Column: A development bank for developing nations

Written by Madan Sabnavis | Updated: Jul 18 2014, 08:09am hrs
The creation of the BRICS bank, named the New Development Bank, is good news for the developing countries which are on the lookout for funds to support their requirements. It does appear that the politics of the issue has been addressed and the task ahead is to get the enterprise moving and start operations.

The need for such a bank was compelling, given the funds required by the emerging markets to support infrastructure growth. The range of funding required has been put at $1-2 trillion over a period of time; and pooling resources is the right way out. There is a feeling that the hegemony of the West came in the way of funding from institutions like the World Bank and there was a need to look at the same from the point of view of a developing economy. The issue of conditionality was controversial as, often, loans were subject to changes in the policy framework instituted to provide a safeguard against improper use of funds. This was considered to be lopsided as it represented the Western view. The concept of a bank coming from the emerging markets looks good in this context. African Development Bank and Asian Development Bank served the interests of continents but still carried forward the ethos of the West.

The getting together of the five leading developing nations is attractive as they had a combined share of around 20% of the global GDP in 2013 (IMF). However, all the nations are quite different in terms of politics, economic structures and governance. The concept of BRICS is more notional as these are countries which are geographically spread out with little competitive advantage in terms of distance or physical contiguity. Hence, this experiment will set a new financial trend.

The funding is to come from the initial capital of $50 billion that can be raised to $100 billion. There is the provision for a contingent reserve fund of $100 billion which will not be equally distributed among these nationshere China will contribute the largest share. This would be a funding facility analogous to IMFs, made available to deal with fundamental problems that come up like the US tapering programme.

Against this capital, the New Development Bank (which can be called NDB till a formal name is accorded) can borrow multiple times from the market to shore up its funds. Intuitively, with a capital of $50 billion and a CAR of 10%, it can lend up to $500 billion which will build up until such time that the organisation earns money which is redeployed. A capital of $100 billion will mean an asset book of $1,000 billion ($1trillion) depending on the CAR adopted by the bank.

Will countries or ventures come to NDB for funds There will definitely be demand for such funds given that there are several projects that are not getting funds domestically. The NDB could also be opened to extend lending to non-member countries at a later date. Also, there will be migration of ventures which are looking at the Western multilateral agencies for funds to NDB, if the latters terms are favourable. Today, there is the choice of using FDI, ECBs and bilateral funds for funding projects depending on the cost. The reason countries or projects approach the multilateral institutions is that the cost is lower and the payback time is much longer.

While an organisational structure will have to be put in place for NDB, two issues stand out. The first is that NDB should actively tie up with regional banks. This becomes necessary for two reasons. The first is that the partner can act as a conduit for channelling funds to the ultimate borrowers. Further, there will be greater security for NDB if it is done this way rather than the bank lending directly to infra companies.

Second, the role of credit rating agencies would be vital as the rating assigned to the country, channelling bank/FI entities funds be critical for NDB. Here, the creation of alternative rating companies in the emerging markets would be important. The setting up of ARC Ratings is such an initiative. ARC Ratings is a credit ratings agency (CRA) with 5 CRAs, of which 3 are from BRICS nations (India, South Africa and Brazil), functioning as equal partners. As there has been a clamour for more competition in the rating space, such an initiative matches the needs of a development bank which is free from the influence of the developed countries. In fact, any borrowing by the NDB, which would be necessary to build volumes, should be rated by the non-Big 3 rating companies to ensure a fair assessment.

Three challenges remain for NDB. First, while it is agreed that the conditions put by World Bank or IMF might be one-sided, can the NDB afford to lend without any such conditions, considering that the inherent risk is high when the economies are in the early- to middle-stages of development

Second, while the amounts disbursed would be large given the size of the projects, the monitoring mechanism has to be strong across the countries.

Third, given that political ideologies are very different for the partners, will such a venture be resilient to public opinion or clash with other global institutions where these member shareholders also voice an opinion For example, a perceived invasion of Ukraine by Russia may not be acceptable to the other partners in a UN forum and hence would create ideological differences in such a financial venture. Or for the matter, the border issues of India with China can cause friction. Also, the possibility of China, which certainly has the largest financial power, pushing its own way would have to be sorted out.While the five partners have an equal share in the equity, the reserve fund is already dominated by China whose stake stands at 41%.

Given the large supply-demand gap, this venture needs to be operationalised soon, with a clear mandate. The success will lead either to more countries joining in, or similar regional development banks coming up. Whichever way it goes, more competition and more funds would always be beneficial for the system.

The author is chief economist, CARE Ratings, the India partner of ARC Ratings. Views are personal