[Audit Report on the Marshall Islands Development Bank, Republic of the Marshall Islands]
[From the U.S. Government Printing Office, www.gpo.gov]

Report No. 99-i-952

Title: Audit Report on the Marshall Islands Development Bank, Republic
       of the Marshall Islands


Date:  September 30, 1999



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U.S. Department of the Interior
Office of Inspector General



                                                N-IN-MAR-003-99-R
AUDIT REPORT

MARSHALL ISLANDS DEVELOPMENT BANK,
REPUBLIC OF THE MARSHALL ISLANDS


REPORT NO. 99-I-952

SEPTEMBER 1999


Mr. Donald Capelle
Chairman, Board of Directors 
Marshall Islands Development Bank
Post Office Box 1048
Republic of the Marshall Islands
Majuro, MH 96960

Subject: Audit Report on the Marshall Islands Development Bank,
         Republic of the Marshall Islands (No. 99-i-952)

Dear Mr. Capelle:

This report presents the results of our review of the operations
of the Marshall Islands Development Bank of the Republic of the
Marshall Islands.  The objective of our audit was  to determine
whether (1) Compact Section 111 and 211 funds were used
efficiently and effectively in accordance with the intent of the
Compact and (2) loans and interest receivables were properly
accounted for and effectively collected.  The audit was requested
by the U.S. Ambassador to the Republic of the Marshall Islands.

We concluded that the Marshall Islands Development Bank did not
comply with provisions of the Compact of Free Association,
Federal and Republic laws, Bank policies and guidelines, and
operating procedures applicable to the Bank's operations and the
use of funds provided by the United States.  Specifically, we
found that:

- The Bank used funds provided by the Compact to issue commercial
loans to businesses and government entities without adequate
assurances that the purposes of the loans conformed to official
economic development plans and that the loans could be and would
be repaid.

- Although the Bank made good faith attempts to collect its
delinquent loans, the Bank did not (1) use all available
collection methods; (2) prepare, collect, and maintain loan
records necessary to ensure that loan collateral was protected
and that loan files were complete and current; and (3) ensure
that management fees were charged on all properties the Bank
managed for delinquent borrowers.

- The Bank combined loans funded by the United States under the
former Trust Territories Economic Development Loan Fund with
loans funded by the Republic.  Therefore, the Economic
Development Loan Fund loans lost their identity as United States-
sourced funds.

These conditions occurred because the Bank (1) issued loans,
according to the Bank's Chairman of the Board and the Managing
Director, based on political considerations and without adequate
financial analyses of the projects' financial viability and the
borrowers' ability to repay; (2) was reluctant to seize loan
collateral and believed that cooperative efforts with the
borrowers would resolve delinquency problems; and (3) did not
ensure that loan files included the history of Bank actions on
the loans and all required documents because loan personnel were
not adequately trained and supervised and devoted significant
time to managing returned property.  Further, the Bank did not
collect management fees because Bank officials had not realized
the time and related costs involved in managing smaller
properties on behalf of delinquent borrowers.  Finally, the Bank
did not follow requirements to separately account for and control
Economic Development Loan Fund accounts because they were not
aware of the requirements when the Bank assumed outstanding
accounts from its predecessor bank.

As a result, potential Bank revenue from outstanding loans
totaling $6.8 million appears to be uncollectible, and loans of
another $6.9 million may become uncollectible.  The
unavailability of this $13.7 million has prevented the Bank from
issuing new commercial loans from Compact funds since July 1996
and from meeting its legally mandated purpose to "promote the
development and expansion of the economy of the Marshall
Islands."  Also, because of ineffective collection enforcement,
additional loans totaling $838,000 appear to be uncollectible,
and loans of another $3.3 million may become uncollectible.  The
Bank also lost an estimated $7,500 by not charging management
fees.  Further, (1) payments totaling $214,938 received on
Economic Development Loan Fund loans were deposited into the
Bank's local revenue accounts and (2) loan balances and loan
payments totaling $167,950 were transferred to and/or combined
with loans from other financing sources and were not available
for new loans to be made pursuant to the established purposes of
the Economic Development Loan Fund.  We made 11 recommendations
to you, as the Chairman of the Bank's Board of Directors, to
correct the deficiencies identified. 

Based on your August 27, 1999, response (Appendix 3) to the draft
report, we consider Recommendations A.4, B.4, and B.5 resolved
and implemented and Recommendations A.2, A.3, B.1, and B.3
resolved but not implemented.  Accordingly, the unimplemented
recommendations will be referred to the Assistant Secretary for
Policy, Management and Budget for tracking of implementation.
Also based on the response, we consider Recommendations C.1 and
C.2 unresolved and request additional information for
Recommendations A.1 and B.2 (see Appendix 4).

Section 5(a) of the Inspector General Act (Public Law 95-452, as
amended) requires the Office of Inspector General to list this
report in its semiannual report to the Congress. Therefore,
please provide a response, as required by Public Law 97-357, to
this report by November 10, 1999.  The response should be
addressed to our Pacific Field Office, 415 Chalan San Antonio,
Baltej Pavilion - Suite 306, Tamuning, Guam 96911.  The response
should provide the information requested in Appendix 4.

We appreciate the assistance provided by the staff and management
of the Development Bank during the conduct of our audit.

                                           Sincerely,



                                           Earl E. Devaney
                                           Inspector General

cc:  President, Republic of the Marshall Islands
Managing Director, Marshall Islands Development Bank

CONTENTS


                                                    Page

INTRODUCTION.......................................  1  

BACKGROUND.........................................  1  
OBJECTIVE AND SCOPE................................. 2  
PRIOR AUDIT COVERAGE................................ 3  

FINDINGS AND RECOMMENDATIONS.........................4  

A.  ISSUANCE OF COMMERCIAL LOANS.................... 4  
B.  COLLECTION OF DELINQUENT LOANS..................14  
C.  ECONOMIC DEVELOPMENT LOAN FUND..................21  

APPENDICES

1.  CLASSIFICATION OF MONETARY AMOUNTS..............24  
2.  MARSHALL ISLANDS DEVELOPMENT BANK OUTSTANDING LOANS 
    BY U.S. FUNDING SOURCES AS OF NOVEMBER 30, 1998 25  
3.  MARSHALL ISLANDS DEVELOPMENT BANK RESPONSE .....26  
4.  STATUS OF AUDIT REPORT RECOMMENDATIONS..........33  


INTRODUCTION


BACKGROUND

The Republic of the Marshall Islands Public Law 1988-1 (codified
as Title 10, Chapter 8, of the Marshall Islands Revised Code)
established the Marshall Islands Development Bank effective March
17, 1988.  Section 810(1) of the Revised Code states, "The
functions of the Bank shall be to promote the development and
expansion of the economy of the Marshall Islands in order to
improve the standard of living of the people by adopting
strategies that will develop and mobilize the human, natural,
capital, technical entrepreneurial and other resources of the
country."  Section 811 of the Revised Code states that the Bank
has the power to provide financial assistance "by extending loans
to enterprises; by guaranteeing . . . the payment of money . . .
[and] by making equity investments in enterprises." Section 811
also states that the Bank has the power to provide nonfinancial
assistance to enterprises operating in the Marshall Islands "by
taking the initiative in the identification of investment
opportunities, the undertaking of feasibility studies, the
promotion and formation of new enterprises, as well as the
expansion of existing enterprises with the objective of enlarging
the economic base of the country" and "by managing or taking part
in the management of, supervision, or conduct of the business of
enterprises."

Title 10, Sections 807 and 808, of the Revised Code states that
the Cabinet of the Republic of the Marshall Islands will appoint
the members of the Bank's Board of Directors, nominate the
Chairman of the Board, and appoint the Bank's Managing Director.
Title 10 of the Revised Code was amended in 1993 to reduce the
"exceptional degree of direction"[1] that the Republic of the
Marshall Islands Government provided over the Bank's operations
by removing the requirements that (1) the Bank's Board should
"serve at the pleasure of the Cabinet," (2) amendments of the
Bank's By-Laws should be approved by the Cabinet, and (3) the
Bank's policies and guidelines also should be approved by the
Cabinet.

As of November 30, 1998, the Bank had received funding of about
$17.5 million from the United States for economic loan programs.
These funds were primarily from Sections 111 and 211 of the
Compact of Free Association between the United States and the
Republic of the Marshall Islands, which became effective on
October 21, 1986.  Although the Marshall Islands Development
Authority initially had responsibility for $10 million provided
for the Compact Section 111 Investment Development Fund, the
Bank's enabling legislation transferred responsibility for these
funds to the Bank.  Additionally, in 1992 the Republic initially
loaned, and later granted to the Bank as contributed capital, $5
million received from revenue bonds that were secured by Compact
Section 211 funds.  The Bank funded its operating expenses from
interest earnings and loan origination fees.

The single audit report of the Marshall Islands Development Bank
for fiscal year 1997 stated that, as of December 31, 1997, the
Bank had loans receivable totaling $17.8 million and a related
allowance for doubtful accounts of $12 million, which resulted in
net loans receivable of $5.8 million.  The single audit report
also stated that the Bank had contributed capital of $17.5
million and an accumulated unreserved retained earnings deficit
of $10.4 million.  Finally, the Bank reported calendar year 1997
interest income of $1 million and an operating loss of $722,000,
which was an increase from the calendar year 1996 operating loss
of $517,000.

The Bank's fiscal year 1999 operating budget totaled $649,518,
including $92,416 for the salaries and related costs of six Bank
employees who were assigned to two loan programs administered by
the Majuro Office, Rural Development, U.S. Department of
Agriculture.  As of November 30, 1998, the Bank had 16 employees,
excluding the employees at Rural Development, as follows: 1
secretary, 7 loan officers, 6 accounting personnel, a Finance
Manager, and a Managing Director. 

OBJECTIVE AND SCOPE

The objective of the audit was to determine whether (1) Compact
Section 111 and 211 funds were used efficiently and effectively
in accordance with the intent of the Compact and (2) loans and
interest receivables were properly accounted for and effectively
collected.  The scope of our review initially included all
Compact-funded loans issued and administered during fiscal years
1997 and 1998 but was expanded to include loans made from
Economic Development Loan Fund monies provided by the Trust
Territory of the Pacific Islands and the entire portfolio of
commercial loans managed and/or issued by the Bank from Compact
funds.  These changes were made because the Bank's loan records
did not adequately summarize the history and status of loans
during our initial audit period and because Republic government
decisions made during the years immediately following the Bank's
creation in 1988 negatively impacted the current availability of
funds for commercial development loans.

To obtain information on the processing, administration, and
collection of loans, we interviewed officials and/or reviewed
loan records at the Majuro offices of the Marshall Islands
Development Bank, Ministry of Foreign Affairs, and Auditor
General; the United States Embassy; an independent public
accounting firm; the Majuro Office, Rural Development, U.S.
Department of Agriculture; and two attorneys in private practice
who had performed services for the Bank.  We also interviewed
officials of the Western Pacific Region, Rural Development, U.S.
Department of Agriculture, located at Hagatna, Guam.

Our review was made, as applicable, in accordance with the
"Government Auditing Standards," issued by the Comptroller
General of the United States.  Accordingly, we included such
tests of records and other auditing procedures that were
considered necessary under the circumstances.

As part of the audit, we evaluated the system of internal
controls related to the financial and operational management of
the Marshall Islands Development Bank to the extent that we
considered necessary to accomplish the audit objective.  Based on
our review, we identified internal control weaknesses in the
areas of issuing commercial loans, accounting for outstanding
loans, protecting loan collateral, collecting delinquent loans,
and complying with a special accounting agreement.  These
weaknesses are discussed in the Findings and Recommendations
section of this report.  Our recommendations, if implemented,
should improve the internal controls in these areas.

PRIOR AUDIT COVERAGE

During the past 5 years, neither the U.S. General Accounting
Office, the Auditor General of the Republic of the Marshall
Islands, nor the Office of Inspector General has issued any audit
reports on the Marshall Islands Development Bank.  However, an
independent public accounting firm issued single audit reports on
the Republic of the Marshall Islands, which included the Bank's
financial statements and the results of audit tests on the Bank's
operations, for fiscal years 1995, 1996, and 1997.  The single
audit report for fiscal year 1997 identified six financial
statement findings.  Specifically, the report stated that (1) the
Bank's accounting was based on the source of funding rather than
on the type of loan by industry; (2) minutes for 7 of 14 Board
meetings were not documented as approved by the Board; (3)
initial credit checks and quality control procedures were not
performed on all prospective loan customers and their requested
loan amounts; (4) subsidiary loan ledgers did not facilitate
accounting and reporting on the Bank's loan portfolio; (5) loans
receivable were not periodically reviewed for collectibility and
assessed for loan losses; and (6) interest income and receivables
were not updated on a regular basis during the year, resulting in
an erroneous $136,605 year-end journal entry.  We found that
these conditions still existed during our review. 

**FOOTNOTES**

[1]:The 1993 amendments were based on a 1992 report entitled
"Institutional Strengthening of the Marshall Islands Development
Bank," issued by an Australian planning and training consultant
firm.  The report stated, "The MIDB [Marshall Islands Development
Bank] Act allows for an exceptional degree of direction by [the]
Government [of the Marshall Islands].  Government intervention is
pervasive and dominates the Bank's lending program.  At the same
time, the relationship with Government inhibits MIDB from
exercising its developmental role and its commercial judgement.
MIDB has no real prospect of developing as a [development
financing institution] unless it is allowed to operate at arms
length from Government.  The MIDB Board has approved revisions to
the MIDB Act drafted by the consultants.  The revisions provide
the necessary framework for MIDB's development along the lines of
other [development financing institutions].  No change to the
By-laws is considered necessary.  It is recommended that: the
MIDB Act be amended as a pre-requisite to any real reform of the
Bank."

FINDINGS AND RECOMMENDATIONS

A.  ISSUANCE OF COMMERCIAL LOANS

The Marshall Islands Development Bank used funds provided by the
Compact of Free Association to issue commercial loans to
businesses and government entities without adequate assurances
that the purposes of the loans were in conformance with official
economic development plans and that the loans could be and would
be repaid.  These conditions were contrary to the Compact's terms
and to the Bank's enabling legislation and operating procedures.
These deficiencies occurred because the Bank issued loans,
according to the Bank's Chairman of the Board and the Managing
Director, based on political considerations and without adequate
financial analyses of the projects' financial viability and the
borrowers' ability to repay.  As a result, as of November 30,
1998, principal and accrued interest on delinquent loans totaling
almost $6.8 million appear to be uncollectible, and an additional
$6.9 million may become uncollectible (see Appendix 1).  In
addition, the unavailability of the $13.7 million represented by
these delinquent loans has prevented the Bank from issuing new
commercial loans from Compact funds since July 1996 and from
meeting its legally mandated purpose to "promote the development
and expansion of the economy of the Marshall Islands."

Loan Policy

Section 211(b) of the Compact of Free Association states, "The
annual expenditure of the grant amounts specified for the capital
account in Section 211(a) . . . shall be in accordance with the
official overall economic development plans provided by those
Governments [of the Compact States] and concurred in by the
Government of the United States."  In addition,  the implementing
agreement for Compact funds provided under Section 111 (c) of
U.S. Public Law 99-239, Article II, paragraph 6, states, "The
Fund is intended to further close economic and commercial
relations between the United States and the Marshall Islands, to
encourage investment and productive participation in economic
development in the Marshall Islands by citizens and commercial
enterprises of the United States and the Marshall Islands,
particularly through joint ventures between United States and
Marshall Islands citizens and commercial enterprises, . . . and
to encourage the private sector employment and training of
citizens of the Marshall Islands and the productive utilization
of the natural resources, manpower resources, and other resources
of the Marshall Islands."

Title 10, Section 810(1), of the Marshall Islands Revised Code
states, "The [Marshall Islands Development] Bank's activities
shall be designed to strengthen the nation's economic base,
increase employment and production, improve standards of housing,
promote exports, and reduce the country's dependence on imports
and foreign aid."  Section 810(2) of the Revised Code states, "In
carrying out its functions the Bank shall have due regard for the
general economic policies and plans of the Government of the
Marshall Islands and to the general objectives of the Investment
Development Fund."  Section 812 of the Revised Code further
states, "The [Bank's] Policies and Guidelines will be made public
and will be strictly adhered to."

Paragraph 5 of the Bank's Policies and Guidelines (adopted by the
Republic's Cabinet on April 13, 1989) states, "As a development
finance institution, the Bank will carry out its operations
according to sound commercial, banking practice."  Paragraph 7 of
the Guidelines states, "The Bank will provide financial
assistance to those projects, which on the basis of its own
analysis, are assessed as technically feasible, economically
justifiable, financially viable and profitable."  Further,
Paragraph 10 of the Guidelines states, "In order to reduce the
concentration of risk, the Bank will seek, as far as possible, to
diversify its portfolio by sectors of operation and by avoiding
inappropriately large investment in any one project.  As a
general rule, no loan or guarantee provided by the Bank to any
single borrower, or equity participation in any single enterprise
shall exceed ten percent (10%) in aggregate of the net worth of
the Bank, however, this general rule will be exercised at the
discretion of the Board."

Political Considerations

Section 16 of the Constitution of the Republic of the Marshall
Islands, which became effective on May 1, 1979, states, "The
Government of the Republic of the Marshall Islands recognizes the
right of the people to responsible and ethical government and the
obligation to take every step reasonable and necessary to conduct
government in accordance with a comprehensive code of ethics."
The Republic's Ethics in Government Act of 1993 (codified at
Title 3, Chapter 17, of the Marshall Islands Revised Code) became
effective on September 21, 1993.  Title 3, Section 1704(5), of
the Revised Code states, "Public officials and Government
employees shall not use public office for private gain."  Section
1704(12) states, "Public officials and Government employees shall
endeavor to avoid any actions creating the appearance that they
are violating the law or ethical standards set forth in this
Chapter."  Prior to September 1993, the Republic did not have a
comprehensive code of ethics.

The Bank had 48 commercial loans (originally totaling $18.5
million) that were funded by Compact Section 111 and 211(b) funds
and administered by the Bank.  Of those 48 loans, we reviewed a
judgmental sample of 21 loans[2] (originally totaling $14
million) that had outstanding balances, including accrued
interest, totaling $13.6 million as of November 30, 1998.  We
evaluated the status of the 21 loans and the financial/economic
basis for approval of the loans, including the purpose of each
loan as it related to the two 5-year official economic
development plans issued by the Republic for the periods during
which the loans were approved.  Of the 21 loans reviewed, 1 loan
was current, 18 loans were delinquent an average of 46.3 months,
and 2 loans (which had been delinquent) were exchanged for common
stock of the borrowing organization.

Based on our review of documents in the loan files and
discussions about the loans with the Bank's Chairman of the Board
and Managing Director, we noted, for 17 loans (11 to business
organizations and 6 to government entities), that they had been
issued as follows: 11 loans (5 loans to businesses and 6 to
government entities) were issued based on the direct or indirect
direction from government officials, 3 loans were issued to
businesses owned by relatives of senior-level government
officials, and 3 loans were issued to businesses owned by elected
government officials.  At least 3 of the 17 loans were made for
purposes that were not clearly within the scope and intent of the
Republic's 5-year economic development plans.  The Chairman of
the Board and the Managing Director stated that "the Bank issued
some loans based on political direction and influence" and that
such loans "may not have been made under normal circumstances."
As a result of issuing loans without performing thorough
financial analyses, requiring additional collateral or other
guarantees, and complying with the Bank's lending guidelines, the
Bank, as of November 30, 1998, appears to have lost $6,621,645 on
seven of the loans and is at risk of losing an additional
$6,442,610 in potential revenues on three other loans.  In
addition, for six of the seven remaining loans, revenues were
also lost or at risk because the Bank's inadequate collection
efforts allowed the loans to become delinquent (see "Collection
Practices" in Finding B).  The 17 loans and lost or potentially
lost revenues are detailed in Table 1.


Table 1.  Questionable Loans

Original Principal       Nov. 1998               Potential 
Date Loan  Loan     Amount Outstanding   Lost      Lost    
Purpose of Loan             Signed     Amount      Paid
Balance    Revenues  Revenues 
Loans to Businesses:
Rental Housing    11/24/89  $631,025  $15,913   $615,112  0     0
Hotel             01/12/90   123,174 120,385    126,235*       00
Fishing           10/02/90 132,000          0   208,021        00
Entertainment Complex   10/11/90   314,029  0   439,680   0     0
Office Building   01/04/91 4,913,549        0   6,032,124       0
   $6,032,124
Fishing           05/27/92 450,000          0   649,193 $349,1930
Manufacturing     07/24/92   101,754   6,331    101,442   0     0
Entertainment Complex   06/09/93 1,103,769  23,658  1,218,346   0
   0
Fishing           06/28/93 188,000          0   254,323  254,3230
Fishing           07/09/93  65,474          0    84,360   84,3600
Rental Housing   01/20/94      232,976            0       257,539
   0      0
Subtotal       $8,255,750$166,287  $9,986,375  $687,876$6,032,124

Loans to Government Related Entities: 
Fishing Partnership  06/15/88$1,000,000       0   $1,835,467
   $1,557,677        0
Fishing Partnership  01/27/89   178,331 $81,050      145,795
   123,595        0
Air Marshall Islands    03/15/91   933,321       0         **
   1,350,809        0
Air Marshall Islands    04/01/92 2,000,000       0         **
   2,901,688        0
Development Authority   10/20/93   185,000      0   $222,851 0
   $222,851
Majuro Government       06/13/95       208,522    18,270      
   219,660   0     187,635
Subtotal           $4,505,174  $99,320  $2,423,773  $5,933,769
   $410,486

Total       $12,760,924$265,607$12,410,148$6,621,645$6,442,610
   __________

*On May 30, 1996, the Bank combined this loan with the $97,994
balance of an earlier delinquent loan for the same hotel project.
**On May 31, 1995, the Bank exchanged the two loans for common
stock of the airline.  The amounts shown as "Lost Revenues" are
the amounts that would have been outstanding, including accrued
interest, if the loans had not been exchanged for stock.


The details of 7 of the 17 loans listed in Table 1 are discussed
as follows:

- Air Marshall Islands.  One loan issued by the Bank on March 15,
1991, was for $850,000[3] and another loan issued on April 1,
1992, was for $2 million to provide operational funding to Air
Marshall Islands, a 100 percent Republic-owned and
Republic-controlled corporation.  Neither of the Republic's two
5-year economic development plans made reference to providing
economic development funding for the establishment of air
service, either within the Republic or internationally.
According to the Bank's Managing Director, the Cabinet directed
that the Bank lend the money to the airline for "operating
funds."  Additionally, the loans were approved by the Cabinet,
although that function was normally performed by the Bank's Board
of Directors.  The airline did not make any payments on the
loans, and on May 31, 1995, the Bank[4] exchanged the two unpaid
loans (which were more than 3 years delinquent at the time and
had outstanding balances totaling $3,488,000, including accrued
interest) for common stock in the airline.  The Bank's 1997
audited financial statements reported that the stock had no
market value, and the Bank's Managing Director described the
stock as "worthless."  Based on the airline's financial
statements, we determined that the airline had not made a profit
in at least 8 years[5] and, as of September 30, 1997, had an
accumulated deficit of $13.4 million.  In addition, all of the
airline's stock was held by government entities.  We also noted
that although the Bank owned about 30 percent of the airline's
outstanding stock, the Bank did not have a representative on the
airline's Board of Directors, which was controlled by the
Republic's government.  Based on the foregoing, we believe that
the Bank may have lost revenues of $4,252,497 represented by the
original loan amounts and the accrued interest through November
30, 1998.

- Office Building Project.  On December 27, 1990,  the Bank's
Board of Directors approved a loan application from a
Marshallese/Korean partnership for $2.3 million to build a
5-story office building near the Republic's Capitol Building,
although this type of project was not included in the Republic's
two 5-year economic development plans.  The Bank initially issued
a loan of $850,000 on January 4, 1991, then increased the loan
amount by $1,450,000 on February 26, 1991; by $962,525 on June
14, 1991; by $1,262,391 on December 7, 1993; and by $388,633 on
December 31, 1994.  The final loan amount was $4,913,549.  As of
November 30, 1998, the borrower had not made any payments against
the loan principal, and the outstanding balance, including
accrued interest, was $6,032,124.  

The initial loan and the subsequent loan increases were approved
by the Republic's Cabinet, even though the Bank's Managing
Director, in a May 20, 1991, letter to the Marshallese partner,
stated that the Bank could not approve the partnership's May 8,
1991, "request for additional funding, because the Board has
already exceeded its given authority."  In response to a
subsequent request for an increase of the loan amount, the Bank's
Managing Director prepared a discussion paper for the November 1,
1991, meeting of the Bank's Board of Directors.  In the
discussion paper, the Managing Director stated, "In the case [of
this loan], it is unfortunate that [the Marshall Islands
Development Bank] never had the option to significantly spread
its risk. . . . if the additional loan is approved, then some 36%
of Bank assets will be at risk . . . .   Such an inordinate risk
is not normally acceptable to any lending institution -
responsible either to a Government or private stockholders - if
it aspires to be an ongoing and commercially oriented
organization with a worthwhile future contribution to make."  As
stated previously, the Bank's lending guidelines limited
individual loans to 10 percent of the Bank's assets.  As of
December 31, 1997, this one loan represented about 28 percent of
the Bank's total contributed capital.  Both the Bank's Chairman
of the Board and the Managing Director stated that this loan was
based on "political direction and influence" and "may not have
been made under normal circumstances."

On December 31, 1994, the Marshallese partner, whose partnership
included relatives of the Republic's recently deceased President,
assumed the entire loan and ownership of the building.  On August
3, 1995, the borrower signed a management agreement that "let the
Bank manage . . . the `Building' for as long as is required to
pay off the . . . loan."  However, the Bank's records indicated
that the building's revenues were insufficient to pay off the
loan and that outstanding interest on the loan had increased by
$647,667 from August 1, 1995, to November 30, 1998.  As of
November 30, 1998, more than 7 years after receiving the loan,
the borrower had not made any payments on the loan principal.

- Fishing and Entertainment Projects.  During the period of
September 1991 through September 1993, the Bank released a total
of $1,017,503 for four loans to the same business entity.  An
October 11, 1990, loan of $314,029 was for the renovation of an
apartment/restaurant/bar building.  A May 27, 1992, loan of
$450,000 was for the purchase of a fishing boat.  A June 28,
1993, loan of $188,000 was for the purchase of a second fishing
boat.  A July 9, 1993, loan of $65,474 was to finance commercial
fishing operations.  One of the two owners of the business was a
relative of a former Republic President.  Although the purposes
of three of the four loans were to establish a commercial fishing
business, which met the objectives of the Republic's 5-year
economic development plans, according to the Bank's Senior Loan
Officer and correspondence in the loan files, the borrowers did
not have commercial fishing experience.  The Bank's Chairman of
the Board and the Managing Director both stated that these loans
resulted from "political direction and influence" and "may not
have been made under normal circumstances."  As of November 30,
1998, the borrowers had not made any payments on the principal
amounts, and the outstanding balance, including accrued interest,
was $1,427,556.

In summary, the Bank's Chairman of the Board and the Managing
Director both stated that the Republic's Cabinet had direct
control over the Bank's operations until August 1993, when the
Bank's enabling legislation was amended to remove the Cabinet's
direct authority over the Bank (see footnote 1).  The two Bank
officials also confirmed that decisions about major loans had
been made either directly or indirectly by the Cabinet and did
not always appear to be based on the borrowers' ability to repay
the loans.  The officials also stated that, even after passage of
legislation reducing the Cabinet's control over the Bank's
operations, the Bank was subject to some political influence.  We
noted, for example, that five of the six Bank  Directors were
government officials.  Therefore, to preclude the potential for
political influence, we believe that the Bank's Board of
Directors should be composed of a more equal mixture of
government officials and private business representatives.  In
addition, the Board should be given the sole authority for
approving loans and should be required to clearly document any
financial risks involved in the issuance of loans.

Financial Analyses

Regarding methods of safeguarding the Bank's interests, Paragraph
20 of the Bank's Policies and Guidelines states that the Bank
"may require the applicant for a loan, guarantee or equity
participation that is over $15,000 to provide a business plan or
feasibility study indicating the technical, economic and
financial feasibility [of the business]"; Paragraph 24 states
that  the Bank "shall use its best endeavors to ensure that the
financial requirement for the completion and commissioning of the
project is covered, including, if appropriate, allowance for cost
overruns"; and Paragraph 25 states that the "Bank shall secure
its loans or guarantees by appropriate collateral coverage and
guarantees from its borrowers in accordance with sound banking
practices."  Also, Paragraph 34 states, "The Bank shall decide on
a scheme for loan repayment which shall be incorporated into the
loan agreement.  The repayment period of a loan, including a
grace period, where appropriate, will be determined taking into
account: . . . the Bank's own interest to recover principal in as
a short a time as possible for the optimum use of its funds to
maximize the turnover of its portfolio."  In addition, Section
3.2.4 of the Bank's Operating Manual states:

"Financial analysis" refers to the assessment of each and every
potential borrower who may come to the Bank for assistance . . .
.  The OBJECTIVES of financial analysis are: 

To judge whether an existing enterprise is solvent. . . . To
assess the ability of the business to prosper and meet its
present commitments, PLUS any new [Bank] loan commitments when
they fall due. . . . To make some judgement of the net (or
residual) value of assets that may be available to the Bank as
collateral for any loan . . . . 

The ultimate purpose of astute financial analysis is to ensure
REALISTIC BUDGETING which, in turn, will demonstrate whether or
not a project has prospects of being commercially viable and thus
may warrant a Bank loan.  In compiling Bank budgets lending staff
must also: 

Apply their knowledge of other similar projects. . . . Make use
of any industry research data that may be available, and
certainly judge carefully such things as site/location and
management potential.

Despite these requirements and guidelines, the files for only 8
of the 21 commercial loans we reviewed contained financial
analyses.  These analyses were of varying degrees of complexity
and all appeared (based on the absence of Bank-related comments
or notations) to have been submitted by the loan applicants.  In
addition, the eight analyses included what we believe were either
unrealistic assumptions or analytical information that was too
general to apply to the specific loan requests.  Further, none of
the 21 loan files included a record of a separate financial
analysis by the Bank or a Bank critique of the analyses submitted
by the applicants.  According to Bank personnel, the Bank did not
always perform thorough credit and financial analyses of
prospective commercial borrowers and did not document reviews
that were performed because management did not require these
actions to be taken and had not provided personnel adequate
training and supervision to accomplish these tasks.  As a result,
the Bank's management did not appear to have had access to the
information needed to evaluate the prospects for repayment of
proposed loans.  As a consequence of the Bank not conducting
adequate financial analyses to determine the feasibility of
proposed projects and the credit worthiness of loan applicants,
delinquent loans totaling $176,256 appeared to be uncollectible
and additional loans totaling $431,004 were also at risk of
becoming uncollectible.  For example:

- On October 22, 1992, the Bank made the final disbursement for a
loan of $160,632 from Compact funds to a construction company to
buy construction equipment and tools necessary to perform on a
$400,000 contract.  The Bank had also made a loan of $398,755 on
February 6, 1991, secured by the same contract, to the same
company from Republic funds.  According to the Bank's Managing
Director, the borrower could not repay the second loan because
the contract was canceled when the Republic canceled the overall
project.  However, we question whether the Bank should have made
loans to the company in excess of its total projected revenue of
$400,000 from the construction contract.  The Bank's file for the
second loan contained no financial analysis or other documented
analysis that addressed this issue.  Although the borrower had
paid $29,216 on the principal of the Compact loan, the last such
payment was made on September 1, 1993.  As of November 30, 1998,
the loan was 63 months delinquent, had an outstanding balance of
$176,256, including accrued interest, and, in our opinion,
appeared to be uncollectible.

- On November 13, 1991, the Bank made a loan of $346,970 to a
business operating a small hotel for the purpose of building
additional rooms and upgrading the hotel's restaurant and bar.
On August 27, 1992, the Bank made another loan of $351,739 to the
business to significantly upgrade the construction quality of the
hotel improvements.  However, the loan file did not include any
indication that the Bank had performed its own financial analysis
on either loan but had relied on the borrower's financial
projections.  Although the first loan appeared reasonable, the
Bank did not perform an analysis to determine whether the
business could repay the second loan from the same revenues.  The
second loan increased the monthly loan payment from $3,833 to
$7,518.  This larger monthly payment was reduced by the Bank on
January 31, 1996, when it reduced its interest rates to 6.5
percent and, for "a limited time" (which was still in effect as
of November 1998), reduced the monthly payment amount to $5,000.
However, as of November 30, 1998, the borrower had not made any
principal payments on the second loan and owed $431,004,
including accrued interest.  In our opinion, this potential
revenue is at risk of loss.

- During the period of November 1989 to August 1997, the Bank
made two loans[6] totaling $631,025 to an individual to build 10
rental houses.  The only financial projections in the loan file
were based on what, in our opinion, were unreasonable assumptions
by the borrower, such as that all 10 houses would be occupied 100
percent of the time, the project would be completed without any
unforseen delays, and there would be no unexpected construction
or operating costs.  There was no indication in the file that the
loan officer or another Bank official questioned the assumptions,
nor was there a financial projection that used assumptions that
we believe were more appropriate.  Although the borrower assigned
all rent collections to the Bank when the Bank renegotiated the
loan in August 1997, only
14 months later, on November 30, 1998, the loan was 6 months
delinquent and had an outstanding balance of $615,112.[7]

Recommendations

We recommend that the Chairman of the Board of Directors,
Marshall Islands Development Bank:

1.  Request the Board of Directors to revise the Bank's Policies
and Guidelines to require that development loans be granted in
conformance with the applicable goals and objectives contained in
the Republic's 5-year economic development plans as a condition
of approval.

2.  Submit a formal request to the Republic's Cabinet to amend
the Bank's enabling legislation so that the number of government
officials is reduced and the number of private business
representatives appointed to the Bank's Board of Directors is
increased and to require formal acknowledgment and approval by
the Bank's Board of Directors of any loan applications subject to
possible political influence.  In that regard, written statements
should be required by voting Board members that they had no
conflicts of interest and that they were not aware of any
financial risks related to politically influenced loans.

3.  Submit a formal request to the Republic's Cabinet to require
that the Board of Directors of Air Marshall Islands include at
least one member who represents the Marshall Islands Development
Bank.

4.  Ensure that the Bank's Managing Director provides training in
financial analysis to the Bank's Senior Loan Officer, requires
that independent financial analyses be performed for all loan
applications, and reviews and formally approves such financial
analyses.

Marshall Islands Development Bank Response and Office of
Inspector General Reply

In the August 27, 1999, response (Appendix 3) to the draft report
from the Bank's Chairman of the Board, the Bank concurred with
the four recommendations.  Based on the response, we consider
Recommendation 4 resolved and implemented and Recommendations 2
and 3 resolved but not implemented and request additional
information for Recommendation 1 (see Appendix 4).

Additional Comments on Finding

The Bank stated that information included in one of the three
examples of the Bank's inadequate credit analysis (see "Financial
Analysis" in this report) was "inaccurate."  The Bank also
provided information on its position that the loan was adequately
secured and that substantial loan payments had been made.
Further, the Bank stated that "most of what is said about non
compliance with provisions of the Compact . . . [and with Federal
and Republic laws] . . . would have been avoided if the Bank had
been given more autonomy and independent [sic] from the start."
The Bank further stated that "the Board feels that these
[instances of] non compliance could have been minimized, or
avoided, if the IDF [Investment Development Fund] Advisory Board,
established [by the Compact] had taken a more active role in its
capacity as an Advisory Board to the fund."  The Bank then stated
that the only advice the Advisory Board provided was "for a loan
to fund a joint venture fishing project" and that the "project
was a failure."  Further, the Bank noted that the President of
the Republic of the Marshall Islands had sent a letter dated
April 26, 1993, to the U.S. Ambassador to the Republic appointing
the Republic's representatives to the Advisory Board and
requesting appointment of the United States representatives to
the Board.  The Bank further stated, "Until now no one knows
whether the appointments were made or not, as there has not been
a meeting of that [Advisory] Board."

The statement that information in one example in the draft was
"inaccurate" is incorrect.  However, we have revised the example
to clarify that (1) we were referring to the date of the final
disbursement on the loan (October 22, 1992), not the date on
which the loan was signed, and (2) the loan was 63 months
delinquent as of November 30, 1998, not as of September 1, 1993.

Regarding the Bank's statement that two additional contracts were
used to secure the repayment of the two loans to the borrower,
this information was not in the Compact-funded loan file provided
to us during the audit, nor was it provided in response to our
inquiries for information concerning the Republic-funded loan.
Additionally, we did not review the files of Republic-funded
loans because the loans did not involve United States-sourced
funds.  Based on the information provided with the response, we
have deleted reference to the delinquency of the Republic-funded
loan.  However, Bank officials did not mention any other
contracts during audit discussions on this loan.  If these
contracts were used to justify the approval of the Compact-funded
loan, this information should have been included in the
Compact-funded loan file and referred to as part of a financial
analysis of the loan, which was not performed.

Regarding the financial status of the Compact-funded loan and the
Republic-funded loan, the Bank listed seven payments, totaling
$100,396.17, with the inference that these payments were applied
to the Compact-funded loan.  However, the Bank's accounting
records showed that only two payments, totaling $8,185.62, of the
seven payments were applied to the Compact-funded loan.
Consequently, the other five payments, totaling $92,210.55, were
apparently applied to the Republic-funded loan.  Further, based
on the Bank's accounting records as of November 30, 1998, the
Compact-funded loan's outstanding principal balance was $131,416,
which, when subtracted from the initial loan amount of $160,632,
results in a total of $29,216 in principal having been paid on
this loan.  In addition, according to the Bank's accounting
records as of March 12, 1999, the most recent payment the Bank
applied to the Compact-funded loan was made on September 1, 1993.
Therefore, we still consider the remaining balance of $176,256,
including accrued interest, to be potentially uncollectible.

We have addressed the issue of the Bank's autonomy through
Recommendation 2.

Regarding the Investment Development Fund Advisory Board, we do
not believe that the Advisory Board had or would have had a
significant impact on the issues discussed in the report.
According to the Compact, the Advisory Board's duties and
responsibilities include providing "advice and guidance" on the
evaluation of proposals and recipients of distributions from the
Investment Development Fund and assisting in other programs
designed to attract investment in the Republic.  Also, as noted
in the Bank's response, the only advice apparently given by the
Board resulted in a "project that was a failure" with related
losses of $1.7 million in principal and interest.  Further,
regarding the appointment of United States representatives to the
Advisory Board, during our audit, we contacted United States,
Republic, and private entities in our efforts to obtain records
relating to the actions of the Advisory Board and to determine
what actions had been taken to appoint United States
representatives to the Board in 1993 or subsequent to 1993.  We
were unsuccessful in obtaining any documentation other than the
Republic President's April 26, 1993, letter referred to in the
response.  However, by December 31, 1993 (the end of the Bank's
fiscal year), the Advisory Board would have had few decisions to
make on loans because most available funds were committed.  As of
that date, the Investment Development Fund had 31 loans, totaling
$12.3 million (including unpaid interest), and of that number, 17
(55 percent) loans were delinquent.

**FOOTNOTES**

[2]:The 21 loans that we reviewed included 2 loans made to Air
Marshall Islands (a government-owned airline) that were
subsequently exchanged for common stock of the airline.  If the
two loans had not been exchanged for common stock, they would
have had outstanding balances totaling $4.3 million as of
November 30, 1998.  Because the Bank's audited financial
statements for 1997 reported the airline's stock as having no
value, we included the $4.3 million that would have been
outstanding on the loans as "Lost Revenues" in Table 1 and as
"Unrealized Revenues" in Appendix 1.

[3]:The amount of this loan was subsequently increased to
$933,321 by the capitalization of accrued interest totaling
$83,321.

[4]:The exchange with the Bank was initiated in August 1994 by
the airline's Board of Directors, which included the Republic's
now-deceased President and three Cabinet ministers.  The exchange
reduced the airline's outstanding debt by $3.5 million and
increased its equity by the same amount.

[5]:The airline reported a fiscal year 1997 operating loss of
$2.9 million, with total operating revenues of $7.7 million.

[6]:The loans consisted of the original loan of $474,169, an
additional loan amount of $64,651, and interest capitalizations
of $18,590 and $73,615.

[7]:Although we consider the outstanding balance of $615,112 on
this loan to be at risk of loss, we did not include it in
Appendix 1 as part of the monetary impact for Finding A because
it is included in the discussion and the monetary impact for
Finding B.

B.  COLLECTION OF DELINQUENT LOANS

Although the Marshall Islands Development Bank made good faith
attempts, it did not collect all delinquent loan amounts.  The
Bank's operating procedures and borrowers' loan documents specify
the responsibilities of the Bank and the borrowers for protecting
collateral and collecting delinquent loans.  However, the Bank
did not (1) use all available collection methods; (2) prepare,
collect, and maintain loan records necessary to ensure that loan
collateral was protected and that loan files were complete and
current; and (3) ensure that management fees were charged to
delinquent borrowers for all properties the Bank managed.  Also,
the Bank's Managing Director said that the Bank was reluctant to
seize loan collateral and believed that cooperative efforts with
the borrowers would resolve delinquency problems.  Further, Bank
personnel stated that they were inadequately trained and
supervised and that they had to expend too much time managing
returned property.  Finally, management fees were not generally
collected because Bank officials had not realized the time and
related costs involved in managing smaller properties.  As a
result, delinquent loans totaling $629,631 appear to be
uncollectible, and loans totaling another $3.3 million may become
uncollectible because of inadequate collection enforcement.
Additionally, delinquent loans totaling $208,021 appear to be
uncollectible because the pledged property was not insured, and
potential management fees of about $7,500 had not been collected.
(The monetary impact of the preceding amounts is presented in
Appendix 1.)  Further, we believe that the Bank's lack of action
to aggressively collect delinquent loans may serve as an
inducement for other borrowers not to repay their loans or not to
repay their loans timely.

Collection  Practices

Paragraph 25 of the Bank's Policies and Guidelines states, "The
Bank shall secure its loans or guarantees by appropriate
collateral coverage and guarantees from its borrowers in
accordance with sound banking practices."  Section 3.3.2 of the
Bank's Operating Manual states:

When arrears do occur, it is most important to quickly identify
why, and then complete appropriate and timely action to return
the account to current status e.g. obtain the repayment/s,
reschedule the repayment/s, rehabilitate the project, or sell off
assets.  The monitoring and control of arrears, plus the
education of borrowers in good credit habits, is a most important
part of the role of all Bank lending staff. . . . Arrears may be
caused by the client/project when borrowers will not pay or
cannot pay.

For client-caused arrears, the Manual continues:

Borrowers who will not pay are those who have sufficient funds to
meet the agreed repayments, but choose not to pay.  In all such
cases, prompt and firm action needs to be taken in order to show
the borrower that the Bank means to enforce the loan agreement. .
. .  This type of borrower does not warrant any leniency from the
Bank . . . and after two reminders and one warning letter the
Bank should proceed to realize upon its securities.

Further, Section 3.3.2.4 of the Manual states:

The accepted basis for classifying the status of delinquent
accounts is: . . . Two Months up to Three Months - third contact
MUST be a Bank visit to the project to undertake a full review
and report back, Over Three Months - generally regarded as
hard-core arrears with deep seated problems needing careful,
consistent, and positive follow-up, Over Twelve Months -
non-performing loans where debt recovery is most definitely in
doubt. . . . Only careful and constant attention to arrears
monitoring will maintain proper control of the Bank's loan
portfolio, protect [the Bank's] capital, and allow the Bank to
continue on with its primary role as a major catalyst for
development in [the Republic of the Marshall Islands].

In addition, loan agreements between borrowers and the Bank
specify that upon default by the borrowers, the Bank can "take
possession of the [loan] collateral or render it unusable; . . .
Sell or dispose of collateral by sale and pursuant to the law; .
. . Foreclose on any real property or appropriate personal
property in accordance with law; . . . and Pursue any and all
other remedies available under law or equity to enforce the term
of this Loan Agreement."

To evaluate the Bank's collection practices, we selected a
judgmental sample of 115 of the Bank's 509 recorded loans (see
Appendix 2), including loans from each category of the Bank's
Federally funded loan programs.  The 115 loans had original loan
amounts totaling $15.5 million and, as of November 30, 1998,
consisted of 23 paid-off loans and of 92 active loans with
outstanding balances totaling $18.7 million, including accrued
interest.  Of the 92 outstanding loans, 49 loans, totaling $18.2
million as of November 30, 1998, were delinquent (32 loans
delinquent 1 year or more and 17 loans delinquent less than 1
year).  Based on our review of the loan payment history and the
age of the loans, we believe that the Bank will not be able to
collect amounts due for 34 of the 49 delinquent loans.  (The 34
loans consisted of 31[8] of the 32 loans that were delinquent 1
year or more and 3 of the 17 loans that were delinquent less than
1 year.)  However, in Finding A, we questioned the Bank's ability
to collect 8 of these 34 loans, with outstanding balances
totaling $8,970,836.  Therefore, to avoid duplicate counting, we
included in the monetary impact reported in Appendix 1 only the
remaining 26 loans, with uncollectible or potentially
uncollectible balances totaling $3,896,575, as shown in Table 2.

Table 2.  Delinquent Loans With Lost or Potential Lost Revenues

Original  Nov. 1998       Potential       Loans   Loans     Loan
Outstanding  Lost      Lost              Source and Type of Loan
ReviewedQuestioned   Amount     Balances  Revenues  Revenues 
Compact 111- Investment Development16  7   $3,304,378  $3,749,829
$439,680  $2,671,126
Compact 211 - Commercial    5    3   622,697    782,227        0
433,004
Compact 211 - Housing       34    4    60,201     55,674   13,475
42,199
Trust Territories - Economic Development20     12
439,417297,091176,476   120,615
USDA - Housing Preservation  36       0              0          0
0         0
USDA - Rural Development      4       0              0          0
0         0
Total   115   26   $4,426,693  $4,884,821  $629,631  $3,266,944


We reviewed the files for 18 nonhousing loans that were among the
49 delinquent loans and determined that the file for only 1 of
the 18 loans included any comments explaining why the loan was
delinquent (the file stated "management weaknesses"). In
addition, none of the files for the 49 delinquent loans included
a financial analysis of the delinquent borrower, a collection
plan, or documentation that the Bank had attempted to seize loan
collateral or had initiated court action. We asked two attorneys
who had worked with the Bank to collect delinquent loans whether
the Bank could successfully seize property and/or take other
court action to collect delinquent accounts.  The attorneys
stated that the enforcement of the security agreements would
likely be upheld in the Republic's courts but added that the Bank
had never filed a court action to enforce the agreements.  The
Bank's Managing Director also stated that the Bank had not taken
legal action against delinquent borrowers.  By not using all
available legal means to collect delinquent loans, the Bank
appears to have lost $629,631 and placed another $3,266,944 at
risk of loss.  For example:

- On January 22, 1999, the Bank's payment agreement (dated
January 20, 1998) with one delinquent borrower was, in effect,
overturned as a result of a decision by the Marshall Island's
High Court to assign the borrower's revenues to another creditor.
The borrower had originally obtained the loan on October 11,
1990, and, as of November 30, 1998, was 77 months delinquent and
had an outstanding balance of $439,680, including accrued
interest.  In addition, the borrower had never made a payment on
the loan principal.  The Bank's Managing Director stated that the
Bank had inadvertently not filed its payment agreement with the
Court.  Therefore, the Bank's claim was not recognized by the
Court and was overturned when another creditor brought suit
against the borrower.  In our opinion, the Bank would have
increased the probability of recovering all or most of the
$439,680 outstanding balance if it had taken more aggressive
actions, such as seizing the secured property.

- By August 1997, the Bank had loaned $631,025 (including
capitalized interest) to an individual to build 10 rental houses
(see "Financial Analyses" in Finding A).  Although the borrower
assigned all rent collections to the Bank when the loan was
renegotiated in August 1997, only 15 months later, by November
30, 1998, the loan was 6 months delinquent.  Prior to August
1997, rents from four of the rental houses had been assigned to
the Bank, but the Bank experienced difficulty in collecting the
rents because the borrower or the borrower's representative would
collect the money  from tenants and not remit the money to the
Bank. As of February 1, 1999, only 4 of the 10 houses were rented
at a total rental income of $3,000 per month, which was $2,500
per month less than the $5,500 monthly loan payment amount.  In
addition, the Bank attempted to convince the borrower to
voluntarily transfer management of the property to the Bank but
had not been successful, although it continued to seek to take
over the project.  Further, based on our site inspection, the
wooden houses appeared to be deteriorating and in need of
renovation to be desirable rentals.  As of November 30, 1998, the
loan balance of $615,112 was outstanding.

Loan Records

Paragraph 5 of the Bank's Policies and Guidelines directs the
Bank to "carry out its operations according to sound commercial,
banking practice."   Section 3.3.6 of the Bank's Operating Manual
states that the Bank "has two major information systems: the
computerized accounting system and the loans filing system
comprised of a separate file for each loan account."  Paragraph
3.3.6.2 of the Manual states, "Given the importance of loan
files, it is absolutely essential that each one must always be a
complete record of all that occurs with a given borrower/loan. .
. .  The loan file should be a record of every single thing that
happens."  Further, Paragraph 30 of the Bank's Policies and
Guidelines states that "the Bank shall require loan applicants to
produce insurance policies . . . for . . . real property
improvements," and Subparagraph 30(d) states that "where
insurance is required, the premiums shall be paid in full by the
borrowers as the standard practice of the Bank."  Further, Title
10, Section 13(4), of the Marshall Islands Revised Code states,
"In the preparation of the [Bank's] financial statements,
adequate and proper provisions shall be made for bad and doubtful
debts"

File Documentation.   The Bank did not include sufficient
documentation in the loan files to support that property used as
loan collateral was adequately protected and that required loan
processing procedures and collection actions were performed.
Based on our review of 21 commercial loan files and 70 housing
loan files,[9] we determined that none of the 91 files included
documents providing (1) the entire payment history, delinquency
status, and aging of the loans; (2) narrative comments on major
loan actions (such as loan amendments and meetings with
delinquent borrowers); and (3)  evidence of supervisory reviews.
In addition, the loan files for neither the 21 commercial loans
nor the 34 Compact Section 211 housing loans included documents
showing that current insurance coverage existed on the property
used for loan collateral.  According to Bank loan officers,
documentation was not included because they had not received
adequate followup training on retaining documentation on
insurance coverage and the loan files were not subject to routine
supervisory monitoring.  The Senior Loan Officer also stated that
much of his time was devoted to managing returned properties.
According to the Bank's Managing Director, many of the housing
borrowers could not afford insurance, and the Bank was therefore
attempting to include funds to pay for the cost of insurance in
the initial amounts of future loans.  As a result, the Bank lost
$208,021 on at least one loan because loan collateral was not
insured.

Specifically, although the Chattel Mortgage Security Agreement
used by the Bank required that borrowers carry insurance on
collateral used as surety for their bank loans, a 50-foot fishing
boat with fishing equipment, which was partially financed by a
Bank loan, was not insured and was considered a total loss when
it burned about 10 months after the borrower obtained the loan.
The Bank's Managing Director stated that during this period,
smaller boats could not get insurance in the Republic and that
the Bank had required the borrower to include as collateral for
this loan a small hotel that was also used as collateral for a
separate $137,000 hotel loan.  Although we could not determine
the value of the mostly wooden hotel, we determined, based on our
site visit, that the hotel was not in operation and needed
extensive repairs before any rooms could be rented.  As of
November 30, 1998, the borrower had not made any payments on the
loan and owed a total of $208,021, including accrued interest.
We believe that the Bank should more adequately protect its
interests by requiring alternate unpledged collateral for the
loans.

Computerized Accounting System.  The Bank did not operate a
computerized accounting system that was adequate to effectively
administer its outstanding loans.  A 1997 consultant study funded
by the Asian Development Bank discussed the need to correct
deficiencies in the Bank's computerized accounting system and
made recommendations for improvement.  Bank officials said that
the recommendations were not implemented because the Bank's
management did not agree with the conclusions of the study.
However, the Bank's Managing Director and its Finance Manager
agreed that the Bank's computerized accounting system was old and
needed improvements.  As a result, Bank personnel and management
and Bank Directors could not readily determine the status of the
Bank's loan portfolio to help ensure that personnel initiated
appropriate collection actions on delinquent loans.  Examples of
the Bank's ineffective system of loan administration are as
follows:

-  The Bank's accounting computer equipment and its local area
network configuration were inadequate to provide the processing
power needed to summarize the payment history of any loan more
than 2 years old, thereby excluding most of the approximately
1,000 (Federal and Republic) loan files, which may include more
than 8 years of transactions.  Therefore, a loan's complete
history could not be provided without extensive manual review.

- The Bank was unable to locate its computerized or manual
accounting ledger files for transactions on the 9 outstanding
Compact Section 211 Bond Proceeds Fund commercial loans for
calendar year 1994; 9 outstanding Compact Section 111 Investment
Development Fund commercial loans for a 6-month period in 1990;
and the 54 Trust Territories Economic Development Loan Fund loans
for 1992, 1993, and 1995. 

- The Bank relied on its external auditors to perform loan
account agings and to adjust loan allowance accounts on an annual
basis instead of using the computerized system,  performing these
reviews periodically during the year, and then providing this
periodic delinquency information to its Board of Directors. 

Property Management

Paragraph 5 of the Bank's Policies and Guidelines states, "As a
development finance institution, the Bank will carry out its
operations according to sound commercial, banking practice."  The
Bank's Senior Loan Officer stated that he was assigned management
of the rental properties that had been turned over to the Bank
and that managing the properties took a "significant portion" of
his time.  In our opinion, the Bank should charge the borrowers a
percentage of revenues collected from the managed properties to
help recover some of the personnel costs incurred.  In addition,
since the Senior Loan Officer was the lead official responsible
for collecting delinquent commercial loans, we believe that the
Bank should consider assigning another staff member to manage the
returned properties.

As of November 30, 1998, the Bank had entered into management
agreements with six delinquent borrowers of either Compact
Section 111 Investment Development Loan Funds or former Trust
Territories Economic Development Loan Funds to manage the
properties that were used to secure the loans until the loans
were paid off.  With the Bank collecting revenues from the
properties and using the revenues to make payments on the
delinquent loans, the number of loan delinquencies was decreasing
at the time of our audit.  However, for five of the six
agreements, the Bank had not required the borrowers to reimburse
the Bank for its property management costs.  We estimated that
using a management fee of 10 percent of collected revenues, the
Bank could have collected  management fees of about $7,500 during
1998, which would have defrayed some of the Bank's operating
expenses.

Recommendations

We recommend that the Chairman of the Board of Directors,
Marshall Islands Development Bank, ensure that the Bank's
Managing Director:

1.  Enforces the loan provisions for seizing loan collateral for
loans that are significantly delinquent.

2.  Provides refresher training in loan file maintenance to all
loan personnel and amends the Bank's Policies and Guidelines to
require regular supervisory reviews of files on loans that  are
delinquent.

3.  Assigns property management responsibilities to Bank
personnel other than loan officers who are responsible for
collecting delinquent loans.

4.  Performs an assessment of the Bank's computerized systems and
develops a plan of action to upgrade the systems to meet the
identified needs.  Any upgrades should include correcting errors
in the loan files (both automated and manual) and providing
training on the upgraded systems.

5. Prepares standard wording to be used in all Bank management
agreements with borrowers which specifies that monthly charges
(such as a percentage of monthly collections) should be assessed
for property management and amends existing management agreements
to include such wording. 

Marshall Islands Development Bank Response and Office of
Inspector General Reply

In the August 27, 1999, response (Appendix 3) to the draft report
from the Bank's Chairman of the Board, the Bank concurred with
the five recommendations.  Based on the response, we consider
Recommendations 4 and 5 resolved and implemented and
Recommendations 1 and 3 resolved but not implemented and request
additional information for Recommendation 2 (see Appendix 4).

**FOOTNOTES**

[8]:One of the 32 loans was excluded because it appeared to be
collectible, even though it had been delinquent for 22 months.

[9]:We did not perform this review on the 4 U.S. Department of
Agriculture Rural Development loans in our sample because the
funds on each of these loans had not been disbursed at the time
of our audit and on the 20 Trust Territories Economic Development
loans in our sample because these loans were issued by the Bank's
predecessor bank and did not relate to the Bank's current
operations.

C.  ECONOMIC DEVELOPMENT LOAN FUND

The Marshall Islands Development Bank combined loans funded by
the United States, under the former Trust Territories Economic
Development Loan program, with loans funded by the Republic,
which resulted in United States-funded loans losing their
identity.  According to the "Agreement By The Federated States of
Micronesia, Republic of the Marshall Islands, Republic of Palau,
and Trust Territory of the Pacific Islands To Amend the EDLF
[Economic Development Loan Fund] Plan," which became effective on
October 24, 1985, and transferred responsibility for the Economic
Development Loan Fund from the Trust Territory of the Pacific
Islands to the Republic of the Marshall Islands, the Republic
agreed to separately account for Economic Development Loan Funds
in a revolving fund.  The Bank's Finance Manager stated that he
was not aware of these requirements when the Bank assumed the
outstanding Economic Development Loan Fund accounts from its
predecessor, the Marshall Islands National Development Bank.  As
a result, (1) loan payments totaling $214,938 were deposited into
the Bank's local revenue accounts and (2) loan accounts totaling
$167,950 were transferred to the borrowers' other related loans
that were financed from other sources (see Appendix 1).  As a
result, these funds were not available for loans that were in
compliance with the established purposes of the Economic
Development Loan Fund.

U.S. Public Law 88-487 (Pacific Islands Trust Territory -
Economic and Social Development), dated August 22, 1964,
established a development fund grant for the Trust Territory of
the Pacific Islands.  The amount of the fund was increased on
March 21, 1972, by U.S. Public Law 92-257 (Trust Territory of the
Pacific Islands) to a total of $5 million.  Public Law 92-257 was
codified in Title 48, Sections 1688 through 1693, of the U.S.
Code Annotated.  Section 1689 states that the use of the grant
depends on the government of the Trust Territory preparing a plan
that "shall provide among other things for a revolving fund to
make loans or to guarantee loans to private enterprise."  Section
1690 established basic loan and guarantee requirements, and
Section 1691 states that the "plan provided for in section 1689
of this title shall set forth such fiscal control and accounting
procedures as may be necessary to assure proper disbursement,
repayment, and accounting for such funds."   The Agreement
reiterated the statements in Sections 1689 through 1691.

Loan Payments

The Bank did not account for and report on loans financed by the
United States-funded Economic Development Loan Fund in a separate
revolving fund,[10] as required by Federal law.  Instead, the
Bank included at least 54 of these loans with other loans
financed by Republic funds.  According to the Bank's Financial
Manager, when the 54 loans were transferred to the Bank in 1989,
the Bank's management did not realize that these loans had
special accounting requirements.  Therefore, the Bank did not
establish a separate revolving fund for the loans.  The oldest
listing of these loans available from the Bank, dated December
31, 1989, identified 54 loans with total outstanding balances of
almost $1.3 million and 6 loans with zero balances.  Of the 54
loans, we reviewed 20 loans with balances totaling $687,476 as of
December 31, 1989, and determined that through November 30, 1998,
the Bank had collected a total of $214,938 on these loans but had
accounted for these collections as Republic revenues and not as
Economic Development Loan Fund revenues.  As a result, the Bank
could not ensure that the $214,938 was or would be used for loans
in compliance with the requirements of the Economic Development
Loan Fund program, as required by the Agreement and United States
law. 

Transferred Accounts

In two instances, the Bank transferred borrowers' Economic
Development Loan Fund account balances to the same borrowers'
accounts under other funds, which was contrary to the
requirements set forth in the "Agreement."  According to the
Bank's Financial Manager,  the loan balances were transferred to
assist in collection efforts, and the Bank's management did not
realize that these loans should have been accounted for
separately.  Details of the transferred loans were as follows:

- On September 13, 1994, the Bank closed out an Economic
Development Loan Fund account totaling $46,038 by writing off
$23,019 and transferring the remaining $23,019 to the borrower's
loan from Republic funds.  According to the Bank's records, the
borrower paid $3,779 on the portion of the loan that was
transferred to the Republic's loan fund.

- On May 30, 1996, the Bank transferred another borrower's entire
Economic Development Loan Fund account balance of $121,912
($97,994 in principal and $23,918 in accrued interest) to the
borrower's loan account in the Compact Section 111 Investment
Development Fund.  Subsequent to the transfer, the borrower paid
an estimated $18,597 on this loan.

As a result, of these two transfers, the Economic Development
Loan Fund lost $167,950 ($46,038 and $121,912) that the Bank
could not lend for Economic Development Loan Fund purposes.

Recommendations

We recommend that the Chairman of the Board of Directors,
Marshall Islands Development Bank, ensure that the Bank's
Managing Director:

1.  Establishes a separate revolving fund to account for loans
made with Economic Development Loan Funds; computes all payments
collected from borrowers since 1988; and deposits these funds, as
well as all future Loan Fund payments, to this fund.

2.  Returns the two loan balances related to the two transfers to
the revolving loan fund established in accordance with
Recommendation 1; computes all payments collected from borrowers
since 1988; and deposits these funds, as well as all future Loan
Fund payments, to the revolving fund. 


Marshall Islands Development Bank Response and Office of
Inspector General Reply

In the August 27, 1999, response (Appendix 3) to the draft report
from the Bank's Chairman of the Board, the Bank said that its
independent auditors "at no time" had "brought up" the combining
of the former Trust Territories Economic Development Loan program
with loans funded by the Republic "as an issue of concern to be
corrected" and that "further reviews" of the Economic Loan Fund
were needed before the two recommendations could be implemented.
Based on the response, we consider Recommendations 1 and 2
unresolved (see Appendix 4).

Based on our review of actions taken by the Bank's Board of
Directors and other information relating to outstanding loans
assumed by the Bank at the time of its establishment, we
determined that certain loans labeled by the Bank as "old loans"
were Federally funded Economic Development loans.  Our
discussions with Bank officials and the Bank's independent
auditors and our subsequent review of working papers from a prior
single audit of the Bank confirmed that the Bank had erroneously
reported the Economic Development loans as Republic-funded loans.
The Bank subsequently located and provided us with a list of
Economic Development loans as of December 31, 1989, which we then
provided to the Bank's independent auditors.  The independent
auditors' resident representative in Majuro, who had performed
the most recent Bank audits, said that when his firm began
auditing the Bank, there was no indication in the Bank's records
that the subject loans were anything but Republic loans.  The
auditors' representative stated that this issue would be
addressed in the calendar year 1998 audit, which was in process
at the time of our discussion.

**FOOTNOTES**

[10]:A "revolving fund" is an "account that is repeatedly
expended, replenished, and then expended again." (Barron's
Dictionary of Accounting Terms)

APPENDIX 1

CLASSIFICATION OF MONETARY AMOUNTS*

Potential    Funds To Be Put To      Unrealized      Additional   
Finding Area                         Revenues        Revenues
Better Use 

A. Issuance of Commercial Loans
Political Considerations$6,621,645   $6,442,610
Financial Analyses         176,256      431,004

B. Collection of Delinquent Accounts
Collection Practices       629,631    3,266,944
Loan Records               208,021   
Property Management                       7,500

C. Economic Development Loan Fund
Loan Payments                          $214,938
Transferred Accounts                    167,950

Total         $7,635,553  $10,148,058  $382,888

*All amounts represent Federal funds.


APPENDIX 2

MARSHALL ISLANDS DEVELOPMENT BANK
OUTSTANDING LOANS BY U.S. FUNDING SOURCES
AS OF NOVEMBER 30, 1998


Total          Total             
Number Amount  Amount           
Funding Source and Bank Fund Title  of Loans   Loaned   Owed*

Compact of Free Association:
Section 111, Investment Development Fund 30       $11,770,484
$13,781,100        
Section 211, Bond Proceeds Fund:

Commercial Loans                 8      905,696     1,034,419
Housing Loans                  130    2,531,156     1,292,315

Trust Territory of the Pacific Islands:
Economic Development Loan Fund      54**   1,273,751** 417,343

U.S. Department of Agriculture:
Housing Preservation Grant Fund   281      492,939     122,896

Rural Development Fund    4      56,000              56,000***

Sub-Total                   507    $17,030,026     $16,704,073

Compact of Free Association Fund Loans
Converted to Air Marshall Islands Stock:
Section 111, Investment Development Fund1    $850,000
$1,350,809****
Section 211, Bond Proceeds Fund      1        2,000,000
2,901,688****

Total                         509    $19,880,026     $20,956,570

                                               _________________

*The current amounts owed were not available from the Bank's
accounting system and are based on our audit calculations.
**The number of loans and loan amounts are based on the recorded
outstanding balances as of December 31, 1989.
***These loans had not been finalized as of November 30, 1998,
and no payments had been made on them.
****These amounts include delinquent principal and interest that
were converted into stock effective December 31, 1994, plus
estimated interest from January 1, 1995, through November 30,
1998.

APPENDIX 3
Page 1 of x


MARSHALL ISLANDS DEVELOPMENT BANK RESPONSE

APPENDIX 4
Page 1 of 2

STATUS OF AUDIT REPORT RECOMMENDATIONS
---------------------------------------------------

Finding/Recommendation

Reference            Status      Action Required                     
Provide the target date

A.1 Management and the title of the concurs;  official
responsible additional for revising the Bank's information
policies and Guidelines needed.   to require that Compact-funded
development loans are

A.2 and A.3 Resolved; in conformance with the not Republic's
5-year implemented.economic plans.

No further response to the Office of Inspector General is
required. The recommendations will be referred to the Assistant
Secretary for A.4 Policy, Management and Implemented. Budget for
tracking of B.1 implementation.

Resolved; However, we request not that copies of the implemented.
Cabinet's responses to the Bank's requests be provided to our
office.

No further action is required.

No further response to the Office of Inspector General is
required. The recommendation will be referred to the Assistant
Secretary for Policy, Management and Budget for tracking of 
implementation. However, we request that a sample copy of 
the revised loan documents be provided to our office.

--------------------------------------------------

APPENDIX 4
Page 2 of 2

----------------------------------------------------------
Finding/Recommendation
Action
Reference             Status      Required
Provide the target date and B.2 Management the title of the
official  concurs; responsible for amending additional the Bank's
Policies and information Guidelines to require needed.
supervisory reviews of files on delinquent loans. However, we
request that a copy of the revised
B.3 Resolved;  Policies and Guidelines be not provided to our
office. implemented.

No further response to the Office of Inspector General
is required.  The recommendation will be referred to the
Assistant Secretary for Policy, Management and Budget for
B.4 and B.5 tracking of implementation.
Implemented.However, a copy of the C.1 and C.2 documentation
showing when Unresolved.a property manager has been assigned
should be provided to our office. No further action is required.

Reconsider the recommendations, and provide responses
indicating concurrence or nonconcurrence. If concurrence is
indicated, provide action plans that include target dates and
titles of the officials responsible for (1) establishing a
separate revolving fund for former Trust Territories loans and
(2) depositing into the fund all loan payments and the two loan
transfers made since 1988 and all futureloan payments.
----------------------------------------------------------





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