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1.6 DEVELOPMENT BANKING

1.6.1 The Different Types of Development Institutions

We have mentioned development banking a few times. It would be interesting now to give some historical perspective, some names, and specific business models.

The term development is fraught with ambiguities and even its intent, which should be straightforward, is often questioned–sometimes even violently.

After the end of World War II it was thought that the mandate of supranational organizations, which had proved ineffective after World War I to prevent the following one, should be strengthened with an economic activity geared toward reconstruction, development, and financial stability. At the Bretton Woods agreements of 1945 the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD) were created. Although the most important outcome of the meetings was probably the system of foreign currency exchanges (in practice a worldwide pegging system that lasted until 1971 when the United States stopped converting dollars into gold), as far as we are concerned the creation of the two institutions is crucial for us as it marks the beginning of development banking.

The IMF and the IBRD both lend only to sovereign entities, but they do so with two distinct missions: the IMF's objective is financial stability, the IBRD's objective is the reduction of poverty. When it comes to lending, providing funds is only half of their activity, the second half consists of offering advice. The IMF would offer a loan to a country and at the same time offer advisory services on how to straighten its finances;[1] the IBRD would offer a loan to a country with the idea of, say, building a road and it would also send infrastructure specialists to advise the country on how best to invest the loan amount.

The crucial difference between the IMF and the IBRD, as far as the source of the money disbursed in the form of loans is concerned, is very important and represents roughly the two broad categories in which development institutions fall. The IMF lends money it obtained either through the shares sold to its member countries[2] or through donations. The IBRD, like any normal bank, funds its loans in small part through equity, but for the majority through debt. This means that the IBRD first needs to borrow in order to lend.

The different source of funds means that the lending is itself different: whereas the rate paid on IBRD loans is driven purely by the cost of funding the IBRD itself, the rate paid on IMF loans, since there is no real cost of funding to speak of, is based on other criteria.

Other development banks originated through the years. Belonging with the IBRD to the World Bank Group, the International Financial Corporation (IFC) lends to corporate entities and it falls in the category of institutions issuing debt; also part of the World Bank Group, the International Development Association (IDA) falls instead in the category of institutions funding loans through equity and donations. Founded in 1960 when most African countries gained independence, IDA only lends to the poorest countries while the IBRD lends to middle-income countries (apart from a few exceptions, countries do not receive loans from both institutions). IDA loans charge a very low interest rate. Falling in the category of debt-issuing institutions, one could mention the Asian Development Bank (ADB), the Inter-American Development Bank (IDB), the European Investment Bank (EIB) with connections to the European Union, and the European Bank for Reconstruction and Development (EBRD), founded in 1991 with a large focus on the countries of the former Soviet block.

The IBRD played a major role in the post-war reconstruction and some of the first loans went to France and a war-ravaged Japan. The marvel that is the Japanese high speed rail system was built in the 1960s using an IBRD loan (after which Japan stopped being a receiver of loans and instead, through its vast network of retail banks, became a great investor in IBRD bonds). Despite development institutions being often criticized (more or less soundly; see for example Weaver [83], Babb [5], or Peet [69]), an alternative to an institution with an excellent credit standing, great risk aversion, and governed by large consensus within what can be described as a credit cooperative has not yet been proposed.

  • [1] Since the receiving country cannot accept the loan without the advice, this is the controversial aspect of the IMF's mission.
  • [2] When member countries joined the IMF, they bought a form of share that corresponded to their respective voting power.
 
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