamounts not mean~ngful. For the purpose of risk management in the investment The credit risk exposure and contract value, as portfolio, IDA is party to a variety of financial applicable, of these financial instruments at June30, instruments, certain of which involve elements of 2006 and June 30,2005 (prior to taking into account credit risk. Credit risk exposure represents the any master derivativesagreements or collateral maximum potential accounting loss due to possible arrangements that have been made) are given below: nonperformance by obligors and counterparties In m~ll~onso f U.S. dollars equ~valent under the terms ofthe contracts. IDA limits trading to a list of authorized dealers and counterparties. Credit limits have been established for each counterparty by Exchange traded Futures and opt~ons type of instrument and maturity category. Not~onalLong pos~t~on $14,539 $8,605 Not~onalShort lsos~t~on 93 1.842 In addition, IDA has entered into master derivatives swaps Cred~texposure 4 - agreements which contain legally enforceable close- Interest rate swaps Not~onalpr~nc~pal 1,975 1,280 out netting provisions. These agreements may further Cred~texposure 37 5 reduce the gross credit risk exposure related to the swaps shown below. The reduction in exposure as a result of these netting provisions can vary as Exchangetraded instruments are deemed to have no additional transactions are entered into under these material credit risk. All outstanding futures and agreements. The extent of the reduction in exposure options contracts at the end of June30,2006 and June may therefore change substantially within a short 30,2005 were interest rate contracts. period of time following the balance sheet date. As of June 30,2006, IDA had received $602 million Restricted notes on account of member subscriptions ($1,153million-June30,2005) of securities under at June30,2006 were $46 million ($44 million-June resale agreements. Of these instruments held by IDA, 30,2005). $479 million ($369 million-June30,2005) has been Fourteenth Replenishment (IDA 14): Under the IDA transferred under repurchase or security lending 14 replenishment, which was approved by the Board agreements. None of these securities have been of Governors on April 13,2005, IDA is expected to included in the assets of IDA. provide concessional financing of about $35 billion At June 30,2006, IDA maintained a line of credit (SDR24 billion), including a significant portion as facilitywith an independent financial institution. This grants duiring the period July1,2005 to June30,2008. facilitywas created for the benefit of both IBRD and Of this amount, new donor contributions are IDA. The available line of credit to each institution is expected to total about $20 billion (SDR 14 billion). $500 million, but usage from both institutions cannot The Fourteenth Replenishment became effective on exceed this amount in aggregate.The line of credit January24,2006 after IDA had receivedcommitments facilityis being used to cover any overnight overdrafts for subscriptions and contributions of SDR 8,952 that may occur due to failed trades. At June 30,2006, million. IDA had not drawn down under this facility ($nil- Donors agreed to provide HIPC-related contributions June 30,2005). to IDA to cover IDA'SHIPC costs during the Fourteenth Replenishment. Such contributions can NOTE C-MEMBER SUBSCRIPTIONS AND be made either directly to IDA or through the World CONTRIBUTIONS Bank component of the HIPC Trust Fund, which are Subscriptionsand Contributions Receivable:At June then transferred to IDA. Donors will receivevoting 30,2006, receivables from subscriptions and rights for these contributions. contributions were $10,048 million ($824 million- As of June30,2006, IDA has received HIPC-related June 30,2005) of which $585 million ($355 million- contributions of $697 million which has been June 30,2005) was due and $9,463 million ($469 recorded in subscriptions and contributions paid in million-June30,2005) was not yet due. on the Statement of Sources and Applications of Subscriptions and contributions due at June 30,2006 Development Resources. Of this amount, $87 million were as follows: was paid through the HIPC Trust Fund. Subsequent Event In m~ll~onsof U.S. dollars equ~valent On July10,2006, IDA received joint communications Amounts initially due from both Serbia and Montenegro (SaM)stating that the two republics had signed an agreement regarding July 1, 2005 through June 30, 2006 $256 the regulation of membership in international June 30, 2005 and earlier 329 financial institutions and the allocation of financial assets and liabilities between the two republics. Under Total $585 this agreement, Serbia will continue the membership of SaM in IDA, retaining its present subscription and voting power, with all rights and obligations Subscriptions and contributions not yet due at June stemming from membership in IDA. In addition, the 30,2006 will become due as follows: republics have agreed on their respective portions of the financial obligations formerly undertaken by SaM In m~ll~onsof U.S. dollars equ~valent with IDA. Period In response, IDA has accepted that Serbia continues SaM membership in IDA and takes on all of the rights, July 1, 2006 through June 30, 2007 $4,669 obligations and assets of SaM in respect of IDA, July 1, 2007 through June 30, 2008 4,625 pending completion of Montenegro's membership in Thereafter 169 IDA. On July17,2006, the Government of Montenegro submitted its application for Total $9,463 membership in IDA. IDA SP ECIALPURPOSE FINANCIALSTATEMENTS: JU NE30, 2006 121 NOTE D-TRANSFERS On September 24,2003, in accordance with the administration agreement for the Trust Fund for At June 30,2006 and June30,2005, cumulative Bosnia and Herzegovina, the Executive Directors of transfers were comprised of: IDA approved the termination of the trust fund and the transfer of its assets to IDA. These assets included In m~ll~oonsf U.5.dollars the right to receive repayments of credits totaling$124 Transfer from 2006 2005 million and $11 million in cash balances. lnternatlonal Bank for Reconstruction and Development $8,445 $8,049 NOTE E-DEVELOPMENT CREDITS Trust Fund for Bosnla and Herzegovina 135 135 Commitment charges on the undisbursed balances of Trust Fund for Kosovo 4 4 IDA credits are set annually by the Board of Executive Trust Fund for West Bank and Gaza 1 1 Directors of IDA. For the fiscal year ended June 30, 2006 the rate for undisbursed credits was set at 0.30 Total percent (June30,2005-0.35 percent). For the fiscal year ending June 30,2007 the rate has been set at 0.20 percent. IBRD's Board of Governors has approved aggregate Currency Composition transfers to IDA totaling $8,357 million through June The currency composition of IDA'Sdevelopment 30,2006 ($7,957million-June30,2005) of which credits outstanding at June30,2006 and June30,2005 $400 million was approved and transfered in is as follows: September 2005. The aggregatetransfers of $8,445 million reported in the above table differs from the In m~ll~oonsfU.S.dollars equ~valent amount of aggregatetransfers approved due to 2006 2005 exchange rate movements on the value of transfers USD $11,518 $12,072 that were approved in SDR. SDR 115,510 108,835 At June 30,2006, $210 million was receivable from Development credlts outstanding $127,028 $120,907 IBRD ($740 million-June30,2005) in accordance with the donor encashment schedule for IDA'S OverdueAmounts Thirteenth Replenishment. At June30,2006, there were no principal or charges On June 30,2005, in accordance with the on development credits in accrual status which were administration agreement for the Trust Fund for overdue by more than three months. Kosovo, $4 million in cash was transferred from the trust fund to IDA. The following table provides a summary of selected financial information related to development credits in nonaccrual status for the fiscal years ended June 30,2006, June 30,2005 and June 30,2004: In m~ll~oonsf U.S.dollars equ~valent Recorded Investment In nonaccrual credlts Overdue amounts Of whlch Prlnclpal Charges Servlce charge Income recognlzed on credlts In nonaccrual status Servlce charge Income not recognlzed as a result of credlts belng In nonaccrual status A summary of borrowers with development credits or guarantees in nonaccrual status follows: In m~ll~onsof U.S. dollars equ~valent June 30,2006 Prlnclpal Prlnclpal and Nonaccrual Borrower Outstanding Charges Overdue Slnce Central Afrlcan Republlc June 2002 CBte d'lvolre November 2004 LIberla Aprll 1988 Myanmar September 1998 Somalla July 1991 Sudan January 1994 Togo May 2002 Zlmbabwe October 2000 Total During the fiscal year ended June30,2006, all IDA cases their completion points, and the estimated development credits outstanding to Serbia and principal component of debt relief that is expected to Montenegro were restored to accrual status following be provided to other eligiblecountries. management's determination that a suitable period of On March 28,2006, the Executive Directors approved policy and payments performance had passed IDA's participation in the MDRI. The objectiveof the subsequent to the clearance of all arrears to IBRD in MDRI is to provide additional support to HIPC January2002. As a result, income from credits for the countries. fiscal year ended June30,2006, increased by $1 million, representing income that would have been Debt relief to be provided under the MDRI will be in accrued in previous fiscal years had these credits not addition to existing debt relief commitments by IDA been in nonaccrual status. and other creditors under the HIPC Debt Initiative. Additional resources for financing IDA's costs of During the fiscal year ended June30,2005, providing debt relief under MDRI will be provided by development credits made to, or guaranteed by, CBte donors under a resolution of IDA's Board of d'Ivoire were placed in nonaccrual status. Income Governors adopted on April 21,2006. Such resources from credits for the fiscal year would have been higher will be added to IDA'sresources and will be accounted by $21 million, had these credits not been in for as subscriptions and contributions. The MDRI nonaccrual status. replenishment will become effectivewhen IDA has During the fiscal year ended June30,2005, all received written commitments from donors whose development credits to, or guaranteed by, Haiti were aggregatecontributions amount to not less than SDR restored to accrual status, after the clearance of all 10,434 million, of which not less than SDR 410 overdue payments on principal and service charges to million are unqualified commitments for payments IDA. As a result, income from development credits for due in FY2007 and FY2008. the fiscal year ended June30,2005 increased by $14 Upon approval of IDA's participation in the MDRI by million, representing income that would have been IDA'sExecutiveDirectors, IDA provided in full for the accrued in previous fiscal years had these credits not expected write off of the principal component of debt been in nonaccrual status. relief to be delivered under the MDRI. The provision Accumulated Provision for HIPC Debt Initiativeand is recorded as a reduction of the disbursed and MDRI outstanding development credits and as a charge to Development credits outstanding are presented in the income. Followingthe start of the MDRI Statement of Sources and Applications of implementation by IDA on July1,2006, the applicable Development Resources before any provision in IDA development credits will be written off and the connection with the HIPC Debt Initiative and MDRI. provision reduced accordingly for the first group of post-completion point HIPC countries that have been The accumulated provision for the HIPC Debt confirmed by the Executive Directors as eligible for Initiative is the sum of the principal component of MDRI relief, and subsequently upon reaching debt relief remaining to be provided to those countries completion point for the other HIPC countries. that have reached their decision points, and in certain IDA SPECIAL PURPOSE FINANCIAL STATEMENTS: JUNE30, 2006 123 Changes to the accumulated provision for HIPC Debt Initiative and MDRI for the fiscal years ended June 30, 2006 and June30,2005 are summarized below: Inmillions of U.5.dollarsequivalent 2006 2005 HlPC MDRl Total HIPC MDRI Total Balance, beginning of the fiscal year $11,719 $ - $11,719 Reallocation (808) 808 - Provision 2,057 30,903 32,960 Principal component of debt relief forgiven (458) - (458) Translation adjustment - 912 912 Balance, end of the fiscal yearlperiod $12,510 $32,623 $45,133 Reductionof incomefrom servicechargesdue to debt subscriptions and contributions were fully utilized. forgiveness Consequently, $16 million of service charges were forgiven without reimbursement during FY 2006. In m~ll~onsof U.S.dollars equ~valent SubsequentEvent In their approval of March 28,2006, the Executive HIPC Directorshad decided that debt cancellation under the MDRI MDRI will take place at the start of FY2007, subject to the effectiveness of the MDRI replenishment. On June Total 23,2006 the Executive Directors approved the implementation of the MDRI commencing July1, 2006, on the target date set by donors, even if the Under the arrangements agreed during IDA14,donors MDRI has not yet become effective on that date. As a have agreed to reimburse IDA for both principal and result, on July1,2006 $30,096million of development charges forgiven under the HIPC debt initiative credits outstanding to countries which have reached during the IDA14 Replenishment period (FY2006- their completion point under the HIPC debt initiative FY2008).These reimbursements are being recorded as will be written off. As of June30,2006, the amounts to Subscription and Contributions and have no effect on be written off on July1,2006 are included in the the Statement of Income. provision of $45,133 million for the HIPC and MDRI Prior to the IDA14 Replenishment, service charges - initiative. forgiven under the HIPC debt relief initiative were Accrued servicescharges at June 30,2006 on these reimbursed to IDA by the HIPC Trust Fund and credits were also reversed thus reducing the service treated as income. However, during FY 2006, all charges by $61 million for FY 2006. contributions to this trust fund that did not represent The following table provides details on the impact of the write off of credits related to these 19 countries: In m~ll~onso f U.S.dollars equ~valent Credlts Cred~tsOutstand~ng Amount written off Outstandlng after Country as o f June 30,2006 o n July 1, 2006 the wrlte-off Charges wrltten off Benln $ 796 $ 689 $ 107 $ 1.4 Bollvla 1,725 1,507 218 3.3 Burklna Faso 1,086 822 264 1.5 Cameroon 1,061 908 153 1.4 Ethlopla 3,493 3,053 440 5.6 Ghana 4,511 3,769 742 8.3 Guyana 230 221 9 0.4 Honduras 1,410 1,103 307 3.2 Madagascar 2,407 1,891 516 3.7 Mall 1,517 1,260 257 2.6 Maurltanla 709 607 102 0.9 Mozambique 1,749 1,189 560 2.8 Nicaragua 1,204 970 234 2.0 Nlger 1,111 967 144 1.9 Rwanda 1,009 866 143 1.4 Senegal 2,143 1,733 410 3.0 Tanzanla 4,045 3,300 745 5.9 Uganda 3,279 2,923 356 6.1 Zambla 2,556 2,318 238 5.3 Total $36,041 $30,096 $5,945 $60.7 The maturity structure of IDA'Sdevelopment credits outstanding at June 30,2006 and June30,2005 were as follows: In m~ll~onso f U.S. dollars equ~valent July I , 2006 through June 30, 2007 a July 1, 2005 through June 30, 2006 July 1, 2007 through June 30, 2008 July 1, 2006 through June 30, 2007 July 1, 2008 through June 30, 2009 July 1, 2007 through June 30, 2008 July 1, 2009 through June 30, 2010 July 1, 2008 through June 30, 2009 July 1, 2010 through June 30, 2011 July 1, 2009 through June 30, 2010 July 1, 2011 through June 30, 2016 July 1, 2010 through June 30, 2015 July 1, 2016 through June 30, 2021 July 1, 2015 through June 30, 2020 July 1, 2021 through June 30, 2026 July 1, 2020 through June 30, 2025 July 1, 2026 through June 30, 2031 July 1, 2025 through June 30, 2030 July 1, 2031 through June 30, 2036 July 1, 2030 through June 30, 2035 July 1, 2036 through June 30, 2041 July 1, 2035 through June 30, 2040 July 1, 2041 through June 30, 2046 July 1, 2040 through June 30, 2045 Total Total a. Includes amounts t o be wrltten off on July 1, 2006 under the MDRI. IDA SPECIAL PURPOSE FINANCIAL STATEMENTS: JUNE30, 2006 125 Guarantees Receivablefrom the HIPCDebt InitiativeTrust Fund Guarantees of $190 million at June 30,2006 A summary of changes to the receivable from the ($191 million-June30,2005) were not included in HIPC Debt Initiative Trust Fund is presented below: IDA'SStatement of Sources and Applications of Development Resources. These outstanding amounts In m~ll~onso f U.S.dollars represent the maximum potential undiscounted 2006 2005 future payments that IDA could be required to make under these guarantees. Balance, beglnnlng of the flscal year $173 $366 Contrlbutlon from the HIPC Debt The existing guarantees issued by IDA expire between ln~t~at~veTrust Fund 176 200 2011 and 2026. Reimbursement recelvedfor prlnclpal repayments forglven (349) (393) At June 30,2006, liabilities related to obligations Balance, end of the flscal year $ - $173 under guarantees of $12 million ($8million-June30, 2005), have been included in Other resources, net on the Statement of Sources and Applications of SegmentReporting Development Resources. Based on an evaluation of its operations, management HIPCDebt Service Relief has determined that IDA has only one reportable As of June 30,2006, total debt service relief of $2,039 segment since IDA does not manage its operations by million has been provided by IDA consisting of $1,762 allocating its resources based on the contribution to million in principal repayments and $277 million in net income from individual borrowers. In addition, service charges. Of these amounts, the HIPC Debt the risk and return profiles are sufficientlysimilar Initiative Trust Fund has reimbursed IDA $1,653 among its borrowersso that IDA does not differentiate million in respect of principal and $261 million in in terms of the nature of products or services respect of service charges.The remaining amount has provided, the preparation process, or the method of been funded by donor contributions and is recorded providing services to its borrowers. as part of Subscriptions and Contributions. Charge income comprises service charges on outstanding development credit balances, commitment charges on undisbursed development credit balances and guarantee fee income. For the fiscal year ended June 30,2006, development credits to one country generated in excess of ten percent of total income from credits, amounting to $185 million. The following table presents IDA'S development credits outstanding and associated charge income, by geographic region, at June30,2006 and June30,2005. In m~ll~onso f U.S. dollars equ~valent 2006 2005 Charge Development Credlts Charge Development Cred~ts Reglon Income Outstanding Income Outstanding Afrlca $289 $ 50,747 $351 $ 48,l19 East Asla and Paclflc 130 17,158 132 16,648 Europe and Central Asla 47 5,853 45 5,420 Latln Amerlca and the Caribbean 29 5,269 55 5,070 M~ddleEast and North Afrlca 27 3,476 28 3,329 South Asla 340 44,525 343 42,321 Total NOTE F-FAIR VALUE OF FINANCIAL months average CIRR as a discount rate provides an INSTRUMENTS alternative estimate for the grant element. Investments: IDA carries its investments at fair value. Since IDA'Sdevelopment credits are denominated These fair values are based on quoted market prices, either in U.S. dollars or SDRs, currency specific rates where available. If quoted market prices are not have been used to discount the corresponding future available, fair values are based on quoted market cash flows for each currency component of the prices of comparable instruments. The fair value of development credits before being aggregated to short-term financial instruments approximates their provide the composite results. carrying value. The grant element calculations consider interest rates, Development Credits: IDA'Sdevelopment credits have maturity structures and grace periods for the credits. a significant grant element because of the concessional They do not consider credit risk, portfolio seasoning, nature of IDA'sterms. Discounting the future cash multilateral and sovereign credit preferences and flows from IDA'sdevelopment credits using other risks or indicators that would be relevant in government reference rates represented by interest calculating fair value. Estimating the impact of these rates of government securities having similar maturity factors is not practicable. to the portfolio of development credits, provides an However, under either alternative, the estimated fair estimate for the grant element. Under the HIPC Debt values of development credits outstanding are Initiative, development credits identified for sale to substantially lower than the $127,028million reflected the HIPC Debt Initiative Trust Fund are written down on the Statement of Sources and Applications of to their estimated net present value using currency Development Resources at June 30,2006 ($120,907 specificCommercial Interest Reference Rates (CIRRs) million-June 30,2005), as shown in the following published monthly by the Organization for Economic table. Cooperation and Development (OECD).Usingthe six In m~ll~onsof U.S.dollars equ~valent 2006 2005 Government Government reference reference rate- rate-based CIRR-based based CIRR-based fair value fair value fair value fair value Development credits outstanding a $127,028 $127,028 $120,907 $120,907 Less grant equivalent Estimated value of development credits outstanding $ 79,239 $ 75,649 $ 83,960 $ 74,833 Estimated grant element 38% 40% 31% 38% Discount Rates Used Discount Rates Used Government reference rates -US dollar 5.14% 3.92% -SDR 4.46% 3.47% CIRRs: Average of six months to June 30 -U.S. dollar 5.67% 5.05% -SDR 4.86% 4.42% a. Before the wr~te-offrelated to MDRI. b. Impl~eswe~ghtedaveragegovernment reference rates of the component currenc~escontamed ~nthe SDR Discounting the future cash flows from IDA'S alternative for the grant element. The estimated grant development credits using the standard 10 percent element based on this standard DAC rate for IDA'S discount rate of the Development Assistance development credits is 63% percent as of June 30, Committee (DAC)of the OECD, provides another 2006 (65 percent-June30,2005). IDA SPECIAL PURPOSE FINANCIALSTATEMENTS: JU NE30, 2006 127 NOTE G-ADMINISTRATIVE EXPENSES and other entities, funds restricted for specific uses which include the cofinancing of IDA lending Administrative expenses represent IDA'Sshare of such projects, debt reduction operations for IDA members, expenses jointly incurred by IBRD and IDA. technical assistancefor borrowers including feasibility The allocation of expenses is based upon an agreed studies and project preparation, global and regional cost sharing formula that reflects the administrative programs and research and training programs. These costs of service deliveryto countries that are eligible funds are placed in trust with IDA andlor IBRD, and for lending from IBRD and IDA. are held in a separate investment portfolio which is not commingled with IDA andlor IBRD funds, nor NOTE H-TRUST FUNDS ADMINISTRATION are they included in the development resources of IDA. IDA, alone or jointly with IBRD, administers on behalf of donors, including members, their agencies At June30,2006 and June 30,2005, the allocation of trust fund assets by executing agent were as follows: Number of Number of Total fiduciary trust fund Total fiduciary trust fund assets accounts assets accounts (In millions) (In millions) IDA executed Recipient executed Total $4,009 2,575 $3,808 2,523 The responsibilities of IDA under these arrangements were charged to income upon signing of the grant vary and range from services normally provided agreement by the recipient country. Management under its own lending projects to full project considers that the new policy is preferable as it implementation including procurement of goods and provides more reliable and relevant information. Had services. IDA receivesfees for administering trust this new policy been in place during the prior periods funds as a reduction of the administrative expenses presented in these financial statements, the opening shared with IBRD. During the fiscal year ended June Accumulated Deficit balance of $8,856 million would 30,2006, IDA received $18 million ($20 million- have been higher by $123 million to $8,979 million, June 30,2005, $18 million-June30,2004) as fees for with the comparative Payablefor Development Grants administering trust funds. balance increasing by an equivalent amount to $3,021 million. Further, the comparative Development NOTE I-DEVELOPMENT GRANTS Grant expense amount for the fiscal year ended June 30,2005 would have been lower by $147 million. Of A summary of changes to the amounts payablefor the $1,939 million of development grant expenses for development grants is presented below: the fiscal year ended June 30,2006, $123 million Inm~ll~oonsf U.S.dollars equ~valent relates to development grants which were approved but not signed as of June 30,2005. For the fiscal years ended June 30,2006 and June 30, Balance, beglnnlng of the flscal year $2,898 $2,088 2005, the commitment charge rate on the undisbursed Commitments 1,939 2,035 balances of IDA grants was zero percent. For the fiscal D~sbursements (1,228) (1,200) Translation adjustment 21 (25) year ending June30,2007 the rate will continue to be zero percent. Balance, end of the flscal year $3,630 $2,898 NOTE J-COMPREHENSIVE INCOME Effective July1,2005, development grants are charged Comprehensive income consists of net income and to income upon approval by IDA'SExecutive other gains and losses affectingsources of Directors. In previous periods, development grants development resources that are excluded from net income. For IDA,comprehensive income is comprised of income or loss after HIPC Debt Initiative and development credits and payablefor development MDRI, currency translation adjustments on grants. The following table presents the changes in development credits, payablefor development grants Accumulated Other Comprehensive Income balances and accumulated provision for MDRI. These items are for the fiscal years ended June 30,2006, June 30,2005 presented in the Statement of Comprehensive Income. and June30,2004: The total accumulated other comprehensive income represents the cumulative translation adjustment on Inmillions of U.5.dollars equivalent Accumulated Other ComorehensiveIncome Balance, beginning of the fiscal year Currency Translation Adjustment Balance, end of the fiscal year IDA SPECIAL PURPOSE FINANCIAL STATEMENTS: JUNE 30, 2006 129