The Invisible Hand: Financial Pressures and Organisational Convergence in Multilateral Development Banks

Abstract

This paper investigates how the unique financial model of multilateral development banks – dependent largely on issuing bonds in private capital markets to raise lending resources – came about in the early history of three different MDBs, and how this in turn shaped their operational characteristics. Historical research demonstrates that the World Bank, Inter-American Development Bank (IADB) and Andean Development Corporation (CAF) converged on organisational and operational arrangements very different to what their founders had intended, and much closer to one another, as a direct result of the need to secure sufficient resources to function as viable development lenders. The findings indicate that in the absence of governments willing or able to provide significant financing out of their budgets, MDBs tend to converge towards a single organisational model in order to maintain access to international capital markets. All three MDBs examined here modified their lending and financial policies in unexpected ways and, in the case of the IADB and CAF, even restructured their original membership, specifically for the purpose of securing adequate financial resources.

Acknowledgements

The author would like to thank: (i) participants in the 2014 European Political Science Association Conference; (ii) participants in the University of Zurich Political Science Department publication seminar; and (iii) two anonymous reviewers for their comments and suggestions on earlier drafts of this article. All errors and omissions are the author’s.

Notes

1. The New Development Bank created by the BRICS nations as well as the Asian Infrastructure Investment Bank. See BBC, 15 July 2014 and New York Times, 24 October 2014.

2. Much of which is actually in callable, guarantee capital, rather than cash. For example, of the World Bank’s US$205.4 billion in capital, only US$12.4 billion (6%) is paid in by 188 member countries, while the remainder (94%) is guaranteed.

3. On the interests of shareholders in MDB operations, see among many others Dreher, Sturm, and Vreeland (2009); Harrigan, Wang, and El-Said (2006) and Kilby (2011, 2013).

4. See Babb (2009), Krasner (1981), Strand (2001) and Woods (2006), among many others.

5. See for example Dreher (2004), Frey (1997) and Vaubel (1986; 2006).

6. The MDB model also requires a steady stream of countries willing to borrow from them. This was a minimal issue during the time period considered here (demand for loans far outstripped supply), but is now a much more important issue for many MDBs in light of the growing financial strength of many middle-income countries. See Humphrey and Michaelowa (2013).

7. See for example Standard and Poor’s reports on the World Bank (2014a), IADB (2014b) and CAF (2014c).

8. The concessional lending windows of MDBs (like International Development Association at the World Bank and the Fund for Special Operations at the IADB) are, of course, another matter, as they are financed not by bond markets but rather via shareholder budgetary contributions.

9. Even with a guarantee, many countries would still be paying considerably more for money then if the Bank borrowed itself and lent it on, which didn’t make sense. Also, regardless of the guarantee, the markets would offer differing interest rates to different clients, which the IBRD feared could impact its own credit rating.

10. This was due to the insistence of the British at Bretton Woods – led by J. M. Keynes – that the member currency portion of paid-in capital would only be used for lending with the explicit consent of the country (Bitterman, 1971). Thus only the 2 per cent of capital paid in convertible currencies for all countries (except the United States, which contributed the full 20% in convertible currency) could be used for lending.

11. The first president was Eugene Meyer, who resigned after only a few months on the job.

12. This is despite the fact that the almost complete fungibility of money in a borrowing government’s accounts made the ‘specific project’ a myth. See, for example, Feyzioglu, Swaroop, and Zhu (1998).

13. The avoidance of socially oriented loans in the early World Bank is discussed in Alacevich (2009).

14. This includes: Argentina; Brazil; Chile; Colombia; Costa Rica; Iran; Israel; Mexico; South Africa; and Uruguay.

15. This includes: Burma; Ceylon; Ecuador; Egypt; El Salvador; Ethiopia; Guatemala; Haiti; Honduras; India; Iraq; Lebanon; Nicaragua; Pakistan; Panama; Paraguay; Peru; Philippines; Sudan; and Thailand.

16. The United States has also always held veto power over changes to World Bank capital structure and charter, though it does not have a formal veto over IDA operations.

17. The United States created the Social Progress Trust Fund as another concessional lending window within the IADB under direct US control in 1960, but by 1965 it had been merged into the FSO.

18. As of end of 2014, no CAF loan to sovereign borrowers has ever gone into arrears. By contrast, a total of 22 countries have fallen behind by six months or more since the World Bank’s inception, including six in Latin America. The IADB has had five sovereigns going into non-accrual (no payments for six months or longer) since 1960, and shorter arrears have been common.

19. For example, MDBs are expected to have a loan portfolio roughly four times their shareholder equity, compared to six or eight times equity for private financial institutions, even though MDBs have generally much lower non-performing loan ratios and have vast sums of callable capital not available to private banks. See Humphrey (2014).

20. See, for example, Standard and Poor’s (2012). The African Development Bank in particular is unable to lend to several countries in North Africa due to what the ratings agencies consider excessive concentration, despite the fact that these countries are in desperate need of financial support and the AfDB has excess lending capacity. On this, see Standard and Poor’s (2013, p. 3).

21. This dynamic has parallels to the way New York infrastructure builder extraordinaire Robert Moses exercised power for many decades, at times against the wishes of New York City mayors, state governors, and even the US president. As described in Robert Caro’s (1974) masterpiece The Power Broker, the key to Moses’ power was the fact that he had himself written the law creating the Triborough Authority in such a way that it could issue bonds based on its own revenues. Hence Moses depended on no one but Wall Street bond buyers for resources, and he made sure that he kept Wall Street happy. Considering that Moses was at the height of his powers when the World Bank was created, and that the early leaders of the Bank were all Wall Street insiders, this may have been an explicit model for the way they ran the Bank.