The future of development finance and global economic governance: the impossible trilemma for the new Multilateral

Development Banks

Luiz Pinto1

Luma Ramos2

Marcos Reis3

AREA 1: MACROECONOMIA, POLÍTICA ECONÔMICA E FINANCIAMENTO DO DESNEVOLVIMENTO

ABSTRACT

This paper discusses two new Multilateral Development Banks (MDBs): The New Development Bank (NDB) and the Asian Infrastructure Investment Bank (AIIB). We observe that the recent transformation of the world economy, with the emergence of developing nations, has not been met with a comparable change in global economic governance, widening the gap between the world’s economic reality and the most central Intergovernmental Organizations. The lack of participation in global decisions and actions and desire of develop an institutionalized financial mechanism in these countries led to these banks. It will be argued that the NDB and AIIB can play important duties. On one hand, they can play a role in diminishing current flaws in global economic governance – distortion, incompleteness, and inelasticity – and kick-start the reshaping of the current economic system to a more “South-South” design. On other hand, they can be a potential source of capital and knowledge for new investment projects. But there are some concerns about the interaction between current objectives/principles, ''best practices'': the paper proposes the existence of a trilemma between i) the use of standard risk management, ii) transparency in their activities and iii) be faster and much less bureaucratic than other MDBs. It concludes that even though the new MDBs can play an important role regarding the current main flaws of the international development finance, they might face the proposed trilemma.

KEYWORDS: BRICS; New Development Bank; Asian Infrastructure Investment Bank; South-South relations; Multilateral Development Banks.

1. Introduction

This paper details an interesting and important idea for approaching the role of Multilateral Development Banks in a fresh global economic governance scenario. In the last decades, not one trend in international economics and politics has been as remarkable as the fast growth and increased economic and political strength experienced by emerging countries. According to IMF, from 2000 to 2013, the share

1 Joint Fellow, Brookings Doha Center-Qatar University. 2 PhD candidate at Institute of Economics at Federal University of Rio de Janeiro (IE/UFRJ), Brazil. Contact: luma.ramos@ppge.ie.ufrj.br3 Postdoctoral researcher at the Institute of Economics at the Federal University of Rio de Janeiro (IE/UFRJ), Brazil.

of developing economies in the world’s total GDP has grown from 41% to 55%, while their participation in international trade rose from 23% to 40%, and foreign official reserves from 35% to 70% (IMF).

On this subject, Brazil, Russia, India, China and South Africa (BRICS) were privileged players. IMF evaluated that their collective GDPs represent 27% of the world’s GDP at PPP. BRICS’ financial power has also increased at a fast pace. They currently hold more than U$5 trillion in global foreign exchange reserves and are responsible for 15% of the total Foreign Direct Investment (FDI) outflow.

The transformation of the world economy, however, has not been met with a comparable change in global economic governance (henceforth, GEG), widening the gap between the world’s economic reality and the most central Intergovernmental Organizations (IO) in GEG. In other words, the “economic convergence” did not result in an “international governance convergence” at the same level.

The Bretton Woods Institutions...These agencies have experienced relatively little change in the last decades, despite the enormous transformation that occurred in the world economy. There is not just a lack of effectiveness, resources, and instruments in the traditional economic multilateral institutions, but also a shortage of representativeness and legitimacy.

In this scenario, new multilateral development banks are being proposed. Among them, there are the New Development Bank (so-called BRICS bank) and the Asian Infrastructure investment bank (AIIB). The BRICS are a group of countries that want to play a central role in ensuring more participation for developing countries in decision- making processes. In this context, the NDB could emerge as a critical platform to support the economic agenda and develop global policies, as well as improve integration and cohesion among its members. Being formed by leading emerging countries from four different continents, the bank has global objectives, not merely focusing its attention some specific sub region or region. Meanwhile, the AIIB is an initiative from heterogeneous countries. Are these initiatives going to be competitive or complementary? What are the main challenges faced? What changes expect from their participation in global economic governance?

The main findings of this paper are the following. First, emerging countries seek to change and align global governance structures therefore, the creation of new MDBs is a desired initiative. Second, the two banks analyzed here can play different and complementary roles. In that sense, they can contribute for a more “South-Led” global system of economic institutions. Lastly, there are possibilities for further integration between the two banks, fostering the relationship among the BRICS and Asian participants. However, there are some uncertainties about their place and weight in the international context and concerns about the interaction between current objectives/principles: ''best practices'', effectiveness and transparency in their activities and an intended to be a different kind of multilateral development bank, faster and much less bureaucratic; it's a governance trap. We will argue that NDB and AIIB cannot pursue these three objectives simultaneously.

This article aims to discuss these two new multilateral development banks, their

challenges and how these institutions can effectively contribute to provision of resources. It is structured as follows, after this brief introduction; section 2 reviews the current state of multilateral development banks and the representativeness of developing countries in the GEG. Section 3 presents the creation of the New Development Bank and the Asian Infrastructure Investment Bank. Section 4 discusses the potential roles of both banks, their singularities and challenges. Finally, section 5 presents our main findings and conclusions.

2. The roles of Multilateral Development Banks and the Global Economic Governance

Multilateral development banks (MDBs) are international institutions that provide financial assistance, typically in the form of loans and grants, to developing countries, in order to promote economic and social development. Their aim is to provide investment finance in human and physical capital. Usually, MDBs finance projects in the form of long-term loans at market rates, very-long-term loans below market rates, and through grants.

The year of 2014 marked the 70th anniversary of the establishment of modern-day multilateral development finance. The United Nations Monetary and Financial Conference, commonly known as the Bretton Woods conference, agreed on the establishment of the International Bank for Reconstruction and Development (IBRD), which has evolved into the five institutions that make up the World Bank Group and the International Monetary Fund (IMF). The two institutions were intended to finance the reconstruction of those countries devastated by the Second World War and stabilize the world economy. Both became operational in 1945 (Wihtol, 2014).

During the following decades, multilateral development finance has evolved dramatically. From the initial two institutions, the world now has a multitude of development banks and funds. These include what are commonly known as multilateral development banks (MDBs), a variety of sub-regional banks, funds and several specialized vertical funds. Large private foundations with a focus on development have also recently emerged. The following institutions are usually classified as the main MDBs:

- World Bank (WB); African Development Bank (AfDB); Asian Development Bank (ADB); Inter-American Development Bank Group (IDB); European Investment Bank(EIB); European Bank for Reconstruction and Development (EBRD); Development Bank of Latin America (CAF) and Islamic Development Bank (IsDB)

There are also several "sub-regional" multilateral development banks (SRMDBs). Membership, typically - but not necessarily -, includes only borrowing nations. Banks lend to their members by borrowing from international capital markets. Because there is a shared responsibility for repayment, banks can often borrow at much lower rates than any member nation alone could achieve. The main ones are:

- Caribbean Development Bank (CDB); Central American Bank for Economic Integration (CABEI); East African Development Bank (EADB); West African Development Bank (BOAD); Black Sea Trade and Development Bank (BSTDB) and Eurasian Development Bank (EDB)

During their first few decades of operations, these MDBs financed public sector infrastructure projects through the provision of sovereign loans primarily to developing countries. The rapid development of international capital markets in the 1990s and the recent experiences of developing countries and transitional economies have prompted many reassessments of the roles of MDBs. The growth of global private capital flows and the development of domestic financial systems have expanded access to commercial finance by governments and private entities alike (Buiter & Fries, 2002).

During the global financial crisis started in 2008, many development banks – including MDBs – played a countercyclical role by providing credit to private firms that were temporarily unable to access funding from private commercial banks or capital markets. As Birdsall (2014) points out, this movement has renewed the interest of policy-makers from different jurisdictions on the roles of development banks during times of distress.

However, as argued by Woods (2014), in the aftermath of the 2008 global financial crisis, GEG seems not to be responding to the demands highlighted by the crisis. Among them: i) institutions that can rapidly allocate resources to prevent countries from collapsing and, ii) globally inclusive institutions that grant more power to developing countries.

If the necessity of financing for developing countries is clear, why private financial institutions do not assume this role? There are several reasons4. Buiter and Fries (2002) stress two general characteristics that distinguish MDBs from private financial institutions and bilateral donors: (1) their multilateral shareholding structure and preferred creditor status, and (2) a subsidized capital base and access to other subsidies. In addition, its necessary to highlight that MDBs are superior to private finance in providing counter-cyclical finance when private flows dry up, as well as in helping to develop market instruments that can better share risks through time between borrowing developing countries and foreign investors (Griffith-Jones, et al. 2008).

It is important to stress that MDBs do not support countries only by lending money. According to Chelsky et al. (2013), among the several ways that this support occurs, the main ones are: i) Direct financial assistance from MDBs; ii) Indirect financial assistance; iii) MDBs Non-financial project assistance and iv) MDBs improving the investment climate. In this sense, Ocampo (2013a) identifies four different roles played by distinct MDBs: i) grant access to finance for countries that lacked it; ii) poverty reduction; iii) provide counter-cyclical financing when private financial markets dry up and iv) foster the development of private sector financing.

The combined capitalization of MDBs and smaller development banks in 2014 was approximately $1.1 trillion (Withol, 2014). The number, although expressive, is far

4 According to Griffith-Jones et al. (2008), several of the problems of international private finance arise from financial market imperfections that are an obstacle for delivering essential finance critical for development and for financing “regional public goods”. These includes: i) asymmetries of information, ii) complementarities and iii) market failures or imperfections specifically linked to infrastructure.

from what is actually needed. Even though current MDBs already provide a significant amount of resources, developing countries need much more. For instance, regarding one of the most critical points, infrastructure, it is estimated that US$57 trillion are required until 2030 in order to keep pace with projected global GDP growth (McKinsey Global Institute, 2013). In regards to developing countries only, the World Economic Forum (2012) estimates that close to US$2 trillion per annum will be required to meet infrastructural needs by 2030. (Moore and Kerr, 2014)

Inadequate infrastructure hampers production and competitiveness, especially in developing economies. About 60% of the world’s infrastructure stock is located in high-income countries, 28% in middle- income countries and only 12% in low-income countries (OECD, 2013). In contrast, according to World Bank data from 2013, population shares were divided as 15%, 72%, and 13%, respectively. In sum, even with current existing MDBs playing an important role on providing development financing, there is great need for additional sources in order to meet developing countries’ necessities.

Another critical point relates to the governance structures of current MDBs. Developing countries are underrepresented in voting shares in all the major MDBs. Taking the World Bank as an example; developing countries have – after the last reform in 2010 – only 47% of total voting power. The BRICS, the countries besides the creation of the New Development Bank (section 3.1), and some of the major economic global players hold only 13.1% (Table 1).

Table 1 – World Bank (Voting Shares in percentage of total votes)

Country Pre-Phase Voice Reform Phase 1(ii) Voice Reform BRICS 11,26 11,21 13,1Developi 42.6 44.05 47.1

Source: World Bank. (i) Pre-2008 scenario. (ii) Reform agreed in 2008. (iii) Reform decided in 2008 that it was expected to be implemented by spring 2011, but it was anticipated for April 2010.

At the International Monetary Fund, another main IO, the situation is similar. The current quota formula is a weighted average of GDP (weight of 50%), openness (30%), economic variability (15%) and international reserves (5%)5. After the last reform, in 2010, developing countries remained with only 44.8% of total votes. The formula clearly benefits developed countries, since they commonly present higher levels of openness and lower economic volatility. In contrast, international reserves, which are heavily concentrated in the hands of emerging markets (as section 4 will discuss), receive a low weight.

MDBs’– and other central IOs, such as the IMF – ownership structures and governance arrangements reflect the economic dominance of advanced countries at the time in which they were founded. Nowadays, the reality is that developing countries, as a group, have a much larger and growing participation in the global GDP. As Birdsall (2014) notes, traditional powers’ continued dominance over existing institutions had

5 For this purpose, GDP is measured through a blend of GDP—based on market exchange rates (weight of 60%)—and on PPP exchange rates (40%). The formula also includes a “compression factor” that reduces the dispersion in calculated quota shares across members. Quotas are denominated in Special Drawing Rights (SDRs), the IMF’s unit of account.

the effect of discouraging developing nations from fully engaging in the policies, leadership choices and financing methods of these organizations.

This can be interpreted as a consequence of the maintenance of a structure that was created at the end of the WWII and has been kept relatively unchanged until nowadays. The Global Governance conceived at the time and its evolution since them resulted in the creation of international regimes and global institutions that are not necessarily inclusive for emerging countries. Hence, there is still a vacuum of legitimacy, equality, democratic accountability and subsidiarity in the existing Global Governance.

Nowadays, IOs, such as the MDBs, divide space with many other organizations, for example, groups of interest, as the G-7 and G-20, trans-governmental bodies (BIS, for instance), NGOs and transnational organizations. However, even with a dense and complex system, the current GEG still suffers from the same problems as other “governance” structures do. The root of this issue lies in the three main structural flaws: distortion, incompleteness, and inelasticity.

Distortion refers to the imbalance of power that exists between some states along with their social forces and their counterparts. There is a “hierarchy” in the financial system that is also observed at the economic governance level. Groups closer to the apex of the system tend to benefit from this situation and have disproportional power in making decisions (Pistor, 2013). In this manner, global governance veers towards reinforcing existing inequalities.

Incompleteness relates to the point mentioned above about the gap between the amounts needed to finance developing economies and what is currently provided. These economies do not have the same possibilities to access international financial markets – especially in relation to long-term funding – as developed countries do, thus they are more reliant on the effectiveness of MDBs and other IOs to match their

funding necessities. In addition, as argued by Ocampo (2013b), it is essential that the economic governance should also include two objectives: macroeconomic and financial stability. This points out, not only the lack of funds and available credit, but also the absence of coordination in the pursuit of common goals among participants of the GEG.

Finally, inelasticity consists of institutional “stickiness” to changes in global economics and politics. As Table 1 showed in the case of the World Bank, changes in IOs are usually very slow and do not happen in the same pace as changes in the economic and political scenario. Since the voting structure represents the agreement of those who held a commanding position during the moment of the agreement, the tendency is to postpone for as long as possible the necessary changes. Therefore, Global Economic Governance does not mirror the current balance of power; it is not merely unequal, but also inelastic.

Summing up, there are two broad scenarios for the future development of the multilateral architecture. The first is the reform of the current system — including significant changes in the financing and decision- making structures of existing MDBs to make room for an expanded role for developing economies within the system. The second entails a fragmentation of the current system and, in parallel with existing institutions, the emergence of strong multilateral and bilateral institutions

driven by emerging economies (Withol, 2014). Due to the previously discussed inelastic characteristic, it is more likely that emerging nations would become discouraged from pushing for reforms in the established system and will look for creating their own institutions. In fact, this is already happening. The next section will discuss two of these new MDBs: the New Development Bank and the Asian Infrastructure Investment Bank.

3. The New Development Bank and the Asian Infrastructure Investment Bank

This section will discuss two new MDBs. Among the other current initiatives for new MDBs6, why the NDB and the Asian Infrastructure Investment Bank are so special? The BRICS-led bank appears as the most outreaching of the initiatives and the one with more potential to impact GEG. Being formed by leading emerging economies from four different continents and counting with four of the ten biggest economies in the world. On the other hand, the AIIB is an Asian and Pacific regional initiative that has 52 countries members and has a deep cooperation and economic integration motivations. Besides that, it is expected that these banks must be leading institutions in the new GEG scenario. Discussions about the challenges of its implementation and its potential role in the region is imperative. The next section aims to analyze both proposals and identifying its complementary points.

According to Griffith-Jones (2012), South-South financial links have become far more important in the last decade7, as the significance of developing economies in the world economy has risen sharply, as have their levels of foreign exchange reserves and domestic savings. In fact, as pointed out by Yang and Mwase (2012), the BRICS already play an important role in this matter. They observe that the scale-up in public investment associated with BRICS‘development financing has benefited Low-income Countries by alleviating key infrastructure bottlenecks, boosting export competitiveness and making goods and services more affordable to consumers.

3.1 The New Development Bank (BRICS-led bank)

The New Development Bank – formerly known as BRICS Development Bank – was officially launched during the BRICS’ Summit in Fortaleza, Brazil on July 2014. The bank is set up to foster greater financial and development cooperation among the five emerging markets and other developing countries. Its objective is “mobilize resources for infrastructure and sustainable development projects in BRICS and other emerging economies and developing countries, complementing the existing efforts of multilateral and regional financial institutions for global growth and development”. (NDB, 2014a: 1-2) The bank will support public or private projects through loans,

6 There are other initiatives for new MDBs controlled by emerging countries. China has launched other initiatives to expand infrastructure financing for developing countries in Asia. In October 2014, 21 Asian countries agreed to establish a new Asian Infrastructure Investment Bank (AIIB) for which China will provide up to 50% of the initial capital. In November 2014 at the APEC Summit, President Xi also announced the creation of the new Silk Road Fund to improve connectivity in Asia, for which China will provide US$ 40 billion of capital (Biswas, 2015). 7 The movement got stronger but on contrary to common sense, it was already paramount. According to Griffith-Jones (2012), “The traditional analysis was that capital would flow from developed, capital-rich countries to poorer, capital poorer countries. In fact, this has never quite been the case, as net capital transfers from developing countries to developed ones have often been the rule, rather than the exception".

guarantees, equity participation and other financial instruments. In addition, will provide technical assistance for projects to be supported by the Bank.

Its initial subscribed capital will be US$ 50 billion and an initial authorized capital of US$ 100 billion, with 20% of that in paid-in capital. The five founding members will equally divide the initial subscribed capital, and consequently, the voting power (NDB, 2014a). Increases in the authorized and subscribed capital stock need to be approved by a “special majority8.” For instance, the World Bank Group9 – which is currently the largest MDB – has an authorized capital of U$280 billion and made U$33.35 billion in loans in 2014. The NDB will start with almost one-third of its capital, but the plan is to revise this number once the Bank passes its implementation phase.

The Bank will have its Headquarters in Shanghai, China, and may establish other offices necessary for the performance of its functions. The first regional office shall be in Johannesburg, South Africa. Looking for a balance of power between the members, the first president will be from India, the inaugural Chairman of the Board of directors will come from Brazil and the inaugural chairman of the Board of Governors will be Russian.

In 2016, the Board of Directors of the NDB approved seven investment projects in all member countries for a total of over USD 1.5 billion. All projects are coherent with the Bank's mandate of supporting infrastructure projects, with more than 75% of projects dedicated to sustainable infrastructure, mainly renewable energy generation.

According to Griffith-Jones (2014), after a period of twenty years, the bank could be lending US$34 billion annually, and the stock of total loans would reach almost US$350 billion. This will depend on the evolution of lending and, especially, the leverage ratio that the bank will adopt.

Membership will be open to borrowing and non-borrowing members. It means that developed countries can participate lending money, and emerging countries can either lend or borrow. Nevertheless, applicants must also be admitted by a “special majority”. According to NDB (2014a), developing countries will hold at least 80% of the voting power, relegating developed countries to a maximum of 20%, with a ceiling of 7% for the non-founding member. Additionally, the BRICS together can never have less than 55% of the total votes. Hence, it can be said the NDB will be an emerging markets ruled-bank.

This represents a breakthrough in relation to the established IOs. As discussed in section 2, developing countries currently hold 47.1% of the votes in the World Bank and 44.8% in the IMF. Despite the sustained efforts of developing countries to urge reforms of Bretton Woods, the pace of changes in the distribution of voting rights has been glacial, even while the status quo is distorted, most notably for China amongst the BRICS nations. For example, the US controls 16.75% of voting rights in the IMF while China, the world’s second largest economy, has 3.81%. Even France, with a GDP in nominal US Dollar terms around one-third the size of China’s in 2013, has

8 Special majority shall be understood as an affirmative vote of four of the founding members concurrent with an affirmative vote of two thirds of the total voting power of the members (NDB, 2014a) . 9 World Bank Group annual Report (2014).

4.29% of IMF voting rights, slightly more than China’s. The share of IMF voting rights of the BRICS as a whole currently totals 11.04%, whereas their share of world GDP is 21.2%. (Biswas, 2015)

However, in the NDB they will hold at least 80% of the voting power, relegating developed countries to a maximum of 20%, with a ceiling of 7% for a non-founding member. Additionally, the BRICS together can never have less than 55% of the total votes. The USA, for instance, has 15.69% of the total voting power in WB and 17.69% in IMF. Hence, it can be said the NDB will be an emerging markets ruled-bank.

As it is worded in the second item of the eThekwini Declaration, issued at the end of the Fifth BRICS Summit:

We met at a time which requires that we consider issues of mutual interest and systemic importance in order to share concerns and to develop lasting solutions. We aim at progressively developing BRICS into a full-fledged mechanism of current and long-term coordination on a wide range of key issues of the world economy and politics. The prevailing global governance architecture is regulated by institutions which were conceived in circumstances when the international landscape in all its aspects was characterized by very different challenges and opportunities. As the global economy is being reshaped, we are committed to exploring new models and approaches towards more equitable development and inclusive global growth by emphasizing complementarities and building on our respective economic strengths.

In addition, as summit President Jacob Zuma (2013) of South Africa put it, leaders agreed "to enter formal negotiations to establish a BRICS-led new development Bank based on our own considerable infrastructure needs, which amounts to around USD 4,5 trillion over the next five years, but also to cooperate with other Emerging Markets and Developing Countries in future." Leaders signed two agreements under the BRICS inter-bank cooperation mechanism: a multilateral agreement on infrastructure co-financing for Africa and a multilateral agreement on green economy co-financing. These are welcome extensions of the BRICS commitments to assist Africa, enhance the natural environment and control climate change.

Besides the NDB, the BRICS also created a $100 billion crisis-lending fund, called Contingent Reserve Arrangement10 (CRA). It is a framework for the provision of support through liquidity and precautionary instruments in response to actual or potential short-term balance of payments pressures. Dollar reserves of each country will remain on the balance sheets of their respective central banks. However, these reserves can be made available at the request of one of the parties.

A $100 billion fund is relatively small. In March of 2015, the BRICS countries controlled more than $5 trillion in international reserves. Thus, only 2% of the foreign reserves are committed to the fund. It is noteworthy that the fund was created only among the BRICS members. However, there is a possibility for other developing countries to adhere to it in the future, making the CRA a viable option for emerging markets to have access to foreign currencies during a period of distress.

With this fund, the BRICS are creating a possible alternative for the IMF. In situations 10 China will contribute with $41billion, Russia, Brazil and India with $18 billion each and South Africa with $5 billion. More information, see NDB (2014b)

of stress, members can look for funding within the group, diminishing the role of the IMF as a global lender of last resort. In the future, this fund can be made available for other emerging markets. In this way, developing countries will have the possibility to choose between the IMF loans and the CRA. The latter, being managed by non-developed countries, could impose fewer conditionalities on the borrowers. As Dixon (2015) observes, CRA can benefit from the extreme reluctance of very many countries to submit to the IMF’s conditionalities.

3.2 The Asian Infrastructure Investment Bank

The Asian Infrastructure Investment Bank was first proposed by Chinese President, Xi Jinping, in 2013, as a regional financing mechanism. At 2014, the bank was established by a Memorandum of Understanding signed by 21 countries. The total authorized capital was US$100 billion, with initial subscribed capital of $50 billion. After a long time of discusses, its activities started in January 2016, at Beijing, with welcomed 57 signatory countries.

Its Public Information Interim Policy pointed out that, the bank`s mission is to foster sustainable economic development and create wealth and improve infrastructure connectivity in Asia and to promote regional cooperation and partnership in addressing development challenges. AIIB`s strategic guidelines are: i) promote sustainable infrastructure and support countries to meet their environmental and development goals- energy efficiency, renewables, clean transport and other projects that help address global warming-; ii) prioritize cross-border infrastructure, ranging from roads and rail to ports, energy and telecoms across Central Asia, and the maritime routes in South East and South Asia, and the Middle East, and beyond; and iii) devise innovative solutions that catalyze and mobilize private capital, in partnership with other MDBs, governments and private financiers. In addition, AIIB could promote interconnectivity and economic integration in the region and cooperate with existing multilateral development banks, including the World Bank and the ADB11.

The AIIB has a governance structure similar to the other MDBs, with two key differences: the AIIB does not have a resident board of executive directors and the AIIB’s articles give a larger degree of decision-making authority to regional countries and the largest shareholder country, China (Callaghan and Hubbard, 2016). Now the institution has 40 regional members and 17 non-regional members, all with voting power, but different voting rights12 and capital amounts. According to the AIIB Articles, regional members hold 75% of the total voting power in the Bank. Fourteen of the G-20 nations are AIIB members.

Table 2 illustrates the composition of the AIIB executive board and the total share of votes of each constituency.

11 As pointed out by its main supporter Chinese President Xi Jinping, in the opening ceremony of AIIB in 2016.12 It has a transparent, predetermined formula to allocate capital and voting rights. The formula, with some minor adjustment, is based on a member’s GDP in current dollar (60% weight) and GDP adjusted by the purchasing power parity (40% weight). As it stands now, China contributes about 30% of the capital and is assigned 26% of voting rights. Therefore, China has the veto power on major decisions. However, if Japan joins the bank, China’s voting right will drop to about 23% and thus losing its veto power.

Table 2- AIIB board of directors

Source: AIIB and CRS.

It can be argued that this bank is an initiative to develop a formal institutional13 framework in the region. As show at ADB(2014), Asian diversity, development pattern, and global links have led to a unique model of regionalism, i.e. a dynamic, open, multitrack, and multispeed regionalism, with an aim to build a regionally integrated and globally connected Asia to enhance prosperity not only in the region but also in the rest of the world. Griffith-Jones(2016) also indicated that,

“[T]he AIIB has the opportunity to have a fresh look at the trade-off […] the overall development impact of projects, including how these vary by country, sector and mode of intervention, and the need to increase the speed as well as the scale of infrastructure investment. This practical and technical analysis is complemented by a broader exploration of what the AIIB could contribute to our understanding of development finance over time. Given the fact that it will be largely funded by developing and emerging countries, and these countries will remain in a voting majority, the AIIB is a valuable addition to the existing development finance landscape, which is comprised of institutions drawn from a similar historical process, and has traditionally been dominated by today’s developed countries, notably the United States (US), Europe and Japan. Establishing the AIIB as a ‘knowledge bank’, to which other developing and emerging countries can turn for a fresh perspective on how to finance development, would inject a healthy dose of plurality into the existing landscape.”

Villafranca (2016) added this issue, as a political ingredient, the Bank poses an implicit 13 In addition, according to ADB (2014), since 2000 the number of free trade agreements (FTAs) involving at least one Asian economy has increased by an average of 15 each year, rising from 55 FTAs in 2000 to 278 as of July 2014, of which close to three quarters are bilateral FTAs, and 75 are plurilateral (involving more than two economies). In recent years, to address the so-called ‘spaghetti bowl’ effect of multiple regional FTAs, ‘mega-regional’ FTAs have been pursued, including the Regional Comprehensive Economic Partnership (RCEP) involving ASEAN+6 economies, the Trans-Pacific Partnership (TPP) involving 12 Asia-Paci- fic nations, the Trans-Atlantic Trade and Investment Partnership involving the United States and the EU, and the Japan-EU FTA under negotiation (ADB, 2014).

challenge to US-dominated institutions and, even more so, to the Japan-dominated ADB. And the European participation gave a helping hand as it contributed to changing the project both in scope and in aims.

After 1 year of operations, the bank approved loans of over US$1.7 billion to support nine infrastructure projects across seven countries, including Pakistan, Bangladesh, Tajikistan, Indonesia, Myanmar, Azerbaijan and Oman. And, recently, the president of the bank said that, it plans to increase operations gradually, investing US$3bn-US$5bn in 2017 and around $10bn in 2018.

4. Analysis: facing the trilemma

In this scenario, there are some concerns about these banks performance and outcomes, especially related to its operational policies and mandates. That means uncertainties presented at i) the actual financial sources versus infrastructure needs and ii) the impossibility to achieve simultaneously a good risk management, a transparency framework (that guarantees the political impartiality of members and act impartially free and independently from political pressures) and a less bureaucracy institution, in the current institutional structure.

On the first subject, NDB and AIIB have their core mandates to fill the existing infrastructure gap in developing and emerging countries and Asian ones, respectively. Besides positively affecting growth, infrastructure investments shape future energy and transportation matrixes, urban landscapes, and a significant part of the supply and quality of public goods and services. Therefore, investing in sustainable infrastructure may be virtually a “silver bullet” to the long-term prosperity, environmental sustainability, and the well-being of people of these nations.

Financing infrastructure in emergent and developing countries is a very ambitious challenge: per example, in Asia and Pacific region 900 million of people do not have access to water and sanitation, 800 million do not have access to electricity and 80% of Asians don’t have access to the internet, as pointed out by Infrastructure Journal (2014). Japan's Mizuho Research Institute said the region would need $6.5 trillion worth of infrastructure investment between 2015 and 2020. In Latin America and the Caribbean, according to the United Nations Economic regional commission (ECLAC), the region requires an additional investment of $120– $150 billion a year.

To boost these investments will require addressing two major constraints: the lack of domestic capabilities to originate and develop technically sound, “financeable” projects- project development skills, particularly for more complex and innovative projects, are limited-; and the scarcity finance for riskier, long-term projects. Recent studies, Gallagher and Studart (2016), indicate that development banks may be critical to promoting projects, and leverage and crowd-in private capital to transformational investments –. NDB and AIIB should be no exception.

In practice, according to Studart and Ramos (2016), these institutions often provide distinct financial instruments that can be articulated to promote the development of new private instruments and markets:

• Direct lending to ultimate borrowers, guarantees schema or equity finance;

• Intermediated lending – providing credit to private lenders (e.g., commercial banks), earmarked for further intermediation to the designated sectors or firms. • Public securitization - purchasing existing loan portfolios of private lenders. • Guaranteed market securitization - guaranteeing private lenders’ loan-backed or mortgage-backed securities (LBS, MBS). • Partial credit guarantees on private loans to, and securities issuance by, ultimate borrowers. • Market liquidity provision - public portfolio investments aimed at increasing the financial market’s depth.

One can even imagine a sequencing of the use of such instruments to promote the de-risking of some investment activities and subsequent development of private instruments and markets to attract private capital to then. Initial interventions could constitute of risk-absorbing instruments - direct lending, guarantees or equity finance, for instance. They can then evolve towards risksharing ones such as intermediated lending and public securitization. According to The Addis Ababa Action Agenda,

We recognize the significant potential of multilateral development banks and other international development banks in financing sustainable development and providing know-how…We stress that development banks should make optimal use of their resources and balance sheets, consistent with maintaining their financial integrity, and should update and develop their policies in support of the post-2015 development agenda, including the sustainable development goals (SDGs).

These are not easy tasks, as mentioned earlier, credits and loans made by MDB or World Bank Group have typically been accompanied by capacity building, technical assistance, evaluation, policy reform, and other elements of a package of interventions that are needed to have an impact. So, to NDB and AIIB pursue financing infrastructure, especially sustainable one, they must have a capable technical staff, create financial instruments and stretch cooperation, enhance knowledge sharing and operational collaboration between them and other multilateral and national development institutions. To do so, they must think new institutional models of development banking that promote structural change in the financial system in the sense that it is becoming more functional for economic growth, and guiding to a more sustainable path.

Another point of concern is related to its mandates: achieve simultaneously a good risk management, a transparency framework (that guarantees political impartiality of members), known as “best practices”, and be a less bureaucracy institution.

Countries members, particularly developing ones, have a common critic to the World Bank and major regional multilateral banks: they are too inflexible, suffocated by bureaucratic; impose more onerous project oversight requirements to non-borrowing countries, slow loan approval time and are dominated by the political interests of wealthy non-borrowing shareholder countries (Dijkstra, 2007; Humphrey, 2012). Trying to avoid some of what they consider failures, these new banks aim to learn from the cumulative experiences and best practices developed by all the MDBs, to simplify the complicated governance structure that many international organizations are using, to stablish a more transparent institution with clear socioenvironmental guidelines, and to be faster and less bureaucratic than other banks. But, as we will explain below, reach simultaneous these objectives, in the current institutional framework, are impossible.

The first intention is to pursue standard principles of risk management. MDBs face no regulatory oversight or systematic, independent financial analysis by regulatory authorities, meaning they are subject, in general, to specific rules or under Basel standard. Consequently, they are evaluated in the same way as a commercial bank, with capital requirements and monitoring tests. It has direct impacts at its operational guideline14: i) restricting their overall capacity to make use of their balance sheet to address development needs and ii) facing pressure to limit counter-cyclical lending, especially in borrowing countries facing difficulties.

Also, as indicated by Perry (2009), multilateral development banks’ risk-management policies have considerably limited their potential support for their clients’ risk-management options. In particular, with few exceptions, multilateral institutions have been willing to retain only their clients’ credit risk on their balance sheets. By so doing, they have limited their potential support to their clients in several ways. As an example, they merely intermediate other risks such as currency risks, which in practice has limited their offer of loans and guarantees in domestic currencies, or of currency swaps, to those countries that already have relatively well-developed local currency or swap markets. In those cases, the intermediation of the multilateral development banks has often reduced costs substantially because they retained the country’s or issuer’s credit risk, but this practice has left out all those countries that have less-developed domestic currency and swap markets—precisely those that would benefit most from multilateral support in this area.

It is argued that in most existing MDBs face statutory limitations to retaining developing country risks other than credit risk on their balance sheets. Inspection of their articles of agreement suggests that this is not the case: most multilateral development banks, like most financial institutions, seem to be allowed to make diverse equity and portfolio investments against their capital. The real issue appears to be with current risk-management policies and practices. In particular, those banks that work mostly with sovereign governments and that benefit from a de facto preferred creditor status are accustomed to bearing very limited risks from their development-oriented operations. It is not surprising, therefore, that a highly conservative risk-management culture has prevailed in which there is little appetite to retain and manage more complex and higher risks.

The second subject is transparency, which can be understood as its organizational structure and mechanisms to denounce and solve conflicts; access to information; automatic disclosure of information with limited exceptions; and public access to decision-making (Romero, 2017). As claimed by Report of the Working Group of Transparency & Accountability (1998), transparency is a process by which information about existing conditions, decisions, and actions are made accessible, visible and understandable. The information released "enables others to evaluate the policies or performance" of the institution(s) involved (Florini, 2000).

14 Regardless of a MDBs operating only with direct operations (first tier), indirect operations (second tier), or both, is not impossible that they (which do not hold cash deposits but are significant lenders of funds to other banks) pose a source of systemic risk. However, given that MDBs are not usually in debt with other financial institutions (rather, are lenders) there would hardly be a possibility of contagion, probably resulting in a reduction of investments in the economy and a possible retraction in production, but not a systemic crisis, in the way this is here conceived (affecting the payment system). As a result, MDBs that do not have cash deposits can affect the payment system - but only indirectly and that possibility is remote (Castro, 2009).

Also, could be a strong accountability systems or insulation from political pressure. These aspects are very complicated and hard to achieve, especially because MDBs don't have a specific regulatory oversight and close surveillance. In this scenario, certain political groups can play a considerable role keeping their interests above global ones. As claimed by their articles of agreement, AIIB and NDB aim to be banks that act impartially free and independently from political pressures. This point is so important because will determine what projects will be selected and their financial conditions, they will be approved. But escape from political interest it is almost impossible to achieve. These banks were created following big plan initiatives, so there is a significant risk that investment decisions ultimately become determined by particular political interests rather than societal, global objectives. The difference now is the actors and countries that will lead this process, primarily, China.

Contrary to the current MDBs, AIIB and NDB pursue to be faster and less bureaucracy. It is possible to expect more agile banks because there are no cumbersome procedures to slow down operating processes and delivery. Differently from current MDBs, that with time-tested ideas and traditional methods have created inefficiencies. However, on the other hand, it is highly observed a bureaucratic culture in this institutions. There is a strong preference for taking on few risks or just the risks that one is already familiar with, creating a typical bureaucratic trait. Build up a pipeline of viable projects, analyze them and lend resources, when there are too many safeguards and standards, slow down processes.

FIGURE 1. The Multilateral Development bank´s proposed trilemma

Standard risk management

A B

Transparency Less bureaucracy C

The point A is characterized by a very conservative risk management, a lot of safeguards and a transparent operational process; it is unlikely to have faster and less bureaucratic multilateral development banks. This is how the World Bank, Interamerican Development Bank and others currently operate.

If the banks follow the point B, they will be able to be faster (less bureaucracy) and use the standard risk management models, but they couldn’t be totally transparent with their stakeholders. The MDBs have many internal and external stakeholders. If the bank chooses transparency it will need to answer the demands of external stakeholders like the press, NGOs and etc. which inevitably bring bureaucracy.

Lastly, they can choose the point C and provide faster decisions and being totally transparent to all the stakeholders. But in this case, they can´t use the standard risk management procedures. Making use of these – while being transparent to the

stakeholders – involves a slow process, making it impossible to be faster and less bureaucratic. Hence, we observe that there new MDBs must or give up some of these principles or implement new institutional models of development banking, making a rupture with the current model.

Finally, we can analyze the contribution of the NDB and the AIIB to the three problems identified in the current GEG – incompleteness, distortion, and inelasticity. As such, their contribution to the incompleteness depends heavily on the financial strategies of the new banks. This will depend on their leverage, level of disbursement, capitalization policy, among others. Clearly, these institutions alone will not be able completely to fulfill the gap between the available and needed resources. However, the AIIB and the NDB can significantly offset long-term funding shortages for emergent and developing economies, contributing to diminishing distortions in the current GEG by channeling resources to fund projects in the non-developed world. In addition, by being developing countries ruled banks, they can diminish distortions at the management level, giving more power to emergent countries in the decision-making process.

Lastly, these initiatives can push for less inelasticity in the system in two different ways. First, through competition, forcing traditional powers accept to reform the already established IOs. Second, by making the whole system more elastic, not only with the reform of the current institutions but also with the entering of new ones, expanding the apex of the GEG.

5. Concluding Remarks

The paper discussed the creation of the NDB and the AIIB, two new developing countries-led MDBs. In section two, we concluded that due to problems with the current global economic governance structure, namely: incompleteness, distortion and inelasticity; lack of funding and mismatch between supply and demand for loans to invest in developing countries, the creation of new MDBs seems as a crucial step.

We argued that these new MDBs have similarities – such as, heterogeneity among its members and the desire to influence current GEG with the creation of new MDBs – and differences in the scope of the banks, their goals and the ease of access to foreign exchange reserves, hence, to make loans in dollars, by its members.

Together, these institutions can partially cope with the flaws identified in the GEG and will be able to provide funds for developing countries and support them with their stabilization funds. Hence, both institutions can play significant roles in the process of reshaping international economy into a more “South-oriented” economic landscape. In sum, the creation of new MDBs can make a significant contribution to the health of global economy, by facilitating the transition to new poles of growth and demand, by helping to rebalance global savings and investments, and by channeling excess liquidity to productive use. It will not only be a driver for sustainable growth in the developing and emerging world, but it will also foster reform in existing multilateral financial institutions (Stern et al. 2013).

Lastly, we indicate that there is a trilemma that needs to be faced by these new institutions. They promise transparency, less bureaucracy and the use of standard risk models. The paper pointed out that this constitutes a trilemma for them, indicating why

it is impossible to fulfill these three objectives at the same time. Hence, they will need to decide how to approach the question and which objectives are more paramount for them in order to successfully contribute with the reshaping of the Global Economic Governance.

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