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June 1, 2007
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.
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.
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:
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.
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.
Several criticisms occur repeatedly:
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.
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):
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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