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The World Bank and International Development Lenders

Author: Andrew Hansen
June 1, 2007
This publication is now archived.

Introduction

Development banks are international financial institutions that specialize in providing loans, grants, and financial expertise to developing nations. The largest and best known is the World Bank. Founded for post-World War II reconstruction in Europe, today the Bank focuses on poverty reduction, stimulating growth, building infrastructure, encouraging foreign investment, and fighting corruption in developing nations. The scandal that led to the resignation in May of President Paul Wolfowitz cast a spotlight on the Bank. Yet the institution was already grappling with questions about its relevancy and the need to compete with other sources of development income.

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What is the World Bank?

The term “World Bank” refers to two Washington-based institutions run by 185 member countries—the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA). The IBRD serves middle-income countries with a per capita income from $1,025 to $6,055, while the IDA helps the world’s eighty-one poorest countries, with incomes less than $1,025 per capita.

The World Bank emerged from the Bretton Woods Conference, which created postwar international financial structures, including the International Monetary Fund. The IBRD made its first loan of $250 million to France in 1947. The end of postwar reconstruction and the realization that the poorest nations needed softer terms for loans led to the creation of the IDA in 1960 (PDF). The first IDA disbursements, known as credits, were approved in 1961 to Chile, Honduras, India, and Sudan.

What does the World Bank do for developing countries?

Many developing countries seem risky to private investors because of economic or political instability. Richer member countries guarantee that World Bank loans will be paid back, effectively eliminating this risk. “What makes them attractive in the first place,” says development economist Claudio de Moura Castro, “is the financial architecture that allows poor countries to borrow at about the same rates that rich countries do.”

The Bank provides services in three ways:

  • Long-term loans.These are normal loans provided to developing nations made at market interest rates.
  • Credits.These very long-term loans are provided at well below market interest rates and are funded largely by direct contributions from donor governments.
  • Advice and technical assistance. The Bank also provides development expertise and economic research, as well as evaluations of existing financial institutions.

The World Bank website says loans by the IBRD and the IDA totaled $23.6 billion in 2006. The Bank’s philosophy shifted several times in the 1990s. In the Washington Post CFR’s Sebastian Mallaby describes how the Bank shifted from free-market orthodoxy to skillfully implementing development projects and allowing borrowers more say in setting development priorities. By the end of the 1990s, the Bank shifted again by prioritizing institution building and corruption fighting.

Where does the World Bank get its money?

At its establishment, the institution’s initial forty-one members provided the IBRD authorized capital of $10 billion. Now, the IBRD raises money on world capital markets by selling bonds to investors. The amount of capital raised varies from year to year and is currently $10 to $15 billion. IBRD bonds have a triple-A rating (PDF), according to Standard and Poor’s rating service, due to guarantees on loans from shareholding countries. The returns, plus the small profit from loans, pay the Bank’s operating costs and an annual transfer to the IDA.

The IDA is funded by direct transfers from the richest member countries in thrice-yearly replenishments of the fund. The United States is the largest contributor historically at 22 percent of the budget. Such donations account for 70 percent of the IDA’s funding; its remainder is provided by repayments from borrowers and investment income.

What are the criticisms of the World Bank?

Several criticisms occur repeatedly:

  • Conditionality. Borrowing countries are required to meet certain conditions before receiving aid, usually involving liberalizing markets and privatizing nationalized industry—economic tenets of the “Washington Consensus.” These conditions, argues the Bretton Woods Project a self-described watchdog of international financial institutions, impose economic doctrine that doesn’t take into account a country’s specific circumstances. A 2005 World Bank report questioned the overall effectiveness (PDF) of conditionality.
  • Environmental Damage. Others say the World Bank doesn’t take environmental damage and the displacement of indigenous populations into account when considering Bank projects. In her book, Masters of Illusion: The World Bank and the Poverty of Nations, Catherine Caufield describes the plight of indigenous populations displaced by Bank projects. Katherine Sierra, World Bank vice president of sustainable development, describes the steps the Bank is taking, including the Global Environment Facility,  to lower the environmental costs of projects.
  • Defensive Lending. Caufield also criticizes the Bank for keeping nations from defaulting on loans by providing additional loans. “This so-called ‘defensive lending’ papers over both the poor quality of the Bank’s lending practices and the consequent growth in debt among its borrowers.” The World Bank responds that the burden of this repeat lending doesn’t present an insurmountable problem to countries with responsible policy (PDF).
  • Voting Rights. Decision-making power for each of the Bank’s institutions is based on a member state’s financial contribution. Some argue this gives disproportionate influence to the United States, which holds 16.45 percent of votes. Since any changes to the Bank’s Articles of Agreement require an 85 percent majority decision, the United States essentially maintains veto power (PDF) over any major decisions.
  • Corruption. Upon becoming president of the World Bank in 2005, Paul Wolfowitz declared his priorities would be fighting corruption among countries that received aid, and strengthening the work of the Department of Institutional Integrity, the Bank’s corruption-fighting arm. Some saw Wolfowitz’s appointment as a much-needed agent of change in an increasingly ineffective and bloated bureaucratic institution. His downfall, ironically brought about by corruption allegations, may accelerate or retard the progress of anticorruption measures under his successor (WashPost). This Backgrounder examines the problem of corruption at the World Bank.
What are some of the Bank’s successes?

Despite many criticisms, “the Bank is still a better aid institution than any of the alternatives,” argues the Economist. “It has global reach and a staff who … are still the best in their field.” Since 2002, twenty-seven countries have graduated from the IBRD, and the Bank cites thirty-two poor countries that have graduated from the IDA since 1960, meaning that they no longer borrow from the Association. However, some have returned to borrowing after a short time.

What are other multilateral development banks?

Multilateral development bank (MDB) is a term used to describe supranational financial institutions, like the World Bank, that provide low-interest loans, credits, and technical advice. Four regional development banks are based largely on the World Bank’s structure. Development economist Stephany Griffith-Jones points out, “in the regional and subregional development banks the borrowing countries tend to have a stronger degree of decision making power than they do at the World Bank,” and thus a greater degree of legitimacy (PDF) in the eyes of borrowing nations. The following MDBs work closely with the World Bank to coordinate their development strategies (PDF):

  • The African Development Bank. Established in 1964, this MDB has fifty-three African members and twenty-four non-African members. Its loans totaled $3.4 billion in 2006. The bank nearly collapsed in the mid-1990s, after corruption, mismanagement, and internal disputes caused Standard and Poor’s to reduce the bank’s bond rating.
  • The Asian Development Bank. Created in 1966, the Asian Development Bank has sixty-seven members, forty-eight from the region and nineteen from other parts of the globe. It provides development aid and advice to Asian and East Asian countries, including pledges of up to $1.5 billion to Afghanistan for reconstruction efforts. A recent report (PDF) from a group convened by the ADP called for the bank to focus more on knowledge and financial assistance for middle-income countries, citing the success of the “Asian Tiger” economies (FT).
  • The European Bank for Reconstruction and Development is owned by sixty-one countries and was created in 1991 to help ex-Soviet countries transition to market economies, and has since invested more than $21 billion in the region. It has also helped these countries meet the standards for EU accession (PDF).
  • The Inter-American Development and Bank (IADB) Group. Created in 1959 and owned by forty-seven member countries, the IADB promotes development in Latin America (PDF). At 50 percent, smaller countries have a much greater share of voting power, which is based on ownership of the capital stock, than they do in the World Bank.
What challenges face the World Bank?

Robert Zoellick, former U.S. trade representative, will take the reins of the Bank in the wake of the Wolfowitz debacle. But some argue that the travails of the Bank’s president weren’t the problem. Writes Justin Fox in TIME, “The bigger issue is that the Washington-based Bank and its sister organization, the International Monetary Fund (IMF), are struggling to justify their continued existence.” The expansion of global capital markets, and new willingness by investors to face risk, challenges the Bank’s position as the preeminent global lender to the developing world.

 “There are other rivals out there that will provide money for development,” says CFR’s Sebastian Mallaby in an April 2007 podcast. Indeed, China has massive foreign exchange reserves and is willing to lend to Africa without the added conditions of democratization and human rights. Development expert Jeffrey D. Sachs suggests that investment by private philanthropists could make a huge impact on global development. “There are 950 billionaires (Australian),” he says, “whose wealth is estimated at $3.5 trillion. An annual 5 percent

‘foundation’ payout would be $175 billion a year—that would do it. Then we don't need the G8 but 950 people on the Forbes list.” Several South American nations are considering a Bank of the South as an alternative to “U.S.-dominated instruments for development finance.”

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