AIIB, NDB and the enforcement mechanism of the Bretton-Woods System

The new BRICS bank, officially called the New Development Bank (NDB, to be headquartered in Shanghai and first to be run by an Indian), has been launched at the sixth summit of the BRICS countries, held in Brazil in July 2014. I hear that it is making relatively slow process. So China has been pursuing recently the creation of yet another multilateral development bank (China-led), the Asian Infrastructure Investment Bank (AIIB), with registered capital planned at $100bn initially double the size of the BRICS bank. By end October 2014, 21 Asian countries – including India – had signed the Memorandum of Understanding on Establishing AIIB. AIIB will be formally established by the end of 2015 and headquartered in Beijing.

The establishment of BRICS-led multilateral development banks (such as the BRICS bank or the AIIB) will be beneficial for global development to the extent that it helps close infrastructure financing gaps and that it helps rebalance representation of the non-OECD countries on the multilateral scene that remains very much US-scripted. The new banks may even speed up ´voice reform´ in the Bretton-Woods institutions – so far effectively hindered despite all rhetoric by the West[1]. However, their very existence makes that reform now less important than in the past when the established MDBs (World Bank, ADB, AfDB, IDB) were the only important sources of infrastructure finance for many poor countries.

In a broader setting, the establishment of multilateral development banks outside the established Bretton-Woods system can be viewed as China´s shadow global diplomacy^[2] that aims at undermining US-led governance structures established after WWII. Competition is building for the existing Bretton-Woods system.

So it does not come as a surprise that the US lobbying against those banks.^[3] Jane Perlez (2014) cites a senior Obama administration official: the Treasury Department had concluded that the new bank (here the AIIB) would fail to meet environmental standards, procurement requirements and other safeguards adopted by the World Bank and the ADB, including protections intended to prevent the forced removal of vulnerable populations from their lands. By contrast, the ADB has become so encumbered with restrictions that it now takes up to seven years on average for a project to go from proposal to approval to completion, the official said. Consequently, a shift of multilateral lending toward would not only speed up ´voice reform´ but also the financing and building of infrastructure, possibly (not necessarily) at costs for the environment and habitats.

Another concern, not publicly discussed yet to my knowledge, is that the establishment of alternative source of multilateral funding will act to weaken the enforcement mechanism of the existing MDBs. They might as well lose their preferred creditor status^[4]. Willem Buiter and Steven Fries (2002) had discussed this after the EBRD had been created: A basic mechanism for fostering compliance with the terms and conditions of MDB loans to the public sector involves the dynamic incentives that arise from the repeated interaction between borrowing governments and the MDBs[5]. The potential for repeated loans, together with the credible threat to cut off future lending when terms and conditions are not met, can be exploited to help ensure borrower compliance. The incentive mechanism arising from repeated interactions is more effective when borrowers face limited access to alternative sources of financing. Therefore, it must indeed be envisaged that the incentive for borrowing countries to comply with the terms and conditions of, say, IDA loans will diminish as the end of the lending relationship nears and is replaced by loans from the AIIB or the BRICS bank.

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[1] Vestergaard, J. and R. H. Wade (2013), “Protecting Power: How Western States Retain the Dominant Voice in The World Bank’s Governance”, World Development, Volume 46, June, pp. 153-164.

[2] Rudolf, M., M. Huotari und J. Buckow (2014), „Chinas Schatten-Außenpolitik: Parallelstrukturen fordern die internationale Ordnung heraus“, MERICS China Monitor No. 19, Berlin, 23. September.

[3] Jane Perlez (2014), „U.S. Opposing China’s Answer to World Bank”, The New York Times, 9^th October.

[4] The term means that the obligations to MDBs by both sovereign borrowers and private entities have a priority claim and treated as senior to those of bilateral and commercial creditors.

[5]  Buiter, W. and S. Fries (2002), „What Should the Multilateral Development Banks Do?”, EBRD Working Paper No. 74, European Bank for Reconstruction and Development, London, June.