Evaluating the Reaction of Development Banks to the Financial Crisis

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  • 2012•02•28

    Stephen Kingah and Aliya Salimzhuarova

    Evaluating the reaction of development banks to the financial crisis

    Abandoned beach resort project in Diani Beach, Kenya. Photo: Joseph Hill

    The global financial crisis of 2008 shocked the world, and left in its wake what has been termed the “Great Recession”. The impact of the crisis has devastated many economies, in the North and South alike. The drying up of capital and the dampening of liquidity flows has had important effects on vital sectors in many countries, especially the countries of the South, and has impacted vast populations.

    The four main sectors that have been adversely affected by the crisis — trade, tourism, infrastructure and agriculture — provide the lifeblood for many struggling economies. Take tourism for instance: the crisis drove away tourists from key destinations that rely mainly on tourism proceeds to power their economies. In countries such as Kenya, South Africa, Egypt and those in the Caribbean, the impact has been dire. In terms of infrastructure, a lack of financing brought projects in many parts of the world to a halt. This, in turn, dealt a blow to efforts to provide essential public goods and services, including roads, schools, publicly funded research, hospitals, and the provision of food. For populations already struggling to make ends meet, the additional pressure is proving burdensome.

    It is not just poor countries that are feeling the pinch. As the financial credibility of some of the countries of the West has tanked, so too does their capacity to extend a helping hand to those in the South. This forces poor countries, and even some middle-income nations, to turn to multilateral development banks, including the World Bank and 13 other regional and sub-regional development banks.

    The development banks are better placed to provide funds for development to countries that lack the credit ratings to access capital from the financial markets. These banks also are more attuned to the needs of their client countries, as they have often funded projects that relate to infrastructure — a salient need in the current time of crisis. Furthermore, they also tend to be geographically close to the realities on the ground. While this is especially so for the regional and sub-regional development banks, even the World Bank has developed a strong army of field officers who are technically adept at coping with the needs of client nations.

    Development banks: Who are the main players?

    On the global scale, the World Bank plays a prominent role; its activities cut across all sectors. The World Bank focuses on providing loans to middle-income countries as well as low-interest loans and grants to low-income countries through its International Development Association (IDA). IDA provides long-term, interest-free loans to the world’s 80 poorest countries, of which 39 are in Africa.

    At the regional level, the Asian Development Bank, the African Development Bank, the Inter-American Development Bank and the European Bank for Reconstruction and Development are among the key institutions. The main purpose of these banks is to contribute to the economic development and social progress of their regional member states, both individually and collectively.

    At the sub-regional level, the main institutions are the European Investment Bank, the Eurasian Development Bank, the Caribbean Development Bank, the Development Bank of Southern African, the East African Development Bank, the West African Development Bank, the Central African Development Bank, the Bank of the South (South America) and the Islamic Development Bank. With some regional (and cultural) variation, depending on specific needs, the sub-regional banks tend to focus on supporting integration efforts in their regions; they place great emphasis on infrastructure support in their investment portfolios, with the aim of promoting social and economic development.

    How did development banks react to the crisis?

    The development banks undertook a number of initiatives in an attempt to mitigate the effects of the crisis in their client countries. At the global level, the World Bank has assumed a leading role in increasing funding through its various lending arms. Through its IDA concessionary lending window, for instance, a US$2 billion facility was created to help countries in need. The bank also augmented funds for its International Finance Corporation (IFC) that is regarded as the private sector arm of the organization.

    At the regional level, the African Development Bank, for example, created a Quick Disbursement Loan Facility as well as an Emergency Liquidity Facility worth US$1.5 billion. In the Americas, the Inter-American Development Bank has been very bold in its response, creating an Emergency Liquidity Fund (US$6 billion) and increasing micro-finance lending through its Multilateral Investment Fund.

    An example of bank action at the sub-regional level is the Targeted Infrastructure Program for poor municipalities implemented by the Development Bank of Southern Africa, which also expanded its research and advisory services.

    The Islamic Development Bank stands out because it offers a different finance model; the practices of riba and garathat, for instance, proscribe excessive credit and speculation. In responding specifically to the crisis, the bank agreed to a 5 percent increase in overall financing and a 17 percent hike in project finance.

    And how successful were they?

    Despite concerted efforts by the various development banks to react effectively to the crisis, a number of shortcomings can be identified.

    Coordination: One of the main challenges for appropriate response from the banks has been the issue of coordination. Although embryonic efforts have been made by some of the banks to coordinate their efforts in dealing with the crisis in client countries, for the most part the banks have tended towards isolationism.

    While individual banks do have specific comparative advantages, it makes sense for the banks to cooperate. Better coordination between the banks will reduce the risk of duplication of services, and help to avoid competition for scarce resources. It is vital for the World Bank and regional and sub-regional development banks to work together to address common global challenges like climate change and food insecurity. Furthermore, the increased involvement of the regional development banks in the work of the World Bank will help dampen the perception from many quarters that the World Bank is a detached, distant organization that seldom reflects the concerns of the poor.

    Resources: The availability of funding also has been a problem, mainly for the sub-regional banks. While the World Bank and the main regional development banks received capital increases thanks to G20 leaders, for those sub-regional banks that have been short on liquidity, little effort has been made to mobilize resources from alternative sources (such as emerging markets, sovereign wealth funds and, more importantly, from other sub-regional and specialized development banks). This dimension of funding also has meant that the global and regional development banks have been able to respond in a more robust and structured manner than the sub-regional development banks. This may signal that in those banks where the involvement of countries of the North is low, bank performance is also diminished.

    Lending focus: Another pertinent issue is that the banks tend to concentrate mainly on lending to states. Admittedly, the role of governments is critical in the provision of facilities for education, health, research and other public utilities, as well as for the regulation of excesses. But the bulk of economic activity in terms of manufacturing and job creation is driven by the private sector. Yet, apart from the World Bank and some of the regional development banks, very little attention has been placed on private actors. The existence of the IFC as a private sector arm of the World Bank is an approach worth emulating by the other banks.

    Red tape: The issues related to the private sector also are linked to problems of red tape. Some practices are confined by needless red tape that makes it very difficult for client states and firms to accede to their credit lines. This problem is also connected to a strong sense that — apart from the World Bank and regional development banks — the banks do not communicate what they do to the public; people tend to be ignorant of the existence and actions of the bank. This is linked to the nature of the benefits of the actions of the banks.None of the banks has entertained the option of, or implemented mechanisms for, directly funding household projects at no or very low cost in terms of interest rates. In this regard, it would be advisable for the banks to revisit the model of the Islamic Development Bank that tends to respond directly to the socio-economic and human needs of the population.

    Business as usual?

    Worryingly, there has been little serious discussion by the banks on rethinking the model of finance that engendered the crisis in the first place. The Islamic Development Bank has a model that frowns on the speculation and excessive credit that brought the global financial system to its knees. Yet there has been no serious engagement regarding how such an approach could be widened and adapted in other contexts.

    Finally, while it is true that the emerging countries are demanding, and gaining, more privilege because of their increasing economic clout, this has not developed into real influence in the development banks due to these countries′ lackadaisical or passive involvement with the development banks. The USA, Japan and other Western nations remain the dominant players in the global and regional development banks, while local hegemons (leaders or forces) remain critical in the various sub-regional development entities.

    In conclusion, the crisis helped to expose the important role that development banks play in addressing specific concerns of countries facing liquidity shortfall. Moving forward, it makes more sense for the banks to enhance coordination in their operational modalities so as to minimize needless duplication of services. But collaboration by the banks can also be extended to the manner in which they source funding. Inter-bank lending needs to be promoted, and development banks could equally be encouraged to join efforts when accessing financial markets and even sovereign wealth funds to secure capital.

    Importantly, it makes little sense to access capital that cannot be aptly mobilized to directly impact the lives of those in need. That is why reducing red tape in allowing private entities access to resources of the banks will add value to the important work that they do.

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    This article is based on a paper presented at the Suffolk Law School for the conference on Post-crisis International Financial Regulation: Fragmentation, Harmonization and Coordination held on 2 December 2011. The paper is downloadable from the sidebar on the right.